Stock Talk: A Closer Look at AIG

Shares of American International Group () took a hit last Thursday on rumors that the company will disclose big write-downs when it announces earnings next week. Since the talk occurred just one day after Merrill Lynch () announced last Wednesday that it had recorded a massive $7.9 billion write down when the brokerage firm released earnings, investors were spooked and AIG shares took it on the chin. The stock has now suffered a three-week 10.4% decline. However, while there is a chance that the insurer will incur costs related to mortgage credit issues, the stock might not fall when the earnings are announced on November 7. Here’s why.

Headquartered in New York, NY, American International Group is a holding company that, through its subsidiaries, provides a variety of insurance and insurance-related products in the United States and overseas. AIG also offers financial services and asset management. Last year, the company generated more than $110 billion in revenues and had $979.4 billion in assets. The stock trades on the New York Stock Exchange under the symbol AIG. It is one of the thirty stocks included in the Dow Jones Industrial Average ().

Shares have not performed very well in 2007. AIG is down 13.3% on the year. It suffered an 8.4% decline during the month of July. The stock fell victim to a sell-off that inflicted the entire financial sector, as skittish investors fled shares of any company that might have exposure to the credit markets. In the middle of 2007, the company reported $29 billion in subprime exposure. The exposure to subprime mortgage market comes through investments and commitments to finance or guarantee debt repayments.

While shares of American International Group held steady in August and September, the stock is sliding once again in October. AIG is down another 8.1% amid renewed concerns about the company’s exposure to the credit markets. One Citi Investment Research analyst said late last week that the insurance company might see a loss related to mortgage credit of $1.6 billion for the previous quarter.

However, some investors apparently expect worse news when the company reports earnings next Wednesday. According to talk on the Street last Thursday, the company was to announce “large securities write downs.” The term “large” is obviously vague, but it came just one day after Merrill announced a $7.9 billion write-down. In addition, for a company that commands $979.4 billion in assets, large could indeed be massive. In short, a rumor that AIG would incur a big write-down sent the stock reeling and, after AIG opened for trading at $63.84 a share, it had fallen to a low of $58.46 in midday trading Thursday.

While the rumor of a massive write-down sent AIG reeling for an 8.4% midday loss midday Thursday, the stock later recovered when CNBC reported that the rumor was simply not true. Indeed, the origins of the rumor are dubious at best. Furthermore, the timing of the write-down rumor was terribly suspicious because a flurry of put volume occurred just before the talk started making the rounds.

The stock started falling on the speculation around noon Eastern time. However, a lot of the day’s put volume occurred before that time. For example, of the 34,692 put contracts that traded Thursday, at least 5,500 contracts of the November 60 calls traded before noon. The volume included two large prints of 1,000 contracts and 2,000 contracts for $1.10 very early in the day. At the peak of selling, at about 2:00, those puts reached a high of $4.40 a contract, or 400% above the lows of the day. Unusual volume was also seen in the November 55 and December 60 puts.

So, there is a chance that some players were taking out bearish bets on AIG before the rumor surfaced. It is also possible that these same players were involved in spreading the rumor and were preying on recent investor fear about problems in the credit markets and possible write-downs. Indeed, if it was a bogus rumor designed to send the share price of AIG lower, the timing could not have been better.

Figure 1: AIG Weekly Chart with Earnings () Dates

Looking forward, there is certainly a risk that AIG will have bad news to disclose related to write-downs, but Thursday’s sell-off was probably an overreaction. As evidence, the stock was able to shake off the selling later in the day and rebound from the worst levels of the day. Shares moved up to $61.79 to close the session down 3.2% and 5.7% above the lows of the day. Late in Monday’s trading session, the stock was up $1.27 to $63.42.

In addition, AIG has a track record of posting better-than-expected earnings. As we can see from the weekly chart above (figure 1), the share price tends to close the week on a strong note when the company releases earnings. Therefore, at this point, the odds of an upside earnings surprise seem just as likely as a write-down announcement when AIG reports earnings on November 7.

Frederic Ruffy
Senior Writer
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