AIG

[muck]

I've not read the annual report, quarterly report or analyzed any of this stuff first hand ... I'm just passing along an article which makes some interesting points about a company which currently represents several billion dollars of our tax dollars at work.

[billay]

How much of AIG's bailout actually went to AIG, and how much was used to pay off all of the various credit default swaps AIG had issued to other companies/invenstment banks/hedge funds? I've always considered that money to have bailed out a lot of people other than AIG.

[WaterMan]

In the end it's all just imaginary numbers being pushed from one computer to another.

[muck]

From a friend of mine who is VERY good at analyzing balance sheets, one of the best "fundamental" professional investors I know, and currently is an investor in AIG. He gave me permission (on a no-names basis) to share the following:

 

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I had the opportunity to be grilled on this article today. The author is confusing hard and fast knowable numbers with management estimates. The author attempts to make the point that AIG’s deferred tax asset changed from a $5.9 billion asset to a $1.2 billion liability, hence the Company is uncertain about its ability to generate taxable income going forward. The author would have been better served to reference Note 22 as opposed to make it sound mysterious, hence questionable. What the footnote displays is a table that shows the components of that add up to the Company’s $25 billion tax credits, NOLs etc. These individual line are quantified, with supporting documentation that would have to pass muster with external auditors, the SEC, the IRS and state insurance regulators. The bottom of this data table contains a $26 billion offset entitled “valuation allowance”. That figure is completely made up by management and has no real backup but needs to be more or less agreeable to the Company’s auditors. Now to the points.

 

In 2010 AIG reported $17.9 billion in pre tax income, $5.9 billion of book tax expense and paid $900 million in cash taxes. The Company’s actual tax bill has nothing to do with the net of the tax assets, tax liabilities and fictional “valuation allowance”. The source of income is matched off against individual tax credits and losses to produce a cash tax payable. The $5.9 billion is the 35% statutory rate applied to pre tax income, reduced by the contribution to pre tax income from the Company’s municipal bonds. The $900 million in cash taxes is the result of applying credits and NOLs listed in the table in Note 22. The valuation allowance has nothing to do with the tax calculation.

 

$5.1 billion of the $5.4 billion change in tax assets was due to improved mark to market in investment securities. AIG owns about $300 billion of bonds, which improved in value in 2010. The tax liability change by approximately $1 billion and the valuation allowance also changed by $1 billion. Point … $5.1 billion of the $7 billion change is due to the change in bond portfolio valuation.

 

The tax assets and liabilities exist. There are real and quantifiable until the earlier of (a) their expiration, ( their utilization or © Congressional action to alter the tax code. The valuation allowance represents the amount of this allowance that AIG wishes to reflect as an asset on its balance sheet and as equity into its capital accounts. Stated another way, the $26 billion tax asset will be utilized if and when the appropriate type of income is produced to match off against it. The valuation allowance has no bearing on the Company’s ability to utilize the tax assets.

 

Assume AIG booked the entire $26 billion of tax assets as assets, i.e. no valuation allowance. This would boost assets by $26 billion and require an equal $26 billion boost to equity accounts. AIG has 1.8 billion shares, so a $26 billion bump in equity would equate to a $14.44 per share boost in common book. If you compensation is tied to ROE and you need to sell equity on behalf of a large shareholder without killing everyone else, then you need to add $14.44 to the current $47 book value like you need another hole in the head. The $26 billion asset write up and equity writeup does not exist because management took a $26 billion offset liability that is almost completely fictional and has no supporting documentation.

 

Conclusion – AIG is massaging the numbers. The Bloomberg author just missed the point of the massage by approximately 179 degrees. AIG will be able to shelter approximately $24 to $26 billion of taxable income over the course of the next 20 to 25 years. The unknown (outside looking in) is timing. Some of the credits apply to ordinary income and others to capital gain / loss. Some credits relate to U.S. activity whereas others relate to non U.S. etc. AIG’s tax people can advise AIG’s investment managers on strategies to maximize tax credit utilization. GE’s, GOOG’s, IBM’s, XOM’s, MET’s, JPM’s tax people all do essentially the same thing. My guess is AIG pays no capital gains taxes for a while, which the recent asset sale proceeds are tax free. The ordinary income items probably get used up over the course of the next couple years as the Maiden Lane derivative portfolios run off. Remember changes in derivative value are ordinary income and loss in the period. AIG incurred massive ordinary losses in 2008 and can employ the derivative gains in 2011 and forward to offset these ordinary losses. This is why AIG wanted the Maiden Lane assets.

 

Bottom line, even if you correctly report facts, you still need to understand the facts in the proper context to convey an accurate message.

 

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Then a little email back-and-forth between he and I, until he summarized up with the following:

 

"The main point is that AIG retains the ability to utilize tax credits and NOLs, the valuation allowance is a fictional number that can be any number management wants and virtually all the change in the tax valuation occurred as a result of the change in market value of investment portfolios and not as a result of a change of management’s view with regards to future profitability."

Edited May 20, 2011 by muck