Merrill Lynch Plans to Write Off ACA Bond Insurance (Update1)

By Mark Pittman


Jan. 17 (Bloomberg) -- Merrill Lynch & Co., the biggest underwriter of collateralized debt obligations, said it will write off $2.6 billion in default protection from bond insurers including ACA Capital Holdings Inc. because it's worthless.

Merrill Lynch cut $1.9 billion of debt insured by ACA, whose debt ratings were lowered 12 levels to CCC in December, and $679 million from other insurers. Guarantors including MBIA Inc. and Ambac Financial Group Inc. are under threat of losing their AAA ratings from Moody's Investors Service and Standard & Poor's.

``We are reserving against ACA dollar for dollar so it's 100 percent reserved,'' said John Thain, chief executive officer of New York-based Merrill Lynch, during a conference call today with analysts and journalists.

Merrill Lynch's writedowns demonstrate how a downgrade of bond insurer credit ratings can spread throughout financial markets. Losing the AAA stamp would cripple the bond insurers and throw doubt on the ratings of $2.4 trillion of securities.

The bond insurers guaranteed almost $100 billion of CDOs backed by subprime-mortgage securities as of June 30, according to an Aug. 2 report by Fitch Ratings. Most of those guarantees are in the form of derivative contracts. Unlike insurance, those contracts are required to be valued at market rates.

ACA Financial Guaranty Corp., a unit of ACA Capital, had to seek approval from the Maryland Insurance Administration before pledging or assigning assets or paying dividends, the New York- based company said in a filing Dec. 27 with the U.S. Securities and Exchange Commission.

Delinquency Proceedings

A telephone call to Karen Barrow, a spokeswoman for the Maryland Insurance Administration, wasn't immediately returned. A message left for Alan Roseman, ACA's chief executive officer, also wasn't immediately returned.

New York-based ACA reached agreements to avoid posting collateral until tomorrow against credit derivatives it uses to insure the debt. The Maryland regulator held off filing delinquency proceedings while ACA seeks ways to raise capital.

ACA was required under its agreements with swap counterparties to post collateral on those contracts if its rating fell below A-.

Canadian Imperial Bank of Commerce had to sell more than C$2.75 billion ($2.7 billion) in stock to investors to rebuild its balance sheet after taking writedowns tied to ACA guarantees. Canada's fifth-biggest bank sold C$1.5 billion in stock to institutions and another C$1.25 billion to individual investors, the Toronto-based bank said in a statement Jan. 14.

CDOs are created by packaging debt or derivatives into new securities with varying ratings.

Default Risk

ACA, down 94 percent this year, fell 12 cents to 47 cents in over-the-counter trading at 3:27 p.m. in New York. The company was founded in 1997 by former Fitch executive H. Russell Fraser.

S&P's projected losses for the bond insurance industry will be 20 percent higher than in its previous review, based on updated results from a new ``stress scenario,'' the ratings company said today.

Credit-default swaps tied to MBIA's bonds soared 15.5 percentage points to 31.5 percent upfront and 5 percent a year, according to broker Phoenix Partners Group in New York. The contracts trade upfront when investors see a high risk of default. The price means it would cost $3.15 million initially and $500,000 a year to protect $10 million in MBIA bonds from default for five years.

Contracts on Ambac, the second-biggest insurer, rose 15 percentage points to 30 percent upfront and 5 percent a year, prices from CMA Datavision in London show.