ACA Financial Guaranty Corp. has entered into a global settlement with its structured credit counterparties that will send it into runoff, continuing to honor its outstanding claims while writing no new business, the company announced Friday.

The Maryland Insurance Administration has approved the settlement, in which 29 counterparties will receive cash and surplus notes in return for terminating transactions that ACA Financial had provided more than $65 billion in credit protection on, according to Chadbourne & Parke LLP, which represented a committee of 12 of the counterparties. (Click here to view document)

 ACA Financial's remaining obligations consist of 726 policies with a par value of $7.3 billion, mostly on municipal debt, which the company has enough assets to meet, according to the order made by Maryland Insurance Commissioner Ralph S. Tyler.

"I feel that all parties involved have made the best of a difficult situation," Tyler said in a statement. "The objectives have always been to make sure that the individuals relying on municipal obligations insured by ACA are protected and that the restructuring is resolved in a matter satisfactory to the counterparties with structured finance exposure."

Like many other bond insurers, ACA Financial mired itself in trouble by moving away from its traditional municipal market into writing guarantees on structured finance products.

ACA wrote its first guarantee on a structured product in 2002, according to the order. By Sept. 30, 2007, it had guaranteed transactions with a par value of approximately $69 billion, including $22 billion on transactions backed by subprime mortgages. ACA Financial insured just $648.7 million in new issues of municipal bonds during 2007, according to Thomson Reuters data.

As the credit crisis deepened, the assets underlying the structured finance transactions deteriorated, exposing bond insurers to potential claims. In addition, many of the contracts required insurers to post collateral in the event of downgrade.

When Standard & Poor's downgraded ACA Financial to CCC from A in December, the insurer was forced to enter a forbearance agreement with its counterparties because it did not have the capital required as collateral. ACA Financial signed five more forbearance agreements before arriving at a settlement.

Under the terms of the deal, parent ACA Capital Holdings Ltd. - which will change its name to Manifold Capital Corp. - will still own ACA Financial indirectly, but will not exercise any control.

Instead, the counterparties will control the company through their ownership of surplus notes with voting rights. Surplus notes worth an aggregate of $1 billion will be issued, and counterparties will share pro-rata in any distributions of dividends, or excess assets following the runoff.

"It's a difficult deal for everybody and it's certainly not a win-win situation for anybody, but it's something that at least works and helps to protect the ultimate public finance policyholders, so in that respect it's ultimately a good thing," said Jim Gkonos, vice-chair of the insurance practice group at Saul Ewing LLP, which represented one of the counterparties. "How this kind of restructure arrangement will play out in the future for other companies that have similar distress is yet to be seen."

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