When Shit Hits The Fan

AIG loss increases to $5bn

AIG loss increases to $5bn

By David Wighton, Aline van Duyn and Stacy-Marie Ishmael in New York

Published: February 11 2008 16:18 | Last updated: February 11 2008 19:05

American International Group, the insurance company, sent fresh tremors through the markets on Monday when it increased its estimates of losses in October and November from insuring mortgage-related instruments from about $1bn to nearly $5bn.

The announcement came as a number of companies are preparing to release audited accounts for 2007. Auditors have been trying to encourage a common approach to valuation amid predictions this will shed new and harsh light on the full scale of the financial damage caused by the subprime crisis.

AIG produced the revised figures after its auditors, PwC, concluded there was a “material weakness” in the way it valued its exposure. AIG, the world’s biggest insurance company by assets, saw its shares tumble 11 per cent, wiping $14bn off its market value.

Measures of credit risk in both the US and Europe reached new record levels indicating widespread investor risk aversion. This followed persistent pressure on the markets last week amid fears about corporate and commercial property debt defaults.

Shares in European insurance companies fell heavily on the news, though observers said that most did not have such exposure to US credit markets and used different accounting policies.

AIG’s move came after Peer Steinbrück, Germany’s finance minister, warned at the weekend that losses on securities linked to US subprime mortgages could reach $400bn.

Some of those losses will be borne by companies such as AIG which have provided insurance for investors in collateralised debt obligations, complex instruments composed of mortgage-backed bonds. AIG has written $78bn of credit default swaps on CDOs, which protect the purchaser from a CDO’s failure to pay.

The primary providers of these hedges are bond insurers such as MBIA and Ambac, whose ability to pay claims is now the subject of growing concern in global financial markets. These companies have written about $125bn of protection on so-called “senior tranches” of CDOs, according to data from Standard & Poor’s.

In December, AIG told investors that it estimated valuation losses on its credit default swaps for October and November at just over $1bn. But this was after an “adjustment” based on the assumption that the risk of default implied by CDO bond prices was higher than should be reflected in the value of the insurance. This adjustment amounted to $3.64bn in November alone.

But AIG has now scrapped the adjustment because difficult market conditions mean it cannot “reliably quantify” the figure.

Catherine Seifert, analyst at S&P, said the news was “very troubling” and AIG’s management would “have an extremely difficult time regaining investor confidence”.

Copyright The Financial Times Limited 2008