In the third quarter of 2006, MBIA finalized a plan to sell MBIA MuniServices Company and certain of its wholly owned subsidiaries (“MuniServices”) to an investor group led by the management of MuniServices. MuniServices provides revenue enhancement services and products to public-sector clients nationwide consisting of discovery, audit, collections/recovery and information services. The Company completed the sale of MuniServices in December 2006.
On November 26, 2007, S&P’s Global Bond Insurance Group announced that it was preparing a comment on bond insurers’ subprime exposure. S&P’s comments on this topic from August 2, 2007 included a stress scenario for the primary bond insurers that reflected an opinion that conservative theoretical deterioration of subprime residential mortgage-backed securities (“RMBS”) and CDOs with subprime collateral would not impair the bond insurer’s capital adequacy.
In determining the case basis reserves of $614 million and the unallocated loss reserve of $200 million recorded in the fourth quarter of 2007 related to the Company’s RMBS exposure, the Company employed a multi-step process using a proprietary cash flow model and a commercially available model, which were used to analyze various collateral performance scenarios and assumptions. The cash flow models used current underlying loan delinquencies and assumptions about future loan delinquencies to project future loan defaults and ultimate cumulative net losses for transactions. The Company is assumed to realize a loss on an insured transaction to the extent that cumulative loan losses exceed available credit support. The Company’s loss reserves were calculated using the following assumptions with respect to the underlying loans within insured RMBS transactions.
4. Benchmark from most relevant spread source (if no specific spreads are available and corporate spreads are not directly relevant, an assumed relationship will be used between corporate spreads or sector specific spreads and collateral spreads)
For example, if current market based spreads are not available then we utilize a generic spread from a published source like CMBX or a corporate cash spread table or a dealer published asset backed spread table. The generic spread utilized is based on the nature of the underlying collateral in the deal. Deals with corporate collateral use the corporate spread table. Deals with asset backed collateral use one or more of the dealer asset backed tables as discussed below. If there are no observable market spreads for the specific collateral, and sector-specific and corporate spread tables are not appropriate to estimate the spread of a given type of collateral, we use the fourth alternative in our hierarchy. An example is tranched corporate collateral. In that case we use corporate spreads as an input and estimate the spread on the tranched position based on an assumed relationship to take account of the tranched structure. In each case the priority is to use information for CDS spreads if available, and cash spreads as a second priority.
The Company’s insurance operations principally comprise the activities of MBIA Corp. MBIA Corp. issues financial guarantees for municipal bonds, asset-backed and mortgage-backed securities, investor-owned utility bonds, bonds backed by publicly or privately funded public purpose projects, bonds issued by sovereign and sub-sovereign entities, obligations collateralized by diverse pools of corporate loans and pools of corporate and asset-backed bonds, both in the new issue and secondary markets. Additionally, MBIA Corp. insures credit default swaps primarily on pools of collateral, which it considers part of its core financial guarantee business.
MBIA is in the process of evaluating how the exposure draft will impact its financial statements. Until final guidance is issued by the FASB and is effective, MBIA will continue to apply its existing policies with respect to the establishment of both case basis and unallocated loss reserves and the recognition of premium revenue. A further description of the Company’s loss reserving and premium recognition policies are included in “Note 2: Significant Accounting Policies” in the Notes to Consolidated Financial Statements.
The Multi-Sector CDO portfolio is comprised of transactions that rely on underlying collateral rated single-A or above (CDOs of High Grade U.S. ABS) and transactions that rely on collateral primarily rated triple-B (CDOs of Mezzanine U.S. ABS). The Multi-Sector CDO portfolio is also comprised of CDOs of Multi-Sector High-Grade collateral, which are diversified transactions generally anchored by high grade tranches of CLOs and contain other collateral including highly rated tranches of CDOs of ABS.
The High Yield Corporate CDO portfolio is largely comprised of middle market/special opportunity corporate loan transactions, broadly syndicated bank CLOs and older vintage corporate high yield bond CDOs. The CDOs in this category are diversified by both vintage and geography (with European and U.S. collateral). The Company did not experience any material credit deterioration to this book in 2007.
A number of liquidity tests are performed to ensure that current liquidity resources are well in excess of expected needs in the short-term and long-term, without relying on new liability issuance. Additionally, liquidity risk is mitigated by (i) provisions in the investment agreements which do not allow discretionary withdrawals and limit an issuer’s withdrawal of funds to specific uses outlined in the agreements, and (ii) risk management procedures that require the regular re-evaluation and re-projection of draw-down schedules and the rebalancing of asset cash flows as needed to meet these draw-downs. Investments are restricted to fixed-income securities with an average credit quality rating of double-A and minimum credit quality rating of investment grade.
During 2008, the Company currently expects that it will be required to make loss payments, before reinsurance, of between $700 million and $800 million primarily relating to insured credits in the RMBS and home equity sectors. In addition, the Company is currently estimating that the Surplus Notes will require interest payments totaling $70 million for 2008. However, the Company anticipates that the estimated cash flow from operations in 2008 in conjunction with its current capital resources, inclusive of the capital strengthening actions taken through February 2008, will be sufficient to meet its estimated liquidity and operating cash requirements in 2008 and the foreseeable future.