Financial pressures on XL Capital Ltd. related to its involvement in Security Capital Assurance Ltd. (SCA) have had negative rating outlook implications for XL sidecar Stoneheath Re.

Rating agency A.M.Best revised the rating outlook to negative from stable for the debt rating of "bbb" on $350 million non-cumulative perpetual preferred securities issued by Cayman Islands-based Stoneheath Re.

The sidecar — essentially a pool of back-up reinsurance capacity for XL and its subsidiaries — was established by the Bermuda insurance giant late in 2006.

Best stated: "The revised outlook is to align the rating of Stoneheath Re with the rating of XL Capital's preferred stock, primarily due to A.M. Best's concerns regarding increased financial and operational pressures currently being experienced by XL Capital and its group members.

"Adverse pressure on XL Capital's profitability and capital adequacy primarily is a result of its ownership interest in Security Capital Assurance (SCA) and the financial pressures SCA is currently experiencing regarding its capital remediation plans.

"In addition to its direct ownership (approximately 46 percent), XL Capital provides SCA's operating companies with reinsurance support and guarantees on certain obligations of theirs.

"Further contributing to A.M. Best's concerns is XL Capital's exposure to subprime assets in its investment portfolio. XL Capital has direct investments in subprime mortgage assets, which could further erode its profitability and capital position."

Best also revised the outlook to negative from stable for the debt rating of "aaa" on $134 million floating rate insured notes, due December 15, 2018, issued by FLAC Holdings, LLC (FLAC Holdings) (New York, NY).

The ratings agency stated its previous outlook took into consideration a multitude of factors including an analysis of the underlying deal model cash flow projections including stress testing, interest rate and investment conditions; review of the structure, legal documentation and regulatory environment; review of the actuarial assumptions and assessment of the underlying cash flow projections; and the assessment of the payment assurance of XL Capital Assurance Inc., the financial guarantor and operating subsidiary of SCA.

"The revised outlook is solely due to A.M. Best's concerns regarding financial pressures currently being experienced by SCA in executing its capital remediation plans and the change in credit profile of XL Capital Group, which provides substantial reinsurance support to SCA's operating subsidiaries and guarantees certain SCA obligations," Best said.

SCA shares fell 18 cents (7.5 percent) to close on $2.23 yesterday, while XL Capital shares fell 40 cents (0.8 percent) to finish at $47.50.