Last week's announcement that XL Capital Ltd. would sever itsfinancial commitments to Security Capital Assurance Ltd. is notsitting well with rating agencies, as the insurer also announced itwill be going through a companywide realignment.

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

All four major rating agencies--A.M. Best, Fitch, Moody's andStandard & Poor's--reacted negatively to the deal, which willhave XL Capital end its relationship with SCA in a transactionwhere XL would pay the bond insurer $2 billion in cash and stock toterminate reinsurance agreements between them and commutate sixexisting contracts.

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

The move makes SCA a solvent company, according to New YorkInsurance Superintendent Eric Dinallo, who said the operation hadbeen in danger of going into receivership if the deal with XL hadnot 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 andprovides greater stability for the bond insurance industry."

However, XL will now have to raise money, and announced it plansto offer $2.5 billion in securities. XL said it will have to recorda charge of between $1.4 billion and $1.5 billion during the thirdquarter because of the SCA deal.

After the announcement:

o A.M. Best put under review the "A (Excellent)" financialstrength rating of XL with negative implications.

o Moody's also put the company's "A1" rating on review forpossible downgrade.

Both Best and Moody's cited the capital-raising position thecompany is now placed in, as well as concerns over completing thedeal in the current economic climate.

o Fitch downgraded the financial strength rating of SCA's XLinsurance subsidiaries from "double-B" to "triple-C," citinguncertainty over completion of the deal.

o Standard & Poor's kept SCA's subsidiaries under creditwatch with negative implications, noting the same concerns asFitch.

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

Net income in the second quarter fell 57 percent ($317 million)to $238 million, or $1.34 a share, from $3 a share for thecomparable period a year ago. Revenues dropped 18 percent ($472million) to $2.12 billion. The combined ratio in the period jumpedsix points, from 86.3 last year to 92.3 in 2008.

For the first half, net income also dropped 57 percent ($635million) to $482 million--translating to $2.54 a share, off $3.52 ashare. Revenues dropped 15 percent ($781 million) to $4.3 billion.For the first half, the combined ratio deteriorated 4.7 points to92.9.

The results were blamed by XL on the combination of strictunderwriting and soft market pressures.

In a statement, XL CEO Michael S. McGavick announced severalexecutive changes and other moves--including eventual reduction ofthe workforce.

He said the company would eliminate between $110 million and$120 million in operating expense to reduce its expense rate $70million from current levels. He said the company would record acharge between $50 million and $60 million for the remainder ofthis year.

The reduction would affect all parts of the organization, "butthe primary emphasis will be on streamlining corporate functions.This will be achieved through job eliminations, increasedoutsourcing and the cessation of certain projects and activities,"according to Mr. McGavick.

The company said it will explore "strategic opportunities"related to its life insurance operations as part of itscapital-raising commitment.

XL also said it is launching a five-year "operationaltransformation" to streamline operations and technology systems,hiring Accenture to provide consulting and tech services under amultiyear contract.

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

Meanwhile, earlier in the week, in what New York'ssuperintendent called a precedent-setting agreement, the insurancedepartment approved a $2 billion infusion of cash to SCA's XLCapital Assurance Inc., ensuring the bond insurer's solvency.

"It's a good agreement for everyone--for the Main Streetmunicipal bond holders, for Wall Street policy or [credit defaultswap] holders, for the bond insurance industry," saidSuperintendent Dinallo.

During a telephone news conference, Mr. Dinallo said SCA hasgone from being close to insolvent, to a solvent company with morethan $1 billion in surplus.

Under the deal announced last week, Bermuda-based XL CapitalLtd., the former parent company of XLCA, will pay less than $2billion, in a combination of cash and stock, to XLCA and XLFinancial Assurance Ltd.

In return, existing financial guarantee and reinsurancearrangements among SCA and XLCA, XLFA and XL will be terminated,commuted or restructured.

The deal also calls for commutation of credit default swapsbetween Merrill Lynch, along with others trusts, SCA and XLCA,where eight CDS agreements will be commuted and litigationdismissed in exchange for a cash payment of $500 million.

The deal does not involve any funding from the state, accordingto Mr. Dinallo, who described this as a good template going forwardbecause it avoids companies going into rehabilitation--something hesaid might have a negative impact on the bond insurance industry asa whole.

He said XLCA was in the most critical of positions, requiringthe attention of the department, characterizing the company as"headed toward rehabilitation."

As for other bond insurers, he said the department is "activelyworking on other situations," adding there is the potential foranother transaction.