AIG Derivatives

Text WASHINGTON–AIG's potential losses from its investment in derivatives of subprime loans could range from not material to a total write-off of 2007's fourth quarter earnings, a Citigroup analyst said today in a note to investors.

And, as AIG issued a statement today saying it doesn't think the potential losses on the exotic securities “will be material,” the fallout from a disclosure which sent its stock to a 20-year low Monday continued.

These included a decision by Standard & Poor's to revise its outlook on the parent company and its core operating subs to negative from stable. But S&P affirmed its AA counterparty credit ratings on the parent company and its AA+ counterparty credit and financial strength ratings on AIG's core subs.

At the same time, Fitch Ratings placed the ratings of AIG Finance Hong Kong Ltd. on rating watch with a negative outlook. That followed Fitch's decision Monday to place the AIG holding company's ratings and certain finance company subsidiary ratings on rating watch with a negative outlook.

The Citi note to investors by analyst Joshua Shanker explained that projecting the potential consequences of AIG's so-called “super senior default swap portfolio involves looking into a box so dark it is difficult to “see in or out.”

Mr. Shanker's comments were made in the wake of AIG's disclosure Monday that PricewaterhouseCoopers, its auditors, have suggested a lack of oversight at AIG has lead to a material weakness in financial controls that render the company unable to reliably quantify the market value that underlie certain underwritten financial guarantees related to subprime investments.

In its statement today, AIG continues to believe that the mark-to-market unrealized losses on the super senior credit default swap portfolio of AIG Financial Products Corp. “are not indicative of the losses AIGFP may realize over time.”

Based upon its most current analyses, AIG believes that any losses AIGFP may realize over time as a result of meeting its obligations “under these derivatives will not be material to AIG, the company said.

Mr. Shanker quantifies AIG's comments as saying that AIG's “worst-case scenario” will be where it writes off all BBB-rated and lower second half of 2005 subprime collateral, all 2006 and 2007 subprime and all CDOs rated A or lower, and only suffers a $600 million loss.

But Mr. Shanker said the numbers could be much bigger. He said that AIG said that the portfolio observed a mark-to-market loss of $1.6 billion as of Nov. 30, 2007. “That number could be as high as $6 billion, compounded by any further deterioration observed in the past 11-12 weeks,” Mr. Shanker said.

Citi, he said, is assuming a $5 billion loss in capital markets, which brings its fourth quarter of 2007 estimated earnings per share to zero.

“While we expect to revise our price target when AIG reports earnings, the lack of transparency makes such a change largely arbitrary at this time,” Mr. Shanker said.