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Troubled bond insurer ACA Capital Holdings may have its credit rating cut, a move that would set off a chain reaction leading banks to take on an estimated $60 billion of CDO obligations, JP Morgan analyst Andrew Wessel said Wednesday. Standard & Poor's began considering cutting ACA's "A" rating in early November when the company reported a $1.04 billion third-quarter loss. ACA noted in a filing this week that it will not meet collateral obligation requirements if its rating falls below "A-." If the company defaults, banks would have to put any ACA guaranteed CDOs onto their books, said Wessel. "ACA is a likely candidate to get thrown to the wolves first," he said. ACA is one of nine bond insurers which may see its credit rating downgraded. Together, they are responsible for insuring about $2.4 billion of debt. Two companies ACA may severely impact are Bear Stearns and Merrill Lynch. Bear Stearns' private equity group bought a 29% stake in ACA for $100 million in 2004; the company is now worth $29 million after its stock has fallen 93% this year. Bear Stearns has likely already written down its losses from its ACA investment, says Lehman analyst Roger Freeman. However, if ACA defaults, Freeman wrote earlier in November that Merrill Lynch may have to take a $3 billion writedown from CDO exposure. Shares of ACA fell another 22.7% to $0.85 on Wednesday, while Merrill Lynch traded down 3.5% to $51.81 and Bear Stearns dropped 2.8% to $91.28.

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Source: ACA Capital Credit Rating Downgrade Could Spark New Round of Massive Writedowns