NEW YORK (Bloomberg) - Bermuda-based bond insurer Security Capital Assurance Ltd., sued by Merrill Lynch & Co. for seeking to cancel coverage on $3.1 billion in collateralised debt obligations, accused the brokerage firm of "blatantly" ignoring terms of the policy.

Merrill Lynch "undertook a rushed campaign" to find third parties willing to take on the CDOs so it could avoid further losses, violating terms of the agreement, SCA said yesterday in a response to the Merrill Lynch lawsuit.

Merrill Lynch, the third-largest US securities firm, sued SCA's XL Capital Assurance unit in March to force the company to honor the default protection on the CDOs, which repackage bonds and other assets into new securities. Losses on CDOs have prompted Merrill Lynch to write down the value of its assets by $25 billion, including $17 billion in the fourth quarter.

"Determined to get these CDO risks off its books at all costs before the third quarter of 2007 closed, Merrill Lynch made the decision to blatantly ignore its prior commitments to XLCA," SCA said in a statement yesterday.

Merrill Lynch "is confident that the credit default swaps are fully enforceable and we will continue to seek a court order to that effect," William Halldin, a spokesman for the New York- based securities firm, said yesterday in an e-mailed statement.

Projected losses on CDOs have led to at least four bond insurers being stripped of their top AAA credit ratings. The CDOs, which repackage mortgage bonds, buyout loans and other assets into new securities with varying risks, also have been the biggest source of the more than $232 billion of write-downs and credit losses reported by the world's largest banks and securities firms since the beginning of last year.

Merrill Lynch sued XL Capital Assurance in a Manhattan federal court. SCA yesterday said it filed a counterclaim asking the court to absolve it of any obligations related to the contracts.

"On behalf of our policy holders and shareholders, we intend to defend the terminations vigorously and look forward to presenting our case to the court soon," SCA said.

The company's financial guaranty subsidiaries — XL Financial Assurance and XL Capital Assurance — were cut six levels to a below-investment-grade rating of BB by Fitch Ratings last week. The rating had been as high as AAA in January. Moody's Investors Service and Standard & Poor's each downgraded the company from AAA in February.

SCA competitor FGIC Corp. said it's walking away from an agreement to provide $1.9 billion in guarantees on mortgage- linked securities because Credit Agricole SA and IKB Deutsche Industriebank didn't live up to their side of the deal.