Fitch Ratings, a firm that assigns ratings to the insurance sector, last week downgraded the ratings it has on Avalon Re?s casualty bonds, because of a loss report from the bond?s issuer.

The casualty bonds were the first to ever be issued when sold to investors last year on behalf of Bermuda mutual insurer Oil Casualty Insurance Ltd.

Fitch said the downgrade followed the release of a quarterly loss report showing that one of OCIL?s policyholders suffered a large loss due to an oil spill, resulting from damage to a storage tank hit by last year?s Hurricane Katrina. Jerry Rivers, OCIL senior vice president, told the downgrade action doesn?t directly bear on the company, but the bonds. Fitch assigns its ratings on the bonds as a service to investors, providing information if the bonds are at risk of a loss. Mr. Rivers said the oil spill loss had not led to any action on the company?s rating from Standard & Poor?s.

To date, OCIL has not ceded any of the oil spill loss to Avalon Re, a special purpose vehicle set up in the Cayman Islands as part of the bond?s issuance. This means that no loss of either principal or interest has been triggered, at this time, for Avalon bondholders.

The Avalon bond was issued in three tranches. Fitch last week downgraded the class B and C variable rate notes, and put classes A, B and C on negative watch, meaning further action on the ratings of the the $405 million bond not been ruled out. Now the class B notes are rated ?BB? and the class C notes are rated ?CCC-?.

The ?C? tranche of the bond would be triggered first, having to make a pay-out if OCIL records a loss of $300 million. Mr. Rivers said that limit won?t be reached under the contract terms relating to the Hurricane Katrina-related oil spill. However, OCIL could sustain a second loss related to two policyholders that are partners in a join venture operating a UK fuel storage terminal that exploded in December, Fitch said.

Mr. Rivers said OCIL still doesn?t have ?concrete numbers? for the second loss. The company is expected to have more information shortly. Under an insurance-linked bond, the bond?s principal is held by a special purpose vehicle. In Avalon?s case, $405 million is set aside. OCIL has a reinsurance contract with Avalon, setting out the ?triggers? or loss amounts that would have to be sustained in order for the insurer to be paid any, or all, of the $405 million. Avalon investors will walk away with principal, and interest payments, if there is no loss that triggers the bond over its three-year life.