Best Lowers XL’s Ratings; S&P Sees No Change

January 28, 2008

A.M. Best Co. and Standard & Poor’s Ratings Services have been reexamining their ratings on the Bermuda-based XL Capital. and its subsidiaries in light of recent announcements (See IJ web site Their main concerns are the current financial difficulties in the subprime mortgage market and XL’s exposure to further losses from its investment in Security Capital Assurance).

Best announced that it has downgraded the financial strength rating (FSR) to ‘A ‘ (Excellent) from ‘A+’ (Superior) and the issuer credit ratings (ICR) to “a” from “aa-” of XL Capital Group and its members. Best also downgraded the ICR to “bbb” from “a-” and all existing debt ratings of Cayman Islands-based, XL Capital Ltd. However, Best maintains a stable outlook on all of the ratings.

Fitch Ratings has also downgraded XL’s ratings (see related article).

S&P, however said that it “is taking no rating action” in response to XL Capital Ltd.’s announcement that it expects to report $1.5 billion-$1.7 billion of fourth-quarter 2007 charges, resulting in a fourth-quarter net loss of $1.0 billion-$1.2 billion.

The differences in the two rating actions are more apparent than real. S&P currently rates XL ‘A-‘ with a stable outlook, which is at the lower end of its third highest category (S&P’s ratings go from ‘AAA’, ‘AA’, ‘A’, etc. further modified by a + or a – sign). Best’s ‘A+’ rating is its second highest (‘A++’ is the highest). XL’s one notch demotion removes its ratings from the “Superior” category, and brings them roughly into line with S&P’s.

In addition to the earnings announcement and the ongoing questions concerning SCA, Best cited XL’s earlier history. In Best’s opinion this reveals “that XL Capital’s risk management controls are below expectations as the company takes an unanticipated charge, albeit below the operating line, continuing the trend established by the litany of NAC Re related reserve charges, the Winterthur acquisition charge and higher than anticipated losses stemming from the 2005 catastrophe season.”

In addition Best noted that XL might still have exposure to SCA losses, as well as “further subprime exposure through its D&O and E&O liability portfolio on both a primary and reinsurance basis. This exposure gives rise to concerns that there may be a potential resurgence in claims for these lines as they relate to subprime issues in the future.”

Best added that, “adverse development charges relating to these lines” which go beyond its current expectations could result in “further rating actions.”

In conclusion, Best essentially summarized its disappointment with XL, by indicating that it had originally been informed that “unanticipated large loss events would be curtailed given management’ s previous representations concerning enhancements to risk controls and processes.” However, while XL’s capital adequacy is not an “immediate concern,” the extent of the losses have raised questions about “XL Capital’ s earnings inconsistency and enterprise risk management,” which Best concluded “are not indicative of a Superior-rated company.”

For a complete listing of XL Capital Group’ s FSRs, ICRs and debt ratings, go to: .

After outlining the extent and origin of the fourth quarter losses, S&P’s analysis pointed out that, “XL’s underlying operating performance remains strong, as demonstrated by net income of $1.5 billion for the nine months through Sept. 30, 2007, and anticipated income of $425 million-$450 million (excluding the announced charges) for fourth-quarter 2007.” S&P added that according to its capital model, “XL’s capital adequacy, though diminished, remains very strong and well supportive of the rating.”

S&P also said: “Recent adverse rating actions by another rating agency on Security Capital Assurance Ltd.’s (SCA) wholly owned financial guaranty operating subsidiaries–XL Capital Assurance Inc., XL Financial Assurance Ltd., and XL Capital Assurance (U.K.) Ltd.–which trigger obligations on XL’s guaranteed investment contracts, also have no impact on the rating.” The comment referred to Fitch Ratings recent downgrade of SCA and the XL guaranty subsidiaries (See related article). S&P made no mention of Fitch’s additional rating action in downgrading XL itself (See related article).

S&P explained that the “$550 million writedown did not affect our view of capital. Similarly, our model incorporated a material quantitative charge relative to outstanding related party arrangements with SCA, thus addressing a significant proportion of the $330 million in additional loss reserves on reinsurance agreements with SCA.” S&P added that it “believes XL has the appropriate liquidity and financial flexibility to address such a scenario.”

From an overall point of view, S&P said its current rating on XL and its subsidiaries is “based on the company’s very strong global market presence, very strong interest and fixed-charge coverage, and diversified earnings stream. Somewhat offsetting these strengths are a track record of inconsistent earnings performance; material, though reduced, exposure to large catastrophic losses; susceptibility to adverse reserve development; and business integration challenges borne from the relatively rapid building of a very strong and diversified global competitive position.

“The stable outlook reflects our expectation that the continued integration of XL’s strongly positioned global platform of insurance, reinsurance, and life operations–in combination with reduced volatility borne from an evolving enterprise risk management process–will result in a strong, consistent earnings stream consistent with similarly rated peers, with capitalization remaining at a very strong level.”

S&P did warn, however, that if there are “significant negative operating developments, particularly in the operating segments, that dampen consolidated results, the outlook could be revised to negative. An unanticipated deterioration in capital, liquidity, or financial flexibility or a diminished assessment of ERM (currently assessed at the high end of adequate) could also result in a negative outlook. A positive outlook is contingent on developing over time, a long and sustained track record of very strong operating performance, strong ERM and the absence of material charges.”

Source: A.M. Best Co –; Standard & Poor’s – www.standardand

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