US CREDIT-AIG spreads to widen as mortgage losses drag on

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)