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| SYCRF.PK > SEC Filings for SYCRF.PK > Form 10-Q on 11-Aug-2008 | All Recent SEC Filings |
11-Aug-2008
Quarterly Report
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the financial statements and the related notes thereto contained in our unaudited interim consolidated financial statements included in this Form 10-Q for the three and six months ended June 30, 2008. This discussion and analysis contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below. See also "Cautionary Note Regarding Forward-Looking Statements" for a list of factors that could cause actual results to differ materially from those contained in any forward-looking statement.
Overview of Our Business
General
On March 17, 2006, XL Capital Ltd ("XL Capital") formed Syncora Holdings Ltd ("Syncora Holdings") (formerly known as Security Capital Assurance Ltd), as a wholly-owned Bermuda based subsidiary holding company. On July 1, 2006, XL Capital contributed all its ownership interests in its financial guarantee insurance and financial guarantee reinsurance operating businesses to Syncora Holdings. The aforementioned operating businesses consisted of: (i) Syncora Guarantee Inc. ("Syncora Guarantee") (a New York domiciled financial guarantee insurance company formerly known as XL Capital Assurance Inc.) and its wholly-owned subsidiary, Syncora Guarantee (U.K.) Ltd (formerly known as XL Capital Assurance (U.K.) Limited) and (ii) Syncora Guarantee Re Ltd ("Syncora Guarantee Re") (a Bermuda domiciled financial guarantee reinsurance company formerly known as XL Financial Assurance Ltd.). Syncora Guarantee was an indirect wholly-owned subsidiary of XL Capital and all of Syncora Guarantee Re was indirectly owned by XL Capital, except for a preferred stock interest which was owned by Financial Security Assurance Holdings Ltd. ("FSA"), an entity which is otherwise not related to XL Capital or the Company. References to the "Company," "we," "us" and "our" mean Syncora Holdings and, unless otherwise indicated, its subsidiaries. On August 4, 2006, Syncora Holdings completed an initial public offering (the "IPO"). In addition, XL Capital sold common shares of Syncora Holdings from its holdings directly to the public in a secondary offering concurrent with the IPO. Immediately after the IPO and the secondary offering, XL Capital, through its wholly-owned subsidiary XL Insurance (Bermuda) Ltd ("XLI"), owned approximately a 63% economic interest in Syncora Holdings. In June 2007, XLI completed the sale of additional common shares of Syncora Holdings from its holdings. Immediately after such sale, XLI owned approximately a 46% voting and economic interest in Syncora Holdings. On August 5, 2008, XL Capital transferred all of the common shares of Syncora Holdings it owned to be held in trust as described below. See -"Overview of Our Business-Recent Developments, Agreements and Related Transactions, Ongoing Strategic Plan, and Continuing Risks and Uncertainties".
Prior to January of 2008 (as more fully discussed below, see "-Recent Developments"), we provided credit enhancement and protection products to the public finance and structured finance markets throughout the United States and internationally through the issuance of financial guarantee insurance policies and credit default swap ("CDS") contracts, as well as the reinsurance of financial guarantee insurance and CDS contracts written by other insurers. Financial guarantee insurance provides an unconditional and irrevocable guarantee to the holder of a debt obligation of full and timely payment of the guaranteed principal and interest. In the event of a default under the obligation, the insurer has recourse against the issuer or any related collateral (which is more common in the case of insured asset-backed obligations or other non-municipal debt) for amounts paid under the terms of the policy. CDS contracts are derivative contracts that offer credit protection relating to a particular security or pools of specified securities. Under the terms of a CDS contract, the seller of credit protection makes a specified payment to the buyer of credit protection upon the occurrence of one or more specified credit events with respect to a referenced security. Our financial guarantee reinsurance provides a means by which financial guarantee insurance companies can manage and mitigate risks in their in-force business and/or increase their capacity to write such business.
Recent Developments
Adverse developments in the credit markets generally and the mortgage market specifically in the second half of 2007, which accelerated in the fourth quarter of 2007 and continued to deteriorate through the first and second quarters of 2008, have resulted in material adverse effects on the Company's business, results of operations, and financial condition, including (i) significant adverse development of anticipated claims on the Company's guarantees of collateralized debt obligations ("CDOs") of asset-backed securities ("ABS CDOs") and significant adverse development of reserves for unpaid losses and loss adjustment expenses on the Company's guarantees of residential mortgage-backed securities ("RMBS"), and (ii) downgrades of the insurance financial strength ("IFS") ratings of the Company's operating subsidiaries by Moody's Investors Service, Inc. ("Moody's"), Fitch Ratings ("Fitch") and Standard & Poor's Ratings Services ("S&P"), which ratings have been fundamental to their ability to conduct business and which have caused the Company to suspend writing substantially all new business since January of 2008, resulting in the loss of future incremental earnings and cash flow.
Furthermore, during the second quarter of 2008, the Company recorded a material increase in adverse development of anticipated claims on its guarantees of ABS CDOs and reserves for unpaid losses and loss adjustment expenses on its guarantees of RMBS (see Note 11 to the unaudited interim consolidated financial statements) causing it to be unable to maintain Syncora Guarantee's compliance with its $65 million minimum policyholder surplus requirement under New York State law as of June 30, 2008. In light of this material adverse development, and in accordance with its previously disclosed strategic plan, the Company, certain financial institutions that are counterparties to CDS contracts with Syncora Guarantee (the "Financial Counterparties"), Merrill Lynch & Co., Inc. ("Merrill Lynch") and certain of its affiliates, and XL Capital and certain of its affiliates, entered into a number of agreements (the "Agreements") on July 28, 2008. The transactions contemplated by the Agreements closed on August 5, 2008 (the "Closing Date"), except for the transactions contemplated by the FSA Master Agreement (as defined below), which closed on August 4, 2008. The Agreements, the transactions contemplated thereby, and related transactions are described below:
Agreements and Related Transactions
Master Transaction Agreement and Merrill Agreement
The Master Transaction Agreement provides for the termination, commutation or elimination of certain reinsurance agreements, guarantees and other arrangements among the Company and XL Capital and certain of its subsidiaries, and between Syncora Guarantee and Syncora Guarantee Re, in exchange for a cash payment by XL Capital to the Company of $1.775 billion, the issuance and transfer of 8 million class A ordinary shares of XL Capital to Syncora Guarantee and the transfer of XL Capital's common shares of Syncora Holdings to be held in trust for the benefit of Syncora Guarantee until such time as an agreement between Syncora Guarantee and the Financial Counterparties is reached, and thereafter the Syncora Holdings shares will be held for the benefit of the Financial Counterparties. As a result of the transfer of the shares of Syncora Holdings to an escrow account pending the release of the shares to the trust (which will occur upon establishment of the trust and obtaining necessary approvals), XL Capital no longer has the right to vote, nominate directors to Syncora Holdings' Board of Directors or any other rights. On the Closing Date, the four XL Capital-nominated directors on Syncora Holdings' Board of Directors resigned. Pursuant to a shareholders agreement to be entered into by Syncora Holdings and trustee of the trust upon transfer of the shares of Syncora Holdings to the trust, the trust will have a number of rights including the right to vote the shares and to nominate to Syncora Holdings' Board of Directors, such number of directors as would equal one nominee less than a majority (if Syncora Holdings, Board of Directors consists of nine or fewer Directors) or two nominees less than a majority (if Syncora Holdings, Board of Directors consists of ten or more Directors).
Under a registration rights agreement, dated as of August 5, 2008, by and among Syncora Guarantee, Syncora Guarantee Re and XL Capital, XL Capital agreed to provide Syncora Guarantee and Syncora Guarantee Re with two demand registration and unlimited piggyback registration rights with respect to
Concurrently with the execution of the Master Transaction Agreement, Syncora Holdings and Syncora Guarantee Re entered into an agreement (the "Merrill Agreement") with Merrill Lynch, Merrill Lynch International ("MLI") and eight trusts affiliated with Syncora Holdings (the "CDS Trusts"), the obligations of which are guaranteed by policies issued by Syncora Guarantee. The Merrill Agreement provides for the termination of eight CDS contracts (the "Swaps") and the related financial guarantee insurance policies issued by Syncora Guarantee with insured gross par outstanding as of June 30, 2008 of approximately $3.7 billion, in exchange for a payment by Syncora Guarantee to Merrill Lynch of an aggregate amount of $500 million. As part of the closing of the transactions comprising the Merrill Agreement, the parties provided mutual releases of claims with respect to the Swaps and the related policies. In addition, Syncora Guarantee and MLI have agreed to dismiss previously disclosed litigation related to seven of the Swaps. As a result of the termination of the Swaps, the Company will record a loss of $94.0 million during the three month period ended September 30, 2008.
The Company and XL Capital have obtained approvals from the New York Insurance Department and the Bermuda Monetary Authority for the Master Transaction Agreement and the transactions comprising such agreement. Other required approvals related to the Master Transaction Agreement have been received from the Delaware Department of Insurance. The New York Insurance Department has also approved the Merrill Agreement and the transactions comprising such agreement.
FSA Master Agreement
Concurrently with the execution of the Master Transaction Agreement, the Company also entered into an agreement (the "FSA Master Agreement") with FSA. The FSA Master Agreement provides for the commutation of all reinsurance ceded by FSA and its subsidiaries to Syncora Guarantee Re, including that ceded under the amended and restated master facultative reinsurance agreement, dated as of November 3, 1998 (the "Old Master Facultative Agreement") that was the subject of a guarantee issued by XLI (see Note 8). Commutation of the Old Master Facultative Reinsurance Agreement and all cessions thereunder was a condition to the obligations of XL Capital under the Master Transaction Agreement. Pursuant to the FSA Master Agreement, FSA and Syncora Guarantee Re entered into the commutation and release agreement (the "Commutation Agreement"), under which all existing cessions to Syncora Guarantee Re by FSA were commuted in return for a payment by Syncora Guarantee Re of approximately $165.4 million, representing statutory reserves less ceding commission plus a commutation premium. In turn, FSA and one of its subsidiaries entered into a new master facultative reinsurance agreement (the "New Master Facultative Agreement") and related reinsurance memorandum (the "Reinsurance Memorandum") with Syncora Guarantee, under which FSA ceded certain of the commuted risks to Syncora Guarantee in return for a payment by FSA to Syncora Guarantee of approximately $88.5 million, representing the statutory unearned premium reserve for such risks, less ceding commission. FSA has undertaken to use its best efforts to reassume such reinsurance from Syncora Guarantee for a period of nine months after the closing, subject to limitations under Article 69 of the New York Insurance Law, which imposes aggregate and single risk limits on insurance that can be written by a financial guaranty insurer, FSA's internal and rating agency single risk limits, other potential limitations and FSA's underwriting guidelines. Syncora Guarantee was required to fund a trust in an initial amount of approximately $104 million to collateralize its obligations to FSA under the reinsurance agreement, which includes regulatory mandated contingency reserves. Finally, Syncora Holdings purchased all class A preferred shares of Syncora Guarantee Re held by FSA and its subsidiary, with a liquidation preference of $39 million, for approximately $2.9 million pursuant to an agreement for the sale and purchase of preferred shares (the "Preferred Shares Purchase Agreement"). As a result of the Commutation
Credit Agreement Amendment
Concurrently with the execution of the Master Transaction Agreement, Syncora Holdings also entered into an amendment, forbearance and limited waiver agreement (the "Credit Agreement Amendment") with the lenders under its credit agreement, dated as of August 1, 2006, as amended (the "Credit Agreement"). Pursuant to the Credit Agreement Amendment, Syncora Holdings agreed (i) to permanently reduce the availability under its revolving credit facility from $250,000,000 to zero, (ii) to reduce the availability under the letter of credit facility to the amount of the letter of credit exposure as of July 28, 2008 and, subsequently, further reduce such exposure for any outstanding letters of credit for FSA's benefit upon the closing the Commutation Agreement, and (iii) collateralize the remaining letters of credit after the consummation of the transactions comprising the Master Transaction Agreement. In consideration of the foregoing, the lenders under the Credit Agreement have agreed to (i) forbear from declaring certain defaults, if any, set forth in the Credit Agreement Amendment, (ii) waive such defaults, if any, upon the satisfaction of certain conditions set forth in the Credit Agreement Amendment, and (iii) grant certain waivers in connection with the consummation of the Master Transaction Agreement. As of the Closing Date the amount of letters of credit outstanding under the Credit Agreement and the amount of collateral posted by the Company in support of such letter of credit was $24.0 million.
Agreement with Financial Counterparties
In consideration for the releases and waivers agreed to by the Financial Counterparties as part of the Master Transaction Agreement, Syncora Guarantee has agreed to hold an aggregate amount of $820 million in cash (plus interest thereon, premiums paid by the Financial Counterparties from July 28, 2008 through October 15, 2008 and any proceeds from the sale by the trust of XL Capital's common shares of Syncora Holdings, in the event such shares are sold) for the purpose of commuting, terminating, amending or otherwise restructuring existing agreements with the Financial Counterparties pursuant to an agreement to be negotiated with the Financial Counterparties. In the event that such agreement is not reached by October 15, 2008, Syncora Guarantee has agreed to use such proceeds only to pay claims under the CDS contracts of the Financial Counterparties. In addition, through such date, Syncora Guarantee and Syncora Guarantee Re have agreed to certain restrictions on their ability to commute, terminate, amend or otherwise restructure policies and contracts to which either is a party. In the event that Syncora Guarantee becomes subject to a rehabilitation or liquidation proceeding, the funds shall no longer be separately held, segregated or limited in use for commutations or restructurings, and will be part of the general assets of Syncora Guarantee.
Related Transactions
In addition to the transactions contemplated by the Agreements, with the exception of the merger of Syncora Guarantee Re with and into Syncora Guarantee discussed below which is expected to be consummated in September 2008, the Company executed the following transactions on or about the Closing Date:
• commutation of certain retrocession agreements the Company had in place with non-affiliates, which will result in a loss of $111.4 million during the three months ended September 30, 2008, which includes $169.6 million of unrealized mark-to-market losses on credit derivatives,
• distribution from Syncora Guarantee Re of $30.8 million to Syncora Holdings,
• discontinuance of Syncora Guarantee Re as a Bermuda corporation and continuance of Syncora Guarantee Re as a Delaware corporation, contribution by Syncora Holdings of all its ownership interests in Syncora Guarantee Re to Syncora Guarantee, which will be followed by the merger of Syncora Guarantee Re with and into Syncora Guarantee, with Syncora Guarantee being the surviving company, subject to required regulatory approvals. Subsequent to the merger of Syncora
Total expenses (consisting of legal, investment advisory, accounting and consulting fees) expected to be incurred in connection with the transactions contemplated by the Agreements and other related transactions discussed above are approximately $26.9 million, of which $5.6 million have been incurred and recorded during the three and six month periods ended June 30, 2008 and approximately $21.3 million is expected to be incurred and recorded during the three months ended September 30, 2008.
After giving effect to transactions contemplated by the Agreements and related transactions discussed above (including the expenses associated with such transactions expected to be incurred during the quarter ended September 30, 2008) as if they had been consummated on June 30, 2008, total consolidated equity of the Company and Syncora Guarantee, in accordance with accounting principles generally accepted in the United States of America ("GAAP"), would have been $1.1 billion and $1.1 billion at June 30, 2008, respectively, as compared to a deficit of $182.1 million and $45.0 million, respectively, actually reported at such date. In addition, after giving effect to the transactions described above as if they had been consummated on June 30, 2008, Syncora Guarantee's policyholder surplus would have been $1.0 billion, as compared to a deficit of $881.1 million actually reported at such date. The total consolidated equity of the Company and Syncora Guarantee and Syncora Guarantee's policyholder surplus numbers described above reflect certain assumptions by the Company concerning the transactions contemplated by the Agreements and related transactions. There can be no assurance that our assumptions will not differ materially from the ultimate treatment of the aforementioned transactions.
Ongoing Strategic Plan
The Company continues to be focused on: (i) mitigating the risk of non-compliance with regulatory solvency requirements and risk limits, (ii) maintaining or enhancing the Company's liquidity, and (iii) mitigating uncertainty in regard to adverse loss reserve development. In this regard, going forward the Company will be primarily seeking to: (i) reaching agreements with Financial Counterparties to commute, terminate or restructure our remaining CDS contracts on terms satisfactory to the Company, (ii) reduce costs, and (iii) remediate troubled credits to minimize claim payments, maximize recoveries, and mitigate ultimate expected losses. The Company does not currently expect to be able to recommence new business production for the foreseeable future.
Continuing Risks and Uncertainties
After the closing of the transactions contemplated by the Agreements and related transactions discussed above, the Company continues to be exposed to certain significant risks and uncertainties that could materially adversely affect its results of operations, financial condition and liquidity, including the following:
• The Company continues to be materially exposed to risks associated with any continuing deterioration in the credit market sectors discussed above, as well as the spread of such deterioration to other sectors of the economy to which the Company has material business exposure. The extent and duration of any continued deterioration of the credit markets is unknown, as is the effect, if any, on potential claim payments and the ultimate amount of losses the Company may incur on obligations it has guaranteed. As a result of the level of Syncora Guarantee's policyholder surplus as of the Closing Date and uncertainty associated with any future adverse loss development, there is a risk that should additional material adverse development of the Company's loss reserves occur, it could cause Syncora Guarantee to be out of compliance with minimum regulatory solvency requirements, which could, in turn, cause its primary regulators to intervene in its operations.
• Establishment of case basis reserves for unpaid losses and loss adjustment expenses on the Company's in-force insurance and reinsurance business and assessing the amount of anticipated claims and recoveries on the Company's in-force credit derivatives requires the use and exercise of significant judgment by management, including estimates regarding the likelihood of occurrence and amount of a loss on an guaranteed obligation. Actual experience may differ from estimates and
• Under the Master Transaction Agreement, the Company agreed with the Financial Counterparties to negotiate in good faith to reach an agreement for the commutation, termination, amendment or the restructuring of the existing agreements with such Financial Counterparties prior to October 15, 2008. Any such agreement must include an agreed upon number of Financial Counterparties. There can be no assurance that the negotiations with the Financial Counterparties will be successful or that we will reach an agreement with the requisite number of Financial Counterparties prior to October 15, 2008. Any agreement with the Financial Counterparties will require addressing the Company's public finance business to the satisfaction of the New York Superintendent of Insurance. There can be no assurances that the negotiations with the Financial Counterparties to reach an agreement on the appropriate treatment of the public finance business of the Company will be successful or that the agreement reached with the Financial Counterparties will be satisfactory to the Superintendent. In addition, until October 15, 2008, the Counterparties will forbear from exercising certain triggered enforcement rights in respect of one or more transactions, agreements, policies, guarantees or treaties to which the Company or its affiliates are a party (the "Forbearance"). If we do not reach agreement with the Financial Counterparties prior to October 15, 2008, this Forbearance will expire. Reaching an agreement with the Financial Counterparties for the commutation, termination, amendment or restructuring of the existing agreements should significantly limit our exposure to future adverse loss development on a significant portion of its in-force business. As a result, failure to reach an agreement with the Financial Counterparties would cause us to continue to be exposed to material adverse loss development on such business, which if such loss development is realized could have a material adverse effect our financial position and results of operations.
• The failure to reach an agreement with the Counterparties for the commutation, termination, amendment or restructuring of the existing agreements with the Financial Counterparties would increase uncertainty with respect to adverse loss reserve development and may have material adverse effect on our liquidity, which would material adverse effect on our business.
Assessment of Company's Ability to Continue as a Going Concern
On July 28, 2008, the Company announced that there was substantial doubt about its ability to continue as a going concern because SGI and SGR were expected to report negative statutory surplus at June 30, 2008, making it likely that, in . . .
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