By Anastasija Johnson
NEW YORK, May 9 (Reuters) - American International Group's (AIG.N) credit spreads are likely to widen further after the world's largest insurer suffered a record loss in the first quarter and warned that the market for mortgage assets has not bottomed out yet.
AIG's $7.8 billion first quarter loss on write-downs of assets linked to faltering subprime mortgages could be a precursor to more bad news next week when bond and mortgage insurers report results.
More losses by troubled bond insurer MBIA Inc (MBI.N) and mortgage insurers PMI Group Inc PMI.N and Radian Group (RDN.N), which report on Monday, could pressure credit spreads after a month-and-half rally.
This would hit AIG, which over the last two quarters recorded about $20 billion of unrealized losses in a credit default swap portfolio linked to faltering U.S. residential mortgage-backed securities.
"Given the extent of AIG's exposures to the subprime market and the flagging performance of its mortgage business and risk of further mark-to-market losses in (its unit's) super senior credit portfolio, we expect that AIG spreads could widen by 20-30 basis points," if other insurers report subpar results, Barclays Capital analysts wrote in a report.
Investors should short AIG credit by buying its credit default swaps at current levels, Barclays Capital analysts said.
The cost to insure AIG's debt against default rose to 119 basis points on Friday, or $119,000 to insure $10 million of debt from around 99 basis points prior to the earnings announcement, according to Markit Intraday.
The credit default swaps traded as high as 256 basis points at the high of credit crisis on March 17 and narrowed to as low as 90 basis points on May 1.
The cost to insure AIG's debt is also rising because rating agencies said they may cut its ratings further if the insurer's plan to raise about $12.5 billion to shore up its balance sheet is not successful.
Standard & Poor's and Fitch Ratings already cut its rating by one notch to "AA-minus," the fourth highest investment grade rating.
Moody's Investors Service on Friday said it may cut AIG by one or two notches because of persistent results volatility and concerns over the capital and liquidity levels of subsidiaries that hold mortgage-related positions.
AIG said the two rating agency downgrades will likely increase funding costs for some of its businesses and have required it to post $1.6 billion more in collateral. For details see [ID:nN09565485].
While the planned capital raising is marginally positive for bondholders, the insurer's weakened overall position may continue to pressure spreads.
"The new capital will provide an additional cushion for bondholders, but this benefit is canceled out by the fact that there is still uncertainty about AIG's ultimate exposure to realized losses on its super senior credit default swap portfolio," Gimme Credit analyst Kathleen Shanley said.
Shanley is maintaining a "deteriorating" credit score on AIG after the earnings announcement.
AIG's rising losses also raise concerns that the company has grown too big to effectively manage its risks.
"We believe that recent losses have increased pressure for a management shakeup or potential breakup of the company, which could exacerbate near-term credit pressure," CreditSights analysts Rob Haines and Joe Di Carlo wrote in a report.
"Until AIG is able to regain investor confidence in its business model and current management, we expect to see weakness in spreads," they added.
(Reporting by Anastasija Johnson; editing by Clive McKeef)