AIG Sinks on Mortgage-Related Losses

Updated from Feb. 28

American International Group (AIG) promised Friday to make the "necessary investments" to correct internal control issues uncovered by its auditors after reporting the worst quarterly results in its history.

The world's largest insurance conglomerate said it swung to a fourth-quarter loss of $5.3 billion, due largely to a raft of writedowns on mortgage-related investments from throughout its various businesses. Most noteworthy, the company's financial products business took a pretax charge of $11.12 billion on its super senior secured credit default swap portfolio.

AIG said Joe Cassano, the head of AIG Financial Products, will retire at the end of March and serve as a consultant for the rest of 2008.

"It looks like Cassano is the fall guy for now, but AIG's problems aren't limited to the financial products business," says Donn Vickrey, editor-in-chief of Gradient Analytics. "They have exposures on all different fronts to the mortgage market."

The stock, which dipped as much as 7.7% early Friday, was more recently trading down 6.4% to $46.95.

In addition to the big writedown on credit default swaps, AIG recorded a $643 million charge related to other investments held by its financial products unit. It also reported a $2.63 billion capital loss largely because of charges in its general investment portfolio related to the mortgage market. Moreover, the company disclosed a dizzying array of exposures it has to asset-backed securities tied to subprime mortgages valued in the tens of billions.

"We are in uncharted waters," AIG CEO Martin Sullivan said during the company's fourth-quarter earnings conference call. "During 2008, we expect the U.S. housing market to remain weak and credit market uncertainty will likely persist. Continuing market deterioration would cause AIG to report additional unrealized market valuation losses and impairment charges."

Sullivan, who took the reins at AIG from Hank Greenberg amid an accounting scandal, said the fourth-quarter writedowns were "not indicative" of realized losses it may eventually record when conditions in the credit market improve. It also said realized losses will not be material to its financial condition, but they may be material to the company's performance in an individual reporting period.

AIG also said the vast majority of its mortgage-related investments have retained stellar credit ratings from major credit ratings agencies, like Moody's Investors Service and Standard & Poor's, but the financial markets are losing faith in the integrity of those ratings. Many of the ratings in the structured finance market are at least partially supported by insurance underwritings from bond insurers MBIA (MBI) and Ambac (ABK), and those firms may still be in danger of losing their own credit ratings as they face huge potential losses on their structured finance underwritings.

Meanwhile, credit woes emerging in the insurance industry weren't isolated to AIG. Swiss Reinsurance reported an 87% drop in fourth-quarter net profit thanks largely to a 1.3 billion franc charge on credit default swaps.

The Dow Jones Industrial Average was recently down more than 200 points due to credit jitters and signs of rising inflation as the value of the dollar continued to sink. Shares of AIG were down $3.52, or 7%, to $46.63.

For its part, AIG on Thursday evening reported a net loss of $5.29 billion, or $2.08 a share, for the quarter, compared with earnings of $3.44 billion, or $1.31 a share, for the year-ago period. Excluding special items, AIG said it lost $3.20 billion, or $1.25 a share, compared with last year's earnings of $3.85 billion, or $1.47 a share.

Analysts on Wall Street were expecting earnings for the quarter of 60 cents a share, according to consensus estimates reported by Thomson Financial. Earlier this month, AIG disclosed in a regulatory filing that its auditor, PricewaterhouseCoopers, concluded it had "a material weakness in its internal control" related to its accounting for that portfolio.