AIG may take huge markdowns on Lehman impact

(Reuters) - Analysts expect American International Group (AIG.N) to incur huge markdowns as the collapse of Lehman Brothers LEH.N puts substantial pressure on structured finance securities and credit default swaps, possibly leading to the insurer's worst quarter yet.

Citigroup analyst Joshua Shanker downgraded the insurer to "hold" from "buy" and said the risk of a distressed sale of Lehman's assets could force AIG to mark its assets down to a level that would produce its worst-ever quarter.

"We believe that a loss of $30 billion (16.7 billion pounds) is possible," Shanker said.

AIG may incur more than $10 billion in super-senior CDS losses and $5 billion in realized investment portfolio losses in the third quarter, UBS analysts said.

AIG, which has incurred $18 billion in losses over the past three quarters from guarantees it wrote on mortgage derivatives, was hit on Friday by Standard & Poor's putting the company's credit ratings on negative watch, indicating a possible downgrade.

Analysts at Wachovia Capital Markets said AIG could be on tap to produce as much as $18 billion at a moment's notice in support of the credit swap business if its credit ratings fall by a single notch.

Even an equity raise is unlikely to avert a ratings downgrade, UBS analysts Andrew Kligerman, Julie Oh and Brian Meredith said.

The New York Times reported earlier that AIG, until recently the world's biggest insurer by market capitalization, had approached the Federal Reserve seeking $40 billion in short-term financing.

UBS analysts, however, said that although the stock could trade down given these events, it still seems to have longer-term upside potential. They maintained a "buy" rating on the stock.

"Even with credit ratings downgrade, we think AIG has sufficient (albeit, far from robust) cash/collateral sources to meet its near-term liquidity/capital needs without raising equity," they said.

Shares of AIG plunged more than 40 percent to $6.88 before the bell.

LIQUIDITY CRISIS

AIG has been negotiating with various parties including officials from the New York Insurance Department and private equity firms as it seeks ways to free up capital, raise new capital and protect policyholders.

According to the Financial Times, AIG was seeking $10 billion to $20 billion of equity infusion from buyout firms Kohlberg Kravis Roberts & Co KKR.UL, TPG Inc TPG.UL and J.C. Flowers & Co.

The New York Times later said the firms withdrew interest, citing anxiousness over the company's financial health.

If AIG plans to dispose its highly profitable aircraft leasing arm International Lease Finance Corp and other holdings, as the Wall Street Journal reported, this could top more than $5 billion in proceeds or in excess of $20 billion if core properties are sold, UBS analysts said.

Sales of the personal lines businesses, annuities business and the aircraft leasing business all seem likely, Citigroup's Shanker said.

"We don't see how AIG gets through the most recent concerns without raising capital," the Wachovia analysts wrote in a note to clients.

"In a sense, AIG needs a bridge loan, a really large bridge loan, to cover its liquidity needs until the company can sell enough assets to fill its capital hole," they said.

The analysts said capital options were plentiful, but "unfortunately AIG will have to likely cut into bone and sell good assets that are earning good returns to support the collateral needs of bad assets earning nothing."

Analysts at UBS cut their price target on AIG to $26 from $41, to reflect further book value erosion from further CDS marks, investment portfolio losses and a likely equity raise.

They widened their 2008 loss-per-share view on AIG to $8.18 from $2.96, and forecast an operating loss of $2.63 per share compared with their prior view of an operating profit of $0.57.

Merrill Lynch also downgraded AIG to "neutral" from "buy," according to theflyonthewall.com.

UBS, Wachovia and Citigroup said AIG could make an announcement as early as Monday.

Shares of AIG closed at $12.14 on the New York Stock Exchange on Friday. They have fallen 79 percent since the start of the year.

(Reporting by Neha Singh in Bangalore; Editing by Jarshad Kakkrakandy, Amitha Rajan and Mike Miller)