2nd UPDATE: AIG Raises Loss Estimate On CDOs; Shares Plunge

Last Update: 2/11/2008 2:08:57 PM

(Updates throughout with additional information from the filing on the change in
how AIG determines its market loss, a Fitch Ratings announcement, and latest
share price.)

By Lavonne Kuykendall and Chad Clinton
Of DOW JONES NEWSWIRES

American International Group Inc. (AIG) said Monday that the value of protection
it provides on complex securities tied to subprime mortgages has fallen
considerably more than originally estimated, heightening concerns about the
impact housing market woes will have on financial results.

The news, disclosed in a regulatory filing in which AIG said its auditor had
identified “material weakness” in the way the insurer determined the value of its
credit derivatives portfolio, sent AIG shares to their lowest level in five
years. Fitch Ratings followed the news by putting some of AIG’s credit ratings on
negative watch, saying it will take a look at AIG’s procedures for valuing its
credit derivatives.

The New York financial services giant said that the gross market value of its
credit derivatives portfolio fell by $4.88 billion in October and November. The
latest estimate is more than four times the $1.15 billion executives had
estimated in December, and the number is likely to rise further when December’s
losses are added.

AIG shares were down 11.4% at $44.92 in recent trading, leading a broader
downturn for insurers amid concerns that fallout from the subprime mortgage
crisis will expand further as the housing market remains in tatters.

AIG is the first insurer to report problems in assigning a value to its portfolio
of credit default swaps, which are a form of payment guarantees written on
collateralized debt obligations owned by investment bank or other institutional
customers. If the securities default on payments, AIG’s guarantee would come into
play to make the scheduled payments to the securities holders.

The market for trading CDOs has come to a virtual halt in recent months, as fears
have grown over skyrocketing defaults in the securities’ underlying pools of
subprime home mortgages.

The credit default swaps written by bond insurers and units such as AIG’s
Financial Products unit typically do not trade, but function as a sort of
insurance policy until the maturity of the security. Companies that deal mainly
in providing bond insurance - such as MBIA Inc. (MBI), Ambac Financial Group
(ABK) and Security Capital Assurance (SCA) - have seen huge writedowns in their
credit derivatives portfolios in recent months.

Morgan Stanley analyst Nigel Dally said in a note to clients that, while the
amount of the AIG write-down could reverse over time as the securities mature and
AIG has significant excess capital, the latest disclosure “will leave investors
worrying about other skeletons in the closet.”

As of Sept. 30, AIG held credit default swaps on $63 billion of subprime
mortgage-backed CDOs.

The big jump in AIG’s mark-to-market loss estimates comes as the company has
decided not to include any estimated benefit of the contracts’ spread
differential, which AIG had estimated could cut as much as $3.276 billion from
the markdown.

The spread differential was developed by AIG to account for the difference
between spreads implied by actual CDO prices and credit spreads implied from the
pricing of the credit guarantees written by AIG.

That differential became a point of contention between AIG and its auditors,
PricewaterhouseCoopers LLC, which disallowed its use.

But AIG said it may still be able to subtract $732 million from its losses
through November 30, to account for structural features in its guarantees that
help it collect on the securities. That would put its total unrealized losses
from its credit derivatives portfolio at $4.15 billion for October and November.

Morgan Stanley’s Dally said that, based on Monday’s filing, “investors should
brace for a mark-to-market loss of roughly $5 billion in the upcoming quarterly
results.”

Fitch, in announcing that it is reviewing AIG credit ratings, noted that the
insurer “has relatively large exposure to the current U.S. residential mortgage
crisis,” adding that the biggest exposure is linked to further deterioration in
the credit derivative portfolio.

While Fitch “believes these losses should be absorbed by the existing capital
base and future earnings stream,” AIG’s latest announcement “brings additional
uncertainty to the potential impact on financial statements.”

The ratings Fitch put under review at AIG include the holding company’s issuer
default rating, which currently stands at double-A, but not the insurance
company’s financial strength rating, which currently is double-A+. Fitch said
that if weakness in AIG’s financial products group leads a downgrade at the
holding company, Fitch believes it would be limited to one notch , and would also
likely affect subsidiaries of the financial products company, which would all get
a similar downgrade, but would not affect the insurance company’s financial
strength rating.

-By Lavonne Kuykendall, Dow Jones Newswires; (312) 750 4141;
lavonne.kuykendall@dowjones.com

-By Chad Clinton, Dow Jones Newswires; (202) 862 1349; chad.clinton@dowjones.com

(END) Dow Jones Newswires

February 11, 2008 14:08 ET (19:08 GMT)

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