Nov. 21 (Bloomberg) -- ACA Capital Holdings Inc., the bond insurer under scrutiny by Standard & Poor's, may have its credit rating cut, forcing banks to take on $60 billion of collateralized debt obligations, JPMorgan Chase & Co. analyst Andrew Wessel said.

S&P on Nov. 9 began considering New York-based ACA's A rating for a downgrade after it posted a $1.04 billion third- quarter loss. ACA said in a filing this week that it won't meet collateral requirements if its rating falls below A-.

ACA is among nine bond insurers being vetted by ratings companies after the value of the CDOs they insure fell. Moody's Investors Service and Fitch Ratings are examining AAA rated insurers including MBIA Inc., Ambac Financial Group Inc. and FGIC Corp. to see if they have enough capital. A loss of the top ranking by the insurers would throw into doubt ratings on $2.4 trillion of debt.

``ACA is a likely candidate to get thrown to the wolves first,'' Wessel said in an interview today. If ACA defaults, banks would then have to bring their ACA-guaranteed CDOs onto their books, said Wessel, who is based in New York and has a neutral rating on the stock.

S&P is the only ratings company that has a rating on ACA.

Messages left for Alan Roseman, ACA's chief executive officer, and David Veno, an analyst in the bond insurance group at S&P, weren't immediately returned.

Record Defaults

Some of the CDOs are backed by home loans issued in 2006 and early 2007 to borrowers with poor credit, who have been defaulting at record paces.

ACA tumbled 93 percent this year, reducing its market value to $28 million. The shares dropped 25 cents to close at 85 cents in Nasdaq Stock Market trading after falling below $1 for the first time.

The private-equity investment arm of New York-based Bear Stearns Cos., the fifth-largest U.S. securities firm, bought a 29 percent stake in ACA in 2004 for about $100 million. The stake is owned by MBP II, one of the funds raised by the merchant banking unit. Bear Stearns has likely written down the declining market value of ACA in previous quarters, according to Lehman Brothers Holdings Inc. analyst Roger Freeman. Even if Bear Stearns had to write down ACA fully, it would face a $6 million charge, according to Bloomberg calculations.

`Very Small Creditor'

``We're a very small creditor and counterparty to the company,'' said Bear Stearns spokesman Russell Sherman. ``Our exposure is limited.''

CDOs package debt or derivatives into new securities with varying ratings. Insurers are required by accounting rules to reflect the current market value of guarantees on the securities and bonds they backed through derivatives contracts.

Merrill Lynch & Co. may need to write down $3 billion of CDOs if ACA defaults on its obligations, Freeman wrote in a note to clients on Nov. 5.

Jessica Oppenheim, a spokeswoman for Merrill Lynch, said it's company policy not to comment on analyst reports.

ACA, which has claims paying resources of $1.1 billion, also has insured bonds with a par value of $7.1 billion, according to the company's Web site. Most of that debt is for tax-exempt organizations, including $51.5 million of bonds sold to finance the construction of a jail in Pinal County, Arizona, and $4.7 million of bonds for the city of Deadwood, South Dakota.

Shares of New York-based Ambac tumbled 73 percent this year and Armonk, New York-based MBIA is down 54 percent.

Fitch Downgrade

ACA was founded in 1997 by H. Russell Fraser, a former Fitch executive known to turn up at meetings in a cowboy hat. The company specialized in guaranteeing municipal bonds with lower underlying credit ratings than those the AAA rated insurers would back.

The insurer averted a downgrade in 2001 after firing 40 percent of its employees and receiving $45 million in new funds from investors including Banc of America Securities Inc. and Keystone Inc. As part of the reorganization, ACA shifted its focus to structured finance and Fraser resigned to oversee a beef jerky manufacturing plant and pioneer town in Wyoming.

In November 2006, the company raised $90 million in a share offering.

A suit filed in federal court in Manhattan today said the company overstated its value and the value of its CDO asset management business when if sold shares to the public.

To contact the reporters on this story: Christine Richard in New York at crichard5@bloomberg.net; Matt Miller in New York at mtmiller@bloomberg.net.

Last Updated: November 21, 2007 17:52 EST