ACA Capital Enters Agreement with Regulator, Averts Delinquency Proceedings

On the heels of a ratings downgrade by Standard & Poor’s last week, bond guarantor ACA Capital Holdings said late Wednesday in a filing with the Securities and Exchange Commission that it has ceded control of the company to the Insurance Commissioner for the State of Maryland. The troubled insurer said it had entered a Letter of Representations and Agreements and a Consent Order with the Maryland regulator as part of a move to prevent deliquency proceedings. “ACA FG … agreed not to engage in certain activities without providing prior notice and opportunity to object to the MIA [Maryland Insurance Administration] including, without limitation, pledging or assigning any assets, paying dividends or engaging in certain material transactions,” the company said in a statement. “ACA FG is similarly limited under the forbearance agreement from engaging in activities consistent with the Letter Agreement and must also comply with financial covenants.” Bloomberg, reporting on ACA’s move, cited sources saying bankruptcy was inevitable. “It’s given them breathing room and a month to stave off bankruptcy,” Nigel Sillis, director of fixed income and currency research at Baring Asset Management in London, was quoted as saying. The downgrade at ACA Capital has the potential to impact a large number of Wall Street banks and associated mortgage banking operations, as a downgrade of any insurer usually means a downgrade of any bonds it insures (including RMBS issues). Bear Stearns, one such bank with counterparty exposure, yesterday characterized that exposure as “well contained.” MarketWatch reports that Bear CFO Sam Molinaro told investors in a conference call Wednesday that the Wall Street giant’s exposure to ACA Capital was already reflected in earnings. “We have no additional exposure to them so I think that that is quite well contained and behind us, whatever the exposure was,” Molinaro is quoted as saying. The Associated Press ran a story Wednesday that asserted bond insurance may soon become a thing of the past, at least for munis — what the AP story fails to note is the often critical role the bond insurers play in the mortgage-backed and related derivatives markets, given the comparatively higher risk of default in many mortgage-related structured securities. I personally doubt that the current crisis will render irrelevant the financial guaranty business, at least within the mortgage industry, but the price of any such ‘AAA’ guaranty will certainly rise for those insurers left standing when the dust settles. We’re already seeing GSE g-fees rise; private sector guarantys will likely see a similar premium. Disclosure: The author holds no positions in ACA Capital.