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Tuesday 12 February 2008

AIG Get Caught By The Auditors


12th February 08



Boy you could here the squeals of pain all the way down Wall St. Getting caught by the auditors is the risk you take when you start playing with exotic instruments and “forget” to let the accountants know things may have changed. PricewaterhouseCoopers applied the pressure, uncovering “material weakness” in the way AIG accounted for it’s Credit Default Swaps.

The material weakness was to under-estimate the losses on CDS by 400%. AIG say the losses of $4.88Bn occured in October and November ‘07 on CDS sold to protect fixed income assets. Which, of course, means that January to March ’08 figures are not going to be any better taking into account the current turmoil in the bond and derivative markets.


AIG chart. Ugly. $35 looks possible.


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This is a 10 year monthly chart with a 6 month moving average. Support at the $50 seems bust and the threat is a monthly close below the ’03 low. It’s yet another chart that flags up the lows from 1998. I’m not saying it’s a short (or a long) that’s not my job. I just want you too see something that looks worse than me in the mornings.


So what does a quarterly loss of $4.88Bn mean to AIG? In recent articles I have been informing readers that I believe banks will attempt to raise income to bolster their capital reserves. It would not be a step too far to say the same applies to Insurers. Yes, that is how bad it is out there in Financial Wonderland now, it’s no longer about profit, it’s about survival.
AIG had an income stream of around $14.93Bn in the last 12 months. If we assume that remains roughly the same AIG has the current and next quarter to sort out it’s derivative mess and stabilise its bond portfolio before its write downs out-strip income. Stripping out the “insurance” by writing off current CDS agreements might help the capital reserves ratio but will leave AIG exposed to bond market movement, increasing risk.


Another alternative is to raise more capital. The sale of preferred convertible bonds or interest bearing shares as seen in the recent bailouts of the investment banks is possible but would dilute shareholder value. Then again does AIG worry too much about that in the current circumstances.


There is a further measure AIG could take. As the 6th largest company in the world in ’07 (according to Forbes Global 2000) AIG has some interesting assets, not all of which are core business.


Amongst those assets are ILFC, an aircraft leasing company, 21st Century Insurance Company, American International Assurance, a near 10% holding in the Peoples Insurance Company of China, Stowe Mountain resort, the Bulgarian Telecom Company and Vivatel, a mobile network, AIG American General (insurance) which owns Matrix Direct Insurance Services and finally Ocean Finance a UK loans company specialising in mortgages and re-mortgages.


A sale of assets or a move by Fund Managers or Hedge Funds to force a release of “value” cannot be discounted. If that does happen, I wonder where AIG will be in the Forbes Global 2000?


By the way, be careful of who you listen to. This was one of the comments I saw on Bloomberg about the AIG drop:
“Investors eventually will look back at yesterday's announcement and conclude they overreacted, said David Katz, chief investment officer for New York-based Matrix Asset Advisors, who supports Sullivan (the CEO).” Must be a coincidence…….


Finally on AIG here is what the management had to say about risk in the 2006 annual report page 86 :


“AIG believes that strong risk management practices and a sound internal control environment are fundamental to its continued success and profitable growth. Failure to manage risk properly could expose AIG to significant losses, regulatory issues and a damaged reputation.

The major risks to which AIG is exposed include the following:

Insurance risk—the potential loss resulting from ultimate claims and expenses exceeding held reserves.

Credit risk—the potential loss arising from an obligor’s benefits inability or unwillingness to meet its obligations to AIG.

Market risk—the potential loss arising from adverse fluctuations in interest rates, foreign currencies, equity and commodity prices, and their levels of volatility.

Operational risk—the potential loss resulting from inadequate or failed internal processes, people, and systems, or from external events.

AIG senior management establishes the framework, principles and guidelines for risk management. The business executives are responsible for establishing and implementing risk management processes and responding to the individual needs and issues within their business, including risk concentrations within their business segments.”

At least we know who to blame.

It was noticeable that the UK markets didn’t ignore the AIG news. Insurers got a haircut along with some banks. Is the market trying to tell us something?


Back to the charts (Bloomberg) UK Insurers:

Aviva. Support at 500.


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Legal and General. Support at circa 100 if current support fails.


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Old Mutual. Support at 90.


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Royal Sun. Support at 70 if current support fails.


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Standard Life. Support at 100 if current support fails.


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That’s what the market is saying to me, it may say something else to you.

Then again we are at point in the markets were hope is being ladled out to the hungry and despondent. As I write this little snippet appears:


“U.S. Industry: Uber-investor Warren Buffett on tv making remarks about the monoline insurance industry, apparently has offered a reinsurance plan to those firms. Talk has boosted the recently ailing monolines and is said to be behind the solid bounce in US stock futures in recent trading. Provided by: Market News International”


I have some bad news for Mr Buffett. This isn’t the bottom even for the better quality debt. As I have maintained for some time contagion in the derivative bond market is deeper than anyone realises and it has spread beyond investment and traditional banks. AIG know that only too well.


As a follow on to Automobile Wreckage. It Isn’t Just Ford and GM I see GM excelled themselves with a loss of $38.7Bn in ’07. That’s the largest ever loss for an Auto manufacturer. Well done.


Market Snippets


From MNI. The ICSC-UBS weekly chain store index shows +1.8% for week/week ended Feb. 9, and -0.7% yr/yr for the same week. ICSC said consumers are pulling back on spending.


Reaction to the offer from Mr Buffett isn’t that overwhelming as the details become known. Warren Buffett has reportedly offered to take on the municipal liabilities of MBIA, Ambac and FGIC -- about $800B of bonds. He noted that one company turned him down on the offer and that the other two have not yet responded.


RBC Cap Mkts TJ Marta says, "We remain doubtful about this deal. Buffett is obviously offering a "deal" that one of the companies could refuse. He is only offering to take on the "good" securities, or municipal bonds. This "offer" is much like that in the MLEC (Super-SIV), in which the bailout plan only bailed out securities that were salvageable anyway. “


Nice try though Mr Buffett.


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