XL Expects A Quarterly Loss Up To $1.2 Billion

XL Capital announced last night that it expects to take fourth-quarter charges in the range of $1.5-to-$1.7 billion related to credit market exposures--principally coming from an investment in Security Capital Assurance, a financial guaranty insurer and reinsurer.

The charges will mar an otherwise profitable quarter for Bermuda-based XL, which would have reported net income of at least $425 million from its core insurance and reinsurance operation, said Brian O'Hara, acting chairman, during a conference call this morning.

Instead, XL expects to record a net loss for the quarter of $1-to-$1.2 billion, while still showing a positive bottom line for the year, with income in the ranged of $200-to-$400 million.

During this morning's conference call, Chief Operating Officer Henry Keeling provided a high-level view of the expected charges related to SCA, and Chief Financial Officer Brian Nocco addressed numerous questions relating to a possible downgrade of XL's ratings and the need to raise new capital to support its XL ratings.

XL owns roughly 46 percent of SCA, which has two subsidiaries--XL Capital Assurance, a U.S.-based primary financial guaranty insurer, and XL Financial Assurance, a Bermuda-based reinsurer of financial guaranty insurers. SCA was a wholly owned subsidiary of XL prior to an initial public offering in 2006.

The biggest charge XL expects--$550 million--is simply a write-down of most of its 46 percent investment in SCA, which had a value of $670 million as of Sept. 30, 2007.

XL also expects to record $500 million of realized losses on other investments not related to SCA but arising from turbulence in the credit markets.

The remaining SCA-related charges arise from reinsurance agreements and guarantees provided by XL for SCA. These include:

o A $300 million charge related to an excess-of-loss reinsurance agreement.

o A $30 million related to facultative reinsurance arrangements between XL subsidiaries and SCA subsidiaries.

Mr. Keeling said that not all potential losses stemming from agreements with SCA are being reserved for in the fourth quarter. In particular, XL has put up no reserves against certain guarantees of pre-IPO contracts under which SCA insures $78 billion par outstanding, he said.

For XL to be on the hook with respect to such pre-IPO liabilities, he said there would not only have to be defaults on interest and principal payments of the underlying obligations guaranteed by SCA, but SCA would also have to fail to meet its payment obligations under related policies.

Further justifying the position to put up no reserves against these guarantees, he noted that SCA's current claims-paying resources were $3.5 billion as of Sept. 30, 2007. Mr. Nocco later added that "if under a very adverse scenario" SCA were to exhaust all claims-paying resources to make payments under pre-IPO contracts (which he suggested are not at great risk because of their age), "it would be many, many years into the future."

Addressing questions from analysts worried that XL will need to raise capital to stave off potential rating agency downgrades of XL, Mr. Nocco and Mr. O'Hara noted that the charges were not a surprise to the rating agencies since XL has been in close contact with them and that the company has no current plans to raise capital.

Responding to a direct question as to whether XL would let its "A-plus" ratings drop to "A," Mr. Nocco responded, "To the extent that we need to raise capital to support the ratings, which is not something we're contemplating at the present, it's something we would pursue if that's necessary." He said the company is now in a healthy capital position.

XL executives also were asked about a decision by SCA not to raise capital--a decision the XL leaders said they supported--and about whether downgrades of SCA by Moody's or Fitch would cause XL to revisit its analysis of SCA-related exposures.

Even as Mr. Nocco referred such questions to SCA, news of a downgrade from Fitch Ratings was released. Fitch downgraded the financial strength ratings of both XLCA and XLFA from "triple-A" down to "A," along with various holding company debt ratings.

Fitch said it had modeled a capital shortfall of more than $2 billion at the "triple-A" threshold. The downgrade and the continuation of a negative rating watch, Fitch said, "reflects the significant uncertainty with respect to the company's franchise, business model and strategic direction; uncertain capital markets and the impact of SCA's recent decisions on future financial flexibility; the company's future capital strategy; ultimate loss levels in its insured portfolio; and the challenges in the financial guaranty market overall."

As for XL's ratings, XL executives said their ability to write insurance business would be most impacted by any action by A.M. Best, which put XL's "A-plus" financial strength ratings on negative outlook in late December, in light XL's relationship with SCA.