American International Group Earnings Preview: Q4 Swings to Profit on Tax Gain

Bailed-out insurance giant American International Group Inc. (NYSE:AIG), boosted by a one-time accounting gain, is expected to return to profitability when it reports its fourth-quarter earnings after markets close Thursday. Favorable stock market conditions and less reserve charges may also have helped offset large losses stemming from Thailand floods.

The New York-based insurer may post earnings per share of 61 cents, a swing from a net loss of $16.20 per share in the year-ago period, based on the average estimate of analysts surveyed by Thomson Reuters. Analysts are forecasting a decline of 37.4 percent in revenue from the year-earlier quarter to $13.19 billion.

"Net income may be substantially higher than operating earnings per share this quarter if AIG removes a portion of its deferred tax asset valuation allowance," Credit Suisse analyst Thomas Gallagher said in a January note. He is calling for higher-than-consensus earnings per share of 67 cents.

For the year, analysts are projecting profit of 77 cents per share, reversing a loss of $6.57 in 2010.

"Without a really big reserve loss or a really big Thailand loss, I think AIG will likely report decent earnings," said Josh Stirling, senior analyst at Sanford C. Bernstein & Co.

Favorable Stock Market

"The one thing that kind of worked against AIG is the low interest rate environment," said Jim Ryan, an ananalyst at Morningstar Inc. "On the other hand, that's offset by a pretty good stock market in the fourth quarter."

Shares of AIA Group Ltd., AIG's Asia life insurance unit, appreciated 8.3 percent in the last quarter of 2011.

Under mark-to-market accounting, AIG records substantial profits when AIA shares rise. But when the stock falls it also generates great losses. At the end of the third quarter, AIA was valued at $11.3 billion.

As part of AIG's efforts to repay the government bailout, AIG took AIA public in Hong Kong in 2010 but retained a one-third stake.

Thailand Floods

"Thailand losses in their Chartis business have the possibility of being material for the earnings in the fourth quarter," Stirling said.

AIG said it expects additional catastrophe losses emerging in Chartis' international operations from the Thailand floods.

AIG has a 2.6 percent in the Thailand property and casualty market and potentially even more exposure from global accounts.

"We believe losses will be about $360 million after tax, resulting in a 19-cents-per-share earnings hit," Gallagher said.

No Reserve Charges Expected

Historically, AIG took charges in the fourth quarter to add to reserves in its Chartis property and casualty insurance unit. Analysts estimate the company has taken about $40 billion in charges over the past decade.

"They took the kitchen sink in 2010," Stirling said. "So it's unlikely that they are going to take material charges in 2011."

AIG added $4.1 billion to the loss reserves at Chartis in the fourth quarter of 2010.

One-Time Tax Gain

Despite a large drop in revenue, AIG is expected to increase its revenue by eliminating a valuation allowance against deferred-tax benefits.

AIG noted in its third-quarter 10-Q filings that is "is possible that the valuation allowance could be released in large part in the fourth quarter of 2011, which would materially and favorably affect net income and shareholders' equity in that period."

"It could be material for book value possibly of as much as $5 billion or $10 billion," Stirling said.

Deferred-tax assets typically consist of tax-deductible losses and expenses carried forward from prior periods. Companies can use these past losses to lower future tax bills.

Under generally accepted accounting principles, such carry-forwards are valuable only to companies that are profitable and paying income taxes. If a company doesn't expect to fully use these assets, it is required to record what is called a valuation allowance on its balance sheet to reduce their carrying amount.

AIG currently holds a full valuation allowance against its $25.6 billion deferred tax asset and, therefore, the deferred-tax asset is not reflected in GAAP book value.

If AIG can demonstrate it can earn enough taxable income in coming years to take advantage of all the tax benefits, the company may not have to pay taxes during the next five years, Ryan wrote in a December research note.

Third-Quarter Losses

AIG lost more than $4 billion in the third quarter, the worst in nearly two years, as its aircraft leasing unit took an impairment charge on a portion of its fleet and the fair value of the company's one-third stake in Asian insurer AIA fell.

The insurer also had substantial catastrophe losses totaling $574 million, mostly because of Hurricane Irene and Tropical Storm Lee.

Stock Performance

"The primary thing that's holding back AIG's stock is the government's ownership," Ryan said.

The government rescued AIG from the brink of bankruptcy in September 2008, at a price tag that exceeded $182 billion. The Treasury still owns a 77 percent stake in what was once the world's largest insurance company.

"Unless you get that out of the way, it's going to be a constant overhang because you are always worried when the government might be selling their shares, which will drive down the price," Ryan added.

American International Group Inc. (NYSE:AIG) shares closed up 1.24 percent to $27.73 in Wednesday's trading, while the broader market fell. The stock lost half its value in 2011 but has rebounded sharply in 2012. Yet, it still remains below the U.S. Treasury's break-even point of $28.73 a share on its stake in the company.

One of AIG's main competitors in the insurance industry is the Travelers Companies Inc. (NYSE:TRV). Its shares fell nearly 1 percent to $59.27.

Other competitors in the financial sector include: Hartford Financial Services (NYSE:HIG), HCC Insurance Holdings Inc. (NYSE:HCC) and American Financial Group (NYSE:AFG).