Bond insurer’s rating cut

Billions of dollars of municipal bonds insured by ACA Financial Guaranty Corp. were cut to “junk” status Wednesday after Standard & Poor’s downgraded the insurer itself because of its exposure to losses on mortgage-backed debt.

S&P; slashed its rating on ACA Financial to CCC from A, which already was the lowest rating among bond insurers. S&P; said ACA’s capital cushion of $650 million was $2.2 billion short of what it needed to cover potential losses.

In downgrading ACA and placing warnings on four other insurers, S&P; cited concerns about rising claims from defaults on mortgage-backed bonds.

The move makes it unlikely that ACA could insure any more bonds and could spark a municipal borrowing crisis, said Peter Schiff, chief executive of Euro Pacific Capital.

He said the downgrades could put a strain on the finances of some municipalities by raising their borrowing costs.

Yields on ACA-backed municipal bonds had recently risen to levels that would normally indicate the bonds had no insurance.

ACA insures less than 0.3% of municipal bonds outstanding.

In cases where the municipality provided its rating as the backstop for a bond insured by ACA, S&P; cut the bond’s ratings to match those of the municipality. Ratings on other ACA-insured bonds fell to CCC to match ACA’s rating.

S&P;’s action came as investment banks, including Merrill Lynch & Co. and Bear, Stearns & Co., were reportedly in talks to bail out the struggling bond insurer. ACA and Merrill Lynch weren’t immediately available to comment. Bear Stearns declined to comment, except to say it had little exposure to the insurer.

As part of a mass review of bond insurers, S&P; placed Financial Guaranty Insurance Co. on a negative watch. FGIC currently carries a rating of AAA. A negative watch suggests a 1-in-2 chance the rating could be downgraded within three months.

Ambac Financial Group Inc., MBIA Insurance Corp. and XL Capital Assurance Inc. were placed on a negative outlook by S&P;, suggesting a 1-in-3 chance their ratings will be cut in the next two years.