Three years ago this week, Hurricane Katrina’s storm surges devastated New Orleans and surrounding areas. But the disaster also had financial effects that extended far beyond the region’s floodwaters and relocation centers.
The U.S. insurance industry was shocked by the record 2005 hurricane season, just as it had been by the attacks of September 11 four years earlier.
Damage was far-reaching, shredding previous risk assessment models and calling into question future insurance policy writing for coastal areas.
Today, a look back yields valuable lessons not just for local citizens and officials, but also for investors who can find value plays through crisis investing.
As a case in point, the post-Katrina stock market response for insurance holding company AIG wasn’t what you might expect.
Crisis Investing, From Katrina to Subprime
American International Group (NYSE:AIG), which operates in over 130 countries as an insurer and financial services provider, was one of the first companies to estimate Katrina’s impact on its balance sheet.
Less than a month after the storm, on September 21, 2005, AIG and Warren Buffett’s Berkshire Hathaway (NYSE:BRK) each estimated about $1.1 billion a piece in after-tax losses for that filing period.
Yet AIG continued a share price climb that had begun in the spring, going from an April 1 low of just above $50 per share up to $60 when Katrina claims were estimated, and maintaining its trajectory to hit $70 by January.
That was a handy 40% gain in eight months for those who hung with AIG despite the gloom.
However, since then, AIG has come up against another crisis and is now trading at a 13-year low under $19.
The storm this time is manmade, and like so many other places in the financial world, the origin is within AIG.
Stock Projections for AIG
For insurance companies, risk is everything. That’s why it’s ironic that today Swiss bank Credit Suisse (AMEX:GOE) forecast a huge upcoming loss for AIG and lowered its stock price target from $30 to $22 per share.
Credit Suisse foresees a potential $6.5 billion hit for AIG in the third quarter of this year, due to a "heightened risk profile owed to uncertainty regarding ratings, the size of a potential capital raise and the ultimate cost of a de-risking strategy especially in its credit default swap (CDS) business."
$6.5 billion for Q3 2008 absolutely dwarfs the Q3 2005 blow dealt by Katrina, and shows us that stormy weather on Wall Street isn’t always accompanied by wind and rain.
Back in 2005, adjustments were made to prepare for the 2006 hurricane season, which in the Atlantic runs from June 1 to November 30.
Today’s models for credit-related risk don’t give any time for winter recalculations, which explains why AIG, Lehman Brothers (NYSE:LEH), and an endless stream of other financial majors are all trying to sweep losses under the rug.
It will take a real change in the way business is done and ratings are rendered to restore market confidence, but at a 13-year low like AIG’s stock is, you can’t help but lick your chops.
But if you’re looking to go long AIG, I say hang tight on this stock for now. In the meantime, check out Ian Cooper’s Options Trading Pit, which is delivering consistent triple-digit gains by taking a cold look at subprime-related risk.
Next week, I’ll highlight an international financial stock that has benefited by steering clear of the credit crunch, even though a natural disaster in its home country scared many away. Those who got spooked missed out on double-digit gains in mere months by not capitalizing on this example of crisis investing.