The value of XL Capital's investment in Security Capital Assurance has dropped by $500 million in the past three months. Now XL has been warned not to get involved in the deepening crisis for its spin-off SCA as shares of both companies fell on the New York Stock Exchange.

But with a 46 percent stake in the company that will mean XL holding tight as its sizeable investment in SCA dwindles and it waits to see whether it has to start honouring billions of dollars of bonds it has guaranteed on behalf of the company.

Shares of SCA plummeted as much as 35 percent during trading in New York yesterday, the worst ever single day fall for the stock, after it said there was no guarantee it would be able to find the extra capital it needs in time to avoid a ratings downgrade.

SCA shares have been in virtual freefall since May when they were worth around $32. Yesterday they dipped below $4 before a late rally to finish at $4.23.

In September XL valued its investment in SCA at $670 million, the current market position means that investment is now worth just $164 million according to one analyst.

SCA's problems have been caused by a warning that it is in danger of losing its AAA rating because of an estimated $2 billion shortfall in excess capital.

XL chief Brian O'Hara resigned from the board of SCA last month raising speculation that XL was preparing to inject capital into SCA to safeguard its rating. By stepping down Mr. O'Hara was no longer in danger of having a conflict of interests should a cash boost be forthcoming from XL.

Yesterday SCA re-stated that it has a plan to meet the shortfall in capital identified by rating's company Fitch, but it also advised: "Fitch stated the company's shortfall is at least $2 billion. There can be no assurance as to the relative amounts of capital to be raised or generated through the various components of the plan or that SCA's plan will successfully address Fitch's capital requirements within the required four to six weeks time-frame."

If it cannot meet the requirement to boost its excess capital in time, SCA faces seeing its XL Capital Assurance unit lose it top ranking AAA rating and, as a consequence, its main business of debt guarantee. Currently, the unit guarantees $154.2 billion of debt.

A bail out from XL seemed on the cards when XL CEO Mr. O'Hara stepped down from the SCA board of directors in late November, clearing the way for a potential capital injection.

But that scenario has now been warned against by Brian Meredith, an analyst with UBS.

A MarketWatch news wire report quotes him as saying: "The best avenue for XL with respect to SCA is stay on the sidelines, take the write-down on its investments in SCA and use its excess capital to repurchase its own shares."

The wire report also states that XL has guaranteed about $78.4 billion of bonds sold by SCA before its initial public offering and that it may have to honour some of that debt if the company losses its top rating.