A wholly-owned subsidiary of National owns the 280,729 square foot office building on approximately 38 acres of property in Armonk, New York, in which the Company, National, MBIA Corp., Cutwater and Optinuity have their headquarters. The Company also has offices with approximately 24,330 square feet of rental space in New York, New York; San Francisco, California; Paris, France; Madrid, Spain; London, England; and Mexico City, Mexico. Cutwater has 10,383 square feet of office space in Denver, Colorado. The Company generally believes that these facilities are adequate and suitable for its current needs.
(1)-During the three months ended June 30, 2011, the Company identified a model input error related to the measurement of fair value and associated unrealized losses on certain insured derivatives. The error related to the quarter ended March 31, 2011 and had understated pre-tax mark-to-market loss by $207 million. This error did not affect any prior consolidated financial statements.
The following are some of the factors that could affect financial performance or could cause actual results to differ materially from estimates contained in or underlying the Company’s forward-looking statements:
failure to obtain regulatory approval to implement our risk reduction and liquidity strategies;
competitive conditions for bond insurance, including potential entry into the public finance market of insurers of municipal bonds, and changes in the demand for financial guarantee insurance;
the effects of governmental regulation, including insurance laws, securities laws, tax laws, legal precedents and accounting rules; and
MBIA operates one of the largest financial guarantee insurance businesses in the industry and is a provider of asset management advisory services. These activities are managed through three business segments: U.S. public finance insurance, structured finance and international insurance, and advisory services. Our U.S. public finance insurance business is operated through National, our structured finance and international insurance business is operated through MBIA Insurance Corporation and its subsidiaries (“MBIA Corp.”), and our advisory services business is operated through Cutwater Holdings, LLC and its subsidiaries (“Cutwater”). We also manage certain business activities through our corporate, asset/liability products, and conduit segments. Our corporate segment includes revenues and expenses that arise from general corporate activities. Funding programs managed through our asset/liability products and conduit segments are in wind-down.
We believe 2011 continued to suggest restrained economic recovery. U.S. Gross Domestic Product growth was limited by supply chain disruptions related to the earthquake in Japan, severe weather in the U.S. and higher energy prices. Additionally, the events in Europe continue to contribute to global volatility and could further impact economic growth both in Europe and the U.S. While the effects of these events may be transitory, we continue to expect sluggish growth within the U.S. employment, housing and financial sectors. MBIA’s business outlook should be viewed against this backdrop since these are some of the key economic conditions which, together with the ineligibility of mortgage loans supporting our insured RMBS transactions and the volatility of unrealized gains and losses on our insured derivatives, significantly impact our financial results.
The reference herein to “ineligible” mortgage loans refers to those mortgage loans that the Company believes failed to comply with the representations and warranties made by the sellers/servicers of the securitizations to which those mortgage loans were sold (including mortgage loans that failed to comply with the related underwriting criteria), based on the Company’s assessment of such mortgage loans’ compliance with such representations and warranties, which included information provided by third-party review firms. The Company’s assessment of the ineligibility of individual mortgage loans has been challenged by the sellers/servicers of the securitizations in litigation and there is no assurance that the Company’s determinations will prevail.
For 2011, we estimated an additional $1.6 billion of credit losses related to our insured CMBS exposure, primarily on insured credit default swap (“CDS”) contracts. This additional amount reflects the cost of commutations during the fourth quarter of 2011, revised expectations for the cost of commuting similar transactions in the future, and deterioration within some transactions. While average debt service coverage in transactions in our aggregate portfolio has decreased over the last year, debt coverage ratios on some loans have deteriorated significantly. Ultimate loss rates remain uncertain, and we have recorded additional impairments on our insured CMBS portfolio every quarter since the beginning of 2010 as our anticipated economic losses have increased during that time period. It is possible that we will experience severe losses or liquidity needs due to increased deterioration in our insured CMBS portfolio, in particular if macroeconomic stress escalates. A “double dip” recession may result in increased delinquencies, higher levels of liquidations of delinquent loans and/or severities of loss upon liquidation. Although we have also seen stabilization in the delinquency rate over the past several months, loan modifications and extensions granted by the special servicers for these CMBS loans and increased liquidations have contributed to the stabilization. The special servicers are responsible for managing loans that have defaulted and for conducting the remediation and foreclosure process with the objective of maximizing proceeds for all bondholders by avoiding or minimizing loan level losses.
In 2011, MBIA Corp. commuted or agreed to commute $32.4 billion of gross insured exposure primarily comprising CMBS pools, investment grade corporate CDOs, and multi-sector CDOs, among other types of exposures. Subsequent to December 31, 2011, MBIA Corp. agreed to commute transactions with additional counterparties. These transactions, primarily comprising investment grade corporate CDOs, totaled $3.7 billion in gross insured exposure. The total amount the Company agreed to pay to commute these transactions was approximately $500 million in excess of its aggregate statutory loss reserve for such transactions. In consideration for the commutation of insured transactions, including the transactions described above, the Company has made and may in the future make payments to the counterparties, the amounts of which, if any, may be less than or greater than any statutory loss reserves established for the respective transactions. The Company enters into commutations in the ordinary course of its business and does not intend to make contemporaneous disclosures regarding any such transactions regardless of the amounts paid to effect such commutations in relation to the statutory loss reserves established for the respective transactions. Our ability to commute insured transactions may be limited by available liquidity as determined based on management’s assessment.
Escalating uncertainties regarding the European sovereign debt crisis have affected the global economy. MBIA does not insure any direct European sovereign debt. However, MBIA’s indirect European sovereign insured debt exposure totaled $11.4 billion as of December 31, 2011 and included obligations of sovereign-related and sub-sovereign issuers, such as regions, departments, and sovereign-owned entities that are supported by a sovereign state, region or department. Of the $11.4 billion insured gross par outstanding, $833 million, $763 million, and $256 million, related to Spain, Portugal, and Ireland, respectively. The remaining $9.5 billion related to countries outside the Eurozone, principally the United Kingdom. The Company has an immaterial amount of direct and indirect European sovereign debt holdings included in its investment portfolios. A default by one or more sovereign issuers could have an adverse effect on our insured debt exposures and investment portfolios.
Our financial results, prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), have been extremely volatile since the fourth quarter of 2007 as a result of unrealized gains and losses from fair valuing our insured credit derivatives, which we do not believe reflect the underlying economics of our business. We fully expect that reported financial results may remain volatile and uncertain during 2012 as a result of actual and perceived future performance of our insured credit derivatives and the perception of MBIA’s credit risk. Our economic performance may also be volatile depending on changes in our loss estimates based on deviations of macroeconomic conditions and collateral performance from our expectations, further deterioration in economic conditions and financial markets in the U.S. and abroad, including events such as the European sovereign crisis, and the degree of ineligible loans in RMBS securitizations.
Our ability to overcome these economic stresses will depend, in part, on the strength of our balance sheet. Our financial guarantee insurance business model has been significantly impacted since 2008 by adverse credit rating actions by Standard & Poor’s Financial Services LLC (“S&P”) and Moody’s Investors Service, Inc. (“Moody’s”). In August 2011, S&P issued new guidelines that reflect significant changes to its rating methodology for financial guarantee insurers. These new guidelines were effective immediately. The changes to S&P’s rating methodology substantially increase the amount of capital required to achieve its highest ratings, implement a new Largest Obligors Test and incorporate additional qualitative considerations into the ratings process. In November 2011, S&P affirmed its rating on National at BBB and on MBIA Corp. at B. In addition, in December 2011, Moody’s downgraded National’s insurer financial strength rating from Baa1 to Baa2 and changed its outlook from developing to negative and also downgraded MBIA Inc.’s senior debt rating from Ba3 to B2 and placed the ratings of MBIA Corp. under review for possible downgrade. Moody’s cited the primary reason for its rating actions was the weakening of the overall MBIA group’s market standing, mainly due to the deterioration of MBIA Corp.’s credit profile. The absence of S&P’s and Moody’s highest ratings has adversely impacted our ability to write new insurance business and the premiums we can charge, and could diminish the future acceptance of our financial guarantee insurance products.
In December 2011, National entered into a secured loan with MBIA Insurance Corporation (“National Secured Loan”) under which National loaned MBIA Insurance Corporation $1.1 billion in order to enable MBIA Insurance Corporation to fund settlements and commutations of its insurance policies. MBIA Insurance Corporation’s ability to repay the National Secured Loan will primarily be predicated on MBIA Corp.’s ability to collect on its future receivables, including its ability to successfully enforce its rights to have mortgage sellers/servicers cure, replace or repurchase ineligible mortgage loans from securitizations it insured. As a result, the existence of the National Secured Loan may adversely affect National’s ability to achieve higher stable ratings and, therefore, its ability to write new business. Refer to the “Liquidity” section herein for information about the terms of the National Secured Loan.
We also use adjusted pre-tax income (loss), a non-GAAP measure, to supplement our analysis of our periodic results. We consider adjusted pre-tax income (loss) a measure of fundamental periodic financial performance, which we believe is useful for an understanding of our results. Adjusted pre-tax income (loss) adjusts GAAP pre-tax income (loss) to remove the effects of consolidating insured VIEs and gains and losses related to insured credit derivatives, which we believe will reverse over time, as well as to add in changes in the present value of insurance claims we expect to pay on insured credit derivatives based on our ongoing insurance loss monitoring. Adjusted pre-tax income (loss) is not a substitute for and should not be viewed in isolation from GAAP pre-tax income (loss), and our definition of adjusted pre-tax income (loss) may differ from that used by other companies. Refer to the following “Results of Operations” section for a reconciliation of adjusted pre-tax income (loss) to GAAP pre-tax income (loss).
During 2011, our business segments continued to maintain adequate liquidity to meet their payment obligations despite minimal collections of recoveries in connection with ineligible loans in our insured RMBS securitizations. However, MBIA Corp.’s liquidity position weakened as a result of commutation and loss payments and MBIA Inc.’s liquidity (primarily comprising of the liquidity positions of its corporate and asset/liability products activities) experienced stress as a result of deterioration in the market values of assets. As of December 31, 2011, National and MBIA Corp. had $703 million and $534 million, respectively, of total liquidity without regard to investments in their subsidiaries. Total liquidity within our insurance businesses includes cash and short-term investments, as well as other assets that are readily available for liquidity purposes. As of December 31, 2011, MBIA Inc. had $226 million of cash and highly liquid assets available for general corporate liquidity purposes, excluding the amounts held in escrow under its tax sharing agreement, and $160 million of cash and liquid assets not pledged as collateral in its asset/liability products activities. A detailed discussion of the Company’s liquidity position is presented within the “Liquidity” section herein.
Our consolidated book value (total shareholders’ equity) was $1.7 billion as of December 31, 2011, compared with $2.8 billion as of December 31, 2010. The decrease was primarily a result of our consolidated net loss for the year ended December 31, 2011, partially offset by a decrease in net unrealized losses within accumulated other comprehensive loss resulting from improvements in the value of our consolidated investment portfolio. Our consolidated book value per share as of December 31, 2011 was $8.80, compared with $14.18 as of December 31, 2010. The decrease in book value per share resulting from the decrease in our consolidated book value was partially offset by lower shares outstanding as a result of repurchases of common shares during 2011.
As of December 31, 2011, ABV per share was $34.50, down from $36.81 as of December 31, 2010, reflecting a modest decline compared with the decline in our consolidated book value described above. The decrease in ABV per share was primarily driven by additional estimated credit impairments on insured credit derivatives and a reduction in the value of expected installment premiums resulting from the early settlement of policies during 2011, partially offset by the effect of repurchasing common shares during 2011.
A detailed discussion of our financial results is presented within the “Results of Operations” section included herein. Refer to the “Capital Resources-Insurance Statutory Capital” section for a discussion of National’s and MBIA Corp.’s capital position under statutory accounting principles (“U.S. STAT”).
Since 2007, the majority of our case basis reserves and insurance loss recoveries were related to insured second-lien RMBS transactions. Refer to “Note 6: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements for a comprehensive discussion of our RMBS loss reserves and recoveries, including critical accounting estimates used in the determination of these amounts.
The fair value pricing of assets and liabilities is a function of many components which include interest rate risk, market risk, liquidity risk and credit risk. For financial instruments that are internally valued by the Company, as well as those for which the Company uses broker quotes or pricing services, credit risk is typically incorporated by using appropriate credit spreads or discount rates as inputs. Refer to “Note 7: Fair Value of Financial Instruments” in the Notes to Consolidated Financial Statements for further information about the Company’s financial assets and liabilities that are accounted for at fair value, including valuation techniques and disclosures required by GAAP.
Substantially all of the Company’s investments are priced by independent third parties, including pricing services and brokers. The fair values of investments for which internal prices were used were not significant to the aggregate fair value of our investment portfolio as of December 31, 2011 or 2010. Investments with fair values derived from pricing services or broker quotes are classified within Level 1, 2 or 3 of the fair value hierarchy, depending on the observability of inputs. Typically we receive one pricing service value or broker quote for each instrument, which represents a non-binding indication of value. When a price is received by more than one source, the Company uses the lower of the prices provided. We review the assumptions, inputs and methodologies used by pricing services to obtain: (i) reasonable assurance that the prices used in our valuations reflect fair value, and (ii) a basis for classification within the three levels of the fair value hierarchy. For example, broker quoted prices are classified as Level 3 if we determine that the inputs used are not market-based and observable. Independent pricing data is received monthly and we use a variety of methods to analyze the reasonableness of these third-party valuations, including comparisons to similar quality and maturity assets, internal modeling of implied credit spreads by sector and quality, comparison to published spread estimates, and assessment relative to comparable dealer offerings or any actual transactions from a recent time period. When we believe a third-party quotation differs significantly from our internal value, whether higher or lower, we review our data or assumptions with the provider. This review includes comparing significant assumptions such as prepayment speeds, default ratios, forward yield curves, credit spreads and other significant quantitative inputs to internal assumptions, and working with the price provider to reconcile the differences. The price provider may subsequently provide an updated price. In the event that the price provider does not update their price, and the Company still does not agree with the price provided, the Company will try to obtain a price from another third party provider, such as a broker, or use an internally developed price which we believe represents the fair value of the investment. All challenges to third-party prices are reviewed by staff of the Company with relevant expertise to ensure reasonableness of assumptions and compliance with internal control and documentation procedures.
While we review third-party prices for reasonableness, we are not the source for any of the inputs or assumptions used in developing those prices. Additionally, we do not have access to the specific models used by the third-party price providers. As a result, we cannot provide the potential impact of reasonably likely changes in inputs and assumptions used in these models. Consequently, we are unable to determine if such reasonably likely changes in inputs and assumptions would have a material impact on our financial condition or results of operations.
Our derivative liabilities are primarily insured credit derivatives that reference structured pools of cash securities and CDSs. We generally insured the most senior liabilities of such transactions, and at the inception of transactions our exposure generally had more subordination than needed to achieve triple-A ratings from credit rating agencies. The types of collateral underlying our insured derivatives consist of cash securities and CDSs referencing primarily corporate, asset-backed, residential mortgage-backed, commercial mortgage-backed, CRE loans, and CDO securities.
The following table presents the fair values of assets and liabilities recorded on our consolidated balance sheets that are classified as Level 3 within the fair value hierarchy as of December 31, 2011 and 2010:
(2)-Valued using quoted prices for which the inputs are unobservable or valuation models with significant unobservable inputs.
Valuation allowances are established to reduce deferred tax assets to an amount that more likely than not will be realized. Changes in the amount of a valuation allowance are reflected within our provision for income taxes in our consolidated statements of operations. Determining whether to establish a valuation allowance and, if so, the amount of the valuation allowance requires management to exercise judgment and make assumptions regarding whether such tax benefits will be realized in future periods. All evidence, both positive and negative, needs to be identified and considered in making this determination. Future realization of the existing deferred tax asset ultimately depends on management’s estimate of the future profitability and existence of sufficient taxable income of appropriate character (for example, ordinary income versus capital gains) within the carry-forward period available under the tax law. In the event that the Company’s estimate of taxable income is less than that required to utilize the full amount of any deferred tax asset, a valuation allowance is established. As of December 31, 2011 and 2010, the Company’s valuation allowance was $236 million and $376 million, respectively. The change in the valuation allowance for the year ended December 31, 2011 was primarily due to generation of capital gains on asset sales and the re-characterization of certain impairments as bad debts resulting in ordinary losses. Our valuation allowance primarily relates to realized losses on sales of investments being carried forward as capital losses and impairments of certain assets also characterized as capital losses. Capital losses may only be offset by capital gains and any capital loss not utilized in the year generated can only be carried forward five years.
For the year ended December 31, 2011, we recorded a consolidated net loss of $1.3 billion or $6.69 per share compared with consolidated net income of $53 million or $0.26 per share, for 2010. Weighted average shares outstanding totaled 197 million for the year ended December 31, 2011, down 3% from 2010 as a result of share repurchases by the Company. Consolidated total revenues (losses) for the year ended December 31, 2011 reported in the above table included $2.8 billion of net losses on insured derivatives compared with $769 million of net losses for 2010. The net losses on insured derivatives in 2011 and 2010 principally resulted from favorable changes in the market perception of MBIA Corp.’s credit risk, which resulted in a tightening of the Company’s credit spreads and an improvement in the Company’s recovery rate, and unfavorable changes in credit spreads and prices of underlying collateral. Consolidated total expenses for the year ended December 31, 2011 included a benefit of $80 million of net insurance loss and LAE compared with an expense of $232 million for 2010. The net insurance benefit in 2011 and loss in 2010 were principally related to our insured RMBS exposure.
For the year ended December 31, 2010, we recorded consolidated net income of $53 million or $0.26 per share compared with consolidated net income of $623 million or $2.99 per share for 2009 after adjusting for preferred stock dividends of MBIA Insurance Corporation. Weighted average shares outstanding totaled 203 million for the year ended December 31, 2010, down 2% from 2009 as a result of repurchases of common stock by the Company. Consolidated revenues for the year ended December 31, 2010 were $894 million compared with $3.0 billion for 2009. The decrease in our consolidated revenues was principally due to a $769 million net loss on insured derivatives in 2010 compared with a $1.5 billion net gain in 2009. The net loss and net gain in 2010 and 2009, respectively, principally resulted from changes in the market perception of MBIA Corp.’s credit risk. The net loss in 2010 principally reflected a tightening of the Company’s credit spreads and an improvement in the Company’s recovery rate while the net gain in 2009 principally reflected a widening of the Company’s credit spreads and a reduction in the Company’s recovery rate. Consolidated expenses for the year ended December 31, 2010 were $989 million compared with $1.7 billion for 2009. The decrease in our consolidated expenses principally reflects a reduction in loss and LAE incurred on our insured RMBS exposure, a decrease in interest expense resulting from a reduction in outstanding debt within our asset/liability products program, and overall lower operating and policy acquisition expenses.
The following table presents our consolidated adjusted pre-tax income (loss) (a non-GAAP measure) and provides a reconciliation of adjusted pre-tax income (loss) to GAAP pre-tax income (loss) for the years ended December 31, 2011, 2010 and 2009:
(4)-The discount rate on insured derivative installment revenue and impairments was 5.0% as of December 31, 2011 and 2010.
For the years ended December 31, 2011, 2010 and 2009, we did not write a meaningful amount of U.S. public finance insurance. The lack of insurance writings in our U.S. public finance segment reflects the insurance financial strength credit ratings assigned to National by major ratings agencies and the impact of litigation over the formation of National in 2009. We do not expect to write a material amount of new business prior to an upgrade of our insurance financial strength ratings and market acceptance that such ratings will be stable in the future. The timing of any such upgrade is uncertain and will depend on a variety of quantitative and qualitative factors used by the rating agencies in their evaluation, including the resolution of pending litigation. We believe that we will resume writing business in the U.S. public finance market before actively re-engaging in the structured finance and international markets.
ADJUSTED PRE-TAX INCOME In addition to the above, we also analyze the operating performance of our U.S. public finance insurance segment using adjusted pre-tax income. We believe adjusted pre-tax income, as used by management, is useful for an understanding of the results of operations of our U.S. public finance insurance segment. Adjusted pre-tax income is not a substitute for pre-tax income determined in accordance with GAAP, and our definition of adjusted pre-tax income may differ from that used by other companies.
For the years ended December 31, 2011, 2010 and 2009, there were no material differences between adjusted pre-tax income and GAAP pre-tax income.
For the year ended December 31, 2010, U.S. public finance net premiums earned were $442 million compared with $551 million for 2009. The decrease was due to a decline in scheduled premiums earned of $71 million and a decline in premiums earned from refunding activity of $38 million. Scheduled premium earnings declined due to the maturity of insured issues within our U.S. public finance portfolio with no material new insurance writings. During 2010, premiums from refunded issues declined as a result of lower premium rates on these transactions compared with higher premium rates on issues refunded during 2009.
NET INVESTMENT INCOME For the year ended December 31, 2011, our U.S. public finance insurance investment portfolio generated $216 million of net investment income compared with $230 million for 2010 and $217 million for 2009. The decrease in net investment income for 2011 from 2010 was primarily due to lower yields on new investment purchases, declines in notional amounts and declining average interest rates on the repurchase and reverse repurchase transactions with our asset/liability products segment. The increase in net investment income for 2010 from 2009 reflects the timing of our insurance business transformation in mid-February 2009 compared with a full year of net investment income in 2010.
National maintains simultaneous repurchase and reverse repurchase agreements (“Asset Swap”) with our asset/liability products segment, which provides yield enhancement to our U.S. public finance insurance investment portfolio as a result of increased net interest earnings from these collective agreements. In addition, during 2011 the interest income on the National Secured Loan, established in December of 2011, was included in our U.S. public finance net investment income and totaled approximately $4 million for the year ended December 31, 2011. The National Secured Loan enhances the overall yield of our U.S. public finance insurance investment portfolio as lower yielding investments were sold to fund the amount loaned under this agreement. Refer to the “Liquidity” section included herein for additional information about these agreements.
FEES AND REIMBURSEMENTS For the year ended December 31, 2011, fees and reimbursements were $8 million compared with $22 million and $16 million for 2010 and 2009, respectively. The decrease in 2011 from 2010 was primarily due to the receipt, in 2010, of amounts in excess of those which were contractually due to National upon the termination of a reinsurance agreement as compensation for potential future performance volatility related to reassumed exposures. The increase in 2010 from 2009 was primarily due to rental income earned from our affiliates related to their occupancy of the Armonk facility and an increase in waiver and consent fees related to the ongoing maintenance of our insured portfolio. Due to the transaction-specific nature inherent in fees and reimbursements, these revenues can vary significantly period to period.
For the year ended December 31, 2011, losses and LAE incurred of $4 million primarily related to two tax-backed transactions, a toll road transaction and a housing transaction, partially offset by net reversals of estimated losses on affordable housing transactions. Additionally, a reversal of loss and LAE reserves principally related to future payments on a tax-backed transaction was offset by the reversal of the corresponding recoveries of such payments. For the year ended December 31, 2010, losses and LAE incurred of $73 million primarily related to three housing transactions, two student loan transactions, a not-for-profit transaction and a health care transaction. Additionally, increases in loss and LAE reserves related to a gaming revenue transaction were offset by expected recovery of the full amount of such losses. For the year ended December 31, 2009, losses and LAE incurred of $94 million primarily related to a housing transaction and a student loan transaction.
POLICY ACQUISITION COSTS AND OPERATING EXPENSES U.S. public finance insurance segment expenses for the years ended December 31, 2011, 2010 and 2009 are presented in the following table:
Amortization of deferred acquisition costs increased for the year ended December 31, 2011 compared with 2010 and decreased for the year ended December 31, 2010 compared with 2009. Theses variances were consistent with the amortization of the related unearned premium revenue. Operating expenses increased for the year ended December 31, 2011 compared with 2010 and 2009. These increases were a result of the increases in gross expenses as we did not defer a material amount of policy acquisition costs during 2011, 2010 or 2009.
Our structured finance and international insurance business is principally conducted through MBIA Corp. The financial guarantees issued by MBIA Corp. generally provide unconditional and irrevocable guarantees of the payment of the principal of, and interest or other amounts owing on, insured obligations when due or, in the event MBIA Corp. has the right at its discretion to accelerate insured obligations upon default or otherwise, upon MBIA Corp.’s acceleration. Certain investment agreement contracts written by MBIA Inc. or its subsidiaries are insured by MBIA Corp. If MBIA Inc. or such subsidiaries were to have insufficient assets to pay amounts due, MBIA Corp. would make such payments under its insurance policies. MBIA Corp. also insured debt obligations of other affiliates, including MBIA Global Funding, LLC (“GFL”) and Meridian Funding Company, LLC (“Meridian”), and provides reinsurance to its insurance subsidiaries. MBIA Corp. has also written insurance policies guaranteeing the obligations of an affiliate, LaCrosse Financial Products, LLC under CDS, including termination payments that may become due upon certain events including the insolvency or payment default of the financial guarantor or the CDS issuer.
MBIA Corp.’s guarantees insure structured finance and asset-backed obligations, privately issued bonds used for the financing of public purpose projects that are primarily located outside of the U.S. which include toll roads, bridges, airports, public transportation facilities, utilities and other types of infrastructure projects serving a substantial public purpose, and obligations of sovereign-related and sub-sovereign issuers. Structured finance and asset-backed securities (“ABS”) typically are securities repayable from expected cash flows generated by a specified pool of assets, such as residential and commercial mortgages, insurance policies, consumer loans, corporate loans and bonds, trade and export receivables, and leases and loans for equipment, aircraft and real property.
ADJUSTED PRE-TAX INCOME In addition to the above, we also analyze the operating performance of our structured finance and international insurance segment using adjusted pre-tax income (loss). We believe adjusted pre-tax income (loss), as used by management, is useful for an understanding of the results of operations of our structured finance and international insurance segment. Adjusted pre-tax income (loss) is not a substitute for pre-tax income (loss) determined in accordance with GAAP, and our definition of adjusted pre-tax income (loss) may differ from that used by other companies.
For the year ended December 31, 2010, adjusted pre-tax loss was $692 million compared with an adjusted pre-tax loss of $1.3 billion for 2009. Adjusted total revenues for the year ended December 31, 2010 increased from 2009 principally due to higher premiums on insured derivative transactions due to the termination of reinsurance with Channel Re, and higher unrealized gains on financial instruments at fair value and foreign exchange. Adjusted total expenses for the year ended December 31, 2010 decreased from 2009 principally due to a reduction in insurance losses and a decrease in policy acquisition and operating expenses.
(1)-Includes gross par outstanding of $11.4 billion and $18.1 billion related to our consolidated VIEs as of December 31, 2011 and 2010, respectively.
Net premiums earned on non-derivative financial guarantee contracts for the years ended December 31, 2011, 2010 and 2009 are presented in the following table. Net premiums earned represent gross premiums earned net of premiums ceded to reinsurers, and include scheduled premium earnings and premium earnings from refunded issues.
Structured finance and international net premiums earned decreased in 2011 and 2010 due to the maturity and early settlement of insured transactions with no new material insurance writings. Additionally, 2009 benefited from $45 million of premiums earned related to the termination of MBIA’s remaining Eurotunnel exposure.
MBIA Corp., as lender, maintained a secured lending agreement with our asset/liability products segment (“MBIA Corp. Secured Loan”). Interest income on this arrangement, totaling approximately $14 million, $30 million and $60 million for the years ended December 31, 2011, 2010 and 2009, respectively, is included in our structured finance and international insurance net investment income. Refer to the “Liquidity” section included herein for additional information about this agreement.
NET CHANGE IN FAIR VALUE OF INSURED DERIVATIVES The following table presents the net premiums earned related to derivatives and the components of the net change in fair value of insured derivatives for the years ended December 31, 2011, 2010 and 2009:
As of December 31, 2011, MBIA Corp.’s five year CDS cost was 31.50% upfront plus 5% per annum compared with 56.25% upfront plus 5% per annum and 64.25% upfront plus 5% per annum as of December 31, 2010 and 2009, respectively. Our mark-to-market on insured credit derivatives uses the most appropriate of the one to ten year CDS cost for each transaction, and those costs ranged from 13.50% upfront plus 5% per annum to 33.50% upfront plus 5% per annum as of December 31, 2011. Those costs ranged from 15.75% upfront plus 5% per annum to 57.50% upfront plus 5% per annum as of December 31, 2010 and ranged from 17.50% upfront plus 5% per annum to 64.25% upfront plus 5% per annum as of December 31, 2009.
As of December 31, 2011, we had $67.0 billion of gross par outstanding on insured credit derivatives compared with $99.5 billion as of December 31, 2010. The decrease in gross par outstanding was primarily due to settlements prior to maturity, contractual terminations, amortizations and maturities. During the year ended December 31, 2011, 48 insured issues, representing $31.4 billion in gross par outstanding, had either matured or were contractually settled prior to maturity. The decrease in gross par was also due to amortization and retranslation of foreign currency exposure at current foreign currency rates partially offset by additional gross par related to the deconsolidation of two VIEs.
Our estimate of credit impairments, a non-GAAP measure, may differ from the fair values recorded in our consolidated financial statements. Although the Company’s statements of operations include the fair values, the Company believes its disclosure of credit impairments on insured derivatives provides additional meaningful information about potential realized losses on these contracts. The fair value of an insured derivative contract will be influenced by a variety of market and transaction-specific factors that may be unrelated to potential future claim payments. In the absence of credit impairments or the termination of derivatives at losses, the cumulative unrealized losses recorded from fair valuing insured derivatives should reverse before or at the maturity of the contracts. Contracts also may be settled prior to maturity at amounts that may be more or less than their recorded fair values. Those settlements can result in realized gains or losses, and will result in the reversal of unrealized gains or losses. The Company is not required to post collateral to counterparties of these contracts.
REVENUES OF CONSOLIDATED VIEs For the year ended December 31, 2011, total revenues of consolidated VIEs within our structured finance and international insurance segment were $337 million compared with $246 million for 2010 and a loss of $58 million for 2009. The increase in revenues of consolidated VIEs for the year ended December 31, 2011, primarily relate to an increase of $331 million from other net realized gains and losses as a result of the consolidation and deconsolidation of VIEs. This increase was partially offset by a decrease of $239 million in net gains and losses on financial instruments at fair value and foreign exchange, principally due to a decrease in RMBS securitizations and favorable changes in the market perception of MBIA Corp.’s credit risk. The increase in revenues of consolidated VIEs for the year ended December 31, 2010, when compared with 2009, was principally driven by an increase of $259 million in net gains and losses on financial instruments at fair value and foreign exchange, as well as a decrease of other-than-temporary impairments of VIE assets.
The Company performs an analysis to determine whether its variable interests give it a controlling financial interest in a VIE. This recurring assessment may require the Company to consolidate or deconsolidate entities that it has variable interests in.
(1)-Included in “Losses and loss adjustment expense,” “Loss and loss adjustment expense reserves” and “Insurance loss recoverable” on the Company’s consolidated statements of operations and consolidated balance sheets.
(3)-Represents statutory losses and LAE and recoveries for insurance contracts accounted for as derivatives. Realized and unrealized gains and losses on these contracts under GAAP are recorded in “Net change in fair value of insured derivatives” on the Company’s consolidated statements of operations and the fair value of these contracts are recorded in “Derivative liabilities” on the Company’s consolidated balance sheets.
(5)-Represents statutory losses and LAE for insurance contracts accounted for as derivatives. Realized and unrealized gains and losses on these contracts under GAAP are recorded in “Net change in fair value of insured derivatives” on the Company’s consolidated statements of operations.
Losses and LAE incurred in our structured finance and international insurance segment totaled $159 million in 2010. Included in the $159 million was $883 million of gross losses related to actual and expected future payments, of which $487 million related to insured second-lien RMBS transactions, and $396 million related to other activity. Offsetting these losses were increases in recoveries of actual and expected payments of $712 million, of which $658 million related to insured second-lien RMBS transactions, and reinsurance of $12 million. The $658 million of recoveries related to second-lien RMBS transactions included $682 million of recoveries resulting from ineligible mortgage loans included in insured exposures that are subject to contractual obligations by sellers/servicers to repurchase or replace such mortgage loans, offset by a $24 million reduction in excess spread within the securitizations.
For the years ended December 31, 2011, 2010 and 2009, losses and LAE incurred included the elimination of a $90 million benefit, a $79 million expense and a $16 million expense, respectively, as a result of the consolidation of VIEs. The $90 million elimination for the year ended December 31, 2011 included recoveries of actual and expected payments of $351 million offset by gross losses related to actual and expected future payments of $261 million. The $79 million elimination for the year ended December 31, 2010 included gross losses related to actual and expected future payments of $1.1 billion offset by recoveries of actual and expected payments of $1.0 billion. The $16 million elimination for the year ended December 31, 2009 included gross losses related to actual and expected future payments of $618 million offset by recoveries of actual and expected payments of $602 million.
MBIA reports expected potential recoveries of certain paid claims within “Insurance loss recoverable” and the corresponding estimated recovery amounts due to reinsurers within “Other liabilities” on the Company’s consolidated balance sheets. As of December 31, 2011 and 2010, our insurance loss recoverable in our structured finance and international insurance segment was $2.9 billion and $2.5 billion, respectively. The increase in our insurance loss recoverable principally resulted from an increase in expected potential recoveries resulting from the aforementioned obligations of the sellers/servicers of second-lien RMBS transactions to repurchase ineligible mortgage loans. As of December 31, 2011 and 2010, our insurance loss recoverable also included estimated recoveries of approximately $731 million and $674 million, respectively, from excess spread within second-lien RMBS securitizations. Insurance loss recoverables due to reinsurers totaled $7 million and $1 million as of December 31, 2011 and 2010, respectively. Insurance loss recoverables are only paid to reinsurers upon receipt of such amounts by MBIA.
The following table presents the par outstanding of MBIA Corp.’s total direct RMBS insured exposure as of December 31, 2011 by S&P credit rating category. Amounts include the par outstanding related to transactions that the Company consolidates under accounting guidance for VIEs.
The following table presents the par outstanding by vintage year of MBIA Corp.’s total second-lien residential mortgage loan securitizations insured exposure as of December 31, 2011. Amounts include the par outstanding related to transactions that the Company consolidates under accounting guidance for VIEs.
During the year ended December 31, 2011, we paid approximately $745 million, net of reinsurance and collections, on insured second-lien RMBS transactions, or $507 million after eliminating $238 million of net payments made on behalf of consolidated VIEs. Through December 31, 2011, we paid a cumulative total of $6.0 billion, net of reinsurance and collections, or $3.9 billion after eliminating $2.1 billion of net payments on insured second-lien RMBS transactions that are currently consolidated as VIEs. As of December 31, 2011, we had loss and LAE reserves related to our remaining insured second-lien RMBS exposure of $285 million before eliminating $93 million of loss and LAE reserves related to our consolidated VIEs. The loss and LAE reserves represent the present value of the difference between cash payments we expect to make on the insured transactions and the cash receipts we expect from the performing mortgage loans in the securitizations. As payments are made, a portion of those expected future receipts is recorded within “Insurance loss recoverable” in our consolidated balance sheets. The payments that we make virtually all go to reduce the principal balances of the securitizations.
As of December 31, 2011, the par outstanding on insured second-lien RMBS transactions included in the preceding table was $4.9 billion compared with $6.0 billion as of December 31, 2010. As of December 31, 2011, we expect to pay an additional $452 million (on a present value basis) on these transactions and expect to receive a total of $991 million (on a present value basis) in reimbursement of past and future expected claims through excess spread in these transactions. Of this amount, $731 million is included in “Insurance loss recoverable” and $260 million is included in “Loss and loss adjustment expense reserves.” In addition, we expect to receive $2.0 billion (on a present value basis) in respect of the sellers’/servicers’ obligation to repurchase ineligible mortgage loans, which is included in “Insurance loss recoverable”.
We have recorded actual or expected put-back recoveries for amounts paid on all second-lien RMBS transactions included in the above table with the exception of two issues with original par insured of $695 million, gross par outstanding of $111 million and gross claims paid since inception of $450 million. There is one additional issue for which a forensic review was performed but has been excluded from the above table because it has not been placed on our “Classified List” and we have not made a claim payment. There are two first-lien alternative A-paper deals for which a forensic review was performed, but have been excluded from the above table.
The following table provides information about second-lien RMBS transactions included in MBIA Corp.’s insured portfolio for which it has made claim payments and LAE, net of collections, as of December 31, 2011 and for which it consolidates under accounting guidance for VIEs. As such, these payments are not reflected as insurance losses in our consolidated financial statements subsequent to consolidation. Of the $2.1 billion gross payments, $655 million were eliminated subsequent to consolidation. As of December 31, 2011, the Company has recorded actual or expected put-back recoveries as a result of forensic reviews and extrapolation for amounts paid on all second-lien RMBS transactions included in the following table:
Second-Lien RMBS Transactions with Claim Payments and Forensic Reviews (Consolidated VIEs)
POLICY ACQUISITION COSTS AND OPERATING EXPENSES Structured finance and international insurance segment expenses for the years ended December 31, 2011, 2010 and 2009 are presented in the following table:
Gross expenses represent total insurance expenses before the deferral of any policy acquisition costs. Gross expenses increased for the year ended December 31, 2011 compared with 2010 due to an increase in compensation as a result of a reversal of accrued bonus expense in 2010. Gross expenses decreased for the year ended December 31, 2010 compared with 2009 due to reductions in compensation and other administrative expenses resulting from the transfer of employees to Optinuity, the service company that we established in the first quarter of 2010.
The decrease in the amortization of deferred acquisition costs for the year ended December 31, 2011 compared with 2010 and 2009 principally reflects the acceleration of deferred costs into earnings in prior periods as policies were terminated. Operating expenses increased for the year ended December 31, 2011 compared with 2010 as a result of the increase in gross expenses. Operating expenses decreased for the year ended December 31, 2010 compared with 2009 as a result of the decrease in gross expenses. We did not defer a material amount of policy acquisition costs during 2011 or 2010. Policy acquisition costs in these periods were related to premium taxes and assessments on installment policies written in prior periods.
Beginning in December 2011, interest expense in our structured finance and international insurance segment includes interest associated with the National Secured Loan. Interest expense on the National Secured Loan totaled approximately $4 million for the year ended December 31, 2011.
The following is a summary of selected significant exposures within the insured portfolio of our structured finance and international insurance segment. The Company has large exposures to many of these sectors. Moreover, many of them are and have been considered volatile over the past several years. As described below, considerable incurred losses and future expected payments are attributable to many of these sectors.
As part of our structured finance and international insurance activities, MBIA Corp. typically provided guarantees on senior and mezzanine tranches of CDOs, as well as protection on structured CMBS pools and corporate securities, and CDS referencing such securities. The following discussion, including reported amounts and percentages, includes insured CDO transactions consolidated by the Company as VIEs.
(1)-Includes one multi-sector CDO-squared transaction with gross par of $153 million as of December 31, 2011.
Our investment grade corporate CDO exposure references pools of predominantly investment grade corporate credits. Additionally, some of these pools may include limited exposure to other asset classes, including structured finance securities (such as RMBS and CDOs). Most of our investment grade corporate CDO policies guarantee coverage of losses on collateral assets once Insured Tranche Subordination in the form of a deductible has been eroded, and are generally highly customized structures. As of December 31, 2011, the majority of insurance protection provided by MBIA Corp. on investment grade corporate CDO exposure was attached at a super senior level. Our gross par exposure to investment grade corporate CDOs of $32.6 billion represents 46% of MBIA Corp.’s CDO exposure and 23% of MBIA Corp.’s total gross par insured. The Company’s insured investment grade corporate CDOs have experienced Insured Tranche Subordination erosion due to default of underlying referenced corporate obligors, as well as certain structured finance securities, but we currently do not expect losses on MBIA Corp.’s insured tranches. As of December 31, 2011, the collateral amount in the portfolio exceeds the gross par outstanding as a result of credit enhancement (such as over-collateralization and Insured Tranche Subordination).
Our gross par of insured investment grade corporate CDOs includes $13.8 billion that was typically structured to include buckets (typically 30% to 35% of the overall CDO) of references to specific tranches of other investment grade corporate CDOs (monotranches). In such transactions, MBIA Corp.’s insured investment grade corporate CDOs include, among direct corporate or structured credit reference risks, a monotranche or single layer of credit risk referencing a diverse pool of corporate assets or obligors with a specific attachment and a specific detachment point. The referenced monotranches in such CDOs were typically rated double-A and sized to approximately 3% of the overall reference risk pool. The inner referenced monotranches are not typically subject to acceleration and do not give control rights to a senior investor. The inner referenced monotranches have experienced Insured Tranche Subordination erosion due to the default of their referenced corporate assets.
As of December 31, 2011, we had $24.9 billion of gross par exposure to the CRE sector through insured structured transactions primarily comprising CRE collateral. Our CRE portfolio can be largely sub-divided into two distinct categories: structured CMBS pools and CRE CDOs. In addition, MBIA Corp. insures approximately $3.4 billion in CRE loan pools, primarily comprising European assets, some of which are subject to commutation agreements. These CRE loans are not included in the following discussion. Subsequent to December 31, 2011, MBIA Corp. agreed to commute $563 million of gross insured CRE exposure.
The collateral in the pools are generally CMBS bonds or CDSs referencing CMBS bonds (collectively, “CMBS bonds”). MBIA Corp.’s guarantee generally is in the form of a CDS referencing the static pooled transactions. MBIA Corp. would have a payment obligation if the volume of CMBS bond defaults exceeds the deductible level in the transaction. Each pool comprising CMBS bonds is ultimately backed by the commercial mortgage loans securitized within each CMBS trust. The same CMBS bonds may be referenced in multiple pools. The Company’s structured CMBS pools are static, meaning that the collateral pool of securitizations cannot be and has not been changed since the origination of the policy. Most transactions comprise similarly rated underlying tranches. The deductible for each transaction varies according to the ratings of the underlying collateral. For example, a transaction comprising originally BBB rated underlying CMBS bonds would typically include a 30-35% deductible to MBIA Corp.’s position whereas a transaction comprising all originally AAA rated underlying CMBS bonds would typically require a 5-10% deductible.
While on an aggregate basis the deductible levels in the above table show little erosion, certain policies reflected in the table have experienced significant deductible erosion. This significant deductible erosion was largely due to liquidations of underlying loan collateral in those transactions over the past two years. Several insured transactions reflected in the table, which have an aggregate gross par outstanding of $4.1 billion, include concentrations of repackaged CRE-related collateral (e.g., a CRE CDO or other re-securitization of CMBS) that, in many cases, had low original ratings. Given the low ratings of the repackaged CMBS collateral, many of the underlying repackaged securities are expected to have substantial or complete losses, which will cause erosion of the deductibles in those insured transactions, and are modeled as such by MBIA for purpose of assessing credit impairments.
In addition, we have experienced ratings erosion in the total CMBS collateral underlying our insured static pools. Whereas approximately 34% of the total CMBS collateral underlying the pools outstanding as of December 31, 2011, was originally rated BBB and below and approximately 44% was originally rated AAA, 64% of the total CMBS collateral underlying these pools as of December 31, 2011 was rated below investment grade. The higher risk of the collateral that was originally rated BBB and below was intended to be offset by the diversification in the collateral pool and the level of the deductible, whereas pools backed by all AAA collateral benefited from diversification and required smaller deductibles. In all cases, regardless of the underlying collateral rating, MBIA Corp.’s insured position was rated AAA at origination of the transaction by at least Moody’s, S&P or Fitch.
Currently, we insure nine static CMBS pools, having $6.4 billion of gross par outstanding as of December 31, 2011, that were originally insured in 2006 and 2007, and in which substantially all of the underlying collateral comprised CMBS tranches originally rated BBB and lower. The remainder of the collateral in these nine pools consisted of higher rated CMBS bonds, REIT debt and other securities. The BBB and below rated CMBS bonds underlying these nine pools had original credit enhancement levels that ranged from 0.0% to 9.0% with an original weighted average credit enhancement level of 3.2%, compared to credit enhancement levels that range from 0.0% to 85.0% with a weighted average credit enhancement level of 2.4% as of December 31, 2011. MBIA Corp.’s original policy level deductibles for these nine insured pools ranged from 23.0% to 82.3% with an original weighted average deductible by gross par outstanding of 37.6%, compared to deductibles that range from 16.4% to 84.8% with a weighted average deductible by gross par outstanding of 32.4% as of December 31, 2011. As of December 31, 2011, most of MBIA Corp.’s estimated credit impairments of $505 million for our static CMBS pools relate to a subset of these nine pools. One of these transactions totaling $325 million of gross par outstanding, will be commuted pursuant to a commutation agreement executed in 2011. The Company has no material credit risk exposure to this pool. Additionally, during 2011, the Company commuted 12 CMBS pools transactions comprised of collateral originally rated BBB or lower, reducing gross par outstanding by $11.2 billion for this subset of static CMBS pools.
The following table presents the vintage and original rating composition of the CMBS collateral in our static CMBS pools:
As of December 31, 2011, our structured CMBS pool portfolio comprised almost 43,000 loans. The current weighted average debt service coverage ratio (“DSCR”) of underlying mortgage loans in the CMBS pools was 1.51 based on net operating income derived from the most recent property level financial statements (based on 82% of the properties having provided 2010 financial statements or a more recent time period) compared with an average DSCR of 1.69 as of December 31, 2010. Although the average DSCR decreased over the past 12 months, many properties experienced significant declines in financial performance over the past year resulting in the percentage of properties with a DSCR less than 1.0 increasing from nearly 15% as of December 31, 2010 to 17.3% as of December 31, 2011. The weighted average loan-to-value ratio was 80% as of December 31, 2011 compared with 76% as of December 31, 2010. The majority of the loans are long-term and fixed-rate in nature. Approximately 21% of the loans will mature within the next three years; however, the weighted average DSCR of these loans was significantly higher at 1.82 based on the latest available financial statements. Approximately eight percent of the loans mature in the next 12 months and these loans have a weighted average DSCR of 2.04. Transaction attachment points range from 5% to 85% and underlying bond level credit enhancement generally ranges from 0% to 30% or higher, both of which are structural factors that were intended to minimize potential losses.
Within our CRE CDO portfolio, we had four transactions with 2006 or 2007 vintage collateral totaling $1.9 billion of gross par outstanding as of December 31, 2011 in which substantially all of the collateral originally comprised BBB or BBB- rated tranches of CMBS. While these transactions were designed to include managed portfolios, trading has been minimal since inception. Two of these transactions, totaling $1.0 billion, will be commuted pursuant to a commutation agreement executed in 2011. The Company no longer has material credit risk exposure to these two transactions.
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. As of December 31, 2011, the total amount available under these letters of credit and trust arrangements was $7 million. 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.
The following table summarizes the results and assets under management of our advisory services segment for the years ended December 31, 2011, 2010 and 2009. These results include revenues and expenses from transactions with the Company’s insurance, corporate, and wind-down operations.
For the year ended December 31, 2011, the favorable change in pre-tax income (loss) compared with 2010 was primarily driven by decreases in operating expenses related to a reversal of accrued long-term compensation costs. Decreases in advisory fees due to declines in asset balances managed for our other segments and for third parties were largely offset by a $7 million performance fee received from our corporate segment for advisory-related services provided in 2011.
The Company had in effect a commitment to the pooled investment programs managed or administered by Cutwater Colorado Investor Services Corp. (“Cutwater-CISC”), formerly known as Colorado Investor Services Corporation. The commitment, which is accounted for as a derivative and recorded on the balance sheets at fair value, covers losses in the programs should the net asset value per share decline below a specified per share value. As of December 31, 2011, the maximum amount of payments that the Company would be required to make under the commitment was $3.3 billion. The fair value of the commitment was not material as of December 31, 2011. The commitment was terminated on January 1, 2012, the date on which Cutwater-CISC was no longer manager or administrator of the programs.
General corporate activities are conducted through our corporate segment. Our corporate operations primarily consist of holding company activities, including Optinuity. Revenues and expenses of our service company, Optinuity, created in the first quarter of 2010, are included in the results of our corporate segment. Optinuity provides support services such as management, legal, accounting, treasury, information technology, and insurance portfolio surveillance, among others, to our corporate segment and other operating businesses on a fee-for-service basis.
The following table summarizes the consolidated results of our corporate segment for the years ended December 31, 2011, 2010 and 2009. These results include revenues and expenses that arise from general corporate activities and from providing support to our other segments.
Corporate operating expenses for the year ended December 31, 2011 increased compared with 2010 primarily as a result of a $7 million performance-based fee paid to our advisory services segment and an increase in compensation-related expenses within Optinuity. Corporate operating expenses increased for the year ended December 31, 2010 compared with 2009 primarily due to general and administrative expenses related to Optinuity.
The following table presents the results of our conduit segment for the years ended December 31, 2011, 2010 and 2009. These results include revenues and expenses from transactions with the Company’s insurance and corporate operations.
For the year ended December 31, 2011, the Company’s effective tax rate applied to its pre-tax loss was higher than the U.S. statutory tax rate of 35%. Included in the December 31, 2011 effective tax rate are tax benefits resulting from the reversal of a portion of our valuation allowance and tax-exempt interest income from investments.
For the year ended December 31, 2009, the Company’s effective tax rate applied to our pre-tax income was higher than the U.S. statutory tax rate of 35% primarily due to an increase in our valuation allowance.
During 2011, we repurchased 6.5 million of common shares of MBIA Inc. under our share repurchase program at a cost of $50 million and an average price of $7.64 per share. As of December 31, 2011, $23 million was available for future repurchases under the program.
National and MBIA Insurance Corporation are incorporated and licensed in, and are subject to primary insurance regulation and supervision by, the State of New York. National and MBIA Insurance Corporation each are required to file detailed annual financial statements, as well as interim financial statements, with the New York State Department of Financial Services (“NYSDFS”), previously referred to as The New York State Insurance Department or NYSID, and similar supervisory agencies in each of the other jurisdictions in which it is licensed. These financial statements are prepared in accordance with New York State and the National Association of Insurance Commissioners’ statements of U.S. STAT and assist our regulators in evaluating minimum standards of solvency, including minimum capital requirements, and business conduct. U.S. STAT differs from GAAP in a number of ways. Refer to the statutory accounting practices note to consolidated financial statements of National and MBIA Corp. within exhibits 99.2 and 99.3, respectively, of this annual report on Form 10-K for an explanation of the differences between U.S. STAT and GAAP.
In order to maintain its New York State financial guarantee insurance license, National is required to maintain a minimum of $65 million of policyholders’ surplus. National is also required to maintain contingency reserves to provide protection to policyholders in the event of extreme losses in adverse economic events. Refer to the following “MBIA Insurance Corporation-Capital and Surplus” section for additional information about contingency reserves under the New York Insurance Law (“NYIL”). National’s policyholders’ surplus was $1.4 billion as of December 31, 2011. National’s policyholders’ surplus will grow over time from the recognition of unearned premiums and investment income and the expected release of the contingency reserves. Conversely, incurred losses would reduce policyholders’ surplus.
National’s statutory policyholders’ surplus was lower than its GAAP shareholder’s equity by $2.1 billion as of December 31, 2011. U.S. STAT differs from GAAP in certain respects. Refer to the statutory accounting practices note to consolidated financial statements of National within exhibit 99.2 of this annual report on Form 10-K for an explanation of the differences between U.S. STAT and GAAP.
National’s CPR, and components thereto, as of December 31, 2011 and 2010 are presented in the following table. In the fourth quarter of 2011, we modified our calculation of CPR to include loss and LAE reserves gross of salvage reserves to reflect the expected availability of salvage to pay claims once it is collected. U.S. STAT requires salvage reserves to be netted against the loss and LAE reserves liability on National’s statutory balance sheet. The modification to CPR was made to all periods presented in the following table.
National’s total CPR as of December 31, 2011 of $5.7 billion remained flat compared with December 31, 2010, as net income was offset by decreases in unearned premiums, estimated future cash collections, and gross loss and LAE reserves.
MBIA Insurance Corporation reported total statutory capital of $2.3 billion as of December 31, 2011 compared with $2.7 billion as of December 31, 2010. As of December 31, 2011, statutory capital comprised $706 million of contingency reserves and $1.6 billion of policyholders’ surplus. For the year ended December 31, 2011, MBIA Insurance Corporation had a statutory net loss of $477 million which was primarily due to losses incurred offset by premium revenue and net investment income. MBIA Insurance Corporation’s policyholders’ surplus as of December 31, 2011 includes a negative unassigned surplus of $427 million.
As of December 31, 2011, MBIA Insurance Corporation recognized estimated recoveries of $2.0 billion, net of reinsurance and income taxes at a rate of 35%, on a statutory basis related to put-backs of ineligible loans in our insured transactions. These expected insurance recoveries represented 89% of MBIA Insurance Corporation’s statutory capital (defined as policyholders’ surplus plus contingency reserves) as of December 31, 2011. There can be no assurance that we will be successful or that we will not be delayed in realizing these recoveries. Refer to “Executive Overview-Economic and Financial Market Trends and MBIA’s Business Outlook” included herein.
MBIA Insurance Corporation’s CPR, and components thereto, as of December 31, 2011 and 2010 are presented in the following table. In the fourth quarter of 2011, we modified our calculation of CPR to include loss and LAE reserves gross of salvage reserves to reflect the expected availability of salvage to pay claims once it is collected. U.S. STAT requires salvage reserves to be netted against the loss and LAE reserves liability on MBIA Insurance Corporation’s statutory balance sheet. The modification to CPR was made to all periods presented in the following table.
As a financial services company, MBIA has been materially adversely affected by conditions in global financial markets. Current conditions and events in these markets, in addition to the failure by the originators of RMBS to repurchase the ineligible loans in securitizations that the Company had insured, have put substantial stress on our liquidity resources.
The liquidity resources of MBIA Inc., which are subject to uncertainty in the timing and amount of cash inflows from dividends paid by National and MBIA Corp., the necessity of having to support the liquidity needs of the asset/liability products business, and potential cross-defaults of holding company debt with other obligations in the consolidated group. The asset/liability products business of MBIA Inc. is subject to ongoing negative cash flow and has a deficit of invested assets to liabilities. In addition, the liquidity resources of MBIA Inc. are subject to collateralization requirements in connection with the liabilities it has issued to third parties and affiliates and in connection with third party derivative contracts;
The liquidity resources of MBIA Corp., which are subject to losses on insured exposures, payments to counterparties in consideration for the commutation of insured transactions, and delays in the collection of contract claim recoveries related to ineligible mortgage loans in certain insured transactions; and
In December 2011, National provided the National Secured Loan to MBIA Insurance Corporation under which National loaned MBIA Insurance Corporation $1.1 billion at a fixed annual interest rate of 7% and with a maturity date of December 2016. MBIA Insurance Corporation has the option to defer payments of interest when due by capitalizing interest amounts to the loan balance, subject to the collateral value exceeding certain thresholds. MBIA Insurance Corporation’s obligation to repay the loan is secured by a pledge of collateral having an estimated value in excess of the notional amount of the loan as of December 31, 2011. The National Secured Loan was approved by the NYSDFS as well as by the boards of directors of MBIA Inc., MBIA Insurance Corporation and National in order to enable MBIA Corp. to fund settlements and commutations of its insurance policies. MBIA Insurance Corporation may seek to increase the size of the loan in the future. Any such increase or other amendment to the terms of the loan would be subject to regulatory approval by the NYSDFS.
National maintains the Asset Swap (simultaneous repurchase and reverse repurchase agreements) with MBIA Inc. for up to $2.0 billion based on the fair value of securities borrowed. The Asset Swap provides MBIA Inc. with eligible assets to pledge under investment agreement and derivative contracts in the asset/liability products business. As of December 31, 2011, the notional amount utilized under each of these agreements was $1.3 billion and the fair value of collateral pledged by National and MBIA Inc. under these agreements was $1.4 billion and $1.5 billion, respectively. The net average interest rate on these transactions was 0.34%, 0.35% and 1.70% for the years ended December 31, 2011, 2010 and 2009, respectively. The NYSDFS approved the Asset Swap in connection with the re-domestication of National to New York. National has committed to the NYSDFS to use commercially reasonable efforts to reduce the amount of the Asset Swap over time.
There is a deficit of invested assets to liabilities issued to third parties and affiliates of $591 million as of December 31, 2011. This deficit is expected to increase as a result of on-going expected operating losses. This deficit will need to be reversed prior to the maturity of the liabilities in order to ensure that there are sufficient funds available to fully retire the liabilities. The Company expects that MBIA Inc. will be able to eliminate the deficit prior to the maturity of the related liabilities from distributions from its operating subsidiaries and by raising third party capital, although there can be no assurance that MBIA Inc. will be able to eliminate the deficit through such means.
Liquidity available in the structured finance and international insurance segment is affected by the payment of claims on insured exposures, payments made to commute insured exposure, the Company’s ability to collect on receivables associated with loss payments, a reduction in investment income, any unanticipated expenses, or the impairment or a significant decline in the fair value of invested assets. The Company may also experience liquidity constraints as a result of New York Insurance Law requirements that the Company maintains specified, high quality assets to back the Company’s reserves and surplus.
MBIA Corp. is seeking to enforce its rights to have mortgage sellers/servicers cure, replace or repurchase ineligible mortgage loans from securitizations and has recorded a total of $3.1 billion of related expected recoveries on its consolidated balance sheets as of December 31, 2011, including expected recoveries recorded in the Company’s consolidated VIEs. A substantial majority of the Company’s put-back claims have been disputed by the loan sellers/servicers and is currently subject to litigation discussed more fully in “Note 23: Commitments and Contingencies” in the Notes to Consolidated Financial Statements. There is some risk that the sellers/servicers or other responsible parties might not be able to satisfy any judgment the Company secures in litigation. There can be no assurance that the Company will be successful or that the Company will not be delayed in realizing these recoveries. The Company believes that it has adequate liquidity resources to provide for anticipated cash outflows; however, if the Company does not realize or is delayed in realizing these expected recoveries, the Company may not have adequate liquidity to fully execute the strategy to reduce future potential economic losses by commuting policies and purchasing instruments issued or guaranteed by the Company, or to repay any intercompany borrowings.
The insurance policies issued or reinsured by National, the entity from which the Company conducts its U.S. public finance insurance business, provide unconditional and irrevocable guarantees of payments of the principal of, and interest or other amounts owing on, insured obligations when due; or, in the event that the insurance company has the right, at its discretion, to accelerate insured obligations upon default or otherwise, upon the insurance company’s election to accelerate. In the event of a default in payment of principal, interest or other insured amounts by an issuer, National generally promises to make funds available in the insured amount within one to three business days following notification. In some cases, the amount due can be substantial, particularly if the default occurs on a transaction to which National has a large notional exposure or on a transaction structured with large, bullet-type principal maturities. The fact that the U.S. public finance insurance segment’s financial guarantee contracts generally cannot be accelerated by a party other than the insurer helps to mitigate liquidity risk in this segment.
For the years ended December 31, 2011 and 2010, net cash provided by investing activities was $4.3 million and $5.0 billion, respectively. Net cash provided by investing activities in 2011 and 2010 resulted from sales and redemptions of securities for purposes of funding commutations of insured derivative contracts, insurance-related loss payments, investment agreement withdrawals, and repayments of other debt. Additionally for 2010, cash provided by investing activities included cash recognized in the consolidation of VIEs.
For the year ended December 31, 2011, net cash used by financing activities was $1.8 billion compared with $3.4 billion for the same period of 2010. Net cash used by financing activities in 2011 and 2010 principally related to principal payments on VIE notes, withdrawals of investment agreements, and payments for the retirement of other debt.
The credit quality distribution of the Company’s fixed-income investment portfolios, excluding short-term investments, based on ratings from Moody’s as of December 31, 2011 is presented in the following table. Alternate ratings sources, such as S&P or the best estimate of the ratings assigned by the Company, have been used for a small percentage of securities that are not rated by Moody’s.
MBIA’s consolidated investment portfolio includes investments that are insured by various financial guarantee insurers (“Insured Investments”), including investments insured by MBIA Corp. and National (“Company-Insured Investments”). As of December 31, 2011, Insured Investments at fair value represented $1.3 billion or 15% of consolidated investments, of which $747 million or 9% of consolidated investments were Company-Insured Investments.
As of December 31, 2011, based on the actual or estimated underlying ratings of our consolidated investment portfolio, without giving effect to financial guarantees, the weighted average rating of the consolidated investment portfolio would be in the Aa range, the weighted average rating of only the Insured Investments in the investment portfolio would be in the Baa range, and 5% of the total investment portfolio would be rated below investment grade.
The underlying ratings of the Company-Insured Investments as of December 31, 2011 are reflected in the following table. Amounts represent the fair value of such investments including the benefit of the MBIA guarantee. The ratings in the following table are based on ratings from Moody’s. Alternate ratings sources, such as S&P, have been used for a small percentage of securities that are not rated by Moody’s.
Without giving effect to the MBIA guarantee of the Company-Insured Investments in the consolidated investment portfolio, as of December 31, 2011, based on actual or estimated underlying ratings, the weighted average rating of the consolidated investment portfolio was in the Aa range, the weighted average rating of only the Company-Insured Investments was in the Baa range, and 3% of the Company-Insured Investment portfolio was rated below investment grade.
As of December 31, 2011 and 2010, we had impaired investments (investments for which fair value was less than amortized cost) with a fair value of $2.4 billion and $7.0 billion, respectively.
Gross insurance claim obligations represent the future value of probability-weighted payments MBIA expects to make (before estimated recoveries, reinsurance and the consolidation of VIEs) under insurance policies for which the Company has recorded loss reserves (financial guarantees) or has estimated credit impairments (insured derivatives). The discounted value of estimated payments included in the table, along with probability-weighted estimated recoveries and estimated negotiated early settlements, on policies accounted for as financial guarantee insurance contracts is reported as case basis reserves within “Loss and loss adjustment expense reserves” on the Company’s consolidated balance sheets. Insured derivatives are recorded at fair value and reported within “Derivative liabilities” on the Company’s consolidated balance sheets. Estimated potential claim payments on obligations issued by VIEs consolidated in our structured finance and international insurance segment are included within “Gross insurance claim obligations” in the preceding table. Obligations of these VIEs are collateralized by assets held by the VIEs, and investors in such obligations do not have recourse to the general credit of MBIA. As of December 31, 2011, VIE notes issued by issuer-sponsored consolidated VIEs totaled $7.6 billion, including $4.8 billion recorded at fair value, and are not considered contractual obligations of MBIA beyond MBIA’s insurance claim obligation. The Company’s involvement with VIEs is continually reassessed as required by consolidation guidance, and may result in consolidation or deconsolidation of VIEs in future periods. As the Company consolidates and deconsolidates VIEs, the amount of VIE debt obligations recorded on its balance sheet may change significantly.
Foreign exchange rate sensitivity can be estimated by projecting a hypothetical instantaneous increase or decrease in foreign exchange rates. The following table presents the estimated pre-tax change in fair value of the Company’s financial instruments as of December 31, 2011 from instantaneous shifts in foreign exchange rates:
Since the Company is now using collateral prices as an input into the new Direct Price Model for certain multi-sector insured CDOs, a sensitivity analysis below shows the estimated pre-tax change in fair value and the cumulative estimated net fair value of the Company’s insurance credit derivatives portfolio of a 10% and 20% change in collateral prices as of December 31, 2011.
Accounting principles for fair value measurements and disclosures require the Company to incorporate its own nonperformance risk in its valuation methodology. Sensitivity to changes in the Company’s credit spreads can be estimated by projecting a hypothetical change in this assumption. The following table presents the estimated pre-tax change in fair value and the cumulative estimated net fair value of the Company’s insurance credit derivative portfolio using upfront credit spreads of 0%, an increase of 50%, and a decrease of 50%. The actual upfront spread used in the valuation as of December 31, 2011 ranged from 13.50% to 33.50% based on the tenor of each transaction. The below amounts include an additional annual running credit spread of 5%.
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of changes in shareholders’ equity and of cash flows present fairly, in all material respects, the financial position of MBIA Inc. and its subsidiaries (the “Company”) as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 15(a)(2), present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included 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. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
MBIA Inc., together with its consolidated subsidiaries, (collectively, “MBIA” or the “Company”) operates one of the largest financial guarantee insurance businesses in the industry and is a provider of asset management advisory services. These activities are managed through three business segments: United States (“U.S.”) public finance insurance, structured finance and international insurance, and advisory services. The Company’s U.S. public finance insurance business is primarily operated through National Public Finance Guarantee Corporation and its subsidiaries (“National”), its structured finance and international insurance business is primarily operated through MBIA Insurance Corporation and its subsidiaries (“MBIA Corp.”), and its asset management advisory services business is primarily operated through Cutwater Holdings, LLC and its subsidiaries (“Cutwater”). The holding company, MBIA Inc., and certain of its subsidiaries also manage certain other business activities, the results of which are reported in its corporate, asset/liability products, and conduit segments. The corporate segment includes revenues and expenses that arise from general corporate activities. While the asset/liability products and conduit businesses represent separate business segments, they may be referred to collectively as “wind-down operations” as the funding programs managed through those businesses are in wind-down. Refer to “Note 15: Business Segments” for further information about the Company’s reporting segments.
In connection with MBIA Corp. obtaining approval from the New York State Department of Financial Services (“NYSDFS”), previously referred to as The New York State Insurance Department or NYSID, to release excessive contingency reserves as of September 30, 2011 and December 31, 2011, MBIA Corp. agreed that it would not pay any dividends without prior approval from the NYSDFS. Due to its significant negative earned surplus, MBIA Corp. has not had the statutory capacity to pay dividends since December 31, 2009 and is not expected to have any statutory capacity to pay any dividends in the near term. In addition, in connection with the approval of the December 31, 2011 contingency reserve release, the Company agreed that National would not pay any dividends without prior approval from the NYSDFS until July 19, 2013 (which is 15 months after the expiration of the period during which National has agreed not to pay dividends in connection with the court proceeding challenging the approval of National’s unassigned surplus reset, as described in “Note 23: Commitments and Contingencies”). Refer to “Note 17: Insurance Regulations and Dividends” for more information about MBIA Corp.’s release of excessive contingency reserves.
The reference herein to “ineligible” mortgage loans refers to those mortgage loans that the Company believes failed to comply with the representations and warranties made by the sellers/servicers of the securitizations to which those mortgage loans were sold (including mortgage loans that failed to comply with the related underwriting criteria), based on the Company’s assessment of such mortgage loans’ compliance with such representations and warranties, which included information provided by third-party review firms. The Company’s assessment of the ineligibility of individual mortgage loans could be challenged by the sellers/servicers of the securitizations in litigation and there is no assurance that the Company’s determinations will prevail.
MBIA Corp.’s efforts to recover losses from the second-lien securitization originators could be delayed, settled at amounts below its contractual claims or potentially settled at amounts below those recorded on its balance sheets prepared under accounting principles generally accepted in the United States of America (“GAAP”) and statutory accounting principles (“U.S. STAT”). Contractual claims could become subject to bankruptcy proceedings of the originators. As of December 31, 2011 and 2010, the Company’s estimated recoveries after income taxes calculated at the federal statutory rate of 35%, were $2.0 billion and $1.6 billion, respectively, which was 119% and 58% of the consolidated total shareholders’ equity of MBIA, excluding preferred stock of subsidiaries and noncontrolling interests. As of December 31, 2011 and 2010, the related measures calculated under U.S. STAT were 89% and 59%, respectively, of the statutory capital of MBIA Corp. Refer to “Note 6: Loss and Loss Adjustment Expense Reserves” for information about the Company’s second-lien residential mortgage-backed securities (“RMBS”) loss recoveries.
MBIA Inc. may not have sufficient liquidity to make all payments due on its liabilities and to meet other financial requirements, such as posting collateral, primarily as a result of a deficit of invested assets to debt issued to third parties and affiliates. In addition, it does not expect to receive dividends from its regulated insurance subsidiaries in the near term. Refer to “Note 17: Insurance Regulation and Dividends” for a discussion of dividend restrictions applicable to the Company’s insurance subsidiaries. Furthermore, during 2011, MBIA Inc. experienced other-than-temporary impairments and deterioration in the market values of some of its assets. If MBIA Inc. were required to sell invested assets at their current market values in order to settle liabilities, the liquidity position of MBIA Inc. would experience additional stress. A failure by MBIA Inc. to settle liabilities that are also insured by MBIA Corp. could result in claims on MBIA Corp. Resolving the deficit will depend on the Company’s ability to successfully implement strategies, such as raising capital and/or receiving further liquidity support under intercompany financing arrangements, and there can be no assurance that the Company will be successful in implementing these strategies or that such strategies will provide adequate liquidity. Refer to the following Liquidity section for additional information about MBIA Inc.’s liquidity position.
The Company’s recent financial results have been volatile, which has impacted management’s ability to accurately project future taxable income. Insurance losses incurred beyond those currently projected may cause the Company to record additional allowances against a portion or all of its deferred tax assets. Refer to “Note 14: Income Taxes” for information about the Company’s deferred tax assets.
Municipal and state fiscal distress in the U.S. could adversely affect the Company’s operations if it resulted in larger-than-expected incurred insurance losses. Additionally, the sovereign debt crisis in the Eurozone could have an adverse impact on insured European exposures and/or cause a global slowdown in growth, thereby adversely affecting U.S. insured exposures.
As a financial services company, MBIA has been materially adversely affected by conditions in global financial markets. Current conditions and events in these markets, in addition to the failure by the originators of RMBS to repurchase the ineligible loans in securitizations that the Company has insured, have put substantial stress on the Company’s liquidity resources.
The liquidity resources of MBIA Corp. which are subject to losses on insured exposures, payments to counterparties in consideration for the commutation of insured transactions, and delays in the collection of contract claim recoveries related to ineligible mortgage loans in certain insured transactions; and
In order to address these liquidity risks and efficiently manage liquidity across the entire enterprise, certain of the Company’s subsidiaries which are less liquidity constrained have entered into intercompany agreements that provide resources to subsidiaries that are more liquidity constrained. These resources include intercompany agreements described further below between the Company’s primary insurance subsidiaries and between these insurance subsidiaries and the asset/liability products business (through MBIA Inc.), which in each case were approved by the NYSDFS and are subject to ongoing monitoring by the NYSDFS.
In December 2011, National provided a secured loan to MBIA Insurance Corporation (“National Secured Loan”) under which National loaned MBIA Insurance Corporation $1.1 billion at a fixed annual interest rate of 7% and with a maturity date of December 2016. MBIA Insurance Corporation has the option to defer payments of interest when due by capitalizing interest amounts to the loan balance, subject to the collateral value exceeding certain thresholds. MBIA Insurance Corporation’s obligation to repay the loan is secured by a pledge of collateral having an estimated value in excess of the notional amount of the loan as of December 31, 2011. The National Secured Loan was approved by the NYSDFS as well as by the boards of directors of MBIA Inc., MBIA Insurance Corporation and National in order to enable MBIA Corp. to fund settlements and commutations of its insurance policies. Any increase or other amendment to the terms of the loan would be subject to regulatory approval by the NYSDFS.
MBIA Corp., as lender, maintained a secured lending agreement with MBIA Inc. (“MBIA Corp. Secured Loan”) for the benefit of MBIA Inc.’s asset/liability products business, which totaled $2.0 billion at inception and which was scheduled to mature in November 2011. In the fourth quarter of 2011, the maturity of the MBIA Corp. Secured Loan was extended with the approval of the NYSDFS to May of 2012 with a maximum outstanding amount of $450 million. The interest rate on the MBIA Corp. Secured Loan is 2.43%. As of December 31, 2011, the amount outstanding under the MBIA Corp. Secured Loan was $300 million after repayments of $675 million during 2011. The fair value of the collateral pledged by MBIA Inc. to MBIA Corp. under this agreement was $168 million as of December 31, 2011.
There is a deficit of invested assets to liabilities issued to third-parties and affiliates of $591 million as of December 31, 2011. This deficit is expected to increase as a result of on-going expected operating losses. This deficit will need to be reversed prior to the maturity of the liabilities in order to ensure that there are sufficient funds available to fully retire the liabilities. The Company expects that MBIA Inc. will be able to eliminate the deficit prior to the maturity of the related liabilities from distributions from its operating subsidiaries and by raising third party capital, although there can be no assurance that MBIA Inc. will be able to eliminate the deficit through such means.
Liquidity available in the structured finance and international insurance segment is affected by the payment of claims on insured exposures, payments made to commute insured exposure, the Company’s ability to collect on receivables associated with loss payments, a reduction in investment income, any unanticipated expenses, or the impairment or a significant decline in the fair value of invested assets. The Company may also experience liquidity constraints as a result of New York Insurance Law (“NYIL”) requirements that the Company maintains specified, high quality assets to back the Company’s reserves and surplus.
The Company believes the current liquidity position of MBIA Corp. is adequate to make expected future claims payments. However, the liquidity position of MBIA Corp. has been stressed due to the failure of the sellers/servicers of RMBS transactions insured by MBIA Corp. to repurchase ineligible mortgage loans in certain insured transactions and payments to counterparties in consideration for the commutation of insured transactions, which have resulted in a substantial reduction of exposure and potential loss volatility. While MBIA Corp. has made and may in the future make payments to counterparties in consideration for the commutation of insured transactions, MBIA Corp.’s ability to commute insured transactions will depend on management’s assessment of available liquidity.
Payment requirements for the structured finance and international financial guarantee contracts fall into three categories: (i) timely interest and ultimate principal; (ii) ultimate principal only at final maturity; and (iii) payments upon settlement of individual collateral losses as they occur after any deductible or subordination has been exhausted, which payments are unscheduled and therefore more difficult to predict, and which category applies to most of the transactions on which the Company have recorded loss reserves. 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 the Company’s monitoring process. While the Company’s financial guarantee policies generally cannot be accelerated, thereby mitigating liquidity risk, the insurance of credit default swap (“CDS”) contracts may, in certain events, including the insolvency or payment default of the insurer or the issuer of the CDS, be subject to termination by the counterparty, triggering a claim for the fair value of the contract. Additionally, the Company’s structured finance and international insurance segment requires cash for the payment of operating expenses, as well as principal and interest related to its surplus notes. In order to monitor liquidity risk and maintain appropriate liquidity resources, the Company uses the same methodology as the Company uses to monitor credit quality and losses within the Company’s insured portfolio including stress scenarios. Refer to “Note 6: Loss and Loss Adjustment Expense Reserves” for further discussion.
MBIA Corp. is seeking to enforce its rights to have mortgage sellers/servicers cure, replace or repurchase ineligible mortgage loans from securitizations and has recorded a total of $3.1 billion of related expected recoveries on its consolidated balance sheets as of December 31, 2011, including expected recoveries recorded in the Company’s consolidated VIEs. A substantial majority of the Company’s put-back claims have been disputed by the loan sellers/servicers and is currently subject to litigation discussed more fully in “Note 23: Commitments and Contingencies”. There is some risk that the sellers/servicers or other responsible parties might not be able to satisfy any judgment the Company secures in litigation. There can be no assurance that the Company will be successful or that the Company will not be delayed in realizing these recoveries. The Company believes that it has adequate liquidity resources to provide for anticipated cash outflows; however, if the Company does not realize or is delayed in realizing these expected recoveries, the Company may not have adequate liquidity to fully execute the strategy to reduce future potential economic losses by commuting policies and purchasing instruments issued or guaranteed by the Company, or to repay any intercompany borrowings.
As of December 31, 2011, MBIA Corp. held cash and available-for-sale investments of $1.5 billion, of which $534 million comprised cash and highly liquid assets. The Company believes that MBIA Corp.’s liquidity resources will adequately provide for anticipated cash outflows. In the event of unexpected liquidity requirements, the Company may have insufficient resources to meet its obligations or insufficient qualifying assets to support its surplus and reserves, and may seek to increase its cash holdings position by selling or financing assets, or raising external capital, and there can be no assurance that the Company will be able to draw on these additional sources of liquidity.
The Company elected, under the fair value option within accounting guidance for financial assets and liabilities, to record certain financial assets and liabilities at fair value. Specifically, the Company has elected to apply the fair value option to all financial assets and liabilities of certain consolidated VIEs on a VIE-by-VIE basis.
The Company’s consolidated statements of operations reflect the full impairment (the difference between a security’s amortized cost basis and fair value) on debt securities that the Company intends to sell or would more likely than not be required to sell before the expected recovery of the amortized cost basis. For available-for-sale and held-to-maturity debt securities that management has no intent to sell and believes that it is more likely than not, such securities will not be required to be sold prior to recovery, only the credit loss component of the impairment is recognized in earnings. For available-for-sale securities, the remaining fair value loss is recognized in accumulated other comprehensive income, net of applicable deferred income taxes.
The Company’s available-for-sale and held-to-maturity securities for which the fair value is less than amortized cost are reviewed no less than quarterly in order to determine whether a credit loss exists. This evaluation includes both qualitative and quantitative considerations. In assessing whether a decline in value is related to a credit loss, the Company considers several factors, including but not limited to (a) the magnitude and duration of the decline, (b) credit indicators and the reasons for the decline, such as general interest rate or credit spread movements, credit rating downgrades, issuer-specific changes in credit spreads, and the financial condition of the issuer, and (c) any guarantees associated with a security such as those provided by financial guarantee insurance companies. Credit loss expectations for ABS and CDOs are assessed using discounted cash flow modeling, and the recoverability of amortized cost for corporate obligations is generally assessed using issuer-specific credit analyses.
The useful lives of each class of assets are as follows:
MBIA has entered into derivative transactions as an additional form of financial guarantee and for purposes of hedging risks associated with existing assets and liabilities. All derivative instruments are recognized at fair value on the balance sheet as either assets or liabilities depending on the rights or obligations under the contract. The recognition of changes in the fair value of a derivative within the statements of operations will depend on the intended use of the derivative. If the derivative does not qualify as part of a hedging relationship or is not designated as such, the gain or loss on the derivative is recognized in the statements of operations as net gains (losses) on financial instruments at fair value and foreign exchange or change in fair value of insured derivatives, depending on the nature of the derivative.
The nature of the Company’s business activities requires the management of various financial and market risks, including those related to changes in interest rates and foreign currency exchange rates. The Company uses derivative instruments to mitigate or eliminate certain of those risks. The Company has designated some derivatives as fair value hedges.
A fair value hedge represents the hedging of an exposure to changes in the fair value of an asset or a liability. For a derivative to be accounted for as a fair value hedge, it must be highly effective in achieving offsetting changes in fair value attributable to the hedged risk during the period that the hedge is designated. The Company tests all fair value hedges at least quarterly to ensure that they are highly effective. The Company considers a hedge to be highly effective if the changes in the fair value of the derivative provide offset of at least 80% and not more than 125% of the changes in fair value of the hedged item. For derivatives that qualify as fair value hedges, the gain or loss on the hedging instrument is recognized in earnings and the gain or loss on the hedged item attributable to the hedged risk shall adjust the carrying amount of the hedged item and be recognized currently in earnings. Any portion of the total change in fair value of the hedging instrument that is ineffective in offsetting designated changes in the fair value of the hedged item are recognized in earnings as net gains (losses) on financial instruments at fair value and foreign exchange.
If circumstances or events arise that require the termination and settlement of a derivative contract prior to maturity, any resulting gain or loss will be recognized immediately in earnings. For qualifying fair value hedges, if the hedge relationship is terminated, the derivative fair value adjustment is reported as part of the basis of the hedged item and is amortized to earnings as a yield adjustment. If the underlying hedged item of a hedge relationship ceases to exist, all changes in the fair value of the derivative are recognized in earnings each period until the derivative matures or terminates.
Refer to “Note 10: Derivative Instruments” for a further discussion of the Company’s use of derivatives and their impact on the Company’s consolidated financial statements and “Note 7: Fair Value of Financial Instruments” for derivative valuation techniques and fair value disclosures.
The level of activity in a market contributes to the determination of whether an input is observable. An active market is one in which transactions for an asset or liability occurs with sufficient frequency and volume to provide pricing information on an ongoing basis. In determining whether a market is active or inactive, the Company considers the following traits to be indicative of an active market:
The Company recognizes potential recoveries on paid claims based on probability-weighted net cash inflows present valued at applicable risk-free rates as of the measurement date. Such amounts are reported within “Insurance loss recoverable” on the Company’s consolidated balance sheets. To the extent the Company had recorded potential recoveries in its claim liability previous to a claim payment, such recoveries are reclassified to “Insurance loss recoverable” upon payment of the related claim and remeasured each reporting period.
Investment agreements and MTNs are recorded as liabilities and carried at their face value, adjusted for any premiums or discounts, plus accrued interest. Interest expense is accrued at the contractual interest rate. Premiums and discounts related to investment agreements and MTNs are amortized on a constant yield basis as an adjustment to interest expense.
Securities sold under agreements to repurchase represent collateralized transactions and are carried on the Company’s consolidated balance sheets at their contractual amounts plus accrued interest.
MBIA Inc. and its eligible U.S. subsidiaries file a consolidated Federal income tax return. The U.S. income taxes, which represent a majority of the taxes paid by the Company, are allocated based on the provisions of the Company’s tax sharing agreement which governs the intercompany settlement of tax obligations and benefits. The method of allocation between the members is generally based upon separate-company calculations as if each member filed a separate tax return on its own. MBIA Inc. also intends, as part of the agreement, that no member’s NOL will expire without compensation.
In establishing a liability for an unrecognized tax benefit (“UTB”), assumptions may be made in determining whether a tax position is more likely than not to be sustained upon examination by the taxing authority and also in determining the ultimate amount that is likely to be realized. A tax position is recognized only when, based on management’s judgment regarding the application of income tax laws, it is more likely than not that the tax position will be sustained upon examination. The amount of tax benefit recognized is based on the Company’s assessment of the largest amount of benefit that is more likely than not to be realized on ultimate settlement with the taxing authority. This measurement is based on many factors, including whether a tax dispute may be settled through negotiation with the taxing authority or is only subject to review in the courts. As new information becomes available, the Company evaluates its tax positions, and adjusts its UTB, as appropriate. If the tax benefit ultimately realized differs from the amount previously recognized the Company recognizes an adjustment of the UTB.
Refer to “Note 14: Income Taxes” for additional information about the Company’s income taxes.
In March 2010, the FASB issued ASU 2010-11, “Derivatives and Hedging (Topic 815)-Scope Exception Related to Embedded Credit Derivatives,” to clarify that embedded credit derivatives created by the subordination of one financial instrument to another qualifies for the scope exception and should not be subject to potential bifurcation and separate accounting. Other embedded credit derivative features are considered embedded derivatives and subject to potential bifurcation, provided that the contract is not a derivative in its entirety. The Company adopted this standard in the third quarter of 2010. The adoption of this standard did not have a material effect on the Company’s consolidated balance sheets, results of operations, or cash flows.
In connection with the adoption of the amended accounting guidance, the Company has elected the fair value option for eligible financial assets and financial liabilities for most, but not all, of the consolidated VIEs. The Company elected the fair value option for certain VIEs designed as RMBS securitizations, multi-sector CDOs, and CRE CDOs. Financial assets and financial liabilities of consolidated VIEs designed as life insurance securitizations collateralized by surplus notes issued by life insurance companies that can only be used to settle obligations of the respective VIEs were measured at the unpaid principal balance as of January 1, 2010. The financial assets of such VIEs are classified as held-to-maturity investments on the Company’s consolidated balance sheets. The Company elected the fair value option for the consolidated VIEs designed as RMBS securitizations, multi-sector CDOs, and CRE CDOs because fair value was considered a more appropriate measurement model for the financial assets and financial liabilities to represent the economic performance and business activity of the respective VIEs. The Company did not elect the fair value option for consolidated VIEs designed as life insurance securitizations because a held-to-maturity classification for the financial assets held by the consolidated VIEs was considered a more appropriate measurement model to represent the economic performance and business activity of the respective VIEs.
The Company’s conduit segment includes two VIEs that were consolidated prior to adoption and remain consolidated under this amended accounting guidance. Financial assets held by the consolidated VIEs in the conduit segment were classified as investments held-to-maturity, both prior to and subsequent to the adoption of the amended accounting guidance. Refer to “Note 7: Fair Value of Financial Instruments” for additional disclosures related to the fair value option election for the financial assets and liabilities of the consolidated VIEs.
In December 2011, the FASB issued ASU 2011-11, “Balance Sheet (Topic 210)-Disclosures about Offsetting Assets and Liabilities.” ASU 2011-11 creates new disclosure requirements about the nature of the Company’s rights of setoff and related arrangements associated with its financial instruments and derivative instruments. The disclosure requirements are effective for the Company beginning in the first quarter 2013. This standard will only affect the Company’s disclosures and will not affect the Company’s consolidated balance sheets, results of operations, or cash flows.
In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820)-Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs”. This amendment results in a consistent definition of fair value and common requirements for measurement of and disclosure about fair value between GAAP and International Financial Reporting Standards. The new guidance is effective for the Company beginning January 1, 2012. This standard is expected to only affect the Company’s disclosures related to fair value; therefore, the adoption of this standard is not expected to affect the Company’s consolidated balance sheets, results of operations, or cash flows.
The following tables present the total assets of nonconsolidated VIEs in which the Company holds a variable interest as of December 31, 2011 and 2010. The following tables also present the Company’s maximum exposure to loss for nonconsolidated VIEs as well as the value of the assets and liabilities the Company has recorded for its interest in these VIEs as of December 31, 2011 and 2010. The Company has aggregated nonconsolidated VIEs based on the underlying credit exposure of the insured obligation. The nature of the Company’s variable interests in nonconsolidated VIEs is related to financial guarantees, insured CDS and any investments in obligations issued by nonconsolidated VIEs.
The carrying amounts of assets and liabilities of consolidated VIEs were $10.9 billion and $9.9 billion, respectively, as of December 31, 2011, and $14.1 billion and $13.1 billion, respectively, as of December 31, 2010. The carrying amounts of assets and liabilities are presented separately in “Assets of consolidated variable interest entities” and “Liabilities of consolidated variable interest entities” on the Company’s consolidated balance sheets. Additional VIEs are consolidated or deconsolidated based on an ongoing reassessment of controlling financial interest, when events occur or circumstances arise, and whether the ability to exercise rights that constitute power to direct activities of any VIEs are present according to the design and characteristics of these entities. Net realized losses related to the initial consolidation of an additional VIE were $16 million for the year ended December 31, 2011 and $76 million for the year ended December 31, 2010. Net realized gains related to the deconsolidation of VIEs were $271 million for the year ended December 31, 2011 and immaterial for the year ended December 31, 2010.
The Company evaluates whether any premiums receivable are uncollectible at each balance sheet date. If the Company determines that premiums are uncollectible, it records a write-off of such amounts in current earnings. The majority of the Company’s premiums receivable consists of the present values of future installment premiums that are not yet billed or due primarily from structured finance transactions. Given that premiums due to MBIA typically have priority over most other payment obligations of structured finance transactions, the Company determined that the amount of uncollectible premiums as of December 31, 2011 and 2010 was insignificant.
(2)-Primarily consists of unrealized gains (losses) due to foreign currency exchange rates.
Insured obligations are monitored periodically. The frequency and extent of such monitoring is based on the criteria and categories described below. Insured obligations that are judged to merit more frequent and extensive monitoring or remediation activities due to a deterioration in the underlying credit quality of the insured obligation or the occurrence of adverse events related to the underlying credit of the issuer are assigned to a surveillance category (“Caution List-Low,” “Caution List-Medium,” “Caution List-High” or “Classified List”) depending on the extent of credit deterioration or the nature of the adverse events. IPM monitors insured obligations assigned to a surveillance category more frequently and, if needed, develops a remediation plan to address any credit deterioration.
The Company does not establish any case basis reserves for insured obligations that are assigned to “Caution List-Low,” “Caution List-Medium” or “Caution List-High.” In the event MBIA expects to pay a claim as determined by probability-weighted cash flow analysis with respect to an insured transaction, it places the insured transaction on its “Classified List” and establishes a case basis reserve. The following provides a description of each surveillance category:
The Company’s RMBS reserves and recoveries relate to financial guarantee insurance policies. The Company calculated RMBS case basis reserves as of December 31, 2011 for both first-lien and second-lien RMBS transactions using a process called the “Roll Rate Methodology.” The Roll Rate Methodology is a multi-step process using a database of loan level information, a proprietary internal cash flow model, and a commercially available model to estimate expected ultimate cumulative losses on insured bonds. “Roll Rate” is defined as the probability that current loans become delinquent and that loans in the delinquent pipeline are charged-off or liquidated. Generally, Roll Rates are calculated for the previous three months and averaged. The loss reserve estimates are based on a probability-weighted average of three scenarios of loan losses (base case, stress case, and an additional stress case).
In calculating ultimate cumulative losses for RMBS, the Company estimates the amount of loans that are expected to be charged-off (deemed uncollectible by servicers of the transactions) or liquidated in the future. The Company assumes that such charged-off loans have zero recovery values.
The Company’s first-lien RMBS case basis reserves as of December 31, 2011, which relate to RMBS backed by Alt-A and subprime mortgage loans were determined using the Roll Rate Methodology. The Company assumes that the Roll Rate for loans in foreclosure, Real Estate Owned (“REO”) and bankruptcy are 90%, 90% and 75%, respectively. Roll Rates for current, 30-59 day delinquent loans, 60-89 day delinquent loans and 90+ day delinquent loans are calculated on a transaction-specific basis. Roll Rates for loans that are current as of November 30, 2011 (“Current Roll to Loss”) stay at the November 30, 2011 level for two months before declining to 25% of this level over a 24-month period. Additionally, the Company runs scenarios where the 90+ day roll rate to loss is set at 90%. The Roll Rates are applied to the amounts in the respective delinquency buckets based on delinquencies as of November 30, 2011 to estimate future losses from loans that are delinquent as of the current reporting period.
In calculating ultimate cumulative losses for first-lien RMBS, the Company estimates the amount of loans that are expected to be liquidated through foreclosure or short sale. The time to liquidation for a defaulted loan is specific to the loan’s delinquency bucket with the latest three-month average loss severities generally used to calculate losses at loan liquidation. The loss severities are reduced over time to account for reduction in the amount of foreclosure inventory, future increases in home prices, and principal amortization of the loan.
Current Roll to Loss is calculated on a transaction-specific basis. A proportion of loans reported current as of November 30, 2011 is assumed to become delinquent every month, at a Current Roll to Loss rate that persists at a high level for a time and subsequently starts to decline. A key assumption in the model is the period of time in which the Company projects high levels of Current Roll to Loss to persist. In the Company’s base case, 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, 2011. In the stress case, the period of elevated delinquency and loss is extended by six months. In the additional stress case, the Company assumes that the current trends in losses will remain through mid-2013, after which time they will revert to the base case. For example, in the base case, as of November 30, 2011, if the amount of current loans which become 30-59 days delinquent is 10%, and recent performance suggests that 30% of those loans will be charged-off, the Current Roll to Loss for the transaction is 3%. In the base case, it is then assumed that the Current Roll to Loss will 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 2011 to May 2012). After that six-month period, the Company further reduces the Current Roll to Loss to 0% by early 2014 with the expectation that the performing seasoned loans will eventually result in loan performance reverting to historically low levels of default. In the model, the Company assumes that all current loans that become delinquent are charged-off.
Beginning in 2008, the Company utilized loan level forensic review consultants to re-underwrite/review mortgage loan files underlying certain first and second-lien RMBS transactions insured by MBIA. The consultants graded the individual mortgages that were sampled into an industry standard three level grading scale, defined as (i) Level 1-loans complied with specific underwriting guidelines, (ii) Level 2-loans contained some deviation from underwriting guidelines but also contained sufficient compensating factors and (iii) Level 3-loans contained material deviation from the underwriting guidelines without any compensating factors. MBIA’s forensic review consultants utilized the same underwriting guidelines that the originators were to have used to qualify borrowers when originally underwriting the loans and determined that more than 80% of the loans reviewed were considered to be ineligible mortgage loans. The Company has developed estimates of breach rates primarily based upon loans with credit breaches or credit and compliance breaches because the Company believes that loans with these types of breaches are not judgmental and cannot be cured. Breach rates were determined by dividing the number of loans that contained credit and/or credit and compliance breaches by the total number of loans reviewed for a particular transaction.
Recent legal decisions have led the Company to conclude that the practice of reviewing individual loans for the purpose of assessing put-back recoveries is no longer necessary. The Company determined in the context of the favorable decision on its motion in limine addressing the use of sampling to establish breach-of-contract claims in the Countrywide litigation (MBIA Insurance Corp. v. Countrywide Home Loans, Inc., et al, Index No. 602825/08 (N.Y. Sup. Ct.)) that a sufficient number of loans in each securitization have already been reviewed to demonstrate widespread breaches of the contractual provisions of the agreements with the sponsors. Furthermore, MBIA has received subsequent opinions which have confirmed that the Company is not limited to a loan-by-loan put-back remedy and can seek a pool-wide remedy based on sampling and extrapolation, as well as decisions in MBIA’s favor related to causation and rescissory damages.
The Company has not recognized potential recoveries related to sellers/servicers that MBIA has determined did not have sufficient capital and resources to honor their obligations. The Company assesses the financial abilities of the sellers/servicers using external credit ratings and other factors. The impact of such factors on cash flows related to expected recoveries is incorporated into the Company’s probability-weighted scenarios. The indicative scenarios and related probabilities assigned to each scenario based on the Company’s judgment about their relative likelihoods of being realized are used to develop a distribution of possible outcomes. The sum of the probabilities assigned to all scenarios is 100%. Expected cash inflows from recoveries are discounted using the current risk-free rate associated with the underlying transaction, which ranged from 0.92% to 1.92%, depending upon the transaction’s expected average life.
The Company’s potential recoveries are typically based on either salvage rights, the rights conferred to MBIA through the transactional documents (inclusive of the insurance agreement), or subrogation rights embedded within financial guarantee insurance policies. The second-lien RMBS transactions with respect to which MBIA has estimated put-back recoveries provide the Company with such rights. Expected salvage and subrogation recoveries, as well as recoveries from other remediation efforts, reduce the Company’s claim liability. Once a claim payment has been made, the claim liability has been satisfied and MBIA’s right to recovery is no longer considered an offset to future expected claim payments, but is recorded as a salvage asset. The amount of recoveries recorded by the Company is limited to paid claims plus the present value of projected future claim payments. As claim payments are made, the recorded amount of potential recoveries may exceed the remaining amount of the claim liability for a given policy.
To date, sellers/servicers have not substituted loans which MBIA has put-back, and the amount of loans repurchased has been insignificant. The unsatisfactory resolution of these put-backs led MBIA to initiate litigation against five of the sellers/servicers to enforce their obligations. The Company has alleged several causes of action in its complaints, including breach of contract, fraudulent inducement and indemnification. MBIA’s aggregate $3.1 billion of estimated potential recoveries do not include damages from causes of action other than breach of contract. Irrespective of amounts recorded in its financial statements, MBIA is seeking to recover the full amount of its incurred losses and other damages on these transactions. MBIA has not collected any material amounts of cash related to these recoveries. Additional information on the status of these litigations can be found in the “Recovery Litigation” discussion within “Note 23: Commitments and Contingencies.”
4. evidence of loan repurchase/substitution compliance by sellers/servicers for put-back requests made by other harmed parties with respect to ineligible loans; this factor is further enhanced by (i) Bank of America’s disclosure that it has resolved $8.0 billion of repurchase requests in the fourth quarter of 2010; (ii) the Fannie Mae settlements with Ally Bank announced on December 23, 2010 and with Bank of America (which also involved Freddie Mac) announced on December 31, 2010, and (iii) the Company’s settlement agreements entered into on July 16, 2010 and December 13, 2011 respectively, between MBIA Corp. and sponsors of certain MBIA Corp.-insured mortgage loan securitizations in which the Company received consideration in exchange for a release relating to its representation and warranty claims against the sponsor. These settlements resolved all of MBIA’s representation and warranty claims against the sponsors on mutually beneficial terms and in aggregate were slightly more than the recoveries previously recorded by the Company related to these exposures;
5. the favorable outcome for MBIA on defendants’ motions to dismiss in the litigations discussed above, where the respective courts allowed MBIA’s contract and fraud claims against the defendants to proceed;
6. the favorable outcome in the Countrywide litigation on MBIA’s motion to present evidence of liability and damages through the introduction of statistically valid random samples of loans rather than on a loan-by-loan basis;
8. the favorable outcome in the Countrywide litigation on MBIA’s motion regarding causation and MBIA’s right to rescissory damages;
9. the unanimous ruling from the New York Supreme Court Appellate Division, First Department, in the Countrywide litigation allowing MBIA to pursue its fraud claims; and
MBIA’s insured ABS CDOs are transactions that include a variety of collateral ranging from corporate bonds to structured finance assets (which includes but are not limited to RMBS related collateral, CDOs of ABS, corporate CDOs and collateralized loan obligations). These transactions were insured as either financial guarantee insurance policies or credit derivatives with the majority insured in the form of credit derivatives. Since the fourth quarter of 2007, MBIA’s insured par exposure within the ABS CDO portfolio has been substantially reduced through a combination of terminations and commutations. Accordingly, as of December 31, 2011, the insured par exposure of the ABS CDO financial guarantee insurance policies and credit derivatives portfolio has declined by approximately 83% of the insured amount as of December 31, 2007.
Credit Impairments Related to Structured CMBS Pools and CRE CDOs, Accounted for as Derivatives
In the CRE CDO portfolio, transaction specific structures require managers to report reduced enhancement according to certain guidelines which often include downgrades even when the bond is still performing. As a result, as well as additional collateral defaults, reported enhancement has been reduced significantly in some CRE CDOs. Moreover, many of the CRE CDO positions are amortizing more quickly than originally expected as most or all interest that would have been allocated to more junior classes within the CDO have been diverted and redirected to pay down the senior most classes insured by MBIA.
The fourth approach stratifies loans into buckets based on delinquency status (including a “current” bucket) and utilizes recent Roll Rates actually experienced within each of the commercial mortgage-backed index (“CMBX”) series in order to formulate an assumption to predict future delinquencies. Ultimately, this generates losses over a projected time horizon based on the assumption that loss severities will begin to decline from the high levels seen in 2010 and 2011. The Company further examines those loans referenced in the CMBX indices which were categorized as 90+ days delinquent or in the process of foreclosure and determined the monthly ratio of such loans which were cured versus those which were liquidated or still delinquent over the past 32 months. The Company then applies the most recent rolling six-month average of this cure ratio to all loans in the 90+ day delinquent bucket or in the foreclosure process (and those projected to roll into late stage delinquency from the current and lesser stage levels of delinquency) and assumes all other loans are liquidated. The Company assumes all loans in the REO category liquidate over the next twelve months.
The loss severities projected by these scenarios vary widely, from moderate to substantial losses. Actual losses will be a function of the proportion of loans in the pools that are foreclosed and liquidated and the loss severities associated with those liquidations. If the deductibles in the Company’s insured transactions and underlying referenced CMBS transactions are fully eroded, additional property level losses upon foreclosures and liquidations could result in substantial losses for MBIA. Since foreclosures and liquidations have only begun to take place during this economic cycle, particularly for larger properties, ultimate loss rates remain uncertain. Whether CMBS collateral is included in a structured pool or in a CRE CDO, the Company believes the modeling related to the underlying bond should be the same. The Company assigns a wide range of probabilities to these scenarios, with lower severity scenarios being weighted more heavily than higher severity scenarios. This reflects the view that liquidations will continue to be mitigated by loan extensions and modifications, and that property values and NOIs have bottomed for many sectors and markets in the U.S. The weightings are customized to each counterparty. If macroeconomic stress were to increase or the U.S. goes into a recession, higher delinquencies, liquidations and/or higher severities of loss upon liquidation may result and the Company may incur substantial additional losses. Relatively little liquidation has taken place to date, so the range of possible outcomes is wider than those for the Company’s exposures to ABS CDOs and second-lien RMBS.
The Company’s financial guarantee insurance losses and LAE for the year ended December 31, 2011 are presented in the following table:
The second-lien RMBS losses and LAE related to actual and expected payments included in the preceding table comprise net increases of previously established reserves. The second-lien RMBS recoveries of actual and expected payments comprise $448 million in recoveries resulting from ineligible mortgage loans included in insured exposures that are subject to contractual obligations by sellers/servicers to repurchase or replace such mortgages, offset by a $68 million reduction in excess spread. Other losses and LAE were primarily driven by first-lien RMBS mortgage and ABS CDO transactions as a result of continued credit deterioration within those sectors. Additionally, the reversal of loss and LAE reserves related to lower expected future claim payments from an insured tax-backed transaction were offset by the reversal of the corresponding recoveries of such payments.
Current period changes in the Company’s estimate of potential recoveries may impact the amount recorded as an insurance loss recoverable asset, the amount of expected recoveries on unpaid losses netted against the gross loss and LAE reserve liability, or both. Total paid losses and LAE, net of reinsurance and collections, for the year ended December 31, 2011 was $729 million, including $507 million related to insured second-lien RMBS transactions. For the year ended December 31, 2011, the increase in insurance loss recoverable related to paid losses totaled $507 million, and primarily related to insured second-lien RMBS transactions.
The following table provides information about the financial guarantees and related claim liability included in each of MBIA’s surveillance categories as of December 31, 2010:
The following table presents the components of the Company’s loss and LAE reserves and insurance loss recoverable for insured obligations within MBIA’s classified list as reported on the Company’s consolidated balance sheets as of December 31, 2011 and 2010. The loss reserves (claim liability) and insurance claim loss recoverable included in the following table represent the present value of the probability-weighted future claim payments and recoveries reported in the preceding tables.
The following table presents the Company’s second-lien RMBS exposure, gross undiscounted claim liability and potential recoveries, before the elimination of amounts related to consolidated VIEs, as of December 31, 2011. All loan files reviewed with potential recoveries are included within the “Classified List.”
The following tables present changes in the Company’s loss and LAE reserves for the years ended December 31, 2011 and 2010. Changes in the loss and LAE reserves attributable to the accretion of the claim liability discount, changes in discount rates, changes in the timing and amounts of estimated payments and recoveries, changes in assumptions and changes in LAE reserves are recorded in “Losses and loss adjustment” expenses in the Company’s consolidated statements of operations. As of December 31, 2011 and 2010, the weighted average risk-free rate used to discount the Company’s loss reserves (claim liability) was 1.53% and 2.73%, respectively. LAE reserves are expected to be settled within a one year period and are not discounted.
The decrease in the Company’s gross loss and LAE reserves reflected in the preceding table was primarily due to a decrease in reserves related to loss payments. Offsetting these decreases were changes in assumptions due to additional defaults and charge-offs of ineligible mortgage loans on insured second-lien RMBS issues outstanding as of December 31, 2010 and changes in the timing of payments.
The decrease in gross loss and LAE reserves reflected in the preceding table was primarily due to a decrease in reserves related to payment activity and an accounting transition adjustment related to the adoption of the amended accounting principles for the consolidation of VIEs. Partially offsetting the decrease were changes in assumptions due to additional defaults and charge-offs of ineligible mortgage loans in insured second-lien RMBS issues outstanding as of December 31, 2009.
The following table presents changes in the Company’s insurance loss recoverable and changes in recoveries on unpaid losses reported within the Company’s claim liability for the year ended December 31, 2011. Changes in insurance loss recoverable attributable to the accretion of the discount on the recoverable, changes in discount rates, changes in the timing and amounts of estimated collections, changes in assumptions and changes in LAE recoveries are recorded in “Losses and loss adjustment” expenses in the Company’s consolidated statements of operations.
The Company’s insurance loss recoverable increased during 2010 primarily due to changes in assumptions associated with estimates of potential recoveries on issues outstanding as of December 31, 2009 resulting from ineligible mortgages included in insured second-lien residential mortgage securitization exposures that are subject to contractual obligations by sellers/servicers to repurchase or replace such mortgages, offset by a decrease due to the adoption of the amended accounting principles for the consolidation of VIEs and collection activity. Recoveries on unpaid losses increased primarily due to changes in assumptions offset by a decrease due to the adoption of the amended accounting principles for the consolidation of VIEs.
The following table presents the Company’s total estimated recoveries from ineligible mortgage loans included in certain insured second-lien mortgage loan securitizations as of December 31, 2011. The total estimated recoveries from ineligible loans of $3.1 billion include $2.0 billion recorded as “Insurance loss recoverable” and $1.1 billion recorded as “Loan repurchase commitments” presented under the heading “Assets of consolidated variable interest entities” on the Company’s consolidated balance sheets.
Costs associated with remediating insured obligations assigned to the Company’s “Caution List-Low,” “Caution List-Medium,” “Caution List-High” and “Classified List” are recorded as LAE. LAE is primarily recorded as part of the Company’s provision for its loss reserves and included in “Losses and loss adjustment expense” on the Company’s consolidated statements of operations. The following table presents the expenses (gross and net of reinsurance) related to remedial actions for insured obligations:
Loans receivable at fair value comprise loans held by consolidated VIEs consisting of residential mortgage loans, commercial mortgage loans and other whole business loans. Fair values of residential mortgage loans are determined using quoted prices for MBS with similar characteristics and adjusted for the fair values of the financial guarantee obligations provided by MBIA Corp. on the related MBS. Fair values of commercial mortgage loans and other whole business loans are valued based on quoted prices of similar collateralized MBS. Loans receivable at fair value are categorized in Level 3 of the fair value hierarchy.
Loan repurchase commitments are obligations owed by the sellers/servicers of mortgage loans to either MBIA as reimbursement of paid claims or to the RMBS trusts as defined in the transaction documents. Loan repurchase commitments are consolidated under the amended accounting principles for the consolidation of VIEs. This asset represents the rights of MBIA against the sellers/servicers for representations and warranties that the securitized residential mortgage loans sold to the trust comply with stated underwriting guidelines and for the sellers/servicers to cure, replace, or repurchase mortgage loans that fail to comply. Fair value measurements of loan repurchase commitments represent the amounts owed by the sellers/servicers to either MBIA as reimbursement of paid claims or to the RMBS trusts as defined in the transaction documents. Loan repurchase commitments are not securities and no quoted prices or comparable market transaction information are observable or available. Loan repurchase commitments at fair value are categorized in Level 3 of the fair value hierarchy. Fair values of loan repurchase commitments are determined using discounted cash flow techniques based on observable inputs including:
the price for bearing the uncertainty inherent in the cash flows (risk premium); and
Refer to the discussion of “Second-lien RMBS Recoveries” within “Note 6: Loss and Loss Adjustment Expense Reserves” for a further description of how these estimates of future cash flows for the assets are determined, as well as the additional risk margins and discounts applied.
The fair values of MTNs are determined using discounted cash flow techniques based on inputs including observable interest rates currently being offered for similar notes with comparable maturity dates, and nonperformance risk. Nonperformance risk is determined using the Company’s own credit spreads.
The Company has elected to record three MTNs at fair value. Fair values of such notes are determined using quoted market prices or discounted cash flow techniques. Significant inputs into the valuation include yield curves and spreads to the swap curve. As these notes are not actively traded, certain significant inputs (e.g., spreads to the swap curve) are unobservable. MTNs are categorized as Level 3 of the fair value hierarchy.
The derivative contracts insured by MBIA cannot be legally traded and generally do not have observable market prices. MBIA Corp. determines the fair values of insured credit derivatives using valuation models. These models include the Binomial Expansion Technique (“BET”) Model and an internally developed model referred to as the “Direct Price Model.” For a limited number of other insured credit derivatives, fair values are determined using a dual-default model. The valuation of insured derivatives includes the impact of its own credit standing. All of these derivatives are categorized as Level 3 of the fair value hierarchy as their fair value is derived using significant unobservable inputs.
As of December 31, 2011, the Company had $74.2 billion of gross par outstanding on insured derivatives. The majority of MBIA’s insured derivatives are “credit derivatives” that reference structured pools of cash securities and CDS. The Company generally insured the most senior liabilities of such transactions and, at transaction closing, the Company’s exposure generally had more subordination than needed to achieve triple-A ratings from credit rating agencies (referred to as “Super Triple-A” exposure). The collateral underlying the Company’s insured derivatives consists of cash securities and CDS referencing primarily corporate, asset-backed, residential mortgage-backed, commercial mortgage-backed, CRE loans, and CDO securities. As of December 31, 2011, the gross par outstanding of the Company’s insured credit derivatives totaled $67.1 billion. The remaining $7.1 billion of gross par outstanding on insured derivatives as of December 31, 2011 primarily related to insured “interest rate” and “inflation-linked” swaps for which the Company has insured counterparty credit risk.
Approximately 76% of the balance sheet fair value of insured credit derivatives as of December 31, 2011 was valued using the BET Model. Approximately 24% of the balance sheet fair value of insured credit derivatives as of December 31, 2011 was valued using the internally developed Direct Price Model. An immaterial amount of insured credit derivatives were valued using other methods, including a dual-default model.
The BET Model was originally developed by Moody’s to estimate the loss distribution on a diverse pool of assets. The Company has modified this technique in an effort to incorporate more market information and provide more flexibility in handling pools of non- homogeneous assets. The modifications are (a) the Company uses market credit spreads to determine default probability instead of using historical loss experience, and (b) for collateral pools where the spread distribution is characterized by extremes, the Company models each segment of the pool individually instead of using an overall pool average.
If there is a high dispersion of ratings within a collateral pool, the collateral is segmented into different rating groups and each group is used in calculating the overall average.
When spreads are not available on either a collateral-specific basis or ratings-based generic basis, MBIA uses its hierarchy of spread sources (discussed below) to identify the most appropriate spread for that asset class to be used in the model.
The model is a consistent approach to marking positions that minimizes the level of subjectivity. Model structure, inputs and operation are well documented by MBIA’s internal controls, creating a strong controls process in execution of the model.
The Company reviews the model results on a quarterly basis to assess the appropriateness of the assumptions and results in light of current market activity and conditions. This review is performed by internal staff with relevant expertise. If live market spreads are observable for similar transactions, those spreads are an integral part of the analysis. For example, new insured transactions that resemble existing (previously insured) transactions are considered, as well as negotiated settlements of existing transactions. MBIA Corp. negotiated settlements of insured CDS transactions in 2010 and 2011. In assessing the reasonableness of the fair value estimate for insured CDS, the Company considered the executed prices for those transactions as well as a review of internal consistency with MBIA’s methodology.
Gross Financial Guarantees-The fair value of gross financial guarantees is determined using discounted cash flow techniques based on inputs that include (i) assumptions of expected losses on financial guarantee policies where loss reserves have not been recognized, (ii) amount of losses expected on financial guarantee policies where loss reserves have been established, net of expected recoveries (iii) the cost of capital reserves required to support the financial guarantee liability, (iv) operating expenses, and (v) discount rates. The MBIA Corp. CDS spread and recovery rate are used as the discount rate for MBIA Corp., while the Assured Guaranty Corp. CDS spread and recovery rate are used as the discount rate for National. Discount rates are adjusted to reflect nonperformance risk of the Company.
Level 3 assets at fair value, as of December 31, 2011 and 2010 represented approximately 30% and 24% of total assets measured at fair value, respectively. Level 3 liabilities at fair value, as of December 31, 2011 and 2010, represented approximately 77% and 78% of total liabilities measured at fair value as of December 31, 2011 and 2010, respectively.
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, 2011 and 2010:
Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Year Ended December 31, 2011
Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Year Ended December 31, 2010
Gains and losses (realized and unrealized) included in earnings pertaining to Level 3 assets and liabilities for the years ended December 31, 2011, 2010 and 2009 are reported on the consolidated statements of operations as follows:
The Company elected to record at fair value certain financial instruments of the VIEs that have been consolidated in connection with the adoption of the accounting guidance for consolidation of VIEs, among others.
The following table reflects the difference between the aggregate fair value and the aggregate remaining contractual principal balance outstanding as of December 31, 2011 and 2010 for loans and long-term debt for which the fair value option was elected.
The Company’s fixed-maturity portfolio consists of high-quality (average rating Aa) taxable and tax-exempt investments of diversified maturities. Other investments primarily comprise equity investments, including those accounted for under the equity method, highly rated perpetual securities and loan receivables that bear interest. The following tables present the amortized cost, fair value and other-than-temporary impairments of fixed-maturity investments and other investments designated as available-for-sale in the consolidated investment portfolio of the Company as of December 31, 2011 and 2010:
The fair value of securities on deposit with various regulatory authorities was $11 million as of December 31, 2011 and 2010, respectively. These deposits are required to comply with state insurance laws.
Substantially all of the obligations under investment agreements require the Company to pledge securities as collateral. As of December 31, 2011 and 2010, the fair value of securities pledged as collateral with respect to these investment agreements approximated $1.9 billion and $2.4 billion, respectively. The Company’s collateral as of December 31, 2011, consisted principally of MBS, state and municipal bonds, and U.S. Treasury and government agency bonds, and was primarily held with major U.S. banks. Additionally, the Company pledged money market securities as collateral under investment agreements in the amount of $224 million and $113 million as of December 31, 2011 and 2010, respectively.
The following table presents the distribution by contractual maturity of available-for-sale fixed-maturity investments at amortized cost and fair value as of December 31, 2011. Contractual maturity may differ from expected maturity as borrowers may have the right to call or prepay obligations.
The following table presents the fair values and gross unrealized losses by credit rating category of ABS included in the Company’s consolidated investment portfolio as of December 31, 2011 for which fair value was less than amortized cost. Of the total fair value and unrealized losses of ABS, $397 million of fair value and $120 million of unrealized losses are included in the Company’s asset/liability products investment portfolio. Fair values include the benefit of guarantees provided by financial guarantors, including MBIA. The credit ratings are based on ratings from Moody’s as of December 31, 2011 or an alternate ratings source, such as S&P, when a security is not rated by Moody’s. For investments that are insured by various third-party guarantee insurers, the credit rating reflects the higher of the insurer’s rating or the underlying bond’s rating.
The following table presents the fair values and gross unrealized losses by credit rating category of MBS included in the Company’s consolidated investment portfolio as of December 31, 2011 for which fair value was less than amortized cost. Fair values include the benefit of guarantees provided by financial guarantors, including MBIA. The credit ratings are based on ratings from Moody’s as of December 31, 2011 or an alternate ratings source, such as S&P, when a security is not rated by Moody’s. For investments that are insured by various third-party guarantee insurers, the credit rating reflects the higher of the insurer’s rating or the underlying bond’s rating.
Sixty-five percent of the Company’s investments in MBS reported in the preceding table were rated investment grade with 23% rated Aaa. Of the total MBS investments reported in the preceding table, $18 million include the benefit of guarantees provided by MBIA Corp. and $239 million include the benefit of guarantees provided by third-party financial guarantors. The average credit rating of all guaranteed MBS investments using the higher of the guarantors’ ratings or the underlying bond ratings was Baa and the average underlying credit rating of guaranteed MBS investments, without giving effect to the guarantees, was below investment grade. Without giving effect to the benefit of guarantees provided by financial guarantors, including MBIA Corp., $262 million or 65% of the securities included in the preceding table were rated below investment grade.
The following table presents the fair values and gross unrealized losses by credit rating category of direct corporate obligations included in the Company’s consolidated investment portfolio as of December 31, 2011 for which fair value was less than amortized cost. Fair values include the benefit of guarantees provided by financial guarantors, including MBIA. The credit ratings are based on ratings from Moody’s as of December 31, 2011 or an alternate ratings source, such as S&P, when a security is not rated by Moody’s. For investments that are insured by various third-party guarantee insurers, the credit rating reflects the higher of the insurer’s rating or the underlying bond’s rating.
Eighty percent of the Company’s investments in corporate obligations reported in the preceding table were rated investment grade with 10% rated Aaa. Of the total corporate obligations reported in the preceding table, $97 million include the benefit of guarantees provided by MBIA Corp., and $74 million include the benefit of guarantees provided by third-party financial guarantors. The average credit rating of all guaranteed corporate obligations included in the preceding table using the higher of the guarantors’ ratings or the underlying bond ratings was A and the average underlying credit rating of these guaranteed corporate obligations without giving effect to the guarantees was Baa. Without giving effect to the benefit of guarantees provided by financial guarantors, including MBIA Corp. and National, $33 million or 5% of the securities included in the preceding table were rated below investment grade.
The following tables present the gross unrealized losses of held-to-maturity investments as of December 31, 2011 and 2010. Held-to-maturity investments are reported at amortized cost on the Company’s consolidated balance sheets. The tables segregate investments that have been in a continuous unrealized loss position for less than twelve months from those that have been in a continuous unrealized loss position for twelve months or longer.
As of December 31, 2010, there were 412 securities that were in an unrealized loss position for a continuous twelve-month period or longer with aggregate unrealized losses of $941 million. Within the 412 securities, the book value of 321 securities exceeded market value by more than 5%.
The following table provides information about securities held by the Company as of December 31, 2011 that were in an unrealized loss position and insured by a financial guarantor, along with the amount of insurance loss reserves corresponding to the par amount owned by the Company:
(2)-These balances are included in the “Net gains (losses) on financial instruments at fair value and foreign exchange” and “Net investment losses related to other-than-temporary impairments” line items on MBIA’s consolidated statements of operations.
Total investment income is generated as a result of the ongoing management of the Company’s investment portfolios. For the year ended December 31, 2011, total investment income increased compared to the same period of 2010 primarily due to an increase in total net realized gains, partially offset by decreases in net investment income. For the year ended December 31, 2010, total investment income increased compared to the same period of 2009 primarily due to a reduction in total net realized losses, partially offset by decreases in net investment income.
For ABS (e.g., RMBS and CDOs), the Company estimated expected future cash flows of each security by estimating the expected future cash flows of the underlying collateral and applying those collateral cash flows, together with any credit enhancements such as subordination interests owned by third parties, to the security. The expected future cash flows of the underlying collateral are determined using the remaining contractual cash flows adjusted for future expected credit losses (which consider current delinquencies and nonperforming assets, future expected default rates and collateral value by vintage and geographic region) and prepayments. The expected cash flows of the security are then discounted at the interest rate used to recognize interest income on the security to arrive at a present value amount. The following table presents a summary of the significant inputs considered in determining the measurement of the credit loss component recognized in earnings for each significant class of ABS for the years ended December 31, 2011, 2010 and 2009:
The change in net unrealized gains (losses), including the portion of other-than-temporary impairments, presented in the table above consisted of:
MBIA has entered into derivative transactions as an additional form of financial guarantee and for purposes of hedging risks associated with existing assets and liabilities and forecasted transactions. CDS are also entered into in the asset/liability products business to replicate investments in cash assets consistent with the Company’s risk objectives and credit guidelines for its asset management business. The Company accounts for derivative transactions in accordance with the accounting principles for derivative and hedging activities, which requires that all such transactions be recorded on the balance sheet at fair value. Refer to “Note 7: Fair Value of Financial Instruments” for the definition of fair value of derivative instruments.
The following table presents information about credit derivatives sold by the Company’s insurance operations that were outstanding as of December 31, 2011. Credit ratings represent the lower of underlying ratings currently assigned by Moody’s, S&P or MBIA.
The following table presents information about credit derivatives sold by the Company’s advisory services business that were outstanding as of December 31, 2011. Credit ratings represent the lower of ratings currently assigned by Moody’s, S&P or external counterparties.
The following table presents information about credit derivatives sold by the Company’s advisory services business that were outstanding as of December 31, 2010. Credit ratings represent the lower of ratings currently assigned by Moody’s, S&P or external counterparties.
As of December 31, 2011, the total fair value of the Company’s derivative assets, after counterparty netting, was $459 million, of which $452 million was reported within “Derivative assets” and “Derivative assets-VIEs” on the Company’s consolidated balance sheets, and the total fair value of the Company’s derivative liabilities, after counterparty netting, was $6.0 billion, which was reported within “Derivative liabilities” and “Derivative liabilities-VIEs” on the Company’s consolidated balance sheets.
As of December 31, 2010, the total fair value of the Company’s derivative assets, before counterparty netting, was $769 million and the total fair value of the Company’s derivative liabilities, before counterparty netting was $6.8 billion. The following table presents the total fair value of the Company’s derivative assets and liabilities by instrument and balance sheet location, before counterparty netting, as of December 31, 2010:
The following tables present the effect of derivative instruments on the consolidated statements of operations for the year ended December 31, 2011:
The following tables present the effect of derivative instruments on the consolidated statements of operations for the year ended December 31, 2010:
The Company routinely pledges securities it owns in accordance with the terms of its collateralized transactions. Securities pledged in connection with investment agreement activities may not be repledged by the investment agreement counterparty. Securities pledged as part of repurchase agreements may be repledged by the counterparty of the contract or by MBIA. As of December 31, 2011 and 2010, the fair value of financial assets pledged as collateral under repurchase agreements in which the counterparties have the right to repledge the securities were $543 million and $552 million, respectively. As of December 31, 2011 and 2010, securities sold under agreements to which the Company has agreed to repurchase were $287 million and $471 million, respectively. There was no cash collateral pledged under these agreements as of December 31, 2011 and 2010.
(3)-Callable on January 15, 2013 and every fifth anniversary thereafter at 100.00.
On January 16, 2008, MBIA Insurance Corporation issued $1.0 billion of 14% fixed-to-floating rate surplus notes due January 15, 2033. As of December 31, 2011 and 2010, the par amount outstanding was $940 million and $945 million, respectively. The surplus notes have an initial interest rate of 14% until January 15, 2013 and thereafter at an interest rate of three-month LIBOR plus 11.26%. Interest and principal payments on the surplus notes are subject to prior approval by the Superintendent of the NYSDFS. The surplus notes are callable at par at MBIA Insurance Corporation’s option on the fifth anniversary of the date of issuance and every fifth anniversary thereafter, subject to prior approval by the Superintendent and other restrictions. The cash received from the issuance of surplus notes was used for general business purposes and the deferred debt issuance costs are being amortized over the term of the surplus notes. During the first quarter of 2011, MBIA Inc., through its asset/liability products segment, purchased $5 million par value of MBIA Insurance Corporation surplus notes at a cost of approximately 55% of par value. The gain on the purchase of the surplus notes by MBIA Inc. is only reflected in the consolidated accounts of the Company. To date, MBIA Insurance Corporation has repurchased a total of $47 million par value outstanding of its surplus notes at a weighted average price of $77.08.
The aggregate maturity of debt obligations, excluding accrued interest and premiums or discounts, as of December 31 for each of the next five years and thereafter commencing in 2012 was:
(2)-Includes discounts of $153 million on investment agreements, net fair value adjustments of $33 million and accrued interest of $10 million.
MTN obligations are recorded as liabilities on the Company’s balance sheets based upon proceeds received, net of unamortized discounts and premiums, plus unpaid accrued interest at the balance sheet date. The MTNs are measured at fair value in accordance with the accounting guidance for certain hybrid financial instruments, which was adopted on January 1, 2007. MTNs are issued by GFL as part of MBIA’s asset/liability products. MTNs have been issued with either fixed or floating interest rates and GFL has issued MTNs in U.S. dollars and foreign currencies. As of December 31, 2011, the interest rates of the MTNs ranged from 0% to 8.68% and the weighted average interest rate was 3.19%. As of December 31, 2010, the interest rates of the MTNs ranged from 0% to 8.37% and the weighted average interest rate was 3.17%. Expected principal payments due under MTN obligations based on their contractual maturity dates are as follows:
(1)-Foreign currency denominated MTNs are presented in U.S. dollars. Amounts reflect principal due at maturity for notes issued at a discount or premium.
The tax effects of temporary differences that give rise to deferred tax assets and liabilities as of December 31, 2011 and 2010 are presented in the following table:
As of December 31, 2011, the Company reported a net deferred tax asset of $1.7 billion. The $1.7 billion deferred tax asset is net of a $236 million valuation allowance. As of December 31, 2011, the Company had a full valuation allowance against the deferred tax asset related to losses from asset impairments and realized losses from sales of investments as these losses are considered capital losses, have a five year carryforward period, and can only be used to offset capital gain income. The 2011 valuation allowance reflects a decrease of $140 million from the 2010 valuation allowance of $376 million. The change in the valuation allowance for the year ended December 31, 2011 was primarily due to generation of capital gains on asset sales and the re-characterization of certain impairments as bad debts resulting in ordinary losses. The remaining valuation allowance reflects the fact that the Company cannot predict capital gains in future years.
While the ratings downgrades by the rating agencies have significantly adversely impacted the Company’s ability to write new insurance business, the downgrades did not have a material impact on earnings from the existing insured portfolio, which the Company believes will be sufficient to absorb losses in the event that the cumulative unrealized losses become fully impaired.
Treatment of Undistributed Earnings of Certain Foreign Subsidiaries-“Accounting for Income Taxes-Special Areas”
On November 6, 2009, as part of The Worker, Homeownership, and Business Assistance Act of 2009, the NOL carryback provision of the Internal Revenue Code was amended to allow all businesses with NOLs in either 2008 or 2009 (but not both) to elect to claim refunds of taxes paid within the prior five years. In the fifth preceding year of the carryback period, the recovery is limited to 50% of taxable income for that carryback year. There is no such limitation to the first four preceding years of the carryback period.
The following table presents the change in the UTB during 2009, 2010 and 2011:
For the years ended December 31, 2011, 2010, and 2009, the portion of the UTB that, if recognized, would affect the effective tax rate was approximately $47 million, $25 million, and $9 million, respectively.
As of December 31, 2011, the Company has a 2008 capital loss carryforward of $155 million which will expire in 2013. The Company also has a cumulative NOL carryforward of $943 million, which will expire from tax years 2029 through 2031, and a minimum tax credit carryforward of $22 million, which has an unlimited carryforward period.
The Company’s U.S. public finance insurance segment is principally conducted through National. The financial guarantees issued by National provide unconditional and irrevocable guarantees of the payment of principal of, and interest or other amounts owing on, U.S. public finance insured obligations when due. The obligations are generally not subject to acceleration, except that National may have the right, at its discretion, to accelerate insured obligations upon default or otherwise. National issues financial guarantees for municipal bonds, including tax-exempt and taxable indebtedness of U.S. political subdivisions, as well as utility districts, airports, health care institutions, higher educational facilities, student loan issuers, housing authorities and other similar agencies and obligations issued by private entities that finance projects that serve a substantial public purpose. Municipal bonds and privately issued bonds used for the financing of public purpose projects are generally supported by taxes, assessments, fees or tariffs related to the use of these projects, lease payments or other similar types of revenue streams. National has not written any meaningful amount of business since its formation in 2009.
The advisory services segment primarily consists of the operations of Cutwater-ISC, Cutwater Asset Management Corp. (“Cutwater-AMC”), and Cutwater Asset Management U.K. Limited (“Cutwater-UK”). Cutwater-ISC and Cutwater-AMC offers advisory services, including cash management, discretionary asset management and structured products on a fee-for-service basis. The Company offers these services to public, not-for-profit, corporate and financial services clients, including the Company and its subsidiaries, as well as portfolio accounting and reporting services. Cutwater-ISC and Cutwater-AMC are Securities and Exchange Commission (“SEC”) registered investment advisers. Cutwater-AMC is also a Financial Industry Regulatory Authority member firm. Cutwater-UK provides fee-based asset management services to the Company’s foreign insurance affiliates and Euro Asset Acquisition Limited (“EAAL”), and to third-party institutional clients and investment structures. Cutwater-UK is registered with the Financial Services Authority in the U.K.
The asset/liability products segment principally consists of the activities of MBIA Inc., MBIA Investment Management Corp. (“IMC”), GFL and EAAL. IMC, along with MBIA Inc., provided customized investment agreements, guaranteed by MBIA Corp., for bond proceeds and other public funds for such purposes as construction, loan origination, escrow and debt service or other reserve fund requirements. It has also provided customized products for funds that are invested as part of asset-backed or structured product transactions. GFL raises funds through the issuance of MTNs with varying maturities, which are, in turn, guaranteed by MBIA Corp. GFL lends the proceeds of these MTN issuances to MBIA Inc. (“GFL Loans”). MBIA Inc. invests the proceeds of investment agreements and GFL Loans in eligible investments, which consisted of investment grade securities at the time of purchase with a minimum average double-A credit quality rating. MBIA Inc. primarily purchases domestic securities, which are pledged to MBIA Corp. as security for its guarantees on investment agreements
and MTNs. Additionally, MBIA Inc. loans a portion of the proceeds from investment agreements and MTNs to EAAL. EAAL primarily purchases foreign assets as permitted under the Company’s investment guidelines.
The Company’s conduit segment administers two conduits through MBIA Asset Finance, LLC. Assets financed by these conduits are currently funded by MTNs and liquidity loans.
The following tables provide the Company’s segment results for the years ended December 31, 2011, 2010 and 2009:
(1)-Represents the sum of third-party financial guarantee net premiums earned, net investment income, insurance-related fees and reimbursements, investment fees and other fees.
Premiums on financial guarantees and insured derivatives reported within the Company’s insurance segments are generated within and outside the U.S. The following table summarizes premiums earned on financial guarantees and insured derivatives by geographic location of risk for the years ended December 31, 2011, 2010 and 2009:
As of December 31, 2011, insurance in force, which represents principal and interest or other amounts owing on insured obligations, had an expected maturity range of 1 to 46 years. The distribution of MBIA Corp.’s and National’s combined insurance in force by geographic location, excluding $4.4 billion and $4.9 billion relating to transactions guaranteed by MBIA Corp. on behalf of various investment management services affiliated companies as of December 31, 2011 and 2010, respectively, is presented in the following table:
The insurance in force by type of bond, excluding transactions guaranteed by MBIA Corp. on behalf of various investment management services affiliated companies, is presented in the following table:
The insurance operations have entered into certain guarantees of derivative contracts, included in the preceding tables, which are accounted for as derivative instruments. MBIA generally guarantees the timely payment of principal and interest related to these derivatives upon the occurrence of a credit event with respect to a referenced obligation. The maximum amount of future payments that MBIA may be required to make under these guarantees is $73.1 billion. MBIA’s guarantees of derivative contracts have a legal maximum maturity range of 1 to 71 years. A small number of insured credit derivative contracts have long-dated maturities, which comprise the longest maturity dates of the underlying collateral. However, the expected maturities of such contracts are much shorter due to amortizations and prepayments in the underlying collateral pools. The fair values of these guarantees as of December 31, 2011 and 2010 are recorded on the consolidated balance sheets as derivative liabilities, representing gross losses, of $4.8 billion and $4.4 billion, respectively.
Investment agreement contracts and MTNs issued by the Company’s asset/liability products segment are insured by MBIA Corp. and are not included in the previous tables. If MBIA Inc. or these subsidiaries were to have insufficient assets to pay amounts due, MBIA Corp. would make such payments under its insurance policies. As of December 31, 2011, the maximum amount of future payments that MBIA Corp. could be required to make under these guarantees is $4.4 billion. These guarantees, which have a maximum maturity range of 1 to 36 years, were entered into on an arm’s length basis and are fully collateralized by marketable securities. MBIA Corp. has both direct recourse provisions and subrogation rights in these transactions. If MBIA Corp. is required to make a payment under any of these affiliate guarantees, it would have the right to seek reimbursement from such affiliate and to liquidate any collateral to recover amounts paid under the guarantee.
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. As of December 31, 2011, the use of reinsurance was immaterial to the insurance operations business and the Company expects that it will continue to be immaterial in the future.
The aggregate amount of insurance in force ceded by MBIA to reinsurers was $7.5 billion and $9.8 billion as of December 31, 2011 and 2010, respectively. For Financial Guaranty Insurance Company (“FGIC”) policies assigned to National from MBIA, National maintains the right to receive third-party reinsurance totaling $9.1 billion and $10.4 billion of insured par outstanding as of December 31, 2011 and 2010, respectively. The aggregate amount of insurance in force for FGIC policies is $16.1 billion and $18.3 billion as of December 31, 2011 and 2010, respectively.
Since December 2007, several of the Company’s financial guarantee reinsurers, including Assured Guaranty Corp., Assured Guaranty Re Ltd., and Old Republic Insurance Co. have had their credit ratings either downgraded or put on negative watch by one or more of the major rating agencies. Although there was no material impact on the Company for any of these rating agency actions relating to these reinsurers, a further deterioration in the financial condition of one or more of these reinsurers could require the establishment of reserves against any receivables due from the reinsurers.
For the years ended December 31, 2011, 2010 and 2009, recoveries received on claims for financial guarantee policies under reinsurance contracts totaled $10 million, $21 million and $41 million, respectively. Ceding commissions from reinsurance, before deferrals and net of returned ceding commissions, were revenue of $3 million, $7 million and $6 million for the years December 31, 2011, 2010, and 2009, respectively.
Effective January 1, 2010, National was granted a permitted practice by the NYSDFS to reset its unassigned surplus to zero. Previously, National had an unassigned surplus deficit principally as a result of the 2009 reinsurance transaction between MBIA Corp. and National. The reset provides National with dividend capacity of $142 million and $91 million as of December 31, 2011 and 2010, respectively. National did not declare or pay any dividends during 2011 or 2010. In October 2010, the plaintiffs in the Transformation litigation initiated a court proceeding challenging the approval of the surplus reset. Refer to “Note 23: Commitments and Contingencies” for further information on the Transformation litigation. In connection with this court proceeding, we have agreed that National will not pay dividends during the current adjournment of the proceeding (i.e., through April 19, 2012). In addition, in connection with the approval of a release of excessive contingency reserves as of December 31, 2011 in MBIA Insurance Corporation, as described below, the Company has agreed that National will not pay dividends without the prior approval of the NYSDFS prior to July 19, 2013 (i.e., for an additional 15 months after the expiration of the current adjournment period in the court proceeding).
As a result of the establishment of National and the reinsurance of the MBIA Corp. and FGIC portfolios by National, National and MBIA Corp. exceeded as of the closing date certain single and aggregate risk limits under the NYIL. These insurers obtained waivers from the NYSDFS of such limits. In connection with the waivers, they submitted a plan to the NYSDFS to achieve compliance with the applicable regulatory limits. Under the plans, they agreed not to write new financial guarantee insurance for certain issuers, and in MBIA Corp.’s case, in certain categories of business, until they were in compliance with their single risk limits and agreed to take commercially reasonable steps, including considering reinsurance, the addition of capital and other risk mitigation strategies, in order to comply with the regulatory single and aggregate risk limits. As a condition to granting the waiver, the NYSDFS required that, in addition to complying with these plans, upon written notice from the NYSDFS, MBIA Corp. and National, as applicable, would cease writing new financial guarantee insurance if it were not in compliance with the risk limitation requirements by December 31, 2009. In 2010, National was not in compliance with its single or aggregate risk limits requirements, while MBIA Corp. was in compliance with its aggregate but not its single risk limits requirements. As of December 31, 2011, both National and MBIA Corp. satisfied their aggregate risk limits requirement but not their single-risk limits requirements. To date, no such notice has been received from the NYSDFS. In 2011 and 2010, MBIA Corp. reported a de minimis number of additional overages to the NYSDFS due to changes in its statutory capital.
Consolidated results of operations for MBIA Corp. determined in accordance with statutory accounting practices for the years ended December 31, 2011 and 2010 were net losses of $477 million and $434 million, respectively. As of December 31, 2011, MBIA Corp.’s statutory capital was $2.3 billion, consisting of policyholders’ surplus of $1.6 billion and contingency reserve of $706 million. As of December 31, 2010, MBIA Corp. had statutory capital of $2.7 billion.
For the years ended December 31, 2011 and 2010, National had statutory net income of $478 million and $409 million, respectively. As of December 31, 2011, National’s statutory capital was $2.8 billion, consisting of policyholders’ surplus of $1.4 billion and contingency reserves of $1.4 billion. As of December 31, 2010, National had statutory capital of $2.4 billion.
The Company also maintains a qualified profit sharing/401(k) plan. The plan is a voluntary contributory plan that allows eligible employees to defer compensation for federal income tax purposes under Section 401(k) of the Internal Revenue Code of 1986, as amended. Employees may contribute, through payroll deductions, up to 25% of eligible compensation. The Company matches employee contributions up to the first 5% of such compensation. The 401(k) matching contributions are made in the form of cash, whereby participants may direct the Company match to an investment of their choice. The benefit of the Company’s contributions vest over a five-year period with 20% vested after two years, 60% vested after three years, 80% vested after four years and 100% vested after five years. Generally, a participating employee is entitled to distributions from the plans upon termination of employment, retirement, death or disability. Participants who qualify for distribution may receive a single lump sum, transfer the assets to another qualified plan or individual retirement account, or receive a series of specified installment payments. Profit sharing/401(k) expense related to the Company’s qualified plan for the years ended December 31, 2011, 2010 and 2009 was $4 million, $3 million, and $3 million, respectively.
A summary of the Company’s restricted shares outstanding as of December 31, 2011, 2010 and 2009, and changes during the years ended on those dates, is presented in the following table:
Employee stock option compensation expense, net of estimated forfeitures, for the years ended December 31, 2011, 2010, and 2009 totaled $4 million, $2 million and $6 million, respectively. During 2011, 2010, and 2009 there were no stock option awards exercised. During 2011 and 2010, the Company wrote off a deferred tax asset of $3 million and $2 million, respectively, related to the cancellation of fully vested stock option awards as a charge to paid-in capital. As of December 31, 2011, there was $5 million of total unrecognized compensation cost related to non-vested stock options. This amount is expected to be recognized as expense over a weighted average period of 1.6 years.
During 2009, the Company granted 1,291,990 restricted shares to the CEO which has a vesting schedule dependent on the achievement of certain stock price targets of the Company. The grant and corresponding compensation expense has been included in the above restricted stock disclosure for 2009. As permitted by the accounting guidance for share-based payment, the Company estimates the fair value of awards that contain only market performance conditions at the date of grant using a binomial lattice model with a Monte Carlo simulation. The binomial lattice model can better incorporate assumptions about a stock price path because the model can accommodate a large number of potential stock prices over the award’s term in comparison to the Black-Scholes model.
During 2011, 2010 and 2009, the Company granted deferred cash-based long-term incentive awards. These grants have a vesting period of either three or five years, after which time the award fully vests. Payment is generally contingent on the employee’s continuous employment with the Company through the payment date. The deferred cash awards are granted to employees from the vice-president level up. Compensation expense related to the deferred cash awards was $9 million, $7 million and $5 million for the years ended December 31, 2011, 2010 and 2009, respectively.
Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects the dilutive effect of all stock options and other items outstanding during the period that could potentially result in the issuance of common stock. For the years ended December 31, 2011, 2010 and 2009, there were 3,797,548, 4,526,442, and 7,401,350, respectively, of stock options outstanding that were not included in the diluted earnings per share calculation because they were antidilutive.
The following table presents the computation of basic and diluted earnings per share for the years ended December 31, 2011, 2010 and 2009:
(1)- Includes 5,080,742, 5,325,428 and 5,259,561 of unvested restricted stock and units that receive nonforfeitable dividends or dividend equivalents for the years ended December 31, 2011, 2010 and 2009, respectively.
The Company granted Warburg Pincus warrants to purchase 11.5 million shares of MBIA common stock at an exercise price of $30.25 per share, “B” warrants, which, upon obtaining certain approvals, will become exercisable to purchase 9.8 million shares at a price of $30.25 per share, and “B2” warrants to purchase 4 million shares at a price of $16.20 per share. Warrants granted to Warburg Pincus are recorded as liabilities and reported within “Other liabilities” on the consolidated balance sheets due to terms and conditions in the agreements that could require net cash settlement. As of December 31, 2011 and 2010, the fair value of the warrants was $38 million and $58 million, respectively.
In accordance with MBIA’s fixed-rate election, the dividend rate on the preferred stock was determined using a fixed-rate equivalent of LIBOR plus 200 basis points. Each share of preferred stock has a par value of $1,000 with a liquidation preference of $100,000. The holders of the preferred stock are not entitled to any voting rights as shareholders of MBIA Corp. and their consent is not required for taking any corporate action. Subject to certain requirements, the preferred stock may be redeemed, in whole or in part, at the option of MBIA Corp. at any time or from time to time for cash at a redemption price equal to the liquidation preference per share plus any accrued and unpaid dividends thereon at the date of redemption for the then current dividend period and any previously accumulated dividends payable without interest on such unpaid dividends. As of December 31, 2011 and 2010, there were no dividends declared on the preferred stock. Payment of dividends on MBIA Corp.’s preferred stock is subject to the same restrictions that apply to dividends on common stock under New York State insurance law. The terms of the preferred stock provide that if MBIA Corp. fails to pay dividends in full on the preferred stock for 18 consecutive months, the authorized number of members of the MBIA Corp. board of directors will automatically be increased by two and the holders of the preferred stock will be entitled to fill the vacancies so created at a special meeting of the preferred shareholders of MBIA Corp. Due to its nonpayment of dividends on the preferred stock for 18 consecutive months, MBIA Corp. held a meeting of preferred stockholders on August 12, 2011 to elect the two new directors. The meeting was adjourned because a quorum was not present.
Management of the Company which includes persons who are responsible for achieving the objectives of the Company and who have the authority to establish policies and make decisions by which those objectives are to be pursued. Management normally includes members of the Board of Directors, the CEO, Chief Operating Officer, Vice President in charge of principal business functions and other persons who perform similar policymaking functions.
Since 1989, MBIA Corp. has executed five surety bonds to guarantee the payment obligations of the members of the Municipal Bond Insurance Association (the “Association”), a voluntary unincorporated association of insurers writing municipal bond and note insurance as agents for the member insurance companies that had their S&P claims-paying rating downgraded from AAA on their previously issued Association policies. In the event that the Association does not meet their policy payment obligations, MBIA Corp. will pay the required amounts directly to the paying agent. The aggregate outstanding exposure on these surety bonds as of December 31, 2011 was $340 million.
MBIA, through its subsidiaries, is responsible for providing investment advisory and certain related administrative services to the MBIA Capital/Claymore Managed Duration Investment Grade Municipal Fund (“the Fund”). MBIA earned investment management, accounting, administration and service fees related to the Fund, net of underwriting fees paid to a third party, and are included in “Fees and reimbursements” in the Company’s consolidated statements of operations. These amounts were not significant for the years ended December 31, 2011, 2010 and 2009.
The Company had no loans outstanding to any executive officers or directors during 2011 and 2010.
The defendants, including the Company, filed motions to dismiss this lawsuit on various grounds. On February 13, 2007, the Court granted those motions, and dismissed the lawsuit in its entirety, on the grounds that plaintiffs’ claims are barred by the applicable statute of limitations. The Court did not reach the other grounds for dismissal argued by the Company and the other defendants. On November 12, 2008, the U.S. Court of Appeals for the Second Circuit affirmed the district court’s dismissal on statute of limitations grounds, but remanded the case to allow the plaintiffs to file an amended complaint. The Second Consolidated Amended Class Action Complaint was filed on February 18, 2009. On September 24, 2009, the Court dismissed plaintiffs’ complaint with prejudice. On November 2, 2009, the plaintiffs filed a Notice of Appeal with the U.S. Court of Appeals for the Second Circuit. On June 22 and 24, 2010, individual defendants Juliette Tehrani and David Elliot, respectively, were voluntarily dismissed from the litigation. On February 28, 2011, the U.S. Court of Appeals for the Second Circuit vacated the district court’s grant of the Company’s motion to dismiss and remanded the case back to the district court for reconsideration of the statute of limitations analysis in light of the intervening U.S. Supreme Court decision in Merck & Co. v. Reynolds as well as to consider additional arguments in favor of dismissal propounded by the Company. On June 10, 2011, defendants filed a renewed motion to dismiss the complaint.
On October 17, 2008, a consolidated amended class action complaint in a separate shareholder class action lawsuit against the Company and certain of its officers, In re MBIA Inc. Securities Litigation, No. 08-CV-264, (KMK) was filed in the U.S. District Court for the Southern District of New York, alleging violations of the federal securities laws. The amended complaint alleged that defendants MBIA Inc., Gary C. Dunton and C. Edward Chaplin violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by, among other things, issuing false and misleading statements with respect to the Company’s exposure to CDOs containing RMBS, specifically its exposure to so-called “CDO-squared” securities, which allegedly caused the Company’s stock to trade at inflated prices. On March 31, 2010, the claims against Dunton and Chaplin were dismissed without prejudice. On April 30, 2010, plaintiffs filed their Second Consolidated Amended Class Action Complaint. On September 6, 2011, the parties entered into a Stipulation and Agreement of Settlement of the lawsuit. On September 30, 2011, the re-alleged claims against Dunton and Chaplin were withdrawn and dismissed with prejudice, and on December 19, 2011, the Court approved the Settlement and dismissed the action with prejudice.
On February 13, 2008, a shareholder derivative lawsuit against certain of the Company’s present and former officers and directors, and against the Company, as nominal defendant, entitled Trustees of the Police and Fire Retirement System of the City of Detroit v. Clapp et al., No. 08-CV-1515, (the “Detroit Complaint”), was filed in the U.S. District Court for the Southern District of New York. The gravamen of the Detroit Complaint is similar to the aforementioned Consolidated Class Action, except that the legal claims are against the directors for breach of fiduciary duty and related claims. The Detroit Complaint purports to relate to a so-called “Relevant Time Period” from February 9, 2006, through the time of filing of the complaint. On December 14, 2010, Judge Karas dismissed the complaint without prejudice. On December 23, 2010, a new demand making similar claims was made on the Company’s Board of Directors.
On August 11, 2008, a shareholder derivative lawsuit entitled Crescente v. Brown et al., No. 08-17595 was filed in the Supreme Court of the State of New York, County of Westchester against certain of the Company’s present and former officers and directors, and against the Company, as nominal defendant. The gravamen of this complaint is similar to the Detroit Complaint except that the time period assertedly covered is from January 2007, through the time of filing of this complaint. The derivative plaintiff has agreed to stay the action pending further developments in the federal derivative litigation.
On July 23, 2008, the City of Los Angeles filed a complaint in the Superior Court of the State of California, County of Los Angeles, against a number of financial guarantee insurers, including MBIA. At the same time and subsequently, additional complaints against MBIA and nearly all of the same co-defendants were filed by the City of Stockton, the Public Financing Authority of the City of Stockton, the City of Oakland, the City and County of San Francisco, the County of San Mateo, the County of Alameda, the City of Los Angeles Department of Water and Power, the Sacramento Municipal Utility District, the City of Sacramento, the City of Riverside, the Los Angeles World Airports, the City of Richmond, Redwood City, the East Bay Municipal Utility District, the Sacramento Suburban Water District, the City of San Jose, the County of Tulare, the Regents of the University of California, Contra Costa County, the Redevelopment Agency of the City of Riverside, and the Public Financing Authority of the City of Riverside, The Olympic Club, the Jewish Community Center of San Francisco and the Redevelopment Agency of San Jose. These cases are part of a coordination proceeding in Superior Court, San Francisco County, before Judge Richard A. Kramer, referred to as the Ambac Bond Insurance Cases, which name as defendants MBIA, Ambac Assurance Corp., Syncora Guarantee, Inc. f/k/a XL Capital Assurance Inc., Financial Security Assurance, Inc., Assured Guaranty Corp., Financial Guaranty Insurance Company, and CIFG Assurance North America, Inc., Fitch Inc., Fitch Ratings, Ltd., Fitch Group, Inc., Moody’s Corporation, Moody’s Investors Service, Inc., The McGraw-Hill Companies, Inc., and Standard & Poor’s Corporation.
In August 2011, plaintiffs filed amended versions of their respective complaints. The claims allege participation by all defendants in a conspiracy in violation of California’s antitrust laws to maintain a dual credit rating scale that misstated the credit default risk of municipal bond issuers and not-for-profit issuers and thus created market demand for bond insurance. Plaintiffs also allege that the individual bond insurers participated in risky financial transactions in other lines of business that damaged each bond insurer’s financial condition (thereby undermining the value of each of their guaranties), and each failed adequately to disclose the impact of those transactions on their financial condition. In addition to the statutory antitrust claim, plaintiffs assert common law claims of breach of contract and fraud against MBIA and the other monoline defendants. The non-municipal plaintiffs also allege a California unfair competition cause of action. On October 20, 2011, the court overruled MBIA’s demurrers to plaintiffs’ amended complaints. On December 2, 2011, MBIA and the other monoline defendants filed a special motion to strike pursuant to California’s anti-SLAPP statute.