$3.9bn of securities affected in Moody’s assessment
Moody's Investors Service has affirmed the Baa1 senior debt rating of XL Capital and the A1 insurance financial strength (IFS) ratings of XL's insurance operating subsidiaries, but changed the outlook on all of the companies to negative from stable. This rating action follows Moody's downgrade of XL Capital Assurance Inc. (XLCA; B2 IFS, negative outlook) and XL Financial Assurance Ltd. (XLFA; B2 IFS, negative outlook)--see separate press release. XLCA and XLFA are wholly-owned subsidiaries of Security Capital Assurance Ltd (Ca preference shares rating, negative outlook), which is approximately 46%-owned by XL (the investment was completely written off as of December 31, 2007).
The negative outlook on XL reflects further stress on the company's capital and financial flexibility resulting from the downgrades of XLCA and XLFA. In addition to XL's approximate 46% ownership stake in SCA, XL Insurance (Bermuda) Ltd (XLI), a wholly-owned subsidiary of XL, guaranteed the reinsurance obligations of XLFA to XLCA for all business in force prior to SCA's IPO on August 4, 2006. As of March 31, 2008, pre-IPO obligations guaranteed by XLI totalled approximately US$70bn.
Moody's notes that two events must occur before XLI is obligated to pay under the guarantee. First, the underlying pre-IPO guaranteed obligation must default and, second, XLFA must fail to meet its obligation. While XLFA has not defaulted on its obligations to date, Moody's believes its downgrade implies the likelihood of default has significantly increased. Furthermore, XL, primarily through XLI, also provided reinsurance to XLCA and XLFA through excess of loss and facultative arrangements.
The rating agency said that XL's ratings could be downgraded if additional significant losses (e.g., more than $1bn) were to result from XL's exposure to SCA (through its reinsurance arrangements, guarantee, or further commitments of internal capital) or XL's investment portfolio of structured mortgage securities. XL has stated publicly that the company is actively working to resolve the SCA situation as quickly as possible. The negative outlook of XL reflects the significant weakening of SCA's creditworthiness given deterioration in its underlying mortgage exposures and, therefore, the greater level of XL's losses likely to result from its exposures to SCA. Although there is uncertainty as to the amount and timing of any potential resolution, Moody's expects that XL would likely try to take appropriate steps to maintain its overall capital adequacy in the event of significant losses. The rating agency said the outlook could be changed back to stable if additional losses from its SCA exposure and structured mortgage investments are modest or if the company undertakes initiatives in response to significant losses to maintain its capital adequacy and financial flexibility.
XL's ratings reflect the group's overall strong market positions in its principal property casualty operating segments as well as its diversified earnings streams by geography and line of business. The ratings also reflect the company's sound liquidity and capitalisation at its Bermuda operating subsidiaries as well as its strengthened underwriting performance in its core property casualty operations and improved catastrophe risk profile. These fundamental strengths are tempered by the intrinsic volatility of XL's reinsurance businesses and certain insurance lines, the company's exposure to natural catastrophes, diminished financial flexibility and its volatile profitability.
Moody's current ratings' expectations for XL include the following:
returns on equity over the cycle in the high single digits; adverse reserve development less than 5% of net reserves; and adverse trends, run-off obligations or catastrophe losses over a 12 month period not resulting in shareholders' equity declining by more than 10%. Moody's also expects coverage of interest and preference dividends above 6x over the cycle while adjusted debt to capital remains below 30% (reflecting adjustments for hybrid securities, pensions, operating leases, and Lloyd's letters of credit).
The following ratings have been affirmed with a negative outlook:
XL Capital Ltd -- senior unsecured debt at Baa1; preferred stock at Baa3; senior unsecured shelf at (P)Baa1; subordinated shelf at (P)Baa2; preferred stock shelf at (P)Baa3;
XL Capital Trust I, II, III -- trust preferred securities shelf at (P)Baa2;
XL Capital Finance (Europe) plc -- senior unsecured debt at Baa1; senior unsecured shelf at (P)Baa1;
Mangrove Bay Pass-Through Trust -- preferred stock at Baa3;
Stoneheath Re -- preferred stock at Baa3;
XL Insurance (Bermuda) Ltd -- insurance financial strength ratings at A1;
XL Insurance Company Limited -- insurance financial strength ratings at A1;
XL Insurance Switzerland -- insurance financial strength ratings at A1;
XL Re Ltd -- insurance financial strength ratings at A1;
XL Reinsurance America Inc. -- insurance financial strength ratings at A1;
Indian Harbor Insurance Company -- insurance financial strength ratings at A1;
Greenwich Insurance Company -- insurance financial strength ratings at A1;
XL Specialty Insurance Company -- insurance financial strength ratings at A1;
XL Insurance Company of New York, Inc. -- insurance financial strength ratings at A1;
XL Life Insurance and Annuity Company -- insurance financial strength ratings at A1;
XLLIAC Global Funding -- backed medium term notes at A1;
Premium Asset Trust Series 2003-7 -- senior secured at A1;
Premium Asset Trust Series 2004-9 -- senior secured at A1.
XL Capital Ltd, headquartered in Hamilton, Bermuda, is a leading provider of insurance and reinsurance coverages through its operating subsidiaries to industrial, commercial and professional service firms, insurance companies and other enterprises on a worldwide basis. As of March 31, 2008, XL Capital Ltd had consolidated assets of $54.8bn and shareholders' equity of $9.3bn.