Sell Side

Fitch Drops XL Capital; Affirms Rating for FSA

Fitch Ratings yesterday downgraded the financial rating of monoline insurer XL Capital Assurance Inc. to A from AAA after its parent, Security Capital Assurance Ltd., said late Wednesday it would not raise new capital.

Fitch also affirmed the AAA rating, with a stable outlook, for financial guarantor Financial Security Assurance Inc.

Fitch said the ratings for XL Capital remain on watch negative. SCA was mulling a capital plan but Wednesday night released a statement saying it would abandon efforts to raise new capital “due to current market conditions.” SCA did say it was pursuing other elements of a capital plan, through reinsurance or the restructuring of certain obligations.

“While they have capital plans in place, they haven’t executed or completed any of those plans to date,” said Tom Abruzzo, a managing director at Fitch. “They put out an announcement [Wednesday] night indicating they would not be raising any additional capital at this time and that was the ultimate trigger.”

On Dec. 12, Fitch placed XL Capital on negative watch, giving the parent, SCA, roughly four to six weeks to come up with the more than $2 billion shortfall Fitch said was needed to avoid a downgrade. At that time, Fitch said the downgrade would most likely go to AA, but Abruzzo said the decision to downgrade further was made in the absence of further details.

“We had anticipated, given where they were back in December, that part of the plan would have been implemented by now and [doing that] probably would have been enough to get the rating higher than single A and probably somewhere in the AA camp,” Abruzzo said. “At the end of the day, we have to evaluate based on the level of capital and financial strength we see today and that would indicate to us only a single-A rated credit.”

SCA did not comment on the action.

XL Capital was the fifth most busiest insurer in 2007, wrapping 6.8% of all issues, for a total of 587 deals worth $13.6 billion, according to Thomson Financial. Through the first three weeks in January, XL Capital had wrapped just one deal worth $8 million.

As companies have announced various aspects of capital plans in recent weeks, rating agencies have taken action. Abruzzo said the timeline for being on negative watch, roughly four to six weeks, is not a firm deadline.

“We are not going to be hard coated on any given date,” Abruzzo said. “Ultimately, assuming we don’t get any press releases from them, we would obviously at some point have to comment and we would.”

XL Capital joins Ambac Assurance Corp. as the only two triple-A bond insurers to suffer downgrades so far, as Fitch took action on Ambac last week, sending the rating down to AA. Moody’s Investors Service rates XL Capital Aaa, on review for possible downgrade, while Standard & Poor’s rates the insurer AAA, with a negative outlook.

After the announcement, Fitch downgraded four asset-backed securities that were supported by a financial guaranty policy provided by XL Capital.

Fitch’s rating action yesterday underscored the need for a solution to the turmoil. On Wednesday, billionaire investor Wilbur Ross said he has been in talks with two financial guarantor companies and may become involved.

A solution could also come from either state or federal regulators. U.S. Treasury Secretary Henry Paulson has said he is closely monitoring the situation, and officials with his department are in close contact with the New York State insurance department.

New York State regulators have been actively searching for a solution, and met with a number of Wall Street banks Wednesday in an effort to get them to pledge emergency funds. Last month, the department fast-tracked the licensing of Warren Buffett’s Berkshire Hathaway Assurance Corp., after Insurance Superintendent Eric Dinallo asked him to form a monoline insurer in an effort to add depth and capacity to the market.

While several media outlets reported unnamed sources at the meeting saying a solution could come in the next couple of days, Dinallo issued a statement yesterday, saying a solution may take some time.

“These are complicated issues involving a number of parties and any effective plan will take some time to finalize,” Dinallo said. “We believe it is important that the goals of market stability, protection for policyholders and a healthy and competitive bond insurance market be realized in the near future.”

One potential solution may take the form of reinsurance, analysts and bond insurance executives have said. SCA, in its announcement last night, left the possibility on the table, and executives from a number of monoline insurers said in the fall that this would be the best option to raise capital. A number of analysts have said recently this may be the most palatable solution for all parties.

“Through reinsurance, the banks could target the credits that they feel most comfortable with while freeing up capital to the bond insurers at the same time,” wrote Steve Stelmach, an equity analyst at Friedman, Billings, Ramsey & Co., in a recent research report. “What would be left to the monolines, however, is a much riskier book of business.”

In the event that a solution is not found, the insurers may have to go into runoff mode. In this, a bond insurer stops writing new business and renews its capital reserves through investment income and the freeing up of reserves as the bonds they insure mature or are called.

Executives at Ambac said in an earnings call earlier this week they are concentrating on getting back to a stable triple-A rating rather than thinking about a runoff. However, in the name of good governance, the executives determined that the company could generate about $1 billion a year without writing new business. Other financial guarantors may have to consider the same solution.

SCA’s stock price fell 31% yesterday, or $1.16, to $2.63 in trading on the New York Stock Exchange.


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