brennpa

AIG and the Lunacy of GAAP Reporting

i'm long aig and generally agree with this analysis; i too think that CDS hits are vastly overstated - AIG stopped writing this crap at the end of 2005 so they were clearly ahead of the mortgage curve and i totally agree that CDO losses from 2005 and earlier will show drastically different loss profiles, not only because of better underwriting standards but also because a larger percentage of the underlying mortgages have already been repaid. the amortization rate for these mortgages is much higher than people realize - loans that have already been repaid cannot default.

one troubling thing is that if you look at AIG's investment portfolio, it holds a fair amount of 2006 and some 2007 vintage CDOs. i think losses will be higher on this paper even if they hold to maturity. it also seems to me that the presence of this paper suggests that the right hand is not speaking with the left - if the CDS team saw such problems with 2006 and 2007 mortgages, why was this information not relayed to the investment portfolio team? Hank may have been smart enough to run this empire but it seems to me that the inconsistent holdings (don't write 2006 CDS but hold 2006 CDO's) combined with the substantial overexposure to the mortgage business (what percentage of AIG’s total capital based was exposed to the US mortgage market? Why was this allowed?) suggests that this thing is too unwieldy for one person to manage – similar situation over at Citigroup (which also holds a pile of high grade CDOs marked down to $0.60 which has yet to suffer 1 dollar of cash flow impairment).

One other thing – I think mark-to-market clearly has problems but this is rule. For that reason, it is not impossible that a further move downward in ABX causes further mark-to-market hits, leading to rating downgrade, additional collateral, and then further equity raise. Stock is so cheap it won’t matter if you hold the Company for several years but if you’re managing money for clients, it is much tougher as you could conceivably endure 20% hit for another follow-on offering!…my two cents