Shares and securities issue could lead to affirmation of stable ratings - Fitch
XL Capital remains on Rating Watch Negative by Fitch Ratings following an announcement regarding its agreement with Security Capital Assurance Ltd (SCA) and concurrent capital raising activities. However, Fitch expects to affirm all ratings with a Stable Outlook if all XL's capital raising efforts are completed as planned.
XL announced that it has reached an agreement to extinguish certain exposure the company had to SCA from its facultative reinsurance contracts, excess of loss reinsurance contract and unlimited guaranty in support of any losses payable on the pre-August 2006 initial public offering (IPO) financial guaranty portfolio. In exchange for the commutation of certain reinsurance agreements and the termination of certain other agreements, XL will transfer $1.775bn in cash and eight million shares of XL common stock to SCA.
Additionally, XL announced it will issue approximately $2.5bn of new securities in a combination of common stock and equity security units. XL will also be exercising the put option under its Mangrove Bay contingent capital facility that has been in place since July 2003 and resulting in net proceeds of approximately $500m in exchange for the issuance of preference ordinary shares. A portion of the net proceeds from the capital raising initiatives will be used to fund XL's payment to SCA and redeem $255m of 6.58% guaranteed senior notes due April 2011 while the remainder will be held for general corporate purposes, including the injection of capital into certain operating subsidiaries.
Fitch believes a successful capital raise will enable XL's leverage and capital ratios to remain near current levels, and also aid liquidity. As of June 30, 2008, XL's equity-adjusted debt-to-total capital, excluding any FAS 115 adjustment for unrealized losses, was 21.4%.
While the charge is somewhat larger than its initial expectation, Fitch views the resolution favorably since it reduces uncertainty and protects XL from any further deterioration in SCA's financial condition. Fitch believes approval of the commutation and release agreement by the New York State Insurance Department and the Bermuda Monetary Authority should reduce XL's risk of litigation by SCA's insureds.
Additionally, resolution of the SCA issue allows XL's management to focus its time and attention on its core insurance operations, which continue to perform reasonably well despite competitive market conditions across a number of lines. Through the first six months of 2008 the company posted a 92.9% combined ratio that includes $249.6m, or 8.2 points, of favorable reserve development partially offset by $174.1m, or 5.7 points, of catastrophe losses.
Through first half-2008, XL recorded other-than-temporary impairment (OTTI) charges of $162.5m and the net change in unrealized losses totaled $1.8bn. Fitch believes XL's investment portfolio remains susceptible to additional mark-to-market losses given continued credit market volatility especially related to commercial and residential mortgage-backed securities; collateralized debt obligations (CDOs) and financial sector and consumer cyclical holdings. However, Fitch believes the additional capital XL has raised in excess of the cash payment to SCA will allow XL to better absorb any future investment losses.
XL is a Bermuda headquartered holding company with subsidiaries providing insurance and reinsurance on a worldwide basis. XL reported consolidated GAAP assets of $52.1bn and shareholders equity of $8.8bn at June 30, 2008.