Insurer AIG seen posting gloomy 2nd quarter

By Lilla Zuill

NEW YORK (Reuters) - The clouds hanging over American International Group Inc (AIG.N) are likely to linger after the insurer's second-quarter earnings report on Wednesday.

"It is not going to be a pretty quarter," said Keefe Bruyette & Woods analyst Clifford Gallant, who predicts the world's largest insurer will be hit for the third consecutive quarter by losses on derivatives linked to subprime mortgages.

Also darkening the horizon are fears that AIG's investment income could disappoint, and that its insurance businesses will post lackluster earnings.

AIG, which sells insurance across the world and other services including asset management, has over the past two quarters recorded more than $20 billion in losses from credit default swaps -- a type of guarantee on debt collateralized with a range of assets, including subprime mortgages.

Swaps written by AIG Financial Products, a unit separate from its main insurance businesses, have had to be written down as underlying subprime mortgage investments have fallen steeply in value.

CREDIT LOSSES

Analysts are divided on how much AIG will be hit by credit swap losses in the quarter. Gallant sees $3 billion in losses, while analysts at Wachovia predict up to $7 billion.

To be sure, AIG has recorded little in the way of realized, or actual, losses from the swaps. But the fact that it has been badly hit by unrealized mark-to-market losses has unnerved investors. Until February, management predicted no significant losses from the swaps, which would leave AIG on the hook in the event of a default on the underlying bonds.

Citigroup analyst Joshua Shanker, in a note late on Monday, predicted investors have already priced more write-downs into the stock. "We believe that shares would rally on credit losses below $5 billion," Shanker said.

And on Tuesday, UBS analyst Andrew Kligerman upgraded the stock to "buy" but cautioned it was not for the "light-hearted," citing AIG's "heightened sensitivity to volatile credit markets, and many operating headwinds."

Kligerman, who sees as little as $1.4 billion in credit swap write-downs in the second quarter, set a 12-month price for the shares of $41. AIG shares, halved from the beginning of the year, were trading up $1.87 or 7 percent at $28.56 on Tuesday.

Analysts polled by Reuters Estimates on average expect second-quarter operating earnings, including credit default swap losses but not realized gains or losses, of 46 cents a share -- about one-quarter the operating income AIG reported in the year-ago period.

END IN SIGHT?

Investors hopeful that AIG will get all the bad news out of the way in the second quarter may be disappointed.

"When people say 'kitchen sink,' they mean it is done. I'm not sure that's going to be the case," said KBW's Gallant.