A.M. Best Co. and Fitch Ratings both announced today that they had downgraded the financial strength ratings of Bermuda-based XL Capital Ltd. and its insurance and reinsurance subsidiaries.

The rating actions by the two firms followed XL Capital's announcement yesterday of $1.5 billion to $1.7 billion fourth quarter 2007 charges for credit related investments, including the company's exposure to the operations of Bermuda-based Security Capital Assurance

Best said it was changing the financial strength rating to A (Excellent) from A plus (Superior) and the issuer credit ratings to "a" from "aa minus" of XL Capital Group and its members.

Concurrently, A.M. Best downgraded the issuer credit rating to "bbb" from "a minus" and all existing debt ratings of Cayman Islands-based XL Capital Ltd. The outlook for all ratings was called stable.

The XL Capital charge also includes reserve increases related to reinsurance coverages provided by XL Capital to certain of SCA's subsidiaries and a write-down of a publicly traded financial affiliate.

Best said that in its opinion 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.

Fitch changed the company's rating to "A" from "A-plus" after the company announced it will record a fourth-quarter charge of $1.5-to-$1.7 billion.

Fitch mentioned the relationship with SCA, including a $550 million write-down of most of its 46 percent investment in SCA and $330 million related to reinsurance agreements with SCA and a subsidiary.

Additional charges include $150 million to reduce the carrying value of a financial affiliate and $500 million of net realized losses arising from turbulence in the credit markets.

Fitch said it "believes the current charges reflect poorly on the company's enterprise risk management capabilities and reduce Fitch's confidence in XL's overall earnings potential."

The rating agency added, "Given the recent charges, Fitch views XL's volatility of earnings to be much greater than comparably rated peers and more than we would expect from a 'double-A'-rated company."

Standard & Poor's reported that it will not be taking any rating actions on XL in the wake of the company's announcement. "The rating on XL is based on the company's very strong global market presence, very strong interest and fixed-charge coverage, and diversified earnings stream," the rating agency said.

But S&P noted, "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."

S&P also said, "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."

Speaking to the stock implications of XL's announcement, a comment released by Morgan Stanley said, "XL's just-concluded conference call detailing their fourth-quarter charge leaves us uninterested in the stock, for now."

Morgan Stanley noted "substantive, unresolved issues facing the company," and stated, "Perhaps those with a longer-term (say two years or more) orientation will see the fruits of risk taken today. Our view--look elsewhere for investment opportunities."

Bear Stearns was also cautious, with analyst David Small noting that while the shares could get a "near-term bounce," his firm "would be less optimistic and would remain on the sidelines longer term...."

Mr. Small added the firm does not think "that valuation is particularly attractive relative to other insurance stocks that are also trading near book value...."

Both Morgan Stanley and Bear Stearns mentioned potential action from rating agencies as one unknown facing XL, but both said their released statements remain unchanged in light of the ratings announcements made by Fitch and Standard & Poor's.

Mr. Small said, "We're going to wait. We want to see what all the rest of the agencies do, particularly AM Best."

Bermuda-based Security Capital Assurance Ltd--through subsidiaries XL Capital Assurance Inc., a monoline financial guarantee insurance provider, and XL Financial Assurance Ltd, a monoline provider of reinsurance to financial guarantee insurers--provides credit enhancement for the obligations of debt issuers,

Bear Stearns in a note said it thought the Best downgrade will incrementally hurt XL business opportunities.

It said the rating action "is a surprise as the company moved from negative outlook to an action - bypassing the usual review process."

The analysts noted that in yesterday's conference call about the Best rating and its impact on the company's ability to write casualty business, the COO Henry Keeling said,"It really depends upon the agency to be candid. The most significant one from our casualty perspective would be A.M. Best. As you know, they have us on negative outlook, not negative watch and therefore obviously we are deeply engaged with them in terms of our discussions..."

This article updated 4:45 p.m. EST

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Fitch, Best Downgrade XL

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