Fitch Ratings today downgraded XL Capital Assurance (XLCA) to 'CCC' from 'BB' one day after the bond insurer’s parent, Security Capital Assurance (SCA), announced agreements with XL Capital and Merrill Lynch to enhance its solvency thanks to a capital infusion and the termination of credit default swaps and other policies. Fitch placed the rating on evolving watch.

Fitch said its decision hinges on the uncertainty of the execution of the agreements, and that a separate set of “post-settlement” ratings of XLCA and XL Financial Assurance Inc. could improve significantly once the deals are closed.

“Any ‘post-settlement’ ratings assessment of SCA would incorporate not only the improvement in SCA’s capital position, but also Fitch’s view of various qualitative factors,” Fitch said in a statement. “These would include SCA’s franchise value and business outlook, which appear to be highly uncertain due to the negative implications from SCA’s exposure to mortgage-related credits.”


Under the agreements — announced by New York State Insurance Superintendent Eric Dinallo late yesterday — SCA’s subsidiaries, XLCA and XLFA, will go from having negative statutory surpluses as of June 30 to a $1 billion surplus.


SCA’s subsidiaries will receive $1.775 million in cash and eight million in XL Capital Ltd. Class A ordinary securities from XL Capital Ltd. in return for the “termination, elimination or commutation” of reinsurance and other financial guarantee agreements made between them and XL Capital Ltd. and its subsidiaries. XL Capital Ltd. today priced shares it is offering, planning to use the expected $2.5 billion proceeds to pay for the settlement.


In addition, XL Capital will transfer its remaining 46% ownership in SCA to a trust held for the benefit of XLCA and eventually its financial counterparties, once agreements with them are reached.


Separately, Moody’s Investors Service this morning placed XL Capitalon review for downgrade.


Under its agreement with Merrill, SCA will pay $500 million in return for the commutation of eight credit default swaps on asset-backed securities. The pending litigation on seven of those CDSs will also be dropped.


“This agreement is good for all — Main Street and Wall Street, the bond insurance industry and SCA policyholders, municipal bond holders and structured bond counterparties,” Dinallo said in a statement.


In addition, Standard & Poor’s today said that its 'BBB'-minus ratings on XLCA and XLFA remain on negative watch.

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