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 of its ownership interests in its financial guarantee insurance and financial guarantee reinsurance operating businesses indirectly to us. 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. (“Syncora Guarantee-UK”, 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. or its subsidiaries (“FSA”), an entity which is otherwise not related to XL Capital or us. 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, we consummated the transactions comprising the 2008 MTA, as defined below, pursuant to which XL Capital transferred all of the common shares of Syncora Holdings it owned to be held in trust by CCRA Purpose Trust (the “SCA Shareholder Entity”) as described below. On September 4, 2008, Syncora Guarantee Re merged with and into Syncora Guarantee, with Syncora Guarantee being the surviving company. See “-Description of the Transactions Comprising the 2008 MTA and Certain Summary Financial Information.”
In light of Syncora Guarantee’s significant statutory policyholders’ deficit and significant anticipated near term claim payments, Syncora Guarantee’s Board of Directors is currently considering a suspension of, and may, in the exercise of its fiduciary duties, determine that it will suspend claim payments in order to preserve its assets for the benefit of all policyholders. If suspended, there can be no assurance when or if claim payments would recommence,
As a result of uncertainties associated with the aforementioned factors affecting our ability to continue as a going concern, management has concluded that there is substantial doubt about our ability to continue as a going concern. Our financial statements as of December 31, 2008 and 2007 and for the years ended December 31, 2008, 2007, and 2006 are prepared assuming we continue as a going concern and do not include any adjustment that might result from our inability to continue as a going concern.
These rating agency actions reflect Moody’s, S&P’s and Fitch’s current assessment of our creditworthiness, business franchise and claims-paying ability. This assessment reflects our exposures to the U.S. residential mortgage market, which has precipitated our weakened financial position and business profile based on increased reserves for losses and loss adjustment expenses, realized and unrealized losses on credit derivatives and modeled capital shortfalls.
On the Closing Date, Syncora Holdings entered into an undertaking with the NYID pursuant to which Syncora Holdings agreed not to make any dividends or distributions to our shareholders during an eighteen month period beginning on that date without their express written consent. In addition, Syncora Guarantee entered into an undertaking with the NYID pursuant to which Syncora Guarantee agreed not to make any dividends or distributions to its shareholders without their express written consent during a two year period commencing on November 18, 2008.
The following table presents the net notional exposure of our guaranteed CDOs by rating as of December 31, 2008:
Subprime RMBS includes securities with a weighted average FICO score of 640 or below per third party data sources.
Based on our analysis, we selected a UELR in 2006, 2007 and 2008 of 20%. We have not changed the UELR in 2008 or 2007 because of our view that the losses recorded by us and others in the industry are concentrated in residential mortgage exposures which are not correlated to the rest of our in-force business. Our expected loss emergence pattern is determined by underwriting year based on the par amortization schedules of the underlying insured and reinsured debt obligations comprising our in-force business. We adjust or realign the expected loss emergence pattern each quarter to reflect the underlying changes in our in-force business (for example, changes in the average life of in-force business resulting from changes in the mix of business and risk or par expiration).
Our methodology applies the UELR to earned premium during the period from our entire in-force book of business (after exclusion of the effect on earned premium of refunding and full limit losses because no more risk exists on these related policies). Significant changes to any variables on which our UELR is based, over an extended period of time, will likely result in an increase or decrease in such ratio. For example, a shift in business written for sectors with high default rates would likely increase our UELR, while a shift for sectors with low default rates would likely decrease our UELR. Additionally, increases in default rates relative to our in-force business and in our actual loss experience or decreases in statistical recovery rates and in our actual recovery experience would increase our UELR, while the inverse would likely decrease our UELR.
in instances where we were in substantive discussions with market participants to transfer the risk in specific CDS contracts, our estimate of the fair value of such contracts was largely based on the price discovery we obtained from such discussions,
As a result of our decision to suspend writing substantially all new business there were no operating costs deferred during the year ended December 31, 2008 and there will be no such costs deferred in the future unless we recommence writing new business. The following table presents the components of acquisition costs, net, for the years ended December 31, 2008, 2007 and 2006:
As of December 31, 2008 and 2007, Syncora Guarantee had readily marketable debt securities and short-term investments with a carrying value of approximately $1,985.6 million and $2,430.8 million, respectively. In addition, at those dates, approximately 99.2% or more of Syncora Guarantee’s fixed income portfolio was rated “A” or higher.
the loss of certain control rights under certain financial guarantee insurance;
further deterioration in general economic conditions, including as a result of the financial crisis as well as inflation, interest rates, foreign currency exchange rates and other factors and the effects of disruption or economic contraction due to catastrophic events or terrorist acts;
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Syncora Holdings Ltd. and its subsidiaries (the “Company”) at December 31, 2008 and December 31, 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule in the index appearing under Item 15, presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements, and the financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
The non-binding terms and conditions in the Letter of Intent contemplate the participation of all of the 23 Counterparties. To date, 18 of the 19 significant Counterparties have indicated their willingness to enter into the transactions contemplated by the Letter of Intent, subject to final documentation and participation by the remaining Counterparties. The 19 significant Counterparties represent substantially all of Syncora Guarantee’s anticipated claims with respect to CDS contracts. One significant Counterparty has indicated that it is presently not contemplating entering into the transactions contemplated by the Letter of Intent. Syncora Guarantee is discussing with the remaining Counterparties alternative terms and conditions that would permit the consummation of the second phase of the 2009 MTA without the participation of all of the Counterparties. There can be no assurance that the 2009 MTA will be consummated by a sufficient number of Counterparties or at all.
Bond discounts and premiums are amortized on a level yield basis over the remaining terms of securities acquired. For pre-refunded bonds, the remaining term is determined based on the contractual refunding date. For mortgage-backed securities, and any other holdings for which prepayment risk may be significant, assumptions regarding prepayments are evaluated periodically and revised as necessary. Any adjustments required due to the resulting change in effective yields are recognized in income.
policy. For upfront premiums on non-amortizing bullet maturity debt obligations, premium revenue recognition is recognized on a straight-line basis over the life of the underlying insured obligation. Deferred premium revenue represents the portion of premiums written that is applicable to the unexpired risk or principal of insured obligations. For both upfront and installment policies, ceded premium expense is recognized in earnings in proportion to and at the same time the related premium revenue is recognized.
The Company has collected, and may collect in the future, certain fees in connection with its guaranteed transactions. Depending upon the type of fee received, the fee is either earned when services are rendered or deferred and earned over the life of the related transaction. Termination fees are earned when due and are included in the accompanying statements of operations under the caption “Fee Income and Other.” Structuring, waiver and consent, and commitment fees are included in the accompanying consolidated statements of operations as premiums and earned on a straight-line basis over the life of the related transaction.
Case basis reserves on financial guarantee reinsurance assumed are generally established by the Company upon quarterly current notifications from ceding companies. There historically has been no time lag between the time the Company records an assumed case basis reserve and the time the Company’s ceding companies record such reserves. For each notification of a ceded case basis reserve from ceding companies, the Company conducts an examination of the basis of the ceding company’s reserve estimate to ensure that the Company concurs with the ceding company’s evaluation and conclusions. In certain instances, the Company may develop its own estimates of losses on assumed business. Except as discussed below, in all instances to date where the Company has assumed case basis reserves, it has concurred with the ceding companies’ evaluation and conclusions with respect to such reserves and, accordingly, there has been no difference between the amount of case basis reserves reported to the Company by its ceding companies and the amount it has recorded in its financial statements. During the year ended December 31, 2008, the Company, based on its own internal analysis, recorded a provision for losses and loss adjustment expenses of $8.6 million relating to a reinsured guarantee covering a global infrastructure financing (see Note 16 (d)) and, in March 2009, the Company was advised by the ceding company that the Company’s share of the estimated reserve that the ceding company had established was approximately $18.0 million. To date, the Company has not completed its assessment of the ceding company’s estimated reserve and, therefore, have not adjusted our provision to reflect the ceding company’s estimate.
The Company will recognize a charge to reduce deferred acquisition costs, and establish a liability if necessary, to the extent the sum of expected losses and loss adjustment expenses, maintenance costs and unamortized policy acquisition costs exceeds the related unearned premiums, the anticipated present value of future premiums under installment contracts written, and anticipated investment income. For policies reinsured with third parties the Company receives ceding commissions to compensate for acquisition costs incurred. The Company nets ceding commissions received against deferred acquisition costs and earns these ceding commissions over the period in which the related premiums are earned.
Prior to suspending writing substantially all new business (see Note 2), the Company issued CDS contracts and entered into arrangements with other issuers of CDS contracts to assume, all or a portion, of the risks in the CDS contracts they issued (“back-to-back arrangements”) and, in certain cases, which are discussed in more detail below, the Company purchased back-to-back credit protection on all or a portion of the risk from the CDS contracts it issued or assumed. Such back-to-back arrangements were generally structured on a proportional basis. In connection with the transactions comprising the 2008 MTA, the Company terminated substantially all its back-to-back arrangements in the third quarter of 2008 (see Note 4).
In March 2008, the FASB issued SFAS No. 161, “Disclosures About Derivative Instruments and Hedging Activities-An Amendment of FASB Statement No. 133” (“SFAS 161”). SFAS 161 establishes the disclosure requirements for derivative instruments and for hedging activities. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. Early application is encouraged. SFAS 161 is not expected to have any effect on the Company’s results of operations or financial position.
The amortized cost and fair value of bonds at December 31, 2008 and 2007 by contractual maturity are shown below. Actual maturity may differ from contractual maturity because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
Debt securities with an amortized cost and fair value of $6.5 million and $7.3 million and $7.1 million and $7.6 million at December 31, 2008 and 2007, respectively, were on deposit with various regulatory authorities as required by insurance laws.
The holders of the Series B Preferred Shares are not entitled to any voting rights as shareholders of Syncora Guarantee and their consent is not required for taking any corporate action. Subject to certain requirements, the Series B Preferred Shares may be redeemed, in whole or in part, at the option of Syncora Guarantee at any time or from time to time after December 9, 2009 for cash at a redemption price equal to the liquidation preference per share plus any accrued and unpaid dividends thereon to the date of redemption without interest on such unpaid dividends. On February 26, 2008, Syncora Guarantee Re elected to declare dividends on the Series B Preferred Shares at the required rate for the next three monthly periods and on May 6, 2008, Syncora Guarantee Re elected to declare dividends on the Series B Preferred Shares at the required rate for the succeeding month. On July 25, 2008, Syncora Guarantee Re elected to declare dividends on the Series B Preferred Shares at the required rate for the July 2008 and August 2008 periods. Syncora Guarantee did not declare dividends on the Series B Preferred Shares for any period after August 2008 through the date hereof.
In connection with the 2008 MTA discussed in Note 4, the Company and XLI terminated and settled the excess of loss agreement for a payment by XL Capital to the Company of $100.0 million. As a result, the Company recorded a loss during the year ended December 31, 2008 of $106.1 million, which represented the excess net carrying value of amounts owed by XLI to the Company under the agreement over the aforementioned settlement payment.
As of December 31, 2008, the Company’s total net direct exposure to RMBS aggregated approximately $8.7 billion, representing approximately 6.5% of its total in-force guaranteed net par outstanding at such date. The RMBS exposure consisted of various collateral types, including prime and Alt-A 1st lien, subprime 1st lien, HELOC and CES mortgage collateral. During the year ended December 31, 2008, the Company recorded a provision for losses and loss adjustment expenses of $1,850.6 million before reinsurance ($1,789.8 million after reinsurance) on certain guarantees supported by HELOC and CES mortgage collateral (see Note 16).
Through December 31, 2008, the Company has paid claims (net of reimbursements from the transactions) aggregating $513.5 million on its guarantees of obligations discussed above.
of the same defendants in the Wilson case above. This complaint asserts claims under Alabama’s quo warranto statutes, Ala. Code §§ 6-6-590, et seq. Quo warranto is an ancient and extraordinary remedy available to annul a corporation’s charter and/or preclude it from operating as a corporation in Alabama where the corporation has engaged in such actions as to warrant a forfeiture of its corporate rights and existence. The factual allegations of the complaint virtually mirror those in the Wilson case. The Company has filed a motion to dismiss. Prior to the court’s ruling on the motion, the plaintiffs voluntarily dismissed the Company, without prejudice, as a defendant. The court subsequently granted the motions to dismiss filed by several of the remaining defendants, but has granted leave for plaintiffs to file an amended complaint. The amended complaint has yet to be filed, and currently the Company is no longer a defendant to this lawsuit. See Note 16(b) for additional information.