Bonds News

INSIGHT-ACA became Wall St's trash can, now haunts Goldman

* Many on Wall St questioned stability of ACA

* ACA started growing fast in middle of decade

* Took on too much risk, didn’t invest enough in staff

* Goldman searched for “flexible” partners like ACA

* Became dumping ground for toxic assets, then collapsed

By Dan Wilchins

NEW YORK, April 29 (Reuters) - It became Wall Street’s trash can.

ACA Capital Holdings Inc, one of the investors that the U.S. government says was duped by Goldman Sachs GS.N, was a bond insurer best known for doing deals that few other companies would touch.

The company, which guaranteed debt and managed portfolios of complicated instruments known as asset-backed securities, collapsed and had to be taken over by state regulators in late 2007.

“It was widely believed, and for very good reason, that ACA was not very sophisticated,” said Arturo Cifuentes, a former structured finance banker at small broker dealer R.W. Pressprich & Co.

ACA is not accused of wrongdoing, and was hardly the only company that misgauged complicated securities in the middle of the decade. Even investors and managers that seemed smart in mid-2007 turned out later to have been dead wrong.

And not everyone in the marketplace viewed ACA as unsophisticated. One trader said he worked with ACA earlier this decade and found them to be careful and diligent.

But many traders said it was an open secret that ACA would consider deals that few others would take.

“They’d say ‘yes’ to pretty much everyone who asked them to dance,” said one Wall Street professional who did business with ACA.

Another veteran trader at an investment firm said the company was not looking at the right issues when analyzing structured credit. “The only thing missing there was the clown car,” he said.

A spokesman for Goldman said ACA was an experienced manager and had every incentive to pick securities well in the transaction in question.

ACA made mistakes that hastened its demise, traders and former employees said, including pursuing relentless growth by diving into risky securities and hiring as few people as possible to analyze them.

One of ACA’s big mistakes was viewing credit risk as something that could be analyzed using black-and-white rules, instead of independent thinking, Cifuentes said. Other bond insurers made that same mistake, he added.

But because ACA had a lower credit rating than many of its competitors, it had to take more risk to win business, traders noted.

ACA spokesman Whit Clay declined to comment.


The lower credit rating was by design. ACA originally staked out its niche as a bond insurer that focused on weaker credits.

ACA was founded in New York in 1997 by Russ Fraser, a former executive at companies including Standard & Poor’s, bond rating company Ambac, and ratings agency Fitch.

Fraser was famous for his passion for the West, and would often show up to work in a cowboy hat, a leather vest, and boots, former employees said. He spent weekends on his cattle and dude ranch in Wyoming.

Fraser focused on guaranteeing debt from municipal utilities, museums and other tax-free bond issuers that had relatively weak credit ratings. ACA had a “single A” credit rating, far below the “triple A” rating of its competitors. But that meant ACA’s guarantee was cheaper, a selling point for its clients.

ACA could insure weaker municipal debt without much concern about it actually defaulting. Because of the tougher standards that ratings agencies used for tax-free issuers, municipal credits defaulted much less often than their ratings implied. And if ACA was particularly concerned about the issuer, it could negotiate to reduce its risk by, for example, demanding collateral.

Those deals could translate into solid profits for ACA, but the company saw limited growth potential in that part of the market, said Michael Satz, who was chief executive of ACA in the first half of this decade, after Fraser left the company.

So ACA took its credit expertise into the land of corporate credit, focusing on niche deals in structured credit, like small pieces of CDOs.

“We limited our exposure and got fees, and in the worst case we would lose a few million dollars,” Satz said.

In 2004, Satz was preparing to take the company public, but the deal was scuttled when lead underwriter JPMorgan Chase & Co JPM.N found that he had tax issues from a prior job.

Bear Stearns stepped in and gave more capital to ACA. Satz was pushed out, and Alan Roseman, a bond insurance veteran, became CEO.

To former employees and people who traded with the company, that was the beginning of the end.

Roseman sought relentless growth for ACA. He was first readying the insurer to go public, which it did in 2006, and then he was trying to generate the kind of growth that would make shareholders happy, former employees said.

Roseman did not return calls to his home and cell phone.

He was particularly keen for the company to dive into the branch of structured finance that would prove the most toxic: consumer debt that had been packaged into bonds and then repackaged into CDOs.

“There was an aggressive push for business in structured finance, which had the most sizzle,” said one former employee.

ACA had at least two ways to earns fees from those deals: by guaranteeing some of the risk in the deals, and by picking portfolios of securities to be packaged into CDOs.

The structured finance business mushroomed. On the guarantee side, it had about $14.6 billion of exposure at the end of 2005. By the fall of 2007, that figure was closer to $70 billion.

But growth came at a price. Traders that worked with ACA noted a real difference in the kinds of deals it was willing to do as the credit bubble inflated further.

Keeping up with rapid growth is tough for any institution, and ACA may not have invested enough in personnel, a former employee said.

He estimated that the company had about 15 to 20 professionals working in structured finance by early 2007, and needed at least 25.

Several traders noted that even firms that did invest heavily in hiring professionals to deal with structured finance lost a good deal of money in the area.


Goldman Sachs, which is accused by the Securities and Exchange Commission of failing to give crucial information to investors in a CDO, seems to have known that ACA wasn’t the most stringent partner to work with.

ACA was nominally in charge of picking the subprime mortgage bonds that were packaged into the CDO, but hedge fund manager Paulson & Co suggested many of the securities, according to the SEC’s complaint. ACA did not know that Paulson was shorting the securities, the SEC said. ACA also indirectly took risk from the deal.

Goldman has said it never misled ACA, and to the extent ACA was misled, it was not intentional.

According to an email exchange released by the Senate Permanent Subcommittee on Investigations, bond trader Fabrice Tourre and his colleagues at Goldman mooted a number of possible managers to pick securities. Tourre suggested brainstorming for managers that were “flexible” regarding picking securities. As colleagues came up with ideas, they continually mentioned that particular managers were “easy” to work with.

The names of the asset managers were redacted in the released email, but in the end, Goldman picked ACA.

Michael DuVally, a spokesman for Goldman Sachs, said that ACA was an independent and experienced portfolio manager, and was the largest investor in the deal in question, and “had every incentive to select appropriate securities.”

For much of the decade, a number of Wall Street firms refused to do business with ACA directly but as the credit crunch intensified in 2007, some additional banks started turning a blind eye to ACA’s obvious problems.

Merrill Lynch offloaded billions of dollars of exposure onto the company. Buying insurance on bad assets allowed banks to avoid writing them down.

“Merrill was giving risk to everyone that would take it, and by then not many were,” said one CDO professional.

In the end, the toxic garbage that it took on from Wall Street overwhelmed ACA.

In December 2007, it was all over for ACA. Maryland’s insurance regulator took significant control of its bond insurance unit, and the company is now winding down its business.