By Lilla Zuill

NEW YORK (Reuters) - American International Group <AIG.N>, after disappointing with a worse-than-expected loss on Thursday, did little to buoy investor spirits on Friday, telling shareholders it does not yet see signs of a rebound in the market for mortgage assets, which have cost it dearly over the past two quarters.

AIG posted a $7.8 billion first-quarter loss, surpassing the then-record $5.3 billion loss it posted in the fourth quarter, largely stemming from a decline in the value of assets linked to subprime mortgages. On Friday, shares fell more than 8 percent.

"The market is not going to look favorably on this quarter's results," said Goldman Sachs analyst Tom Cholnoky, in a note.

Over the past two quarters, AIG has recorded unrealized losses of about $20 billion in a credit swap portfolio, as the credit crisis all but closed the market for bonds that these swaps guaranteed.

AIG on Thursday said it plans to raise $12.5 billion to strengthen its balance sheet. Two ratings firms downgraded the insurer.

On a call with investors, Chief Executive Martin Sullivan said the downgrades will likely increase funding costs for some of its businesses, including its aircraft leasing operation, one of the few units to do well in the first quarter. The insurer also has to post $1.6 billion more in collateral.

AIG, which over nearly nine decades in business has grown into the world's largest insurer, is one in a procession of companies to write down bad assets. Analysts estimate that companies globally have recorded more than $300 billion in write-downs and raised more than $200 billion in fresh capital.

Disappointing results over the past two quarters have marred Sullivan's previous track record of posting profits in every period since he became CEO in 2005.

Now, analysts say Sullivan must work to stem losses, shore up capital, and regain investors confidence, which has fallen as potential losses from credit swaps have ballooned.

Last year, Sullivan assured investors that AIG was unlikely to see any actual losses from its CDS portfolio. But on Friday AIG raised its estimate of potential realized losses to $1.25 billion from a $900 million "worst-case scenario" disclosed in February.

An outside market-based analysis put AIG's potential actual losses in a much higher range -- between $9 billion and $11 billion, or roughly half the unrealized losses recorded to date. But Steve Bensinger, who is stepping aside as chief financial officer to assume another role at AIG, said "we continue to believe that a market-based analysis is not the best methodology (for) potential realized losses."

AIG's credit default swaps essentially insured subprime mortgage bonds and other assets against default.

RATINGS BLOW

The one-notch downgrades by Standard & Poor's and Fitch followed AIG's Thursday loss announcement.

Sullivan told investors the downgrade was "manageable."

"Importantly, both agencies kept the financial strength ratings of our insurance company subsidiaries at the "AA-plus" level, which is most important to us," Sullivan added.

While AIG is raising capital and working to stem losses, investors have been hopeful that there would be an improvement in the mortgage market that could boost AIG's results as early as the second quarter.

But Bensinger, who is assuming the role of vice-chairman of financial services, told investors that he does not yet see signs of a recovery in the structured credit market for residential mortgage securities, including subprime.

"We don't see any precise evidence to date that those markets have rebounded," said Bensinger.

The company has said it expects much of the costly revaluation of its credit swaps to reverse over time, as market conditions improve.

Although disappointed by AIG's larger than expected loss and the weak operating results across much of its business, analysts said the insurer's main business of selling property-casualty and life insurance was still viewed favorably.

"If you throw the credit business to the side, the operating business is fairly decent," said Morningstar analyst Matt Nellans. "The big issue is the credit swap business, and they do not have any control over market prices."

Wachovia Capital Markets in a research note said it saw AIG's insurance franchises as "valuable properties, with good long-term growth prospects, that are obscured by the murkiness of the current capital markets environment."

AIG shares were trading 8 percent lower at $40.57 in afternoon trade on the New York Stock Exchange. The stock has fallen about 44 percent over the past year, compared with a 25 percent decline in the S&P insurance index.

(Editing by Dave Zimmerman, Phil Berlowitz)