By Hugh Son and Jesse Westbrook
Feb. 11 (Bloomberg) -- American International Group Inc., the world's largest insurer by assets, fell the most in 20 years in New York trading after its auditor found faulty accounting may have understated losses on some holdings.
So-called credit-default swaps issued by AIG, which protect fixed-income investors against losses, declined by $4.88 billion in value in October and November, four times more than previously disclosed, the company said today in a regulatory filing. AIG's auditors found ``material weakness'' in its accounting for the contracts, and the firm doesn't know what they were worth at the end of 2007, the filing said.
AIG Chief Executive Officer Martin Sullivan has presided over a 30 percent decline in the company's shares since replacing Maurice ``Hank'' Greenberg in March 2005. Investors have been concerned that losses tied to the U.S. housing slump might reduce earnings and the value of AIG's holdings. Sullivan assured investors that writedowns from the U.S. housing market were ``manageable'' on Dec. 5.
``It raises the question about whether management is in control of what's going on with their derivatives,'' Edward Ketz, a Pennsylvania State University accounting professor, said in an interview. ``The uncertainty as to whether additional losses are coming is as unsettling as anything.''
AIG retreated 12 percent to $44.74 at 4:01 p.m. in New York Stock Exchange composite trading, the biggest full-day decline since Oct. 19, 1987.
`Still Accumulating' Data
The company ``is still accumulating market data in order to update its valuation'' of the portfolio, according to its independent auditor PricewaterhouseCoopers LLP, the insurer said in today's filing with the U.S. Securities and Exchange Commission. AIG said it believes it has ``procedures to appropriately determine the fair value'' of the holdings.
The company's financial products unit issues contracts that promise to reimburse investors for losses tied to $505.5 billion of securities as of Nov. 25, including corporate debt, European mortgages and collateralized debt obligations, which bundle together loans.
Fitch Ratings may lower the insurer's AA credit rating because AIG's ``weakness in internal controls,'' coupled with ``current market conditions, contributes to uncertainty regarding the valuation'' of the derivative portfolio, the credit-ratings company said in a statement today.
Today's announcement ``will leave investors worrying about other skeletons in the closet,'' Nigel Dally, an analyst at Morgan Stanley, said in a note to clients. ``Investors should brace for a mark-to-market loss of roughly $5 billion in the upcoming quarterly results.'' He rates the New York-based company ``overweight.''
AIG's third-quarter net income declined 27 percent to $3.09 billion on losses linked to the U.S. housing slump, including a $352 million reduction in the value of the derivatives. The company, which has units that originate, insure and invest in subprime mortgages or securities, is expected to announce fourth-quarter results later this month.
The pretax estimate of declines for the first two months of the fourth quarter was confirmed by company spokesman Chris Winans. Previous guidance of $1.1 billion in losses was based on a $3.63 billion accounting adjustment that won't be used because AIG can't ``reliably quantify'' its merit, the insurer said in the filing.
AIG's residential mortgage-backed securities declined by a total of $2.6 billion in October and November, the company said Dec. 7. The insurer has said it doesn't expect to sell mortgage- related assets at a loss while markets remain weak.
The company said Aug. 9 that almost all of its subprime mortgage holdings were safe unless the U.S. housing market crashes to ``depression proportions.''
``It would take declines in housing values to reach depression proportions, along with default frequencies never experienced, before our AAA and AA investments would be impaired,'' Chief Risk Officer Robert Lewis said on a conference call with analysts on Aug. 9.
The world's largest financial institutions have reported at least $146 billion in asset writedowns and credit losses tied to the collapse of the subprime mortgage market.
Contracts on AIG's debt increased 30 basis points to a record 200 basis points, CMA Datavision prices show. Credit- default swaps, which rise when perceptions of credit quality worsen, protect bondholders against default and pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.
Benchmark credit-default swap indexes in the U.S. and Europe rose to the highest since they started trading in 2004.
`Fear in the Market'
``Any doubt as to their accounting accuracy would definitely strike fear in the market,'' said Brian Yelvington, a strategist at CreditSights Inc. in New York. ``They are considered to be a very sophisticated and large counterparty in the structured-finance world.''
Property and casualty insurers have stumbled as they expanded into contracts related to home values. Swiss Reinsurance Co., the world's biggest reinsurer, lost 1.2 billion Swiss francs ($1.07 billion) on derivatives in October. Losses occurred on two credit-default swaps Swiss Re sold to protect clients against declines in investments backed mostly by mortgages, the insurer said.
``It's likely that AIG wrote insurance contracts against securities it thought'' had minimal risk, said Jim Grant, editor of Grant's Interest Rate Observer, in an interview with Bloomberg Television. ``In reality, these securities were plenty risky.''
AIG said Oct. 11 that it rehired PricewaterhouseCoopers after considering other auditing firms as part of its February 2006 settlement with then-New York Attorney General Eliot Spitzer.
PricewaterhouseCoopers, AIG's auditor for more than two decades, had approved financial results from 2000 to 2005 that were restated amid Spitzer's probe, lowering earnings by $3.4 billion. AIG in 2006 agreed to pay $1.64 billion to end probes of its accounting and sales practices under Greenberg.
David Nestor, a spokesman for the accounting firm, and Ken Frydman, a spokesman for Greenberg, declined to comment.