AIG discloses hole in derivatives valuation

By Lilla Zuill

NEW YORK (Reuters) - American International Group Inc (AIG.N: Quote, Profile, Research) disclosed potential losses in its derivatives portfolio, raising fears it would become the latest casualty of the credit crisis and pushing its shares down almost 12 percent to a 5-year low.

AIG's disclosure, in a regulatory filing on Monday, is the latest sign that credit worries sparked by the subprime mortgage crisis are feeding through to insurers. Swiss Re, the world's largest reinsurer, last November stunned markets with a 1.2 billion Swiss franc ($1.1 billion) write-down related to credit default swaps.

AIG's mark-to-market unrealized loss on its credit default swap (CDS) portfolio is expected to result in a charge of roughly $4.88 billion based on October and November pricing, according to Morgan Stanley analyst Nigel Dally in an investor note.

That is more than triple the decline in the value of the portfolio estimated by AIG in early December -- a figure that benefited from a spread differential offset that the insurer said it will no longer factor into its calculations.

In December, AIG Chief Executive Martin Sullivan told investors it had "a high degree of certainty in what we have booked to date."

AIG has not yet disclosed if its analysis of December data will lead to further deterioration in the value of the CDS portfolio. The company is expected to report its fourth-quarter results later this month.

PricewaterhouseCoopers PWC.UL, AIG's outside auditors, concluded that AIG had a material weakness in its internal controls over financial reporting as a result of how it was valuing the credit default swap portfolio obligations held by AIG Financial Products Corp., according to the company's filing with the U.S. Securities and Exchange Commission.

While Morgan Stanley's Dally wrote that AIG could reap back some, if not all, of the write-down over time, the development will likely rattle investors.