A.M. Best Co. and Fitch Ratings both announced today that theyhad downgraded the financial strength ratings of Bermuda-based XLCapital Ltd. and its insurance and reinsurance subsidiaries.

The rating actions by the two firms followed XL Capital'sannouncement yesterday of $1.5 billion to $1.7 billion fourthquarter 2007 charges for credit related investments, including thecompany's exposure to the operations of Bermuda-based SecurityCapital Assurance

Best said it was changing the financial strength rating to A(Excellent) from A plus (Superior) and the issuer credit ratings to"a" from "aa minus" of XL Capital Group and its members.

Concurrently, A.M. Best downgraded the issuer credit rating to"bbb" from "a minus" and all existing debt ratings of CaymanIslands-based XL Capital Ltd. The outlook for all ratings wascalled stable.

The XL Capital charge also includes reserve increases related toreinsurance coverages provided by XL Capital to certain of SCA'ssubsidiaries and a write-down of a publicly traded financialaffiliate.

Best said that in its opinion XL Capital's risk managementcontrols are below expectations as the company takes anunanticipated charge, albeit below the operating line, continuingthe trend established by the litany of NAC Re related reservecharges, the Winterthur acquisition charge and higher thananticipated losses stemming from the 2005 catastrophe season.

Fitch changed the company's rating to "A" from "A-plus" afterthe company announced it will record a fourth-quarter charge of$1.5-to-$1.7 billion.

Fitch mentioned the relationship with SCA, including a $550million write-down of most of its 46 percent investment in SCA and$330 million related to reinsurance agreements with SCA and asubsidiary.

Additional charges include $150 million to reduce the carryingvalue of a financial affiliate and $500 million of net realizedlosses arising from turbulence in the credit markets.

Fitch said it "believes the current charges reflect poorly onthe company's enterprise risk management capabilities and reduceFitch's confidence in XL's overall earnings potential."

The rating agency added, "Given the recent charges, Fitch viewsXL's volatility of earnings to be much greater than comparablyrated peers and more than we would expect from a 'double-A'-ratedcompany."

Standard & Poor's reported that it will not be taking anyrating actions on XL in the wake of the company's announcement."The rating on XL is based on the company's very strong globalmarket presence, very strong interest and fixed-charge coverage,and diversified earnings stream," the rating agency said.

But S&P noted, "Somewhat offsetting these strengths are atrack record of inconsistent earnings performance; material, thoughreduced, exposure to large catastrophic losses; susceptibility toadverse reserve development; and business integration challengesborne from the relatively rapid building of a very strong anddiversified global competitive position."

S&P also said, "The stable outlook reflects our expectationthat the continued integration of XL's strongly positioned globalplatform of insurance, reinsurance and life operations--incombination with reduced volatility borne from an evolvingenterprise risk management process--will result in a strong,consistent earnings stream consistent with similarly rated peers,with capitalization remaining at a very strong level."

Speaking to the stock implications of XL's announcement, acomment released by Morgan Stanley said, "XL's just-concludedconference call detailing their fourth-quarter charge leaves usuninterested in the stock, for now."

Morgan Stanley noted "substantive, unresolved issues facing thecompany," and stated, "Perhaps those with a longer-term (say twoyears or more) orientation will see the fruits of risk taken today.Our view--look elsewhere for investment opportunities."

Bear Stearns was also cautious, with analyst David Small notingthat while the shares could get a "near-term bounce," his firm"would be less optimistic and would remain on the sidelines longerterm...."

Mr. Small added the firm does not think "that valuation isparticularly attractive relative to other insurance stocks that arealso trading near book value...."

Both Morgan Stanley and Bear Stearns mentioned potential actionfrom rating agencies as one unknown facing XL, but both said theirreleased statements remain unchanged in light of the ratingsannouncements made by Fitch and Standard & Poor's.

Mr. Small said, "We're going to wait. We want to see what allthe rest of the agencies do, particularly AM Best."

Bermuda-based Security Capital Assurance Ltd--throughsubsidiaries XL Capital Assurance Inc., a monoline financialguarantee insurance provider, and XL Financial Assurance Ltd, amonoline provider of reinsurance to financial guaranteeinsurers--provides credit enhancement for the obligations of debtissuers,

Bear Stearns in a note said it thought the Best downgrade willincrementally hurt XL business opportunities.

It said the rating action "is a surprise as the company movedfrom negative outlook to an action - bypassing the usual reviewprocess."

The analysts noted that in yesterday's conference call about theBest rating and its impact on the company's ability to writecasualty business, the COO Henry Keeling said,"It really dependsupon the agency to be candid. The most significant one from ourcasualty perspective would be A.M. Best. As you know, they have uson negative outlook, not negative watch and therefore obviously weare deeply engaged with them in terms of our discussions..."

This article updated 4:45 p.m. EST