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Ex-CEOs' missteps still haunt AIG

Robert Willumstad will have to undo much of the expansion his predecessors championed.

By Colin Barr, senior writer
Last Updated: August 8, 2008: 1:34 PM EDT

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Analysts say AIG needs to take drastic steps to right itself, but there's no consensus yet on what those measures should be.
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NEW YORK (Fortune) -- Two months into his new job, American International Group chief Robert Willumstad is struggling to undo the mistakes of his predecessors, the hard-charging Hank Greenberg and the hapless Martin Sullivan.

AIG (AIG, Fortune 500) shares posted their biggest single-day decline in nearly three decades Thursday, plunging 17% to $24 apiece after the New York-based financial services conglomerate reported its third straight quarterly loss. The quarter featured another round of hefty writedowns in the firm's financial services unit as well as poor investment performance elsewhere. AIG has now lost $18 billion over the past three quarters.

Investors, who have seen their holdings lose nearly two-thirds of their value over the past year, are pressuring Willumstad to take bold action to address the insurer's problems.

AIG says its capital position is sound, following $20 billion in stock and debt sales this spring, but analysts expect the company to have to raise as much as $10 billion in new capital in coming months, at prices - as low as $20 a share - that could further punish shareholders.

The changes could go much deeper. Willumstad has said he will present the results of his strategic review of AIG's businesses next month, though fixing AIG won't be easy.

Willumstad's challenge "is to dial back the leverage, the risk and simplify AIG to be more an insurance company where its core strengths lie as opposed to a financial services firm," wrote Bank of America analyst Alain Karaoglan, who rates the stock buy and has a $35 price target. "If he is successful, the AIG stock could offer tremendous returns beyond our target price over time."

But in deleveraging and simplifying AIG, Willumstad must reverse decades of rapid and often ill-advised growth. He faces the prospect of trying to sell or spin off parts of the business he deems noncore when buyers may be few.

By its own description, AIG serves "commercial, institutional and individual customers through the most extensive worldwide property-casualty and life insurance networks of any insurer," while also competing with countless financial firms to offer retirement, asset management and commercial financing services.

What's more, Willumstad must find a way to make the company easier for analysts and investors to understand.

"AIG was opaque even in the good times," said David Merkel, chief economist at broker-dealer Finacorp Securities. "That opaqueness has got to go away."

Wall Street's struggle to comprehend the workings of AIG's many moving parts was apparent Thursday. The most acute problems reside at AIG's financial products unit, which is saddled with billions of dollars in depreciating positions on so-called credit default swaps - essentially agreements to cover losses tied to securites backed in part by subprime mortgages.

But even the results at the company's insurance operations remained somewhat mysterious. Noting the disparity between solid revenue growth and weak earnings at AIG's life insurance operations, Lehman Brothers analyst Eric Berg wrote, "Our theory (something we can't necessarily prove) is that there were investment issues and claims issues in the quarter, with lower equity-market results abroad likely weighing on results."

Strayed from its strengths

Willumstad's challenges are rooted in the missteps of his predecessors. Under Greenberg, AIG grew rapidly and churned out soaring profits. But like many other financial firms, it strayed from its strengths, particularly in international insurance, and took on massive debt to keep profits growing to Wall Street's specifications.

The firm's return on assets in the mid-1980s was an enviable 4%, says Merkel, the Finacorp Securities economist and a longtime investor in the insurance industry.

But as AIG got bigger, the company started edging into businesses that faced heavier competition and earned lower margins. In a bid to continue to show profit growth, AIG began amplifying those returns with leverage. By 2005, Merkel says, the company was still making substantial profits - earnings that year were $10.5 billion - but its return on assets had shriveled to 1%. Greenberg left AIG that year as regulators probed his involvement in an accounting scheme that aimed to appease investors by making the company's reserves look more robust.

Unsurprisingly, Greenberg doesn't share this view.

"Mr. Greenberg retired from AIG in 2005 and is not responsible for AIG's performance since his retirement," writes spokesman Glen Rochkind in an e-mail. "Over his 38 years leading AIG, Mr. Greenberg managed risk effectively and increased AIG's market capitalization from approximately $300 million to approximately $180 billion. By contrast, in the last 3 quarters, AIG reported total losses of nearly $19 billion, including the $5.4 billion loss reported last quarter. These massive losses result from the failure to manage AIG's balance sheet and businesses effectively and have driven the company's stock price down to $23.88 at yesterday's close. Those same shares traded at $70 a year ago."

In any event, in Greenberg's place AIG installed Sullivan, who promptly reached a $1.6 billion settlement with state and federal insurance and securities regulators over various Greenberg-era excesses. But like Chuck Prince, the lawyer turned executive who took over for wheeler-dealer Sandy Weill at Citi (C, Fortune 500), Sullivan proved less than adept in managing the business or in building relationships with investors.

Crisis? What crisis?

A year ago, as Wall Street started to come to grips with the scale of the crisis gripping debt markets, AIG insisted the firm's exposure to subprime mortgages was minimal and that the housing market would have to be hit by depression-level declines for the firm to take a major hit.

Since then, AIG has marked down the value of its credit default swap holdings by $26 billion. Compounding his errors, Sullivan then insisted on boosting AIG's quarterly dividend in May, even as the company announced another huge quarterly loss and embarked on a big capital-raising plan.

Sullivan was forced out of AIG in June in favor of Willumstad, who on Thursday called the company's performance in the first half of 2008 "unacceptable." Now, Willumstad is left to pick up the pieces of AIG and see what he can make of it.

Merkel, who has no position in the stock, says he believes management should break the company into five or so distinct and transparent entities, so investors can finally say, "I get what's going on here."

Until that day, AIG investors seem likely to keep saying something else: Sell.  To top of page

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