Wednesday, May 25, 2011

Can Syncora Clear That Hurdle?

The multiple viewpoints of pluralism bring perspective to the sovereign. Or is pluralism the myopic, schizophrenic in-law in the family of political economy? 

If the mention of a schizophrenic in-law brings one or several real faces to mind, I recommend reading more statutory financial reports. Other than averting injury to your non-blood-related kin, this will offer you an opportunity to reconsider a security that was written off for having suffered an intense permanent impairment of capital. 

For background, Syncora struck a deal with its most toxic CDS counterparties with the help of former parent and one-time namesake XL Group to tear up contracts. This deal - the 2008 Master Transaction Agreement - was in fact effected with $1.1B of assistance from the one-time parent. XL also threw its remaining ownership interest into a bucket - a fancy word for trust - for the benefit of other would-be commutation counterparties. As 2008 rolled off and 2009 progressed, those shares proved uncompelling. So a second, 2009 MTA was struck in which 23,736,349 shares were issued to counterparties, diluting shareholders by almost half. Additionally, surplus notes were issued to the counterparties of which $680M in face value is still outstanding (at a carrying value of $625M).

After the 2009 MTA closed, only an unfathomable positive loss recovery development could propel cash to the holding companies shareholders. Two years of repurchase litigation has made a few investors scratch their chin. Then consider that a Statutory Based Adjusted Book Value (of sorts see our inputs here) of $6.25 per share. If you assume the company recovers all of its Jefferson County Sewer exposure then tack on another $110M or about $1.75 per share. In September, a receiver was appointed with the power to raise rates and increase revenue to pay those obligations off.

Now there's the good ol' repurchase litigation upside. Here's a notable quotable from the latest SGI statutory filing:

"As of March 31, 2011 and December 31, 2010, the amount of mortgage loans that the Company is seeking sponsors to repurchase aggregated approximately $1.5 billion and $1.3 billion, respectively; the sponsors of a substantial majority of such mortgage loans are Countrywide (as defined in Note 21.C.), GreenPoint Mortgage Funding, Inc. (“GreenPoint”), and EMC Mortgage Corporation (“EMC”). No assurance can be given that the Company will be successful in enforcing its rights to require sponsors to repurchase the mortgages discussed above."

Using this as the basis for a calculation of possible total recoveries is flawed by more than the normal reliance on assumptive extrapolation of peer financials. Syncora has the additional skew of their past rehabilitation efforts reducing possible recoveries. With that this next excerpt tells us the benefits they have marked on their books:

"As of March 31, 2011 and December 31, 2010, the Company estimated that it would realize a net benefit from such recoveries aggregating $209.3 million and $168.5 million, respectively."

If we assume they are booking amongst the higher recovery-to-incurred-loss ratios of their peers, it looks to us that they still have over $100M of additional paid losses on the table with creditworthy counterparties. We think that the real number is probably closer to double that plus poor counterparties could cough up material amounts as well.

ABV is a large exaggeration of shareholder value for an inactive guarantor. In fact, if operating expenses and investment income match, ABV is something like par for a zero coupon bond. Still the size of ABV in Syncora's case and the lack of a bankruptcy threat (there are no bonds or loans outstanding) make this $0.4 - $0.5 priced stock something of an attractively priced call option on recoveries. This is very similar to how we continue to view Ambac's Sr. Debt (see earlier posting.)

But what is the likelihood of such recoveries? At times, there is no accounting for the actions of management to impair a companies value. But the incentives seem clear to The Blue Dragon that the inactive guarantors should assert their full rights to recovery. We will let Assured off the hook for their BoA deal, as that guarantor has rating agency and pricing issues at hand.

Then consider that our government the Cerberus has one head now peering ever closer at the guarantors putback claims. With obstinate banks refusing to cough up the demanded $20B settlement, attorney generals and bank-bashing political opportunists everywhere would view the banks atoning for their sins to anyone as rather palatable. With that backdrop, if I were an attorney general I would send subpoenas and task forces all over such an issue. And when the rulings and settlements were inked, I would stamp the state seal on the headlines.

It seems that the political pressure is pushing for resolution to these settlements, but they are pushing against the stone wall of Civil Procedure. The time that has already elapsed is their more powerful ally. Both forces could make a leveraged bet on repurchases very rewarding at some unknown time over the next couple years.

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