ACA Capital Holdings: An unfair shake?

Shares of ACA Capital Holdings (NYSE: ACA), which have tanked nearly 50 percent since June 20 amid concerns about the company's exposure to the subprime mortgage market roared back today, gaining almost 16 percent.

Perhaps this was short covering. Perhaps some positive comments from the company's largest shareholder Bear Stearns (NYSE: BSC) Merchant Banking, helped as well. Regardless, there is no way to know for sure if this rally is sustainable though Keefe Bruyette & Woods defends the stock saying "in our worst-case scenario, we think the stock has a double-digit valuation," according to the Times.

ACA has written off billions of dollars worth of insurance on financial assets and manages collaterized debt obligations on billions more. The New York Times noted that some of the collaterized debt obligations or CDOs. ACA manages for others were mentioned by bond rating agencies as potential candidates for a downgrade though the exact impact this action will have on ACA isn't clear.

Yesterday's 22% decline in the stock was triggered after S&P said it was considering downgrading various securities issued by four CDO's that were managed, but not owned, by ACA, citing "the increased probability of default" for the underlying mortgages. The company also said it could lose money on 2006 and 2007 contracts tied to $4.5 billion of subprime securities.

Nonetheless, The CEO of Bear Stearns Merchant Banking, John D. Howard said in a statement, "We have great confidence in ACA's management team."

Remember there's plenty at stake for the Wall Street firm. As Bloomberg News notes, Bear Sterns last month agreed to extend a $1.6 billon loan to one of its two hedge funds that "almost collapsed because of CDO bets."

They must have some confidence. The fund owns a 27.6% stake in ACA Capital Holdings and in the past month has lost almost $90 million in market value.