ACA Financial: Closure Would Lead to Billions in Writedowns

Includes: ACAH, C, CM, MER, UBS
by: FP Trading Desk

If U.S-based ACA Financial Guaranty Corp. (ACA) is forced to shut its doors as the result of its exposure to the subprime mess, CIBC analyst Meredith Whitney estimates it could cost the banks billions of dollars in writedowns.

"While it is literally impossible to know who ACA's counterparties are due to literally zero disclosure of such, an estimate can be formed on the potential write down risk to such counterparties," she said in a note to clients adding she estimates such exposures could be worth $13-billion.

Ms. Whitney told clients she believes UBS (NYSE:UBS), Citigroup (NYSE:C)and Merrill Lynch (MER) have the greatest potential exposure risk to ACA, and could take writedowns associated with their exposure to the tune of roughly $1-billion each.

The analyst used an admittedly "best guess" approach in coming up with her exposure estimates, simply looking at the banks that had the greatest market share in 2007. Merrill Lynch, she noted, had an almost 18% market share in in CDO underwriting in 2007 while Citigroup and UBS had market shares of 16% and 12%, respectively.

While Merrill was the biggest underwriter of ABS CDOs for the year and during the 1st quarter, Citigroup was the largest underwriter in the 2nd quarter and UBS was the largest underwriter in the 3rd quarter when ACA placed the greatest amount of exposure.

ACA, which provides financial guarantee insurance to players in credit derivatives markets and structured finance capital markets had its credit rating downgraded to "CCC" from A by Standard & Poors recently. ACA's auditors have warned the downgrade would result in default payments that it cannot afford, and puts in question the company's survival.

In Canada, CIBC (NYSE:CM) admitted Thursday that it will likely take another $2-billion in charges tied to $3.5-billion of securities that have been hedged by ACA. Ms. Whitney made no mention of CIBC in the note and does not cover Canada's fifth largest bank.

ACA vs. UBS vs. C vs. MER vs. CM 1-yr chart: