Description

Syncora is a monoline insurer that blew up on RMBS exposure back in the financial crisis and has been in stabilization/wind-down mode ever since. I believe that the company is at an inflection point as a result of recent events, and that they will be able to utilize significant asset value over the next 12-24 months. This is a rather simple pitch; I will give background on the situation followed by an analysis of the remaining asset value (the background is helpful, but not necessary). While all of this information can be found in company filings, obscurity, trading on the OTC, and (perceived) lack of visibility keep Syncora undervalued.  Syncora is now essentially a pile of cash with NAV at ~$5.75 per share (excluding significant NOLs).

Company Background

‘08-’14

For the uninitiated, bond insurance, or “financial guarantee insurance”, is where an insurance company guarantees interest and principal payments. Syncora took heavy losses on RMBS guarantees in 08/09 and was forced to go through an in-depth restructuring accompanied by restrictions on their business still in place today.  Syncora completed a major restructuring in 2008 when it terminated a number of contracts and guarantees from its former parent XL Capital. As a result of its restructuring effort, SGI restored itself to positive surplus from a negative level of 3.8 billion at Q1 2009. In the years that followed, Syncora completed several very important remediations. These include American Roads and Jefferson County in 2013 and Detroit in 2014, as well as large commutations in the structured single risk and project finance areas. Syncora's net par outstanding declined dramatically from a high of 165 billion pre-cris to $45 billion in 2014.

It’s also important to note the restrictions placed on Syncora by the restructuring agreement (“MTA 2”). MTA 2 prohibits Syncora from writing new insurance business, and requires them to gain approval from both RMBS counterparties + the regulator NYDFS to make significant business moves (including payments on surplus notes or preferred shares).

2016 Restructuring

Syncora took another major step with a 2016 restructuring which allowed Syncora to: (i) de-lever its capital structure by eliminating SHL preferred shares and obtaining a discount on SGI Surplus Notes; (ii) make the first ever payment on SGI’s surplus notes; and, (iii) reallocate $1.75bn of NOLs to SHI. The structure pictured below is the same today, except for the merger of SCAI with and into SGI that took place this year.

Recent Developments

Even after an arduous process spanning 9 years, uncertainty with regard to asset sales and the remaining insurance portfolio plagued Syncora - until now.

In January, Synora reached a settlement over a long-standing dispute relating to a 2006 GreenPoint transaction. As a result of the settlement, Syncora received approximately $335 million in January with an additional present value of $15 million expected to be received over the remainder of the transaction based on the performance of the assets remaining in the related trust. Syncora’s share price surged commensurately, but this monetization makes it far more clear as to what can be expected in asset value. In July, Syncora closed on their sale of American Roads for $220mm, adding $.75/share in incremental book value from the gain. As previously mentioned, the company continued the simplification of its corporate structure by  merging SCAI with and into SGI.

Reinsurance Transaction

The most critical development in crystalizing asset value is the reinsurance transaction that Syncora entered into in February with Assured Guaranty. Assured agreed to provide reinsurance to SGI, on approximately $13.5 billion of net par outstanding. This represents approximately 91% of SGI's outstanding insured exposure as of December 31, 2017. SGI paid approximately $360 million, including material ceded reserves. Below is the retained portfolio of $1.2bn.

Following are management’s comments on the retained credits (from the 1Q18 call): “There are certain credits that are in salvage mode, meaning that we have paid claims on those. We now have rights to reimbursement on those claims. So, we obviously wouldn't want to trade away those rights to reimbursement. There are also a few credits where we expect a refunding in the near-term and it would make sense to pay for reinsurance on those credits. So at the end of the day, we are very comfortable with the credits we have retained, the level of reserves we have on those”. Prior to this transaction, ending asset value was far more difficult to ascertain.

Now with the majority of risk (outside Puerto Rico, which will be discussed) out of Syncora’s hands, we get a clear picture of the pile of cash that remains. In addition, the NYDFS approved a  $400mm payment on Surplus Note (essentially a debt instrument for an insurance company) principal and interest. This (1) signals a vote of confidence that NYDFS will approve further value-creating transactions and (2) significantly reduces interest expense, of which there was $46mm in 2017, by cutting outstanding par value of Surplus Notes from $677mm to $389mm.

Asset Value

Assets are made up of $888mm cash + invested assets (~$340mm corporate, ~$120mm US gov bonds, ~$100mm MBS, ~$70mm ABS, and ~$40mm state debt) and ~290mm in receivables/salvage. Liabilities are mostly made up of reserves/expected insurance payments, Surplus Notes, and preferred shares. Taken with the adjustments to shareholders’ equity to more accurately reflect economic value, adjusted book value here appears reasonable as an estimate of ending asset value.

Footnotes: Page10  http://scafg.gcs-web.com/static-files/49a3955e-3b27-42ba-8563-4e7d440eeb07

The large drop from the prior quarter is due to the reinsurance transaction and related unearned premium assumptions coming off the books. We also need to add in $.75/share from the sale of American Roads (as mentioned on 2Q18 call, this will hit books in 3Q18), so NAV is $5.70/share. Additionally, Syncora has $2.5bn in NOLs, potential for Puerto Rico reserves to be released, and potential gains from the Macquarie litigation going to trial early 2019. These outcomes shouldn’t be counted on, but provide some additional upside.

Potential Outflows

Main outflow risks are Puerto Rico exposure and ongoing operating expense. For Puerto Rico, remaining insured exposure breaks down to: $110mm PREPA, $85.7mm GO, $25.3mm mixed state and local. Management has not given great color when asked on reserves except that they are “appropriately reserved” and that they feel confident in their conservatism. What we do know is that in 2Q16 PREPA was reserved with a loss given default of 26%, and GO bonds with 25%. Of course, since then the adverse developments in Puerto Rico have necessitated substantial additional reserves, none of which have been reversed. In late July, PREPA came to an agreement with an ad hoc group of lenders which exluded the monoline insurers (Syncora, Assured, etc.). In the new deal, the non-monolines were offered 77.5 cents on the dollar, essentially providing a floor for the monolines who have more bargaining power. The General Obligation bonds are murkier but should be well reserved for considering the recent positive developments in PR.

Yearly cash flows:  There was $38mm for 1H18 ($57mm cash OpEx FY2017, down from $72mm FY2016). But that is (1) elevated by the reinsurance transaction and (2) there should be significant cuts now that the portfolio size has shrunk. Should have ~$26mm interest expense on the Surplus Notes annually. Offsetting this is ~$52mm in interest income (FY2017), and ~$20mm other cash receipts + insurance cash flow certificates. I see this as wash.

End Game
The goal is to use this pile of cash in a way that best utilizes the NOLs and Syncora's existing abilities. Syncora can’t raise capital until 3Q19 due to Section 382 restrictions which would impact the NOLs, but they've recently given more clarity on the type of business they are looking to acquire:

In our evaluation of business opportunities, we have identified potential asset classes for an asset management business. One of the possible approaches to a new business initiative would be to create a separate vehicle for additional third-party investment to maximize returns and utilize the NOLs. In fact, we have already made investments in some higher yielding assets in areas where the Company has very strong core competencies, like CLO equity, which ultimately could be transferred to the separate vehicle.

Broadly speaking, management intends for any new business to be profitable from the outset, without unduly increasing operating expenses, which we’ve been working so hard to reduce. We focused on asset management as one very good area, good fit for Syncora. We have purchased CLO equity investments over the last year in SGI's investment portfolio. So we have the NOL, which is a strategic advantage, but our view is the business needs to stand on its own merits to justify making a long-term commitment to it.

While there is still some work left to do here, the heavy lifting has been done. The board unlocks substantial incentive payments above $4.50/share and are well-aligned with shareholders from that perspective.  They have thus far proven capable of making prudent, perhaps overly-conservative decisions. This is a highly idionsycratic bet, with little downside barring unforseen disaster. Maybe it's dead money for a while, but I believe it should trade up to $5 over the next 12-18 months (a ~15% discount to book seems reasonable given solidity of assets).

Risks

--It remains to be seen what management will do with this cash and there is certainly execution risk. However, at such a discount to NAV there is substantial margin for error.

--Additional losses could be incurred; (low probability event given nature of remaining credits and reserve levels, but always a possibility in this line of business).

--Regulator does not approve of payments or acquisition that unlocks value

Catalyst

--Ability to utilize asset value/NOLs end of 2019 through purchase of new business, reversal of PR reserves, macquarie litigation