Yesterday's announcement that XL Capital Ltd. would sever its financial commitments to Security Capital Assurance Ltd. (SCA) is not sitting well with rating agencies as the insurer also announced it will be going through a companywide alignment.

The news from the Hamilton, Bermuda-based firm comes as it reported net income for the second quarter fell 57 percent.

Today, all four major rating agencies–A.M. Best, Fitch, Moody's and Standard & Poor's–reacted negatively to the deal that will have XL Capital end its relationship with SCA in a transaction where XL would pay the bond insurer $2 billion in cash and stock to terminate reinsurance agreements between them and commutate six existing contracts.

XL said the agreement eliminates $64.6 billion in exposure it had with SCA and its subsidiaries XL Capital Assurance Inc. and XL Financial Assurance Ltd., which were once owned by XL.

The deal makes SCA a solvent company. New York Insurance Department Superintendent Eric Dinallo said yesterday that the operation was in danger of going into receivership if the deal had not been struck.

The chief executive officer of the Bermuda Monetary Authority, Matthew Elderfied, said in a statement, “We welcome this agreement as it lifts a shadow of uncertainty from SCA and XL Capital and provides greater stability for the bond insurance industry.”

However, XL will now have to raise money and announced it plans to offer $2.5 billion in securities. XL said it will have to record a charge of between $1.4 billion and $1.5 billion during the third quarter because of the deal.

After the announcement, A.M. Best put under review the “A (Excellent)” financial strength rating of XL with negative implications.

Moody's also put the company's “A1″ rating on review for possible downgrade. Both cited the capital raising position the company is now placed in and concern over completing the deal in the current economic climate.

Fitch downgraded the financial strength rating of SCA's XL insurance subsidiaries from “double-B” to “triple-C” saying there is uncertainty over completion of the deal. Standard & Poor's kept SCA's subsidiaries under credit watch with negative implications noting the same concerns as Fitch.

As it announced the deal, XL also reported its second-quarter results.

Net income in the second quarter fell $317 million to $238 million, or $1.34 a share, from $3 a share for the comparable period. Revenues dropped 18 percent, or $472 million, to $2.12 billion. The combined ratio in the period rose 6 points from 86.3 last year to 92.3.

For the six months, net income dropped 57 percent, or $635 million, to $482 million, translating to $2.54 a share, off $3.52 a share. Revenues dropped 15 percent, or $781 million, to $4.3 billion. For the first half of the year the combined ratio has deteriorated 4.7 points to 92.9.

The results were from the combination of strict underwriting and soft market pressures, XL said.

In a statement Michael S. McGavick, XL's chief executive officer, announced several executive changes and other moves including eventual reduction of the workforce.

He said the company would eliminate between $110 million and $120 million in operating expense to reduce the company's expense rate $70 million from current levels. He said the company would record a charge between $50 million and $60 million for the remainder of this year.

The reduction would affect all parts of the organization, “but the primary emphasis will be on streamlining corporate functions. This will be achieved through job eliminations, increased outsourcing and the cessation of certain projects and activities,” said Mr. McGavick.

The company said it will explore “strategic opportunities” related to its life insurance operations as part of its capital raising commitment.

XL also said it is launching a five-year “operational transformation” to streamline operations and technology systems, hiring Accenture to provide consulting and technology services under a multiyear contract.

The insurer announced the retirement of Henry Keeling, executive vice president and chief operating officer, who Mr. McGavick said will be replaced.

Special Reports /

XL To See Seismic Shift In Wake Of SCA Agreement

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