Best Revises Stoneheath, FLAC Outlooks to Negative on SCA/XL Concerns

January 10, 2008

A.M. Best Co. has revised the rating outlook to negative from stable for the debt rating of “bbb” on $350 million non-cumulative perpetual preferred securities (issuer preferred securities) issued by Stoneheath Re, a Cayman Islands exempted company.

Best also revised the outlook to negative from stable for the debt rating of “aaa” on $134 million floating rate insured notes, due December 15, 2018, issued by FLAC Holdings, LLC of New York.

Both entities are linked to Bermuda-based XL Capital, and are affected by the financial problems associated with Security Capital Assurance (SCA).

Stoneheath is licensed as a restricted Class B reinsurer under the laws of the Cayman Islands. It was formed to provide multi-year reinsurance capacity to certain insurance and reinsurance subsidiaries (ceding insurers) of XL Capital.

“The terms of the reinsurance agreement between Stoneheath Re and XL Capital provide that upon a payment by the issuer to the ceding insurer under the reinsurance agreement, XL Capital will issue and deliver to the issuer Series D preference ordinary shares of XL Capital (XL preferred securities) in an amount equal to the payment made by the issuer,” Best explained. “Cash from the issuance of preferred securities by Stoneheath Re, which previously had been deposited into a trust account and subsequently disbursed as claim payments, will be replaced by the XL preferred securities.”

The FLAC Holdings insured notes involve a ” multitude of factors,” said Best, “including an analysis of the underlying deal model cash flow projections including stress testing, interest rate and investment conditions; review of the structure, legal documentation and regulatory environment; review of the actuarial assumptions and assessment of the underlying cash flow projections; and the assessment of the payment assurance of XL Capital Assurance Inc. (XLCA), the financial guarantor and operating subsidiary of Security Capital Assurance (SCA).”

Best said it had revised its outlook on FLAC’s notes solely due to the “financial pressures currently being experienced by SCA in executing its capital remediation plans and the change in credit profile of XL Capital Group, which provides substantial reinsurance support to SCA’s operating subsidiaries and guarantees certain SCA obligations.”

Best revised its outlook on Stoneheath Re to align it “with the rating
of XL Capital’s preferred stock. Best said it is primarily concerned with the “increased financial and operational pressures currently being experienced by XL Capital and its group members. Adverse pressure on XL Capital’s profitability and capital adequacy primarily is a result of its ownership interest in Security Capital Assurance (SCA) and the financial pressures SCA is currently experiencing regarding its capital remediation plans.”

Best also noted that in addition to its direct ownership (approximately 46 percent), “XL Capital provides SCA’s operating companies with reinsurance support and guarantees on certain obligations of theirs.” XL Capital’s exposure to subprime assets in its investment portfolio is a further concern.

“XL Capital has direct investments in subprime mortgage assets, which could further erode its profitability and capital position,” said Best, adding that it will “continue to monitor XL Capital’s activities to assess any further impact to its ratings (both long and short term).”

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Source: A.M. Best –

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