Yesterday, American International Group Inc. (AIG) has repaid $1.5 billion it owed to the US Treasury against the preferred equity investment special purpose vehicle (SPV) in AIA Aurora LLC (AIA SPV). The payment was made a year ahead of the schedule.

To facilitate the holding of ordinary shares of American International Assurance Company Ltd. (AIA), the AIA SPV was founded in 2009. Although initially held by the Federal Reserve Bank of New York (FRBNY), the AIA SPV was later transferred to the Treasury, as part of the recapitalization in January 2011. Meanwhile, AIG raised $1.5 billion from the sale of $2 billion senior unsecured notes, in a two-part offering.

The US government had preferred interests in two SPVs, one of which was against the sale of ALICO to MetLife Inc. (MET) and has been paid off. Moreover, AIG has agreed to squeeze out another $1.6 billion from the escrowed cash proceeds from the sale of its American Life Insurance Co. (ALICO) subsidiary to MetLife in 2010.

The cash proceeds from the ALICO sale is expected to be released in two parts. While the first tranche of approximately $1.0 billion, subject to certain reserve amounts, will be paid by November 2012, the remaining amount is slated to be paid by May 2013.

Loan Update

AIG has come a long way in repaying more than 75% of the $182.3 billion loan it had acquired from the US government at the peak of the financial conundrum in 2008. The company has repaid a chunk of its debt by selling more than $50 billion of its assets and raising funds through equity and debt offerings in the open market.

While about $21 billion of the debt remained unutilized or expired, AIG currently owes about $45 billion to the US government. This includes about $9 billion in an investment vehicle – Maiden Lane III, which contains collateralised debt obligations (CDOs) that were held by AIG’s counterparties, and were bought by the Federal Reserve to terminate credit default swaps (CDS) issued by the company. AIG has been retiring this debt, part by part, through the cash flows from the interest and principal payments and liquidation of the assets in the facility.

The remaining approximate $36 billion of debt lies in the form of shares owed by the Treasury. Earlier this month, AIG reduced the Treasury’s equity stake in the company to 70% from 77%, which was reduced from 92% in May last year, by selling stock worth $6 billion in the open market. Including this, the company has already retired about $14.6 of debt in this month alone.

Further, divestiture of over $50 billion of assets is also considered crucial for gaining capital flexibility and focusing on its core life and property-casualty business. With net operating earnings of $20 billion in the fourth quarter of 2011, AIG has been showcasing an impressive rebound, particularly in its core operations – Chartis and SunAmerica. The company’s credibility is also validated by its debt and financial leverage of 13% and 20%, respectively, at the end of 2011. Although AIG had a low fixed charge coverage given the severe catastrophe losses incurred by Chartis in 2011, it should improve this year. This again infuses ample confidence in AIG’s core fundamental growth going ahead.

Overall, we believe that AIG is poised to accentuate its operating and capital leverage upon dilution of the government stake. However, the risk of execution continues to chase AIG considering the increasing competitive pressure and market volatility. Alongside, several non-recurring charges, associated with the intense restructuring, are also expected to mar the desired upside in the upcoming quarters. This is also reflected by the Zacks Rank #3 for AIG, which translates into a short-term Hold rating and long-term Neutral stance.

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Zacks Investment Research