Note 3: Fresh Start Accounting
Under ASC 852, the application of fresh start accounting results in the allocation of reorganization value to the fair value of assets, and is required when (a) the reorganization value of assets immediately prior to confirmation of a plan of reorganization is less than the total of all post-petition liabilities and allowed claims and (b) the holders of voting shares immediately prior to the confirmation of the plan of reorganization receive less than 50 percent of the voting shares of the emerging entity. The Company adopted fresh start accounting as of the Effective Date, which represents the date on which all material conditions precedent to the effectiveness of the Plan were satisfied or waived. As of the Effective Date, the Company believes that it satisfied both of the aforementioned conditions.
The Company’s reorganization value (“Equity Value”), upon emergence from bankruptcy, was determined to be $76.6 million, which represents management’s best estimate of fair value based on a calculation of the present value of the Company’s consolidated assets and liabilities as at March 19, 2012. As part of our fresh start reporting, we applied various valuation methodologies to calculate the reorganization value of the Successor. These methods included (a) the comparable company analysis, (b) the precedent transactions analysis and (c) the discounted cash flow analysis. The application of these methodologies requires certain key estimates, judgments and assumptions, including financial projections, the amount of cash available to fund operations and current market conditions. Such projections, judgments and assumptions are inherently subject to significant uncertainties and there can be no assurance that such estimates, assumptions and projections reflected in the valuation will be realized and actual results may vary materially.
A significant difference exists between the Equity Value determined by management and the value determined by the Court in an opinion dated September 13, 2011 in which the Court expressed its view with respect to the Company’s value (including the value of the NOLs). While the NOL asset has been recorded on the Company’s opening balance sheet at the value assigned by the Court, management also has recorded a full valuation allowance relative to these assets. The valuation allowance was determined to be necessary as management is unable to identify potential earnings from its existing operations and assets which would allow the Company to benefit from the utilization of these NOLs now or in the future. In the event that earnings are recognized in future periods, the availability of NOLs could result in additional value to the shareholders. The utilization of NOLs may be subject to significant additional limits. See Note 6: Income Taxes for additional detail. No cash will be used for Plan-related liabilities as WMIHC is not liable for pre-petition claims under the terms of the Plan and the estimated minimum level of cash required for ongoing reserves was deducted from total projected cash to arrive at the amount of remaining or available cash. The Effective Date Equity Value of $76.6 million is intended to reflect a value that a willing buyer would pay for the Company’s assets immediately after emerging from bankruptcy.
The value of a business is subject to uncertainties and contingencies that are difficult to predict and will fluctuate with changes in factors affecting the prospects of such a business. As a result, the estimates set forth herein are not necessarily indicative of actual outcomes, which may be significantly more or less favorable than those set forth herein. These estimates assume that the Company will continue as the owner and operator of these businesses and related assets and that such businesses and assets will be operated in accordance with WMMRC’s historical business practices, which is the basis for financial projections. The financial projections are based on projected market conditions and other estimates and assumptions including, but not limited to, general business, economic, competitive, regulatory, market and financial conditions, all of which are difficult to predict and generally beyond the Company’s control. Depending on the actual results of such factors, operations or changes in financial markets, these valuation estimates may differ significantly from that disclosed herein.
The Company’s Equity Value was first allocated to its tangible assets and identifiable intangible assets and the excess (if any) of reorganization value over the fair value of tangible and identifiable intangible assets would be recorded as goodwill. Liabilities existing as of the Effective Date, other than deferred taxes, were recorded at the present value of amounts expected to be paid using appropriate risk adjusted interest rates. The only intangible asset identified related to reinsurance contracts which were held by WMMRC. The contracts were evaluated to determine whether the value attributable to such contracts was either above market or in a loss contract position. After taking such evaluation into consideration, a loss contract fair market value reserve totaling $63.1 million was recorded. WMMRC’s deferred taxes were determined in conformity with applicable income tax accounting standards.
Material differences, including with respect to its business operations, financial performance, asset size and other factors, exist with respect to the pre-petition operations and financial position of WMI and its subsidiaries as compared with the post-emergence operations and financial position of the Company. In order to address such differences, in preparing these and future financial statements, management has concluded that it is appropriate to use the financial information of the Company’s wholly-owned subsidiary, WMMRC as the basis for its past and ongoing financial reporting. Information in these financial statements labeled as “Predecessor” refers to periods prior to the adoption of fresh start reporting, while those labeled as “Successor” refer to periods following the Company’s reorganization and emergence from bankruptcy.
Adjustments recorded to the Predecessor, after giving effect to the implementation of the Plan and to record assets and liabilities at fair value pursuant to the adoption of fresh start accounting are summarized below:
| (dollars in thousands except per share amounts) | Predecessor March 19, 2012 |
Reorganization Adjustments (a) |
Fair Value Adjustments (b) |
Successor March 19, 2012 |
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ASSETS |
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Investments held in trust, at fair value: |
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Fixed-maturity securities |
$ | 303,169 | $ | — | $ | — | $ | 303,169 | ||||||||
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Cash equivalents held in trust |
26,249 | — | — | 26,249 | ||||||||||||
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Total investments held in trust |
329,418 | — | — | 329,418 | ||||||||||||
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Cash and cash equivalents |
7,014 | 75,000 | (c) | — | 82,014 | |||||||||||
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Fixed-maturity securities, at fair value |
6,049 | — | — | 6,049 | ||||||||||||
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Accrued investment income |
2,313 | — | — | 2,313 | ||||||||||||
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Other assets |
3,389 | 210,000 | (d) | (210,000) | (i) | 3,389 | ||||||||||
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Total assets |
$ | 348,183 | $ | 285,000 | $ | (210,000) | $ | 423,183 | ||||||||
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LIABILITIES AND SHAREHOLDERS’ EQUITY |
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Liabilities: |
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Notes payable—principal |
$ | — | $ | 130,000 | (e) | $ | — | $ | 130,000 | |||||||
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Losses and loss adjustment reserves |
141,010 | — | — | 141,010 | ||||||||||||
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Losses payable |
7,585 | — | — | 7,585 | ||||||||||||
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Unearned premiums |
409 | — | — | 409 | ||||||||||||
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Accrued ceding commissions |
466 | — | — | 466 | ||||||||||||
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Loss contract fair market value reserve |
— | — | 63,064 | (j) | 63,064 | |||||||||||
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Other liabilities |
27,156 | (23,109) | (f) | 2 | (f) | 4,049 | ||||||||||
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Total liabilities |
176,626 | 106,891 | 63,066 | 346,583 | ||||||||||||
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Shareholders’ equity: |
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Common stock, $.00001 par value; 500,000,000 authorized, 200,000,000 shares issued and outstanding |
— | 2 | (g) | — | 2 | |||||||||||
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Common stock, $1 par value, 1,000 shares issued and outstanding |
1 | — | (1) | (k) | — | |||||||||||
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Additional paid-in capital (Predecessor) |
69,879 | — | (69,879) | (l) | — | |||||||||||
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Additional paid-in capital (Successor) |
— | 154,998 | (g) | (78,400) | (m) | 76,598 | ||||||||||
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Retained earnings |
101,677 | 23,109 | (h) | (124,786) | (n) | — | ||||||||||
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Total shareholders’ equity |
171,557 | 178,109 | (273,066) | 76,600 | ||||||||||||
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Total liabilities and shareholders’ equity |
$ | 348,183 | $ | 285,000 | $ | (210,000) | $ | 423,183 | ||||||||
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The following notes relate to the table above and should be read in conjunction with the information in such table.
| (a) | These adjustments are necessary to give effect to the Plan, including the receipt of cash proceeds associated with the contribution of cash from certain creditors, issuance of debt securities, issuance of 200 million shares of common stock and other transactions as contemplated under the Plan. |
| (b) | These adjustments are necessary to reflect assets and liabilities at fair value and elimination of Predecessor equity. The primary operating business of the Successor is the WMMRC subsidiary which has a net asset value higher than its Fair Market Value (“FMV”). |
| (c) | This adjustment reflects $75 million of cash contributed to the Company on the Effective Date by certain creditors. |
| (d) | This adjustment reflects the Court’s valuation of WMMRC of $140 million and additional value attributable to the NOLs. These items have been adjusted to FMV as part of the application of Fresh Start Accounting. The Court’s valuation is presented solely for information purposes, however, because management does not believe that the Court’s valuation necessarily reflects the actual or FMV of the Company’s assets and liabilities under GAAP. This adjustment is eliminated as described in (i) below. |
| (e) | This adjustment reflects the issuance of $130 million of Runoff Notes as described in Note 8: Notes Payable below. |
| (f) | This adjustment reflects eliminating an intercompany payable occurring from carve-out allocated costs related to historic charges allocated as if services had been performed and charged to the Predecessor in accordance with Staff Accounting Bulletin (“SAB”) Topic 1B and 1B1. The methodology for these charges is based on applying the current contractual relationships described in Note 7: Service Agreements and Related Party Transactions as if they had been in place since the formation of WMMRC. The impact on historic earnings is described in (h) below. Additionally, this eliminates the offsetting intercompany amount created when Predecessor common stock is eliminated. |
| (g) | This adjustment reflects the calculated value of the 200 million shares of common stock issued before adjusting for FMV as a result of Fresh Start Accounting. This amount results from the use of the Court-assigned (non-GAAP) values attributed to assets and liabilities which are then utilized in calculating the resulting balance attributable to equity. The common stock is recorded at par value calculated as 200 million shares at a par value of $0.00001 per share. The remainder of the value is then attributed to additional paid-in capital. |
| (h) | This adjustment increases the retained earnings of the Predecessor due to the elimination of the carve-out costs which decreased historic earnings of the Predecessor. The resulting intercompany payable is described in (f) above. These costs and the related retained earnings are eliminated as the costs were allocated in accordance with SAB Topics 1B and 1B1 and would have eliminated in consolidation. |
| (i) | This adjustment reflects the elimination of the Court assigned values described in (d) above. There has been no goodwill recorded as a result of this transaction. WMMRC is reported as the Predecessor and therefore is carried at FMV in individual line items. Management believes that the Court’s valuation was inconsistent with GAAP and such information related to such valuation is being presented here for informational purposes only. Therefore, elimination is required to present the opening balance sheet in accordance with GAAP. |
| (j) | This adjustment is required to reflect a loss contract fair market value reserve of $63.1 million relating to contractual obligations of WMMRC. This is in compliance with ASC 805-10-55-21(b)(1) which defines a loss contract as a “contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it.” The net assets or equity value of WMMRC totaled $171.6 million prior to reorganization and fair value adjustments. The elimination of the costs and intercompany payable allocated to the predecessor in accordance with SAB Topic 1B and 1B1 and described in (f) above increase the equity value to $194.7 million. The value of WMMRC was reduced by $63.1 million based upon the FMV analysis described above. |
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Predecessor retained earnings |
$ | 101,677 | ||
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Adjustment for carve-out allocations |
23,109 | |||
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Predecessor adjusted retained earnings |
124,786 | |||
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Predecessor additional paid-in capital |
69,879 | |||
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Predecessor common stock eliminated in consolidation |
(1) | |||
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Predecessor equity value |
194,664 | |||
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Fair market value of WMMRC |
131,600 | |||
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Loss contract fair market reserve allowance |
$ | 63,064 | ||
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| (k) | This adjustment reflects the elimination of common stock of the Predecessor. |
| (l) | This adjustment reflects the elimination of additional paid-in capital of the Predecessor. |
| (m) | This adjustment reflects the reduction of equity value resulting from Fresh Start Accounting. It is comprised of a reduction (relative to Court assigned FMV) in WMMRC’s FMV totaling $8.4 million and the elimination of the Court assigned value of $70 million related to NOLs. Although the Company has substantial NOLs they are subject to a 100 percent valuation allowance as described in Note 6: Income Taxes, and there can be no assurance the Company will be able to realize any benefit from the NOLs. |
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Fair market value of WMMRC (Court assigned) |
$ | 140,000 | ||
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Fair market value of WMMRC |
131,600 | |||
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Fair market value reduction |
8,400 | |||
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Elimination of Court assigned value related to NOLs |
70,000 | |||
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Total change in fair market value affecting Equity Value |
$ | 78,400 | ||
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Court assigned Equity Value recorded as additional paid-in capital |
$ | 154,998 | ||
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Total change in fair market value affecting Equity Value |
78,400 | |||
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Additional paid-in capital at March 19, 2012 |
$ | 76,598 | ||
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| (n) | This adjustment reflects the elimination of adjusted retained earnings of the Predecessor. |
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Predecessor retained earnings |
$ | 101,677 | ||
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Adjustment for carve-out allocations |
23,109 | |||
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Predecessor adjusted retained earnings |
$ | 124,786 | ||
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