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Cue the Losses: S&P Downgrades ACA Financial Guaranty to Junk

On the heels of Moody’s recent warning on major financial guarantors, Standard and Poor’s said Wednesday that it has completed it’s own review — and promptly downgraded ACA Financial Guaranty Corp. to junk status, moving the guantor from an ‘A’ rating to ‘CCC.’ ACA guarantees $26 billion in mortgage-backed securities. In addition to downgrading ACA Capital, S&P also placed AAA-rated Financial Guaranty Insurance Co. on negative credit watch. Ambac Assurance Corp., MBIA Insurance Corp., and XL Capital Assurance Inc. and XL Financial Assurance Ltd. were affirmed but assigned a negative outlook. Here’s S&P’s formal announcement (registration req’d). For those who really want to get into the weeds, the full report is available here. From the S&P report:

The financial strength and financial enhancement ratings on ACA are lowered to ‘CCC’ and placed on CreditWatch Developing. The lower rating reflects the substantial excess-of-modeled stress test losses of nearly $2.2 billion over the company’s adjusted capital cushion at Dec. 31, 2007 of approximately $650 million. While ACA has been diligently working to address contingent liquidity concerns, it has not focused significantly on raising additional capital. Lower new business activity during this period of rating uncertainty is a positive from a capital adequacy standpoint but the incremental improvement is not sufficient to close the gap between stress losses and the capital cushion. The magnitude of the gap is large enough to create significant doubt that the company could possibly access sufficient hard capital resources to resolve the problem.

S&P said that the downgrade of ACA led the rating agency to also cut the ratings on nearly 3,000 municipal bonds, a move that comes on the heels of Fitch placing 114,811 FGIC-wrapped municipal bond issues on negative ratings watch earlier in the week. The actions by S&P came as the New York Times reported this morning that various banks were furiously trying to bail out the troubled guarantor to prevent just this sort of scenario from playing out. From the NYT’s story:

Officials from Merrill Lynch, Bear Stearns and other major banks are in talks to bail out a struggling bond insurance company that has guaranteed $26 billion in mortgage securities, according to two people briefed on the situation, because the insurer’s woes could force the banks to take on billions in losses they had insured against.

With the bailout failing, those potential losses are getting very real, very quickly. The Associated Press reported that within minutes of S&P’s announcement, CIBC World Markets said insurance for $3.5 billion in securities it holds backed by subprime mortgages may no longer be viable. I don’t think CIBC is alone here, obviously.

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