Subprime's Ultimate Time Bomb? by Jonathan R. Laing
Summary: Loan insurer ACA Capital Holdings' (ACA) shares lost almost 2/3 of their value, dropping from $15 in mid-June to just over $5 on July 24, before rallying back to a current $7. Barron's says investors' relief may be short lived. Its $326 million capital base and $61 billion loan exposure equate to 180-to-1 leverage. Critics say Wall Street lenders like Bear Stearns (BSC), Merrill Lynch (MER), Lehman Brothers (LEH) and Citigroup (C) have used the company to move billions of dollars in risky, volatile loans off their books. $9.3 billion of its exposure is to the top 60% of mezzanine CDOs, meaning it shouldn't take a hit until the bottom 40% collapses. However, all it takes to wipe out the lower level are cumulative losses of 7% -- this after Standard & Poors recently forecast a 11-14% hit. ACA also has another $5 billion exposed to 'high-grade' subprime CDOs, which could be 2/3 wiped out by a 10% cumulative loss. It also insures $444 million in 'CDO-squared pools,' which could be destroyed by as little as a 4.5% loss in the collateral. Including shareholder net worth, the company says it has claims-paying resources of over $1 billion. Should subprime woes prove systemic, Barron's says, losses could be $3 to $5 billion.