XL Eyes 'Value-Enhancing Opportunities'

In the wake of rumors that XL Capital Ltd. is up for sale–with the company admitting only to exploring “value-enhancing opportunities available to it”–Standard & Poor's lowered ratings on the firm's core operating companies, citing the Bermuda insurer's diminished underwriting performance and competitive position.

An outright denial of a potential sale was not part of the company's vaguely worded announcement, which noted that while not typically responding to rumors, XL felt it was appropriate under “the current circumstances.”

The company said it is looking at opportunities and is being assisted in this effort by Goldman, Sachs & Company.

Meanwhile, XL said it “remains focused on operating its business and meeting the needs of its customers” while taking action to maximize shareholder value.

Bloomberg News, citing anonymous sources, reported on Dec. 10 that the company is looking for a buyer because it reported investment losses larger than its market value. But XL said it expects to report fourth-quarter mark-to-market declines in its investment portfolio largely in line with its third-quarter report.

In a filing with the U.S. Securities and Exchange Commission, XL reported a net loss of more than $1.6 billion for the third quarter (compared to net income of $372 million for the third quarter of 2007)–in line with what it reported in a preliminary announcement in mid-October.

For the first nine months, the company reported a net loss of more than $1.13 billion, compared to net income of $1.5 billion the previous year.

The loss was primarily the result of a $1.4 billion charge related to an Aug. 5 payment to Syncora Holdings Ltd. to terminate, commutate or restructure financial guaranty and reinsurance arrangements with Syncora–a former subsidiary of XL dealing in guaranty insurance.

The company also reported losses from Hurricanes Gustav and Ike totaling $221.8 million, net of reinsurance recoveries and reinstatement premiums.

XL reported in the same filing that as of Sept. 30 it had cash and cash equivalents of approximately $5.6 billion, and that it “maintains credit facilities which provide additional liquidity.”

Noting that the financial markets are in flux, XL said these movements will affect the ultimate worth of its investment portfolio. The company added that it estimates it will report approximately $200-to-$220 million in net investment fund affiliate losses from its alternative investment portfolio for the fourth quarter.

During a conference call in October, XL Chief Executive Officer Michael S. McGavick condemned rumors at the time that painted a bleak financial picture of the company. He also said during the call that XL was undertaking a strategic review of its life reinsurance operations.

Meanwhile, Standard & Poor's Ratings Services last week lowered the financial strength and counterparty credit ratings on XL Capital Ltd.'s core operating companies.

S&P lowered XL's financial strength rating to “A” from “A-plus,” and its counterparty credit rating to “triple-B-plus” from “A-minus.” S&P's outlook for the companies is negative.

“Perceived franchise issues stemming from a string of material earnings and capital charges over the past several years” have led to the diminished competitive position and underwriting performance, according to S&P analyst Steven Ader.

“Although XL remedied many of these issues this past summer, the material deterioration in the unrealized position of XL's investment portfolio in the third quarter has again pressured XL's market presence,” he added.

While XL maintains a strong liquidity position, S&P said it believes there will be a reduction in new business opportunities for XL, and that renewal activity will be modestly below historical norms.

“This would hamper prospective underwriting performance, which, though strong, is inconsistent with what we typically expect for the prior rating,” said the ratings firm.

Mr. McGavick issued a statement disagreeing with S&P's announcement. “We are very disappointed with S&P's decision, particularly in light of the many positive comments S&P made about XL in its release,” he said.

S&P called XL's capitalization strong, and also mentioned XL's initiatives to refocus operations on the company's solid property-casualty insurance and reinsurance operations while reducing non-core risks.

S&P also said continuation of XL's “adequate” focus on enterprise risk management will help it going forward. “If, in the next two years, ERM continues to develop, additional investment losses fail to materialize and no negative surprises arise that dampen consolidated results, we could revise the outlook to stable,” Mr. Ader said.

However, he warned, “if more unexpected adverse events occur”–citing unexpected additional realized investment losses, large underwriting losses, or large operational related risk–”if the company does not meet our financial tolerance levels, or if there is inadequate progress related to XL's ERM, another downgrade would most likely result.”

Mr. McGavick issued an additional comment later, noting that “based on very recent discussions with A.M. Best in which we reviewed our business and financial condition, A.M. Best is leaving our 'A' Excellent/Stable outlook rating on our core operating subsidiaries unchanged.”

“As we indicated…XL has no need or intent to seek additional capital at this time,” he said. “We are pleased with the results of our discussions with A.M. Best and believe it is indicative of our financial strength and the power of our franchise.”

(With additional reporting by Phil Gusman.)