by Calculated Risk on 11/20/2007 05:19:00 PM

MaxedOutMama has the story: Hell's Bells Ringing On Wall Street

Here is the 10-Q from the SEC.

UPDATE: To help make the problem clear, from the Financial Times a couple weeks ago: ACA’s downgrade threat could leave CDS counterparties without recourse

ACA Financial Guaranty could default on insurance agreements if Standard and Poor’s chooses to downgrade the bond insurer’s rating ...

In total, ACA Financial insures USD 69bn of asset backed and corporate bonds for 31 counterparties through the use of credit default swap contracts ... Those contracts include coverage of USD 25.7bn in AAA rated ABS CDO notes backed by subprime RMBS, many of which are held on the balance sheets of investment banks.

Citigroup has USD 43bn in exposure to super senior ABS CDO notes, while Morgan Stanley has USD 8.3bn in exposure, according to the companies. Merrill Lynch has USD 14.2bn in ABS CDO super senior exposure.

Because ACA Financial is rated A – well below the industry norm of AAA – its CDO CDS contracts contain a provision requiring it to post collateral in the event of a downgrade ... Such provisions require ACA to post cash equivalent to the mark-to-market loss of the CDS contract pursuant to a ratings cut.

In the event of a downgrade by S&P, ACA Financial would become insolvent, confirmed company Treasurer Alex Willkomm ...

There is more in the FT article. In the 10-Q filed yesterday, auditor Deloitte Touche wrote:

... on November 9, 2007 Standard & Poor’s Rating Services (“S&P”) placed its financial strength rating of ACA Financial Guaranty Corporation (“ACA FG”) ... on “CreditWatch with negative implications”. Should S&P ultimately downgrade ACA FG’s financial strength rating below “A-”, under the existing terms of the Company’s insured credit swap transactions, the company would be required to post collateral based on the fair value of the insured credit swaps as of the date of posting. The failure to post collateral would be an event of default, resulting in a termination payment in an amount approximately equal to the collateral call. This termination payment would give rise to a claim under the related ACA FG insurance policy. Based on current fair values, neither the Company nor ACA Financial Guaranty would have the ability to post such collateral or make such termination payments.

So a downgrade would effectively wipe out ACA, and the counterparty (the Investment Banks) would be left without insurance for their CDOs.