Fitch Ratings has downgraded the ratings on Security Capital Assurance Ltd. (SCA) and its financial guaranty insurance subsidiaries following downgrades to well below 'AAA' by each of the three major rating agencies.

The downgrades include the insurer financial strength (IFS) of XL Capital Assurance Inc. (XLCA), XL Capital Assurance Ltd.(XLCA-UK) and XL Financial Assurance Ltd. (XLFA) to 'BB' from 'A', the long-term issuer of SCA Ltd. to 'B-' from 'BBB', and its $250 million fixed/floating series A perpetual non-cumulative preference shares to 'CCC' from 'BBB-',

In addition, Twins Reefs Pass-Through Trust's $200 million pass-through trust securities was downgraded to 'B' from 'BBB'.

Fitch has also removed the affected ratings from Rating Watch Negative, where they were originally placed on December 12, 2007. The Rating Outlook is Negative.

The downgrade of SCA and its financial guaranty subsidiaries centres on Fitch's updated assessment of the company's capital position, a review by Fitch of the company's current capital enhancement plans, and an update on Fitch's current views of US sub-prime related risks.

The downgrade also reflects what Fitch views as the material erosion in SCA's franchise value and competitive business position following downgrades to well below 'AAA' by each of the three major rating agencies.

Fitch believes that SCA's current level of capital and claims paying resources is no longer consistent with Fitch's guidelines for an investment grade IFS rating.

Fitch currently believes that expected losses on SCA's structured finance collateralised debt obligations (SF CDO) backed by sub-prime residential mortgage-backed securities (RMBS) will ultimately fall within a range of about $3 to $4 billion. This compares to SCA's modeled claims paying resources and committed external reinsurance coverage of $4.2 billion as of December 31, 2007.

Expected losses reflect Fitch's current estimates of the range of projected losses over the life of these transactions, stated on a present value basis. From a present value perspective, Fitch discounts the expected future loss rates on SF CDOs by five percent over a two-year period for CDO-squareds, five years for mezzanine SF CDOs and seven years for high-grade SF CDOs.

SCA recently disclosed that it has unilaterally terminated seven credit default swap (CDS) contracts with Merrill Lynch International (MLI) under which XLCA had covered risk of losses on SF CDO transactions. While Fitch is not in a position to opine on the validity or merits of the termination, Fitch notes that a ruling in SCA's favor could have meaningful positive impact on the company's capital position and credit ratings in the future. Projected losses on the seven SF CDO transactions account for a material percentage of the aggregate SF CDO expected losses estimated by Fitch.

According to SCA, MLI repudiated the contracts by committing to provide third parties with the same CDO control rights that it had previously promised to XLCA. MLI disputes the terminations and has filed suit in US District Court to seek legal enforcement of XLCA's obligations under the contracts. Fitch believes it could be several years before the dispute is settled.

Fitch notes that SCA has been aiming to restore the company's financial and capital position. In the interim, with the loss of its top credit ratings and its decision to defer raising additional capital at the present time, SCA has chosen to forego underwriting new financial guaranty business for the foreseeable future to preserve capital. The suspension of new underwriting is expected to help SCA's capital position as the company will benefit from the amortisation of existing insured obligations, some of which exhaust a material amount of targeted capital.

Favorably, Fitch notes that SCA's maintains solid liquidity, as the company would not be expected to pay a majority of its claims, particularly on SF CDOs, for many years into the future. In addition, SCA is not subject to any notable collateral posting or termination provisions that could effectively accelerate the draw on its existing capital resources.