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WSJ -- A Bond Insurer Is Cut To Junk, and the Street May Get Pinched, Too ...............
December 20, 2007
Key Downgrade Adds New Layer To the Crunch
A Bond Insurer Is Cut To Junk, and the Street May Get Pinched, Too
By SERENA NG
The credit-rating downgrade of the small bond insurer ACA Financial Guaranty Corp. could send fresh shock waves across Wall Street, as billions of dollars of guarantees made by the insurer may become effectively worthless.
Standard & Poor's yesterday cut its "A" credit rating on ACA to the deep junk rating of "CCC," a heavy blow for the financial guarantor, which depends on a sound credit standing for access to capital and to get business. S&P said it had "significant doubt" that the company can come up with the capital needed to resolve its problems. The company said last night that it is working to stabilize its finances.
ACA insures the interest and principal payments on bonds, committing to pay investors if a bond issuer defaults. Initially this business was tied to the stable municipal-bond market. But, in the past few years, ACA wrote insurance on more than $60 billion of securities backed by mortgages and corporate debt. A big chunk of these were known as collateralized debt obligations, or CDOs, that pooled risky subprime bonds, whose value has deteriorated substantially in recent months.
Many buyers of this insurance were large Wall Street firms and banks -- including Merrill Lynch & Co., Canadian Imperial Bank of Commerce and others -- that are now potentially exposed to additional losses. CIBC yesterday warned it may have to take up to a $2 billion charge on its CDO holdings insured by ACA, prompting Fitch Ratings to place the Canadian bank's own "AA-" credit rating on review for a downgrade.
Firms that bought insurance from ACA may have to shoulder losses on insured bonds. This highlights another market problem: counterparty risk. Many might find themselves exposed not only to bad bonds -- but also to shaky trading partners.
With the downgrade, ACA may soon be forced to pony up cash or collateral against some of its guarantees, a move that could render it insolvent. S&P said the company's capital cushion of $650 million was insufficient to cover estimated expected losses of more than $2 billion. That means it faces intense pressure to raise capital in an inhospitable environment.
In a statement last night, ACA said it has entered into a forbearance agreement with its counterparties that will help it avoid defaulting on its guarantees until Jan. 18. It said it was surprised at the magnitude of S&P's downgrade, and plans to work with its counterparties to find "a more permanent solution to stabilize its liquidity and capital position."
"The future looks tenuous for ACA; it's hard to see how they will make it through this without outside help," said David Havens, an analyst at UBS Securities.
Investors and analysts had been bracing for the ACA downgrade for weeks. Still, it is unclear exactly how the sharp downgrade will affect the financial institutions that bought credit guarantees from the insurer.
These guarantees have acted as hedges for some of these banks, helping them to keep some of the risk of their mortgage holdings off their balance sheets. If the guarantees become void, the banks may have to make further write-downs on their own CDO positions. Merrill Lynch was among roughly 30 firms that entered into credit default swap agreements with ACA, according to people familiar with the matter. In a report last month, Roger Freeman, a stock analyst from Lehman Brothers, estimated Merrill had hedged more than $5 billion of its CDO exposures with ACA. Merrill's shares fell 78 cents, or 1.4%, to $54.73 in 4 p.m. New York Stock Exchange composite trading yesterday.
The investment bank took a massive $8.4 billion write-down in the third quarter due mainly to mortgage-related holdings. It is not known if Merrill recognized losses on CDO positions against which it held guarantees from bond insurers like ACA. Analysts have been expecting Merrill to make additional write-downs of $4 billion to $6 billion in the fourth quarter. With ACA now in trouble, that tally could mount. Merrill is expected to report its fourth-quarter results in mid-January. A Merrill spokeswoman declined to comment.
A New York Times report yesterday said a group of banks, including Merrill Lynch and Bear Stearns Cos., which has a minority stake in ACA, had been in talks to bail out the bond insurer. That plan is now moot, given that ACA has lost its investment-grade rating.
"They've missed their opportunity. It's over for ACA," said Sean Egan, managing director of Egan Jones, an independent credit rating firm. "It's going to be nearly impossible to stop the slide of this company," and nothing short of a multibillion-dollar cash infusion can save it, he added.
S&P yesterday also adjusted its views on several other bond insurers, which are better capitalized than ACA, but are also facing potential losses from mortgage CDOs. The rating company said it has a negative outlook on financial guaranty units of Ambac Financial Group Inc., MBIA Insurance Corp., and XL Capital Assurance Inc., which all still have their top AAA ratings. It is reviewing the AAA rating of Financial Guaranty Insurance Co. for a possible downgrade. Over the past few days, Moody's Investors Service and Fitch also took a more bearish view on some bond insurers.
Yesterday's wave of trouble, which also included a large mortgage-related write-down by Morgan Stanley, helped push super-safe Treasury bonds higher. The benchmark 10-year Treasury note rose 13/32, or $4.06 for every $1,000 invested, pushing its yield down to 4.07% from 4.12%. The two-year Treasury note's yield slipped to 3.14% from 3.18%.
--Lavonne Kuykendall contributed to this article.
New ABX Index Is Delayed
The newest incarnation of the widely followed subprime-mortgage-based index has been postponed by three months amid a lack of deals that underlie it, according to Markit Group, its administrator.
The ABX is rebuilt twice a year to capture the most current state of the subprime-mortgage-bond market. Originally scheduled to launch Jan. 19, the new index -- which was to be based on 20 of the largest deals from the second half of 2007 -- has been delayed because only five deals qualified to be in the index, Markit said in a statement.
The older indexes will continue to trade. Over the past year the ABX index has become one of the most oft-quoted and criticized measures of credit risk linked to mortgages made to subprime borrowers.
--Anusha Shrivastava
Write to Serena Ng at serena.ng@wsj.com
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