AIG is heavily exposed to the U.S. residential mortgage market:
American General Finance, Inc. (AGF) originates principally first- lien mortgage loans and to a lesser extent second-lien mortgage loans to buyers and owners of residential housing;
United Guaranty Corporation (UGC) provides first loss mortgage guaranty insurance for high loan-to-value first and second-lien residential mortgages;
AIG insurance and financial services subsidiaries invest in mortgage- backed securities and collateralized debt obligations (CDOs) in which the underlying collateral is composed in whole or in part of residential mortgage loans; and
AIGFP provides credit protection through credit default swaps on certain super senior tranches of CDOs that have AAA underlying or subordinate layers.
The operating results of AIG 's consumer finance and mortgage guaranty operations in the United States have been and are likely to continue to be adversely affected by the factors referred to above.
The above issues will continue to ensure there is a dark cloud over earnings for the next few years. In addition, AIG has already taken significant hits on the CDSs (insurance) it has written on some $63bn of subprime CDOs. However, there are much graver thunderstorms on the horizon.
AIG has written super senior (AAA+) CDS protection on a whopping $513bn of CDOs and other assets via credit default swaps. (This includes the $63bn written on CDOs which contain US sub-prime mortgages mentioned above). The two areas of concern going forward are the remaining CDS of which $141bn has been written on European residential mortgages (primarily UK and Spain !) and the remaining $309bn. It is extremely difficult to value the remaining CDS exposures as admitted by AIG and now the result of a regulatory enquiry.
Until recently, this protection has been viewed as risk free income. However, the recent downgrades of the two big monolines, introduces further significant downside for AIG in the following areas:
o AIG holds a large number of AAA bonds some of which have been wrapped by Ambac and MBIA
o AIG has purchased significant CDS (insurance) against its subprime exposures (estimated at $5.2bn) from Ambac and MBIA – the value of which will now have to written down
o The downgrading of Ambac and MBIA is likely to significantly increase the potential exposure AIG has to its AAA+ insurance mentioned above as these CDOs are downgraded and attachment points continue to drop – THIS IS THE SIZE 15 SHOE !
Given the above, AIG could well sink to well below book value until these issues work their way through. Expect shareprice to hit $25 in the next 6 months.
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