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XL Arm Offers Senior Notes

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XLIT Ltd., a subsidiary of XL Group plc (XL - Free Report) has priced the offering of its $600 million senior notes.

While A.M. Best Co. assigned a debt rating of “bbb” with a positive outlook, Moody's Investors Service of Moodys’ Corp. (MCO - Free Report) assigned a Baa2 rating to the senior notes.

The notes will be offered in two tranches – 2.30% $300 million senior notes with maturity scheduled in 2018 and 5.25% 300 million senior notes with maturity scheduled in 2043. The notes are guaranteed by XL Group.

The estimated net proceeds of $592.96 million will be deployed to pay back $600 million 5.25% senior notes due 2014 at maturity.

XL Group’s debt-to-equity ratio at third-quarter end was 16.9%, up 100 basis points (bps) from 2012-end level. With the new issuance, the ratio is expected to move up by 600 bps.

Nonetheless, it is a prudent approach to issue notes with lower coupon rate to pay back notes with higher coupon rates that will in turn cushion interest expense. Interest expense for the company inched up 0.1% in the third quarter of 2013 to $37.9 million.

With respect to other rating actions, Moody's retained the insurance financial strength at A2 of XL Group's principal operating subsidiaries. Ratings carry stable outlook. The ratings account for solid market presence of property and casualty insurance and reinsurance operating units’ of XL Group. A diversified earnings stream, sturdy capitalization of Bermuda-operating subsidiaries, solid financial position, reasonable financial leverage, improved core underwriting performance and moderate catastrophe risk profile also accounted for the rating.

However, unstable reinsurance businesses and certain insurance lines, moderate profitability in recent years and exposure to natural and man-made catastrophes weigh on these positives.

Nevertheless, improving profitability, returns on capital in the low double digit percentage, financial leverage of 20% or below, and sustained coverage of interest and preferred dividends of greater than 5x might lead to rating upgrades.

However, the ratings might be subject to a downgrade if shareholders' equity moves down by 10% or more; financial leverage crosses 30%; and profitability erodes with returns on capital below the mid-single digit range.

Rating affirmations or upgrades from credit rating agencies play an important part in retaining investor confidence in the stock along with maintaining credit worthiness in the market. Therefore, rating downgrades adversely affect the business, apart from increasing the costs of future debt issuances. We believe that strong ratings will help XL Group retain investor confidence and help it write more businesses going forward.

XL Group presently carries a Zacks Rank #3 (Hold). However, property and casualty insurers, Cincinnati Financial Corp. (CINF - Free Report) and HCI Group, Inc. (HCI - Free Report) look attractive. These stocks carry a Zacks Rank #1 (Strong Buy).

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