Deconstructing AIG's Record Loss

Updated from 8:22 a.m. EST on Feb. 28.

American International Group (AIG - commentary - Cramer's Take) reported an annual adjusted net loss from operations of $3.20 billion, or $1.25 per share, compared to last year's gain of $3.85 billion, or $1.47 per share.

The net loss for the fourth quarter was $5.3 billion, or $2.08 per share, compared to a gain of $3.44 billion, or $1.31 per share last year. The quarter included pretax net realized capital losses of $2.63 billion ($1.71 billion after tax) from other-than-temporary impairment charges in the investment portfolio and $643 million in pretax ($418 million after tax) in other-than-temporary impairment charges in AIG Financial Products' (AIGFP) available-for-sale investment securities. These came from the declines in the market values of residential mortgage-backed securities that management does not believe are temporary (i.e., real losses).

The big point of contention is the $11.1 billion of unrealized pretax loss ($7.2 million after tax) in the AIGFP super senior credit default swap portfolio. This was greater than I (and probably most other analysts) expected. The company gave out 499 pages of financial information in an attempt to state its case and quell investor fears.

There is now $11.25 billion of unrealized market valuation loss on the GAAP balance sheet, yet via AIG's own models, a severe stress equal to the 1974-1975 recession would result in a $0.9 billion loss on this same $61 billion of multisector collateralized debt obligations (CDOs) that include subprime exposure.

The financial markets are shut down now, so the bid-ask spreads result in valuations that are not based on rational analysis by participants. The only thing close to rational is the approximate 18% to 23% losses for subprime exposure that the rating agencies are now predicting. These losses are not high enough to cause losses in the super senior (upper level of AAA) CDOs. I believe that there would need to be an approximate doubling of loss expectations for sizable losses to occur there, which could be the reason that Standard & Poor's decided not to downgrade AIG when the losses were announced.

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At the time of publication, Thomas was long American International Group.