LONDON (Bloomberg) - Merrill Lynch & Co.'s agreement to tear up bond insurance contracts sold by Security Capital Assurance Ltd. (SCA) may provide a template for Wall Street, Bank of America Corp. analysts said.

SCA will pay Merrill $500 million to cancel $3.7 billion of the guarantees it provided on collateralised debt obligations (CDOs), the analysts wrote. Both companies said they were discussing ways of terminating guarantees with other counterparties when the transaction was announced on July 28.

"We expect further deals to emerge from here,'' analysts Michael Barry, Seth Levine and Brian Turner in New York wrote in a report on Thursday. Tearing up the contracts in exchange for some payment "can be an important part of a securities firms' broader strategy of stepping away from their mortgage woes", the analysts wrote.

SCA, based in Bermuda, is among insurers including MBIA Inc. and Ambac Financial Group Inc. struggling to meet their commitments because of the worst housing slump since the Great Depression, causing financial firms to write down the value of bonds they had insured.

Ambac, which lost its top AAA credit rating this year, today said it agreed to pay $850 million to Citigroup Inc. to terminate a contract guaranteeing a CDO. The New York-based bond insurer had already written down the value of the transaction by about $1 billion, allowing it to record a $150 million gain on the settlement, it said in a statement.

New York-based Merrill said it sold CDOs with a face value of $30.6 billion this week for 22 cents on the dollar as it seeks to draw a line under losses and writedowns of almost $52 billion mainly on mortgage-linked securities.

While securities firms have written down the value both of the insured CDOs and of the credit-default swap contracts, most of the insurers have yet to follow, the Bank of America analysts wrote.

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

Investment banks can book a gain if an insurer is willing to pay more to terminate its liability on a default swap contract than the amount at which the bank has it on its books, Bank of America said. The insurers win by paying less now than they will probably have to later as markets deteriorate, the analysts wrote.

Banks will also be able to liquidate or sell CDOs more easily if insurers have no claim on them, the report said.

Securities firms bought credit-default swaps on the bond insurers that have increased in value. "Monetisation of these gains, we feel, would follow,'' according to the analysts.

Another incentive for the securities firms to accept some payment now is regulators will probably seize the insurers and pay the holders of municipal bonds they guaranteed before the banks, the analysts wrote.

CDOs are securities that repackage pools of bonds and loans and divide their cash flow into notes of varying risk and returns that are sold to investors.

• Moody's Investors Service said on Wednesday that it may upgrade the bond insurance units of Security Capital Assurance if recently announced deals with XL Capital and Merrill Lynch go through later this year.

The rating agency put the B2 insurance financial strength ratings of XL Capital Assurance Inc., XL Capital Assurance (UK) Ltd. and XL Financial Assurance Ltd. under review with direction uncertain.

The move "reflects the significant improvement to SCA's capital adequacy position and upward pressure on the ratings that would occur following the successful completion of the aforementioned transactions, as well as the likelihood of downgrades if the transactions fail to be completed", Moody's said in a statement.