Security Capital Assurance Ltd.’s (SCA) bailout agreement with parent XL Capital Ltd. (NYSE:XL) and Merrill Lynch & Co. (MER) to cancel billions of dollars in insurance contracts helps stave off official insolvency for the bond insurer. But the news confirms just how bad second quarter losses in subprime ABS CDOs have been and how tenuous the financial condition of SCA really is, Blackmont Capital analyst Brad Smith told clients.
SCA’s financial future is also linked to CIBC (NYSE:CM), which has already taken C$6.7-billion in writedowns on structured product since the credit crunch began and is expected to take another hit of at least C$1-billion when it reports third quarter results on Aug. 27.
As of April 30, CIBC has C$4.3-billion in net notional exposure to SCA, one of its monoline counterparties that provided financial guarantees to CIBC’s book of credit derivatives.
Mr. Smith also noted that it is the only Canadian bank to have a disclosed exposure to SCA. This is comprised of $1-billion in current receivables on its balance sheet and a future loss potential of $3.3-billion if the contract between the two companies were to fully develop and SCA was unable to honor its obligations.
Mr. Smith said:
While much of this rising capital risk profile is currently reflected in the share price, the risk of further severe adverse loss development, in our view, limits the attractiveness of trying to capture a portion of this discount.
He reiterated his “hold” rating and C$74 per share price target on CIBC.
Even this, which represents upside of more than 20%, “optimistically” assumes that the bank’s current capital risks resolve themselves favorably and the shares move to a 5% discount to peers, the analyst noted.