Security Capital Downgraded by Fitch; Second Insurer to Lose AAA Rating

Fitch Ratings on Thursday downgraded its second ‘AAA’-rated insurer, Security Capital Assurance Ltd. and its primary financial guaranty subsidiaries, cutting its rating five notches to ‘A’ on SCA’s XL Capital Assurance Inc. and XL Financial Assurance Ltd.

The move to downgrade SCA’s guaranty businesses comes after Fitch struck Ambac’s ‘AAA’ insurer financial strength rating down two notches to ‘AA’ on January 18.

Much like Ambac before it, SCA said on Wednesday that it would not raise new capital in an attempt to maintain its ‘AAA’ rating, and that it would instead seek to reduce risk through reinsurance agreements.

Meanwhile, XL Capital also said Wednesday that it expected to report a fourth quarter loss between $1.0 and $1.2 billion, including a $550 million write-off of its 46 percent investment into Security Capital Assurance and a $300 loss provision to cover reinsurance claims tied to SCA.

Saying that it expected SCA to “have likely reduced at least a portion of its capital shortfall” after being put on negative watch last December, Fitch noted that SCA’s execution of its capitalization plan has “fallen materially short of prior expecations.” The rating agency had originally warned it would drop XL’s ratings to ‘AA,’ making today’s cut larger than might have been expected by market participants.

The downgrade of Security Capital means that three bond insurers have been downgraded as a result of the current mess; Standard & Poor’s also downgraded ACA Financial Guaranty Corp. to junk on December 19, sending the guarantor running into the arms of its regulator in an effort to stave off bankruptcy.

What’s next?
Many of the largest US banks have been under pressure to bail out the monolines as part of an effort to prevent future losses stemming from counterparty risk. Per the Financial Times:

Eric Dinallo, New York insurance superintendent, on Wednesday met executives at the banks and has strongly urged them to provide $5bn in immediate capital to support the bond insurers and to ultimately commit up to $15bn.

Regulators in the US have worked round the clock to find some way of getting the monolines to patch up their capital bases after they miscalculated the risks associated with insuring payments on bonds backed by risky mortgage loans.

Rumors have been flying as well that none other than Wilbur Ross — who swooped in and picked up American Home’s mortgage servicing business out of bankruptcy for $435 million in October of last year — is considering a $14 billion takeover of troubled insurer Ambac. (H/T: Calculated Risk).

The question still seems to be getting a grip on just how much risk really exists in the monoline insurance business, particularly as it relates to insurance written on mortgage-related derivatives. Which means, of course, that $15 billion might not be nearly enough: Egan Jones went on record Thursday with the suggestion that mortgage bond insurers would need a whopping $200 billion to maintain their AAA ratings.

Disclosure: The author held no positions in any insurer or guarantor mentioned in this story at the time it was published.