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XL faces day of reckoning

XL Capital’s short-call announcement yesterday that it would report second quarter results after markets close later today comes as speculation grows that the troubled Bermudian is set to reveal details of a strategy to turnaround its fortunes.

Key to addressing a crisis that has seen the (re)insurer’s shares slump to a historical low of $14.61 in recent weeks – compared to a 52-week high of $84.68 – is a finality solution to draw a line under its exposure to bond insurer affiliate Security Capital Assurance (SCA).

With XL’s Q2 earnings call scheduled to immediately follow the results release, market commentators have suggested that new CEO Michael McGavick is set to unveil plans to resolve the problems besetting the company.

Thought to be among the possible outcomes is a regulator-backed deal with a third party such as Berkshire Hathaway to cap exposures to SCA, and a potential infusion of capital.

It is also thought the (re)insurer may reveal a significant shake-up of senior management.

Analysts from Fox-Pitt Kelton Cochran Caronia Waller (FPK) noted: “What XL reports for EPS in the quarter will be largely irrelevant. What the new CEO says will be all important.”

“We anticipate that [McGavick]… may roll out his plans to fix the problems at XL, namely the SCA run-off and related XL guarantee,” they added, suggesting that management changes may also be announced, while third party transactions “could very much overshadow the quarterly results”.

A spokesman for XL, meanwhile, told The Insurance Insider last week: “Mike McGavick… has made no secret of the fact that job number one for him is resolving the SCA issue. He’s been saying that now since starting on 1 May and he continues to tell everybody that this remains job number one.”

But whether the (re)insurer is able to secure a cost effective solution that closes out its exposure without a significant increase in its own capital requirements remains to be seen.

One senior Bermudian executive suggested: “If [McGavick] is able to negotiate a settlement with SCA it will be good news from a certainty standpoint and bad news because it will crystallise the hole and they will need to raise a lot of fresh capital quickly.”

A reinsurance solution with the likes of Berkshire Hathaway to cap exposure, meanwhile, could also prove prohibitively expensive.

“XL is not going to get unlimited cover from [a company such as] Berkshire Hathaway given what [Warren Buffett] has said about financial alchemy in the past.

“So how much value is there for shareholders in having that protection when we have more or less paid most of it up front [in premium],” a leading US investor added.

XL – which has a holding of around 46 percent in SCA – is thought to have been in ongoing dialogue with the New York department of insurance and its superintendent Eric Dinallo in recent months over the bond insurer, which no longer writes new business.

Initially, discussions focussed on injecting capital into SCA to shore up a balance sheet decimated by sub-prime and other credit related losses as Dinallo set about driving solutions to keep the ailing monoline sector on its feet.

But with the company’s ratings slashed by the major ratings agencies, and its loss of a $3.1bn lawsuit against investment bank Merrill Lynch relating to credit default swap obligations, the focus has shifted to who will ultimately assume the run-off of the bond insurer’s liabilities.

Although the majority of SCA losses to date have been incurred on business written after its August 2006 IPO, XL has exposure to its former subsidiary through reinsurance contracts and guarantees of business written by the bond insurer before the spin-off.

In late June and early July, fears over the relationship with SCA led rating agencies Standard & Poor’s, Fitch Ratings and Moody’s Investor Services to warn they may downgrade XL.

The (re)insurer had already been downgraded by Fitch and, crucially, by AM Best earlier this year from A+ to A, after confirming it would take up to $1.7bn of sub-prime related fourth quarter 2007 charges. At the time analysts warned the actions would limit the (re)insurer’s competitive position, particularly in its US casualty business.

Concerns over the company and the prospect of further downgrades has already had an impact, with XL recently removed from US insurer Chubb’s security list for facultative placements.

One of the biggest buyers of facultative business AIG, meanwhile, confirmed it is “monitoring the situation closely”.

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