Billions in write-downs on derivates and other losses related to mortgages put insurer American International Group Inc. deeply in the red during the fourth quarter, and the company expects another “significant operating loss” at its mortgage insurance division in 2008.

AIG said a $5.3 billion fourth-quarter loss was largely driven by $11.2 billion in write-downs of credit default swaps that cover investments with exposure mortgages.

AIG also reported a $2.63 billion fourth-quarter capital loss related to the reduced value of its investment portfolio, and a $643 million charge related to investments held by its financial products unit, AIG Financial Products Corp.

The fourth-quarter losses put a considerable dent in the company’s profits for the year, which totaled $9.3 billion, down nearly 40 percent from $15.4 billion in 2006.

In a press release, the company said it expects U.S. housing markets to remain weak and that credit market uncertainty will likely persist in 2008, which could force AIG to report additional unrealized market valuation losses and impairment charges.

AIG’s insurance and financial services subsidiaries invest in mortgage-backed securities (MBS) and collateralized debt obligations (CDOs) backed in whole or in part by residential mortgage loans. AIG Financial Products Corp. provides credit protection through credit default swaps on certain super senior tranches of CDOs.

AIG also has exposure to losses in mortgage lending through its residential mortgage insurance unit, United Guaranty Corp. (UGC), and through loans originated by its American General Finance Inc. subsidiary.

UGC reported an operating loss of $348 million in the fourth quarter of 2007, compared with operating income of $27 million in the same quarter a year ago. The mortgage insurer saw a $637 million operating loss for the year, compared with operating income of $328 million in 2006, as losses on first- and second-lien loans more than tripled from 2006.

AIG said the downward cycle in the U.S. housing market is not expected to improve until residential inventories return to a more normal level and the mortgage credit market stabilizes. AIG expects UGC will see a “significant operating loss” in 2008.

UGC’s domestic mortgage risk in force at the end of the year totaled $29.8 billion, up nearly 20 percent from a year ago, with 81 percent secured by first-lien, owner-occupied properties. The 60-day delinquency ratio also rose, from 2.1 percent at the end of 2006 to 3.7 percent, AIG said in its annual report to investors.

AIG also originates mortgages through its American General Finance Inc. unit, which saw fourth-quarter operating income fall to $9 million, down from $157 million a year ago. The decrease was attributed to a sharp decline in origination volume and higher warranty reserves in AGF’s mortgage banking operation.

Last year AIG set aside $178 million to settle charges by bank regulators that its subprime mortgage lending subsidiaries failed to adequately evaluate the credit of some borrowers and charged high broker and lender fees (see Inman News story).

The agreement with the Office of Thrift Supervision covered mortgages originated between July 2003 and May 2006 in the name of AIG Federal Savings Bank by Wilmington Finance Inc.

AIG said it terminated its services arrangement with AIG Federal Savings Bank, a federally chartered thrift, in the first quarter of 2006, and that AGF’s mortgage banking subsidiaries now originate nonconforming real estate loans using their own state licenses. Most of the loans are originated by brokers and sold to investors, the company said.

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