The primary strategies of our U.S. public finance insurance segment are to generate new insurance business in National, consistent with our portfolio management and return requirements, and to maximize the economics of our existing insured portfolio through effective surveillance and remediation. The primary strategies of our international and structured finance insurance segment are risk reduction, loss mitigation and value preservation. We do not expect to write new business in our international and structured finance insurance segment in the foreseeable future. Our corporate segment manages financing for and provides general support services across the MBIA group. In the second quarter of 2014, we exited our conduit business through the liquidation of Meridian Funding Company, LLC (“Meridian”). Effective in the fourth quarter of 2014, our previously reported asset/liability products segment and our corporate segment are managed and reported as one operating segment referred to as our corporate segment. Effective on January 1, 2015, we exited our advisory services business through the sale of Cutwater. Refer to “Note 12: Business Segments” in the Notes to Consolidated Financial Statements for a discussion of changes to our business segments.
MBIA Corp.’s primary strategies are maximizing the collection of excess spread and put-back recoveries and mitigating potential losses on MBIA Corp.’s insurance exposures. MBIA Corp. has significant negative earned surplus and accrued and unpaid interest on its outstanding surplus notes, and therefore, has no current capacity to pay dividends. Since July 15, 2012 no payments on MBIA Corp.’s outstanding surplus notes have been approved by the New York State Department of Financial Services (“NYSDFS”) and as of January 15, 2015 there was $286 million of accrued and unpaid interest on MBIA Corp.’s outstanding surplus notes. MBIA Corp. contributes to the Company’s net operating loss carryforward (“NOL”), which is used in the calculation of our consolidated income taxes. We believe it is unlikely that MBIA Corp. will generate sufficient income to use its portion of the NOL. Refer to the “Capital Resources-MBIA Corp.” section for additional information on MBIA Corp.’s surplus notes and statutory capital.
Refer to “Note 6: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements for a comprehensive discussion of our loss reserves and recoveries, including critical accounting estimates used in the determination of these amounts.
NET INVESTMENT LOSSES RELATED TO OTHER-THAN-TEMPORARY IMPAIRMENTS Net investment losses related to OTTI for 2014 was primarily related to one impaired security for which a loss was recognized as the difference between its amortized cost and the net present value of its projected cash flows. This OTTI resulted from liquidity concerns, downgrades in credit and other adverse financial conditions of the issuer. Refer to the “Liquidity” section included herein for additional information about impaired investments.
The decreases in the amortization of deferred acquisition costs for the year ended December 31, 2014 compared with 2013 and 2012 principally reflect the acceleration of deferred costs into earnings in prior periods as policies were terminated. Operating expenses decreased for the year ended December 31, 2014 compared with 2013 and 2012 due to decreases in gross expenses. We did not defer a material amount of policy acquisition costs during the years ended 2014, 2013 or 2012. Policy acquisition costs in these periods were primarily related to commissions and premium taxes on installment policies written in prior periods.
During the year ended December 31, 2014, we collected approximately $12 million, net of reinsurance and $104 million in payments made, on insured second-lien RMBS transactions, or $25 million after eliminating $38 million of payments and $25 million of excess spread collections made on behalf of consolidated VIEs. Through December 31, 2014, we made claim and LAE payments for 37 out of 43 insured second-lien RMBS policies. The total collections of $116 million on our insured second-lien RMBS transactions comprised $98 million of excess spread and $18 million of mortgage insurance. Mortgage insurance is received periodically from the servicers.
Reinsurance enables the Company to cede exposure for purposes of syndicating risk and increasing its capacity to write new business while complying with its single risk and credit guidelines. When a reinsurer is downgraded by one or more of the rating agencies, less capital credit is given to MBIA under rating agency models and the overall value of the reinsurance to MBIA is reduced. The Company generally retains the right to reassume the business ceded to reinsurers under certain circumstances, including a reinsurer’s rating downgrade below specified thresholds. The following table presents information about our reinsurance agreements as of December 31, 2014 for our U.S. public finance and international and structured finance insurance operations:
MBIA requires certain unauthorized reinsurers to maintain bank letters of credit or establish trust accounts to cover liabilities ceded to such reinsurers under reinsurance contracts. The Company remains liable on a primary basis for all reinsured risk, and although MBIA believes that its reinsurers remain capable of meeting their obligations, there can be no assurance of such in the future.
For the year ended December 31, 2014, the unfavorable change in net income (loss) compared with 2013 was primarily due to a loss as a result of the consolidation of VIEs and decreases in fee revenues due to declines in asset balances managed for third parties and our other segments, partially offset by decreases in compensation, legal and consulting expenses.
During 2014, the remaining $23 million available for repurchases under our 2007 share repurchase program was used to repurchase 2,086,737 common shares of MBIA Inc. at an average share price of $11.02 per share.
Corporate’s liquidity resources support our MBIA Inc. entity. The primary sources of cash within MBIA Inc. available to meet its liquidity needs include:
Insured transactions that require payment in full of the principal insured at maturity could present liquidity risks for MBIA Corp. since payment of the principal is due at maturity but any salvage could be recovered over time after payment of the principal amount. MBIA Corp. has insured transactions with substantial principal amounts due at maturity that are scheduled to mature in the near term. MBIA Corp. expects the transactions to be repaid on or prior to the maturity date. MBIA Corp. is generally required to satisfy claims within one to three business days, and as a result seeks to identify potential claims in advance through our monitoring process. While our financial guarantee policies generally cannot be accelerated, thereby helping to mitigate liquidity risk, the insurance of CDS contracts may, in certain circumstances, including the occurrence of certain insolvency or payment defaults under the CDS contracts, be subject to termination by the counterparty, triggering a claim for the fair value of the contract. In order to monitor liquidity risk and maintain appropriate liquidity resources, we use the same methodology as we use to monitor credit quality and losses within our insured portfolio, including stress scenarios. Refer to “Note 6: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements for a discussion of our loss process.
The following discussion of investments, including references to consolidated investments, excludes investments reported under “Assets of consolidated variable interest entities” on our consolidated balance sheets. Investments of VIEs support the repayment of VIE obligations and are not available to settle obligations of MBIA. In addition, as of December 31, 2014, investments carried at fair value of $6 million within our advisory services segment are also excluded due to the sale of Cutwater in January of 2015. These assets are reported under “Assets held for sale” in our consolidated balance sheet. Our AFS investments comprise high-quality fixed-income securities and short-term investments. The following table presents our investment portfolio as of December 31, 2014 and 2013:
Certain amounts have been reclassified in prior years’ financial statements to conform to the current presentation. These reclassifications had no impact on total revenues, expenses, assets, liabilities, or shareholders’ equity for all periods presented.
The Company capitalizes and defers acquisition costs that are directly related to the successful acquisition of new or renewal insurance business. Acquisition costs are costs to acquire an insurance contract which result directly from and is essential to the insurance contracts transaction and would not have been incurred by the Company had the contract transaction not occurred. Acquisition costs include compensation of employees involved in underwriting, certain rating agency fees, state premium taxes and certain other underwriting expenses, reduced by ceding commission income on premiums ceded to reinsurers. Acquisition costs also include ceding commissions paid by the Company in connection with assuming business from other financial guarantors. Acquisition costs, net of ceding commissions received, related to non-derivative insured financial guarantee transactions are deferred and amortized over the period in which the related premiums are earned. Acquisition costs related to insured derivative transactions are expensed as incurred.
Income Taxes (Topic 740)-Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (ASU 2013-11)
In the base case scenario, the Company assumes that the Current Roll to Loss begins to decline immediately and continues to decline over the next six months to 25% of their levels as of November 30, 2014. For example, if the amount of current loans which become 30-59 days delinquent were 10%, and recent performance were to suggest that 30% of those loans will be charged-off, the Current Roll to Loss for the transaction is 3%. In the base case, the Current Roll to Loss will then reduce linearly to 25% of its original value over the next six months (i.e., 3% will linearly reduce to 0.75% over the six months from December 2014 to May 2015). After that six-month period in the base case scenario, the Company further reduces the loss to 0% by late 2015 with the expectation that the performing seasoned loans will eventually result in loan performance reverting to lower levels of default consistent with history. In the stress and additional stress case scenarios, the Current Roll to Loss trends persist for six months and eighteen months, respectively, before reverting to historic trends.
Costs associated with remediating insured obligations assigned to the Company’s surveillance categories are recorded as LAE and included in “Losses and loss adjustment” expenses on the Company’s consolidated statements of operations. For the years ended December 31, 2014, 2013 and 2012, gross LAE related to remediating insured obligations were $36 million, $57 million and $137 million, respectively. Decreases in LAE are due to lower litigation expenses as a result of settlements.
The Company’s derivative liabilities are primarily insured credit derivatives that reference structured pools of cash securities and CDSs. The Company generally insured the most senior liabilities of such transactions, and at the inception of transactions its exposure generally had more subordination than needed to achieve triple-A ratings from credit rating agencies. The types of collateral underlying its insured derivatives consist of cash securities and CDSs referencing primarily corporate obligations, ABS, RMBS, CMBS, CRE loans, and CDOs.
The fair values of investment agreements are determined using discounted cash flow techniques based on contractual cash flows and observable interest rates currently being offered for similar agreements with comparable maturity dates. Investment agreements contain collateralization and termination agreements that substantially mitigate the nonperformance risk of the Company. As the terms of the notes are private, and the timing and amount of contractual cash flows are not observable, these investment agreements are categorized as Level 3 of the fair value hierarchy.
As of December 31, 2014 and 2013, the Company’s net insured CDS derivative liability was $244 million and $1.2 billion, respectively, based on the results of the aforementioned models. A significant driver of changes in fair value is MBIA Corp.’s nonperformance risk. In aggregate, the nonperformance calculation resulted in a pre-tax net insured derivative liability that was $92 million and $394 million lower than the net liability that would have been estimated if MBIA Corp. excluded nonperformance risk in its valuation as of December 31, 2014 and 2013, respectively. Nonperformance risk is a fair value concept and does not contradict MBIA Corp.’s internal view, based on fundamental credit analysis of MBIA Corp.’s economic condition, that MBIA Corp. will be able to pay all claims when due.
The following tables present information about changes in Level 3 assets (including short-term investments) and liabilities measured at fair value on a recurring basis for the years ended December 31, 2014 and 2013:
Investment agreement obligations require the Company to pledge securities as collateral. Securities pledged in connection with investment agreements may not be repledged by the investment agreement counterparty. As of December 31, 2014 and 2013, the fair value of securities pledged as collateral for these investment agreements approximated $532 million and $735 million, respectively. The Company’s collateral as of December 31, 2014 consisted principally of RMBS and U.S. Treasury and government agency bonds, and was primarily held with major U.S. banks. Additionally, the Company pledged cash and money market securities as collateral under investment agreements in the amount of $26 million and $22 million as of December 31, 2014 and 2013, respectively.
With the weighting applied on the fair value of each security relative to the total fair value, the weighted average contractual maturity of securities in an unrealized loss position as of December 31, 2014 and 2013 was 13 and 18 years, respectively. As of December 31, 2014 and 2013, there were 143 and 77 securities, respectively, that were in an unrealized loss position for a continuous twelve-month period or longer, of which the fair values of 23 and 50 securities, respectively, were below book value by more than 5%.
As of December 31, 2014, the total fair value of the Company’s derivative assets, after counterparty netting of $81 million, was $10 million, of which $2 million was reported within “Other assets” on the Company’s consolidated balance sheets. Embedded derivatives of $8 million were reported within “Medium-term notes” on the Company’s consolidated balance sheets.
During 2013, the Company met with New York State Department of Taxation and Finance to discuss the Company’s respective tax positions regarding certain issues related to the 2008 tax year. In the fourth quarter of 2014, the Company settled with the state.
As of December 31, 2014, the aggregate amount of insured par outstanding ceded by MBIA to reinsurers under reinsurance agreements was $6.1 billion compared with $7.1 billion as of December 31, 2013. The following table presents information about the Company’s reinsurance agreements as of December 31, 2014 for its U.S. public finance and international and structured finance insurance operations.
The following table presents the computation of basic and diluted earnings per share for the years ended December 31, 2014, 2013 and 2012:
The following table presents the changes in the components of AOCI for the years ended December 31, 2014, 2013, and 2012: