Insurers Escape Big Q2 Mortgage Losses – So Far

By | August 5, 2008

The first read on insurance companies’ second-quarter earnings shows they’re taking hits from the same kinds of mortgage-backed investments as other financial firms, but so far, most companies haven’t had the severe losses that banks and investment firms have seen.

The Travelers Cos., Hartford Financial Services Group Inc. and MetLife Inc. have all reported profit declines and Genworth Financial Inc. posted a quarterly loss driven by credit-related investments. This week, investors will get more clues about the damage insurers have suffered when American International Group Inc., Ambac Financial Group Inc. and Marsh & McLennan Cos. issue their reports.

AIG will be under particular scrutiny after the world’s largest insurer lost $7.8 billion in the first quarter due to mortgage-backed investments.

Insurers, like other financial companies, have taken losses on money they put into investments including collateralized debt obligations, or CDOs, securities backed by pools of mortgages or other assets. CDOs have plummeted in value since the credit crisis erupted a year ago.

“Will these investments cause a collapse in the insurance industry? My emphatic answer would be no,” said Morningstar analyst Jim Ryan. “To the extent that the big insurance companies invested in those securities, they will either take a write-down or they won’t.”

AIG, after reporting its first-quarter losses due to credit default swap and investment portfolio losses in May, said it would raise $12.5 billion to shore up a capital base that has been hurt by deterioration in the credit markets. Credit default swaps are contracts that allow bondholders to protect their investments, such as structured securities backed by mortgages, against a default.

The company may have another $2.5 billion of write-downs in the second-quarter for such swaps because of the securities they guarantee, Citi Investment Research analyst Joshua Shanker wrote in a recent client note on AIG. But analysts surveyed by Thomson Financial, on average, forecast a profit of 63 per share. “We believe pessimism at the world’s largest insurer is overdone,” Shanker said. “Favorable quarterly earnings numbers at several early-reporting financial institutions suggest credit concerns may be overblown.”

If Wall Street is disappointed with AIG’s results, it will be make it harder for Chief Executive Officer Robert Willumstad to reverse the company’s more than 50 percent stock slide this year.

But Friedman, Billings, Ramsey & Co. analyst Randy Binner said investors have already looked at which companies held risky investments, and factored many of those risks into insurers’ stock prices. “It would seem to me that we would be in the early stages of a credit cycle, a down part of the credit cycle,” Binner said. “You would expect that these things would continue to happen.” And they have.

Allstate Corp. posted a 98 percent drop in net income after the auto and homeowner insurer said it suffered losses on some of its big mortgage-related investments. The company suffered $1.2 billion of realized losses in the latest quarter, mainly on securities that have dropped in value as the housing bust deepened.

At Genworth Financial, write-offs of mortgages and asset-backed securities related to subprime and Alt-A mortgages were $326 million in the second quarter. Alt-A mortgages are given to people with minor credit problems or who lack proper documentation to get a traditional prime loan, while subprime mortgage loans are given to customers with poor credit histories.

And while MetLife Inc.’s second-quarter results were also affected by market turmoil, Chief Investment Officer Steve Kandarian said in an investor call last week that the company holds few of the risky investments that have been the cause of billions of dollars of write-downs for other financial firms.

At the end of June, Kandarian said, MetLife had cut its holding of Alt-A mortgages to $4.9 billion and was not buying any more. It had subprime mortgage investments of $1.8 billion. MetLife has $1.4 billion in CDO exposure. However, Kandarian said 98 percent of the company’s holdings were rated investment grade, indicating a lower risk of default.

Investors will also look to Ambac Financial, which posted a steep loss in the first quarter as turmoil in the bond market pummeled the value of many of the bond insurer’s deals.

Bond insurers like Ambac Financial have struggled since late 2007, as ratings agencies worried there will be a spike in claims, as bonds backed by troubled mortgages are likely to default. The rise in claims would severely cut into cash reserves for some bond insurers and potentially put others out of business.

On Friday, Ambac Financial said it settled one of its largest exposures to risky collateralized debt obligations. The Company agreed to pay $850 million to end an insurance agreement covering a $1.4 billion CDO transaction. Analysts forecast a loss of 64 cents per share.

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