Friday, June 24, 2011

More Work on Syncora

Since our last look at the company, Syncora published the hold co annual report for the period ending 2010. This was the first financial statement release containing either GAAP or consolidated numbers since the 2009 release was published on 3/31/10. Better late than never.

The information is exceptionally useful. Despite management warnings to the contrary, this information suggests that Syncora common may be an in-the-money call option rather than the at-the-money option we considered it earlier.

Here's a spreadsheet we've been working on

To start, look at Syncora's operating and adjusted common equity book values. With all of the standard adjustments for FAS 163, FAS 46, and unearned premiums, we added the full liquidation value of preference shares and surplus notes. This is somewhat economic as Syncora will likely not be allowed to repurchase even surplus notes until its financial profile has noticeably improved and holders demand lower discounts. Finally, we made adjustments to Syncora's loss reserves and related balance sheet items to fully reflect the economics of the Insurance Cash Flow Certificates (Certificates). The accounting involved is unique and a bit murky so we made two stabs at it.

The first method took a comment in the notes in isolation referring to the accrual of a deferred gain on Certificates in the amount of $421M. We simply added it. But since the certificates are showing up in several accounts, a second method replaces the GAAP loss reserve (and reinsurance assets, including Certificates) with statutory loss reserves. This gets us around another problem: no credit impairment is given for the FAS 163 accounts but statutory reserves account for those expected payments. OBV is ($35M) and $60M in method 1 and 2 respectively. ABV is $742M and $847M respectively.

ABV of a company in runoff is akin to maturity value of a zero coupon bond if interest income and premium accretion offset operating expenses and net loss developments including accretion. Investment income including JeffCo Sewer warrants was approximately $66M in 2010 while operating expenses including surplus notes but not (unpaid non-cumulative) preferred dividends was approximately $86M. This indicates a zero coupon treatment would be too generous but that residual value will flow to common absent excessive adverse loss developments.

Finally, we created a securities only balance sheet with assets at fair value and liabilities at full liquidation value that shows net assets of over $200M and more investment income than interest costs.

Then there is what we did not do. We gave absolutely no value to the company's real option of eventually repurchasing liabilities. We also have given no credit to Syncora continuing to manufacture Certificates. And we have left the upside we see in repurchases and JeffCo Sewer untouched.

As a quick and final note, we saw some suggestions recently that the county's withholding of $75M from the sewer system as a final step towards bankruptcy and grave concern to sewer debt as rather funny. The reason is that they are both part of the same municipal corporation, which means it would all be quite schizophrenic. Meanwhile, this $75M will effect the timing of some repayment, but the sewer system receiver will see the bonds and warrants paid regardless - bankruptcy or not.

Correction 6/24: Added "a zero coupon bond if" to first sentence of fourth to last paragraph.

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