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ACA Capital Signs Third Forebearance

ACA Capital Holdings Inc. Tuesday said it signed a third forbearance agreement with its structured finance counterparties, to delay until April 23 any collateral posting requirements, termination rights, and policy claims related to the rating of ACA Financial Guaranty Corp.

ACA also disclosed the hiring of Blackstone Group as financial adviser, under a deal inked in December.

A spokesman with ACA confirmed the collaboration, but declined to comment further.

It is the third forbearance the company has entered into since Standard & Poor's downgraded the financial guarantor to CCC from A on Dec. 19. The credit derivatives sold by ACA require the insurer to post collateral if downgraded to below A-minus. With the drop to CCC, ACA was required to put up about $1.7 billion, an amount the company said it could not produce.

ACA has also avoided delinquency proceedings in Maryland, the state where the financial guarantor is domiciled. Karen Barrow, a spokeswoman with the Maryland Insurance Administration, said delinquency proceedings would not commence as long as collateral postings and other claims were deferred. Previously, the administration had said it would start such proceedings if at any time ACA is rated BBB-plus or lower and does not have forbearance agreements in place.

"This company is financially solvent unless and until that collateral call is due," Barrow said. "As long as that collateral call is not due, they are financially solvent, and there would be no reason."

Barrow said Maryland regulators are currently conducting a financial analysis of ACA, and have been for some time. She could not confirm when the analysis might conclude.

A Moody's Investors Service report earlier this week gives some indication of why counterparties are willing to agree to the forbearance. Last month, ACA said it was working with 29 counterparties to reach an agreement.

About 20 banks have exposure to the monoline bond insurers via credit default swaps that hedge about $120 billion of asset-backed security collateralized debt obligations, Moody's said. Further downgrades could cause the banks to increase loss reserves from a low of $7 billion to a high of $30 billion, the report said.

"The eroded creditworthiness of some financial guarantors has already led a number of banks and securities firms to recognize losses or to establish counterparty reserves on their CDS hedges with financial guarantors, although not all of these firms have disclosed the size of such reserves," Moody's said in the report.

David Fanger, managing director at Moody's and the author of the report, said ACA has publicly disclosed $18 billion to $19 billion in asset-backed security CDOs on its book.

"That is largely held with banks or financial institutions, the firms that we are including in our study," Fanger said. "In our number we definitely incorporate ACA in our estimates of incremental reserve requirements and in either case, we [say that] the exposures on ACA need to be fully reserved for."

The firms that have disclosed losses based on exposures to the financial guarantors, such as Merrill Lynch & Co. and Canadian Imperial Bank of Commerce, attribute much of the losses to hedges associated with ACA. In January, Merrill Lynch announced $1.9 billion in ACA-related write-downs, while CIBC reported a $2.5 billion write down, made up in part of falling values in CDS protection offered by ACA.

In late January, Oppenheimer & Co. analyst Meredith Whitney released a report that looked at the banks' exposure to the insurance provided by ACA by looking at the banks with the greatest share of the market in 2007 in terms of CDO underwriting. She then used these numbers to estimate the possible exposure the banks might have.

Under her analysis, UBS had the largest exposure to ACA, with an estimated $1.76 billion, followed by Citi with an estimated $1.75 billion. Merrill Lynch was third, at $1.66 billion. Underneath those three, Whitney listed Wachovia Bank NA, Goldman, Sachs & Co., Banc of America, Deutsche Bank, Lehman Brothers, Royal Bank of Scotland, and Morgan Stanley, with a low exposure of $736 million for the top 10, according to her analysis.

Whitney said that in total she expected financial firms' exposure to the monoline bond insurers to be between $40 billion and $70 billion.

ACA finds itself in its current position because of expansion into insuring credit derivatives under the leadership of current chief executive officer, Alan Roseman. Hired in May of 2004, Roseman helped ACA retool its business model to begin focusing more on its structured-finance and collateralized debt obligation management business lines.

As ACA went deeper into structured finance, its public finance business also grew. However, the municipal side grew much more slowly.

In 2007, ACA backed 31 public finance deals for a combined total of $648.7 million, according to Thomson Financial.


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