Bond insurer Security Capital Assurance, LTD, which has been stripped of its AAA bond insurance rating, is trying to cancel insurance it wrote

Bond insurer Security Capital Assurance, LTD, which has been stripped of its AAA bond insurance rating, is trying to cancel insurance it wrote on certain collateralized debt obligations or CDOs. It was reported on March 14, 2008 by Jody Shenn at Bloomberg.com that Security Capital was seeking to terminate seven contracts on CDOs with an entity that it said had not met its obligations under the contracts. At that time Security Capital declined to identity the other entity that was disputing the termination.Subsequently, Merrill Lynch sued a Security Capital subsidiary to prevent the bond insurer from canceling $3.1 billion in contracts on CDOs. Merrill, which has already taken $24.5 billion in writedowns on mortgage-related debt, faced additional losses if the insurance is cancelled.
According to Saskia Scholtes of Financial Times Online, Merrill Lynch saw its share price fall 11% on concerns that it may have to take further writedowns. These concerns were apparently fueled by Merrill’s recent lawsuit against XL Capital, the Security Capital subsidiary. Scholtes reported that Merrill’s lawsuit alleged that XL Capital improperly terminated seven derivative contracts “without any basis and under a pretext based entirely on rank speculation.... Apparently, in light of the current dramatic downturn and deterioration in the credit markets, defendants are having ‘sellers’ remorse’ and are seeking to avoid their potential obligations of up to $3.1 billion under the credit default swaps at issue.”Security Capital has acknowledged that it cancelled the CDO guarantees sold to Merrill Lynch but claims that is was justified in doing so. In a statement, Security Capital said that Merrill gave the control rights on seven CDO “contracts to one or more third parties without our knowledge and in direct violation of our agreements.... As a result, we have a responsibility to take appropriate action and terminate these contracts.”
It is likely that many similar disputes will arise over the coming months as the subprime crisis rolls on.