MBIA Inc. (“MBIA”, the “Company”, “we”, “us”, or “our”) operates one of the largest financial guarantee insurance businesses in the industry and engages in several ancillary activities. MBIA manages five operating segments: 1) United States (“U.S.”) public finance insurance; 2) international and structured finance insurance; 3) corporate; 4) advisory services; and 5) conduit. Our U.S. public finance insurance business is primarily operated through National Public Finance Guarantee Corporation and its subsidiaries (“National”), our international and structured finance insurance business is primarily operated through MBIA Insurance Corporation and its subsidiaries (“MBIA Corp.”), and our asset management and advisory services business was operated through Cutwater Holdings, LLC and its subsidiaries (“Cutwater”). Unless otherwise indicated or the context otherwise requires, references to “MBIA Corp.” are to MBIA Insurance Corporation, together with its subsidiaries, MBIA UK Insurance Limited (“MBIA UK”) and MBIA Mexico S.A. de C.V. During the fourth quarter of 2014, we changed the name of our structured finance and international insurance operating segment to international and structured finance insurance.
National is the largest U.S. municipal-only bond insurer in the financial guarantee industry as measured by total insured gross par outstanding of $222.3 billion as of December 31, 2014. Our primary strategy is to insure new issue and secondary market municipal bonds while providing ongoing surveillance of National’s existing insured portfolio. National’s ability to write new business and to compete with other financial guarantors is largely dependent on the financial strength ratings assigned to National by major rating agencies. As of December 31, 2014, National was rated AA+ with a stable outlook by Kroll Bond Rating Agency, AA- with a stable outlook by Standard & Poor’s Financial Services LLC (“S&P”), and A3 with a negative outlook by Moody’s Investors Service, Inc. (“Moody’s”). With these current ratings, National seeks to support the credit enhancement needs of municipal debt issuers across the U.S.
National seeks to generate shareholder value through appropriate risk adjusted pricing; however, current market conditions and the competitive landscape may limit National’s new business opportunities and its ability to price and underwrite risk with attractive returns. Financial guarantee insurance competes in nearly all instances with the issuer’s alternative of foregoing insurance. If the interest savings from insurance are not greater than the cost of the insurance, the issuer will generally choose to issue bonds without insurance.
Prevailing interest rate levels can affect demand for financial guarantee insurance. Higher interest rates and higher levels of issuance of new municipal debt would present more favorable new business opportunities for National in the U.S. public finance market. Lower interest rates are typically accompanied by narrower spreads between insured and uninsured obligations. This is, in part, due to the fact that investors may choose to forego insurance to increase the yield on their investments. Therefore, the purchase of insurance during periods of relatively narrower interest rate spreads will generally provide lower cost savings to the issuer than during periods of relatively wider spreads. These lower cost savings could be accompanied by a corresponding decrease in demand for financial guarantee insurance. As interest rates begin to rise, we expect the demand for financial guarantee insurance to grow.
Our U.S. public finance insured portfolio continues to perform satisfactorily against a backdrop of strengthening domestic economic activity. While this trend will generally benefit the tax revenues and fees charged for essential municipal services which secure our insured bond portfolio, some state, local governments and territory obligors we insure remain under financial and budgetary stress. This could lead to an increase in defaults by such entities on the payment of their obligations and losses or impairments on a greater number of our insured transactions. We continue to monitor and analyze these situations and other stressed credits closely, and the overall extent and duration of this stress is uncertain.
National has exposure to the City of Detroit, which filed for Chapter 9 protection in July of 2013. In the fourth quarter of 2014, the City of Detroit entered into a number of settlements with creditors, helping to clear the path toward a bankruptcy exit in December of 2014. In connection with its exit, the City of Detroit issued new unlimited tax general obligation bonds, through the Michigan Finance Authority, to each holder of its then existing unlimited tax obligation bonds on the plan effective date (collectively, the “Restructured UTGO Bonds”). The Restructured UTGO Bonds have the same principal amount, interest rate, maturity and redemption provisions as the City of Detroit’s original UTGO Bonds. Under the settlement between National and the City of Detroit, National will pay a portion of the future debt service of the Restructured UTGO Bonds. The Restructured UTGO Bonds that remain the responsibility of the City of Detroit are secured by (i) a lien, to the extent permitted by law, on the specific voter approved ad valorem tax levy pledged thereto, and (ii) a 4th lien on the Distributable State Aid the City of Detroit receives from Michigan. National continues to insure all of the Restructured UTGO Bonds.
In September of 2014, the City of Detroit agreed not to reduce interest rates and eliminate call protection on the DWSD Bonds insured by National. Instead, the City of Detroit publicly tendered for and ultimately called or refinanced approximately $1.8 billion of DWSD Bonds. In connection with this refinancing, National insured approximately $300 million of new DWSD Bonds, while reducing its total DWSD exposure by approximately $432 million. As of December 31, 2014, National had $1.6 billion of gross insured exposure related to the DWSD Bonds.
During the year ended December 31, 2014, MBIA Corp. commuted $7.1 billion of gross par exposure, of which $6.8 billion was previously disclosed, primarily comprising structured commercial mortgage-backed securities (“CMBS”) pools, investment grade corporate collateralized debt obligations (“CDOs”), small business securitizations, commercial real estate (“CRE”) CDOs, and asset-backed securities (“ABS”) CDOs. MBIA Corp. may make negotiated settlement payments to counterparties and/or forego its right to all or some termination premiums when it commutes insurance exposures. We continue to evaluate opportunities to commute additional high risk insurance exposures, although our ability to commute is limited by available liquidity and the willingness of counterparties to enter into commutations.
If MBIA Corp. were to experience liquidity shortfalls in the future, it may have insufficient resources to continue to pay claims, which may cause the NYSDFS to put MBIA Insurance Corporation into a rehabilitation or liquidation proceeding. We do not believe that a rehabilitation or liquidation proceeding of MBIA Insurance Corporation by NYSDFS would have any significant long-term liquidity impact on MBIA Inc. or result in a liquidation or similar proceeding of MBIA UK. Refer to the “Liquidity-MBIA Corp. Liquidity” section for additional information on MBIA Corp.’s liquidity position.
In September of 2014, we moved into our new headquarters in Purchase, New York. We had entered into a lease agreement for this facility in March of 2014. Refer to “Note 21: Commitments and Contingencies” in the Notes to Consolidated Financial Statements for a further discussion of this lease agreement.
In October of 2014, the Company signed an agreement to sell Cutwater to a subsidiary of The Bank of New York Mellon Corporation. This transaction, which was effective January 1, 2015, had a positive but immaterial impact on the Company’s financial position and results of operations. In connection with the sale, the Company entered into an agreement for Cutwater to manage its proprietary investment assets for the next several years.
The U.S. economy developed substantial momentum in 2014, with the last three quarters being the best string of quarterly performances in more than a decade. This momentum was bolstered by the lowest unemployment rate in over six years and falling energy prices which helped to increase consumer spending and business investments. In addition, the housing sector improved and with a continued increase in consumer confidence this should lead to more demand in 2015. The Federal Reserve has indicated that there may be an increase in the federal funds rate in 2015, which would be the first in over five years. If an increase in the federal funds rate occurs, the risk of market volatility will likely remain present given the historic nature of elongated zero interest rate policy changing course. Despite these positive economic results, concerns remain within the U.S. economy primarily related to fiscal policy uncertainties and growing worldwide political and economic conflicts from the effects of terrorist acts and wars. Throughout much of Europe, economic growth and employment have improved, and the European Central Banks’ implementation of Quantitative Easing is intended to facilitate economic growth, however, substantial risk remains. We believe interest rate hikes are approaching and growth today is more durable as global economic risks are less likely to derail expansion. Information concerning our interest rate sensitivity appears in Part II, Item 7A, “Quantitative and Qualitative Disclosures about Market Risk.”
Economic and financial market trends impact MBIA’s business outlook and its financial results. An ongoing low interest rate environment will adversely impact the demand for municipal bond insurance as well as National’s ability to price risk at levels that meet its underwriting objectives and returns. However, the consistent gradual improvement of economic indicators at the state and local levels will benefit the performance of our insured public finance portfolio and could reduce the amount of National’s incurred losses.
Our financial results, prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), have been volatile as a result of unrealized gains and losses from our insured credit derivatives, as well as a result of insured losses and recoveries on second-lien RMBS. Our economic performance has also been volatile due to changes in our loss estimates based on changes in macroeconomic conditions in the U.S. and abroad and deviations in collateral performance from our expectations.
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 gain) within the carryforward 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. During 2014, the Company’s valuation allowance against its deferred tax asset was fully released primarily due to the capital losses generated by the sales of previously impaired assets, which were utilized against current year capital gains. The release was also due to the impact of tax planning strategies which used unrealized gains to absorb any remaining impairment losses. As of December 31, 2013, the Company’s valuation allowance was $93 million which was related to impairments of certain assets 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.
In addition to our results prepared in accordance with GAAP, we also analyze the operating performance of the Company using operating income (loss) and operating income (loss) per diluted common share, both non-GAAP measures. We consider operating income (loss) and operating income (loss) per diluted common share fundamental measures of periodic financial performance which we believe is useful for an understanding of our results. Operating income (loss) and operating income (loss) per diluted common share are not substitutes for net income (loss) and net income (loss) per diluted common share determined in accordance with GAAP, and our definitions of operating income (loss) and operating income (loss) per diluted common share may differ from those used by other companies. Previously, we had used adjusted pre-tax income (loss), a non-GAAP measure, to supplement the analysis of our results. As a result of the recognition of the minor impact of shareholder value of the results of our international and structured finance insurance segment, the liquidation of our conduit and advisory services businesses and the realignment of the management of our asset/liability products and our corporate activities, we consider operating income (loss) a better metric than adjusted pre-tax income (loss) to assess our performance. Previous to using adjusted pre-tax income (loss), and before the financial crisis, we used a non-GAAP measure similar to our current operating income (loss) measure.
In addition to removing our Non-Core Segments, operating income (loss) is adjusted for the following:
Elimination of the after-tax impact of net gains (losses) on the extinguishment of debt as we believe it is useful to exclude these gains (losses) since they are executed when we believe it is an appropriate deployment of capital in excess of amounts needed to support our liquidity needs.
(3)-Operating income (loss) per diluted common share is calculated by taking operating income (loss) divided by GAAP weighted average number of diluted common shares outstanding.
For the year ended December 31, 2014, our combined operating income increased when compared with 2013 primarily as a result of decreases in insurance losses and LAE, operating and interest expense and amortization of deferred acquisition costs, partially offset by lower premiums earned and lower net investment income.
In addition to book value per share, we also analyze ABV per share, a non-GAAP measure. We consider ABV a measure of fundamental value of the Company and the change in ABV an important measure of financial performance. ABV adjusts GAAP book value to remove the after-tax results of activities in our Non-Core Segments. In addition, ABV adjusts for certain items which the Company believes will reverse from GAAP book value through GAAP earnings and other comprehensive income, as well as to add in the impact of certain items which the Company believes will be realized in GAAP book value in future periods. The Company has limited such adjustments to those items that it deems to be important to fundamental value and performance and which the likelihood and amount can be reasonably estimated. ABV assumes no new business activity. We have presented ABV to allow investors and analysts to evaluate the Company using the same measure that MBIA’s management regularly uses to measure financial performance and value. ABV is not a substitute for and should not be viewed in isolation of GAAP book value, and our definition of ABV may differ from that used by other companies.
Our “Net unearned premium revenue” adjustment to book value per share consists of unearned premium revenue net of prepaid reinsurance premiums related to financial guarantee insurance contracts and the unamortized portion of insurance-related deferred fee revenue.
During 2014, National insured $343 million of par, including $300 million relating to the DWSD Bonds. Subsequent to December 31, 2014, National insured an additional $26 million of gross par exposure, through February 26, 2015. Low interest rates, narrow spreads and competitive pricing levels continue to severely limit new business opportunities. As of December 31, 2014, National was rated AA+ with a stable outlook by Kroll Bond Rating Agency, AA- with a stable outlook by S&P and A3 with a negative outlook by Moody’s. With these current ratings, National seeks to support the credit enhancement needs of municipal debt issuers across the U.S. National maintains underwriting criteria for most municipal risk types and expects opportunities for new business across the spectrum of municipal sectors. National’s underwriting criteria does not limit it to particular sectors. We expect that the majority of its new business will be in the general obligation, tax-backed and revenue bond sectors.
OPERATING INCOME (LOSS) In addition to the above results, we also analyze the operating performance of our U.S. public finance insurance segment using operating income (loss), a non-GAAP measure. We believe operating income (loss), as used by management, is useful for an understanding of the results of operations of the Company. Operating income (loss) is not a substitute for net income (loss) determined in accordance with GAAP, and our definition of operating income (loss) may differ from that used by other companies.
The following table presents a reconciliation of GAAP net income (loss) to operating income (loss) for the years ended December 31, 2014, 2013 and 2012:
NET INVESTMENT INCOME The decreases in net investment income for 2014 compared with 2013 and 2012 were primarily due to lower yields on investment assets as a result of the repayment of a higher yielding secured loan by MBIA Corp. in May of 2013.
The benefit in losses and LAE for the year ended December 31, 2014 primarily related to decreases in reserves for certain general obligation bonds, partially offset by increases in reserves for Puerto Rico exposures. The losses and LAE for the year ended December 31, 2013 primarily related to certain general obligation bonds and a loss related to the difference in the value of a salvage receivable recorded and the fair market value of the marketable securities received in the third quarter of 2013 in connection with the restructuring of a gaming revenue transaction. Any subsequent change in the fair market value of the marketable securities is accounted for in accordance with available-for-sale (“AFS”) securities. Refer to “Note 2: Significant Accounting Policies” in the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K for additional information related to AFS securities. For the year ended December 31, 2012, losses and LAE primarily related to certain general obligation bonds and lease transactions.
The following table presents information about our U.S. public finance insurance loss and LAE reserves and recoverables as of December 31, 2014 and 2013:
Included in our U.S. public finance loss and LAE reserves are both reserves for insured obligations for which a payment default has occurred and National has already paid a claim and also for which a payment default has not yet occurred, but a claim is expected in the future. The following table includes LAE reserves, but excludes par outstanding, as of December 31, 2014 and 2013 for one issue that had no expected future claim payments, but for which National was obligated to pay LAE incurred in prior periods. As of December 31, 2014 and 2013, loss and LAE reserves comprised the following:
Par outstanding as of December 31, 2014 increased compared with December 31, 2013 as a result from the addition of a Puerto Rico issue to our “Classified List.”
POLICY ACQUISITION COSTS AND OPERATING EXPENSES U.S. public finance insurance segment expenses for the years ended December 31, 2014, 2013 and 2012 are presented in the following table:
The following table presents the credit quality distribution of MBIA’s U.S. public finance outstanding gross par insured as of December 31, 2014 and 2013. Capital appreciation bonds (“CABs”) are reported at the par amount at the time of issuance of the insurance policy. All ratings are as of the period presented and represent S&P ratings. If transactions are not rated by S&P, a Moody’s equivalent rating is used. If transactions are not rated by either S&P or Moody’s, an internal equivalent rating is used.
The following is a summary of exposures within the insured portfolio of our U.S. public finance insurance segment related to Puerto Rico as of December 31, 2014.
In February of 2015, S&P and Moody’s further downgraded the ratings of all the issuers of Puerto Rico and its instrumentalities, including COFINA, to below investment grade ratings with a negative outlook due to narrowing liquidity, sluggish economic growth and uncertainty regarding the administration’s proposed tax legislation.
Our international and structured finance insurance portfolio is principally operated 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, non-U.S. public finance and global structured finance 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 guaranteed investment contracts written by MBIA Inc. are insured by MBIA Corp., and if MBIA Inc. or such subsidiaries were to have insufficient assets to pay amounts due upon maturity or termination, MBIA Corp. would make such payments under its insurance policies. MBIA Corp. also insured debt obligations of other affiliates, including GFL and MBIA Investment Management Corp. (“IMC”). MBIA Corp. has also written insurance policies guaranteeing the obligations under credit default swaps (“CDS”) contracts of an affiliate, LaCrosse Financial Products, LLC (“LaCrosse”), including termination payments that may become due in certain events, including the insolvency or payment defaults of MBIA Corp. or LaCrosse. MBIA Insurance Corporation also provides reinsurance to its insurance subsidiaries.
Since our insured credit derivatives have similar terms, conditions, risks, and economic profiles as our financial guarantee insurance policies, we evaluate them for impairment periodically in the same way that we estimate loss and LAE for our financial guarantee policies. Credit impairments on insured derivatives represent actual payments plus the present values of our estimates of expected future claim payments, net of expected future recoveries. MBIA Corp.’s expected future claim payments were discounted using a rate of 5.17%, the same rate used to calculate its statutory loss reserves as of December 31, 2014. MBIA UK used a rate of 2.20% to discount its expected future claim payments and statutory loss reserves. We estimated that additional credit impairments on insured derivatives (excluding LAE) for the year ended December 31, 2014 were $79 million across eight insured issues. As of December 31, 2014, statutory loss and LAE reserves related to credit impairments were $129 million. Refer to the following “Loss and Loss Adjustment Expenses” section for additional information about credit impairments on insured derivatives.
NET GAINS (LOSSES) ON FINANCIAL INSTRUMENTS AT FAIR VALUE AND FOREIGN EXCHANGE The decreases in net gains on financial instruments at fair value and foreign exchange for 2014 compared with 2013 and 2012 were primarily due to realized losses from foreign currency revaluation related to Chilean Unidad de Fomento and decreases in net realized gains from the sales of securities.
REVENUES OF CONSOLIDATED VIEs For 2014, total revenues of consolidated VIEs were $102 million compared with total revenues of $217 million for 2013 and $61 million for 2012. The decrease in revenues of consolidated VIEs for 2014 when compared to 2013 was primarily related to a decrease in net gains from second-lien RMBS put-back claims on ineligible mortgage loans. The increase in revenues of consolidated VIEs for 2013 when compared to 2012 was primarily related to an increase in net gains from second-lien RMBS put-back claims on ineligible mortgage loans.
The following table presents information about our financial guarantee insurance losses and LAE recorded in accordance with GAAP for the years ended December 31, 2014, 2013 and 2012:
For 2014, the increase in losses and LAE related to expected payments of $72 million primarily related to insured first-lien RMBS transactions, high yield corporate CDOs and other activity, partially offset by benefits related to an international road transaction and ABS CDOs. The decrease in recoveries of expected payments of $71 million primarily related to decreases of projected collections from excess spread within insured second-lien RMBS securitizations and expected recoveries on an international road transaction, partially offset by an increase in recoveries of expected payments related to insured first-lien RMBS transactions.
For 2013, the increase in losses and LAE related to expected payments of $69 million primarily related to insured second-lien RMBS transactions and other activity. This was partially offset by a benefit related to insured first-lien RMBS transactions. Included in the increase in recoveries of expected payments of $56 million were recoveries primarily resulting from ineligible mortgage loans included in insured exposures and activity related to insured first-lien transactions, partially offset by a reduction in excess spread within the securitizations. In addition, there was a decrease in other activity that related to a reversal of recoveries related to high yield corporate CDOs, partially offset by an increase in recoveries related to an international road transaction.
For 2012, the increase in losses and LAE related to expected payments of $412 million primarily related to insured second-lien RMBS transactions, insured first-lien RMBS transactions and other activity. Included in the increase in recoveries of expected payments of $382 million were recoveries related to second-lien RMBS transactions resulting from ineligible mortgage loans included in insured exposures that were subject to contractual obligations by sellers/servicers to repurchase or replace such mortgage loans. This was partially offset by a reduction in excess spread within the securitizations.
Included in MBIA Corp.’s loss and LAE reserves are both reserves for insured obligations for which a payment default has occurred and MBIA Corp. has already paid a claim and also for which a payment default has not yet occurred but a claim is expected in the future. The following table includes LAE reserves, but excludes par outstanding, as of December 31, 2014 and 2013 for two issues and one issue, respectively, that had no expected future claim payments or par outstanding, but for which MBIA Corp. was obligated to pay LAE incurred in prior periods. As of December 31, 2014 and 2013, loss and LAE reserves comprised the following:
The impact of insured exposures on MBIA Corp.’s liquidity position is best understood by assessing the ultimate amount of payments and recoveries with respect to these exposures. In this regard, the Company discloses the discounted expected future net cash flows under all insurance contracts, irrespective of the legal form of the guarantee (i.e., financial guarantee insurance policy or insured derivative contract) or the GAAP accounting basis.
(6)-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.
The following tables present the gross par outstanding by vintage year of MBIA Corp.’s total direct RMBS insured exposure as of December 31, 2014 and 2013. Amounts include the gross par outstanding related to transactions that the Company consolidates under accounting guidance for VIEs.
As of December 31, 2014, MBIA Corp.’s $13.8 billion CDO portfolio represented 25% of its total insured gross par outstanding of $55.2 billion. As of December 31, 2013, MBIA Corp.’s $29.7 billion CDO portfolio represented 37% of its total insured gross par outstanding of $80.4 billion. In addition to the below table, MBIA Corp. insures approximately $519 million in CRE loan pools, primarily comprising European assets. The distribution of our insured CDO and related instruments portfolio by collateral type is presented in the following table:
NET INVESTMENT INCOME The decreases in net investment income for 2014 compared with 2013 and 2012 were primarily due to lower average asset balances as investments were sold to generate liquidity and repay or repurchase liabilities.
FEES Fees are generated from support services provided to the Company’s other operating businesses on a fee-for-service basis. Fees for 2014 decreased compared with 2013 and 2012 primarily due to declines in fees paid by our conduit segment for administrative and other services. During the second quarter of 2014, we dissolved our conduit segment.
NET GAINS (LOSSES) ON FINANCIAL INSTRUMENTS AT FAIR VALUE AND FOREIGN EXCHANGE The favorable change in net gains (losses) on financial instruments at fair value and foreign exchange for 2014 compared with 2013 was primarily due to foreign currency exchange gains on Euro denominated liabilities from changes in the U.S. dollar\Euro foreign exchange rate, an increase in realized gains from asset sales and changes in the fair value of outstanding warrants issued on MBIA Inc. common stock. The changes in the fair value of outstanding warrants were primarily attributable to fluctuations in MBIA Inc.’s stock price and volatility, which are used in the valuation of the warrants. This favorable change was partially offset by losses on fair valuing financial instruments. The favorable change in net gains (losses) on financial instruments at fair value and foreign exchange for 2013 compared with 2012 was primarily due to derivative gains in 2013 compared with losses in 2012 and a decline in losses from the sale of investments. This favorable change was partially offset by an increase of losses on MTNs that are carried at fair value.
NET GAINS (LOSSES) ON EXTINGUISHMENT OF DEBT Net gains (losses) on extinguishment of debt was primarily due to gains from terminations of MTNs and investment agreements issued by the Company.
REVENUES OF CONSOLIDATED VIEs For 2014 and 2013, total revenues of consolidated VIEs related to net losses as a result of the deconsolidation of VIEs.
OPERATING EXPENSES Operating expenses for 2014 decreased compared with 2013 primarily due to decreases in expenses related to the settlement with Bank of America that occurred in 2013 and lower compensation expense in 2014. Operating expenses for 2013 increased compared with 2012 primarily due to an increase in compensation expense related to severance and expenses related to the settlement with Bank of America that occurred in 2013.
PROVISION (BENEFIT) FOR INCOME TAXES The 2014 benefit for income taxes includes a favorable adjustment of $87 million for the release of the full valuation allowance against the deferred tax asset which resulted from the sales of previously impaired investments. In addition for 2014, there was a $61 million reversal in our reserve for uncertain tax positions. The 2013 benefit for income taxes was impacted by an unfavorable increase in the reserve for uncertain tax positions, additional state tax expense and the non deductibility of the valuation on warrants issued by the Company. The 2012 benefit for income taxes was favorably impacted by the release of a portion of the valuation allowance against the deferred tax asset.
For the year ended December 31, 2014, our corporate segment’s operating loss decreased when compared with 2013 primarily as a result of decreases in operating and interest expense and an increase in the benefit for income taxes as a result of the release of our valuation allowance against the deferred tax asset from the sales of previously impaired investments and the reversal in our reserve for uncertain tax positions. These changes were partially offset by lower fees paid by our conduit segment for support services.
For the year ended December 31, 2013, the unfavorable change in net income (loss) compared with 2012 was primarily driven by a decrease in fees due to declines in asset balances managed for third parties and our other segments.
The Company’s conduit segment was operated through Meridian and administered through MBIA Asset Finance, LLC. Assets financed by Meridian were funded by MTNs. In the second quarter of 2014, we retired the remaining $129 million of outstanding MTNs issued by Meridian and dissolved the conduit segment. Certain of MBIA’s consolidated subsidiaries had received fees for services provided to Meridian.
The Company’s income taxes and the related effective tax rates for the years ended December 31, 2014, 2013 and 2012 are presented in the following table:
For 2013, our effective tax rate applied to our income (loss) before income taxes was higher than the U.S. statutory tax rate of 35% primarily due to the provision for deferred taxes on basis differences of certain foreign subsidiaries, non-deductibility of warrants issued by the Company, and the fluctuation of the value of those warrants. These items are partially offset by a benefit for the reduction in the valuation allowance against our deferred tax asset.
The Company is party to a tax allocation agreement with members of its holding company system effective January 1, 1987. The agreement was amended and restated effective September 8, 2011 to change the method of calculating each domestic insurer’s tax liability to the method permitted by paragraph 3(a) of Department Circular Letter #33 (1979). The agreement was submitted to the NYSDFS for review and non-disapproval pursuant to Section 1505 of the New York Insurance Law (“NYIL”).
The Company manages its capital resources to minimize its cost of capital while maintaining appropriate claims-paying resources (“CPR”) for National and MBIA Corp. The Company’s capital resources consist of total shareholders’ equity, total debt issued by MBIA Inc. for general corporate purposes, and surplus notes issued by MBIA Corp. Total capital resources were $5.4 billion and $4.8 billion as of December 31, 2014 and 2013, respectively. MBIA Inc. uses its capital resources to support the business activities of its subsidiaries. As of December 31, 2014, MBIA Inc.’s investments in subsidiaries totaled $4.0 billion.
In addition, MBIA Inc. also supports the MTN and investment agreement obligations originally issued by the Company. MBIA Inc. seeks to maintain sufficient liquidity and capital resources to meet its general corporate needs. As of December 31, 2014 and 2013, net debt of MBIA Inc., which primarily comprised long-term debt, MTNs, investment agreements and derivative liabilities net of cash and investments at amortized cost and a tax receivable from subsidiaries, totaled $740 million and $1.0 billion, respectively. The Company expects that MBIA Inc. will generate sufficient cash to satisfy its net debt and its general corporate needs over time from distributions from its operating subsidiaries. In addition, the Company may also consider raising third-party capital. There can be no assurance that the aforementioned factors will generate sufficient cash to satisfy its net debt. Refer to the following “Liquidity-MBIA Inc. Liquidity” section for additional information about MBIA Inc.’s liquidity.
In the fourth quarter of 2014, the Company’s Board of Directors authorized the repurchase of up to $200 million of its outstanding shares, against which we repurchased 1,247,337 common shares of MBIA Inc. at an average share price of $9.44. Subsequent to December 31, 2014, we repurchased an additional 6,317,901 common shares of MBIA Inc. at an average share price of $8.70 per share. As of February 26, 2015, $133 million remained available to repurchase under this new program.
National reported total statutory capital of $3.3 billion as of December 31, 2014 and 2013. As of December 31, 2014, statutory capital comprised $1.1 billion of contingency reserves and $2.2 billion of policyholders’ surplus. National had statutory net income of $238 million for the year ended December 31, 2014. As of December 31, 2014, National’s unassigned surplus was $1.6 billion.
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 Corp.-Capital and Surplus” section for additional information about contingency reserves under the NYIL. National’s policyholders’ surplus would grow over time from the recognition of unearned premiums and investment income and the expected release of the contingency reserves. Conversely, dividends and incurred losses would reduce policyholders’ surplus. As of December 31, 2014 and 2013, National was not in compliance with certain of its single risk limits but was in compliance with its aggregate risk limits.
National had positive earned surplus as of December 31, 2014, which provides National with dividend capacity. As a condition to the NYSDFS’ approval of the simultaneous repurchase and reverse repurchase agreements (“Asset Swap”) between MBIA Inc. and National, the NYSDFS requested that, until the notional amount of the Asset Swap has been reduced to 5% or less of National’s admitted assets, each of MBIA Inc., MBIA Corp. and National provide the NYSDFS with three months prior notice, or such shorter period as the NYSDFS may permit, of its intent to initiate cash dividends on shares of its common stock.
National provided such notice. In October of 2014, National declared and paid a dividend of $220 million to its ultimate parent, MBIA Inc. Declared and paid dividend amounts from National in the foreseeable future will be limited based on net investment income and will be substantially lower than previous dividends.
National’s CPR and components thereto, as of December 31, 2014 and 2013 are presented in the following table:
MBIA Corp. reported total statutory capital of $859 million as of December 31, 2014 compared with $825 million as of December 31, 2013. As of December 31, 2014, statutory capital comprised $317 million of contingency reserves and $542 million of policyholders’ surplus. For the year ended December 31, 2014, MBIA Corp. had a statutory net loss of $35 million, primarily due to losses and LAE incurred partially offset by net premiums earned. MBIA Corp.’s policyholders’ surplus as of December 31, 2014 included a negative unassigned surplus of $1.5 billion. As of December 31, 2014, MBIA Corp.’s policyholders’ surplus was negatively impacted by $106 million because under NYIL it was not permitted to treat as an admitted asset the portion of its investment in subsidiaries in excess of 60% of net admitted assets less the par value of common and preferred stock and liabilities. This overage was caused by a decrease in MBIA Corp.’s policyholders’ surplus due to insured losses in the past. MBIA Corp.’s policyholders’ surplus may be further negatively impacted if future additional insured losses are incurred and the percentage of its assets invested in subsidiaries continues to increase.
Under NYIL, MBIA Corp. is also required to establish a contingency reserve to provide protection to policyholders in the event of extreme losses in adverse economic events. The amount of the reserve is based on the percentage of principal insured or premiums earned, depending on the type of obligation (net of collateral, reinsurance, refunding, refinancings and certain insured securities). Reductions in the contingency reserve may be recognized based on excessive reserves and under certain stipulated conditions, subject to the approval of the Superintendent of the NYSDFS. As a result of regulatory approved reductions, MBIA Corp.’s contingency reserves of $317 million as of December 31, 2014 represented reserves on 54 of the 376 outstanding credits insured by MBIA Corp. For risks associated with MBIA Corp.’s failure to meet its contingency reserve requirement, see Part I, Item 1A, “Risk Factors-Capital, Liquidity and Market Related Risk Factors- If our insurance companies fail to meet regulatory capital requirements they may become subject to regulatory action” in this Annual Report on Form 10-K.
MBIA Corp.’s CPR and components thereto, as of December 31, 2014 and 2013 are presented in the following table:
(3)-This amount primarily consists of expected recoveries related to the Company’s excess spread.
National maintains the Asset Swap with MBIA Inc. which provides MBIA Inc. with eligible assets to pledge under investment agreements and derivative contracts. As of December 31, 2014, the notional amount used under each of these agreements was $443 million and the fair value of collateral pledged by National and MBIA Inc. under these agreements was $458 million and $474 million, respectively. The net average interest rate on these transactions was 0.23%, 0.24% and 0.44% for the years ended December 31, 2014, 2013 and 2012, respectively.
servicing outstanding corporate debt instruments, investment agreements and the intercompany loans that support MTNs issued by GFL;
We expect that for the foreseeable future National will be the primary source of dividends and tax sharing agreement payments. There can be no assurance as to the amount and timing of any such dividends or payments under the tax sharing agreements. During 2014, National declared and paid a dividend of $220 million to its ultimate parent, MBIA Inc. Declared and paid dividend amounts from National in the foreseeable future will be limited based on net investment income and will be substantially lower than previous dividends. Refer to the “Capital Resources-Insurance Statutory Capital” section for additional information on payments of dividends. We do not expect that liquidity stress at MBIA Corp. would have any direct impact on MBIA Inc. given that we do not expect MBIA Inc. to receive distributions from MBIA Corp. for the foreseeable future.
Currently, the majority of the cash and securities of MBIA Inc. is pledged against investment agreement liabilities, derivatives and the Asset Swap, which limit its ability to raise liquidity through asset sales. A significant portion of MBIA Inc.’s assets are pledged against Asset Swap liabilities. If the market value or rating eligibility of the assets which are pledged against MBIA Inc.’s obligations were to decline, we would be required to pledge additional eligible assets in order to meet minimum required collateral amounts against these liabilities. To mitigate these risks, we seek to maintain cash and liquidity resources that we believe will be sufficient to make all payments due on our obligations and to meet other financial requirements, such as posting collateral. Contingent liquidity resources include: (1) accessing the capital markets; (2) sales of invested assets exposed to credit spread stress risk, which may occur at losses and increase MBIA Inc.’s net debt; and (3) termination and settlement of interest rate swap agreements. These actions, if taken, are expected to result in either additional liquidity or reduced exposure to adverse credit spread movements. There can be no assurance that these actions will be sufficient to fully mitigate this risk. Information concerning our credit spread sensitivity appears in Part II, Item 7A, “Quantitative and Qualitative Disclosures about Market Risk.”
Liquidity available in our international and structured finance insurance segment is affected by:
MBIA Corp. has recorded expected excess spread recoveries of $628 million as of December 31, 2014 associated with insured second-lien RMBS issues, including recoveries related to consolidated VIEs. MBIA Corp. has also recorded expected recoveries related to its claims against Credit Suisse related to ineligible loans included in an MBIA Corp. insured RMBS transaction. There can be no assurance that we will be successful or that we will not be delayed in realizing these recoveries. During 2014, MBIA Corp. collected $116 million of recoveries related to insured second-lien RMBS issues comprising $98 million of excess spread and $18 million of mortgage insurance. Mortgage insurance is received periodically from the servicers. During 2014, recoveries on second-lien RMBS issues exceeded paid claims and LAE by $12 million.
As of December 31, 2014, National held cash and short-term investments of $595 million, of which $528 million was highly liquid and comprised highly rated commercial paper, money market funds and municipal, U.S. agency and corporate bonds. As of December 31, 2013, National held cash and short-term investments of $665 million, of which $627 million was highly liquid and comprised commercial paper, money market funds, and highly rated municipal, U.S. agency and corporate bonds.
Net cash used by operating activities increased for the year ended December 31, 2014 compared with 2013 primarily due to a decrease in financial guarantee recoveries received of $2.5 billion partially offset by a decrease in financial guarantee losses and LAE paid of $203 million. Net cash provided by operating activities increased in 2013 compared with 2012 primarily due to an increase in financial guarantee recoveries received of $2.4 billion as a result of the Bank of America Settlement and the sale of the Residential Funding Company, LLC Claims, a decrease in payments for losses and LAE of $452 million primarily due to reductions in payments for second-lien RMBS and a gaming related transaction, and a decrease in interest expense paid of $176 million as a result of the NYSDFS’ denial to approve interest payments on the surplus notes. These changes were partially offset by a decrease in cash received from investment income of $168 million due to sales of investments to fund claim and commutation payments.
Net cash provided by investing activities increased for the year ended December 31, 2014 compared with 2013 primarily due to a decline in purchases of AFS securities of $903 million and an increase in cash due to the consolidation of a VIE of $221 million, partially offset by declines in proceeds from net sales, paydowns and maturities of investments and loans receivables of $390 million. Net cash used by investing activities decreased in 2013 compared with 2012 due to declines in proceeds from net sales, paydowns, and maturities of investments of $5.6 billion for purposes of funding commutation and loss payments, partially offset by a decline in purchases of AFS securities of $689 million and a reduction in collateral posting of $407 million.
Net cash used by financing activities decreased for the year ended December 31, 2014 compared with 2013 primarily due to a decrease in principal paydowns of debt related to financial guarantee VIEs and investment agreements of $596 million and an increase in proceeds from the issuance of VIE notes of $79 million, partially offset by purchases of treasury stock of $32 million. Net cash used by financing activities decreased in 2013 compared with 2012 primarily due to decreases in payments of long-term debt related to our conduit segment of $537 million, drawdowns of investment agreements of $403 million and securities sold under agreements to repurchase of $287 million.
The credit quality distribution of the Company’s AFS fixed-maturity investment portfolios, excluding short-term investments, based on ratings from Moody’s as of December 31, 2014 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.
Without giving effect to the National and MBIA Corp. guarantees of the Company-Insured Investments in the consolidated investment portfolio, as of December 31, 2014, 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 investments rated below investment grade in the Company-Insured Investments were 2% of the total consolidated investment portfolio.
As of December 31, 2014 and 2013, we held impaired AFS investments (investments for which fair value was less than amortized cost) with a fair value of $2.1 billion and $3.5 billion, respectively.
We analyze impaired investments within our investment portfolio for OTTI on a quarterly basis. Key factors considered when assessing OTTI include but are not limited to: (a) structural and economic factors among security types that represent our largest exposure to credit impairment losses; (b) the duration and severity of the unrealized losses (i.e., a decline in the market value of a security by 20% or more at the time of the review, or 5% impaired at the time of review with a fair value below amortized cost for a consecutive 12-month period); and (c) the results of various cash flow modeling techniques. Our cash flow analysis considers all sources of cash, including credit enhancement, that support the payment of amounts owed by an issuer of a security. This includes the consideration of cash expected to be provided by financial guarantors, including MBIA Corp., resulting from an actual or potential insurance policy claim.
Included in international and structured finance insurance segment’s surplus notes is interest related to the 2013 and 2014 interest payments in which MBIA Corp.’s requests for approval to pay was denied by the NYSDFS. This deferred interest payment will be due on the first business day on or after which MBIA Corp. obtains approval to make such payment. No interest will accrue on the deferred interest. There can be no assurance that the NYSDFS will approve any subsequent payments, or that it will approve any payment by the scheduled interest payment date.
Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2014, 2013 and
Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2014,
National seeks to generate shareholder value through appropriate risk adjusted pricing; however, current market conditions and the competitive landscape may limit National’s new business opportunities and its abilities to price and underwrite risk with attractive returns. Refer to “Risks and Uncertainties” below for a discussion of business risks related to National’s insured portfolio.
During 2014, the Company continued to focus on the collection of excess spread and put-back recoveries and the mitigation of MBIA Corp.’s high risk insurance exposures, primarily through commutations of insurance policies. During 2014, MBIA Corp. commuted $7.1 billion of gross par exposure, primarily comprising structured commercial mortgage-backed securities (“CMBS”) pools, investment grade corporate collateralized debt obligations (“CDOs”), small business securitizations, commercial real estate (“CRE”) CDOs and asset-backed securities (“ABS”) CDOs. During 2013, MBIA Corp. commuted $20.0 billion of gross par exposure, including $7.4 billion and $4.2 billion commuted with Bank of America and Societe Generale, respectively, primarily comprising structured CMBS pools, investment grade CDOs, ABS CDOs, first-lien residential mortgage-backed securities (“RMBS”), high yield corporate CDOs, CRE CDOs and structured insurance securities. During 2012, MBIA Corp. commuted $13.4 billion of gross par exposure, primarily comprising structured CMBS pools, CRE CDOs, investment grade CDOs, ABS CDOs, and subprime RMBS transactions. MBIA Corp. may make negotiated settlement payments to counterparties and/or forego its right to all or some termination premiums when it commutes insurance exposures. The difference between the fair values of the Company’s derivative liabilities for the commuted policies and the aggregate cost of the commutation is reflected in earnings.
The following table summarizes the components of assets and liabilities held for sale as of December 31, 2014 and 2013:
The Company’s financial statements include estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. The outcome of certain significant risks and uncertainties could cause the Company to revise its estimates and assumptions or could cause actual results to differ from the Company’s estimates.
The amount and timing of projected collections from excess spread from second-lien RMBS and the put-back recoverable from Credit Suisse Securities (USA) LLC, DLJ Mortgage Capital, Inc., and Select Portfolio Servicing Inc. (collectively, “Credit Suisse”) and the potential of claims from MBIA Corp.’s remaining insured exposures are uncertain. Further, the remaining insured portfolio, aside from these exposures, could deteriorate and result in additional significant loss reserves and claim payments. Management’s expected liquidity and capital forecasts for MBIA Corp., which include expected put-back recoveries from Credit Suisse and excess spread recoveries, reflect adequate resources to pay claims when due. However, if MBIA Corp. experiences higher than expected claim payments or is unable to terminate the remaining exposures that represent substantial risk to the Company, MBIA Corp. may ultimately have insufficient resources to continue to pay claims, which could cause the New York State Department of Financial Services (“NYSDFS”) to put MBIA Insurance Corporation, exclusive of MBIA UK, into a rehabilitation or liquidation proceeding. The Company does not believe that a rehabilitation or liquidation proceeding of MBIA Insurance Corporation by NYSDFS would have any significant long-term liquidity impact on MBIA Inc. or result in a liquidation or similar proceeding of MBIA UK. Such a proceeding could have material adverse consequences for MBIA Corp., including the termination of insured credit default swaps (“CDS”) contracts for which counterparties may assert market-based claims, the acceleration of debt obligations issued by affiliates and insured by MBIA Corp., the loss of control of MBIA Insurance Corporation to a rehabilitator or liquidator, and unplanned costs.
As of December 31, 2014 and 2013, the liquidity position, which comprise cash and liquid assets available for general liquidity purposes, of the Company’s corporate segment was $498 million and $359 million, respectively. During 2014, $220 million was released to MBIA Inc. under the MBIA group’s tax sharing agreement (the “Tax Escrow Account”) and National declared and paid a dividend of $220 million to its ultimate parent, MBIA Inc. Subsequent to December 31, 2014, an additional $228 million was released to MBIA Inc. from the Tax Escrow Account. While MBIA Inc.’s liquidity position improved during 2014 due to the Tax Escrow Account release and dividends received, MBIA Inc. continues to have liquidity risk. If invested asset performance deteriorates or the flow of dividends from subsidiaries is interrupted and/or access to the capital markets is impaired, its liquidity position could be eroded over time.
Property and equipment consists of land, buildings, leasehold improvements, furniture, fixtures and equipment and software owned by the Company. All property and equipment held for use is recorded at cost and, except for land, is depreciated over the appropriate useful life of the asset using the straight-line method.
Leasehold improvements are amortized over the useful life of the improvement or the remaining term of the lease, whichever is shorter. The cost and related accumulated depreciation applicable to assets sold or retired are removed from the Company’s balance sheet and any gain or loss on disposition is recognized in earnings as a component of “Other net realized gains (losses).” Maintenance and repairs are charged to current earnings as incurred.
The Company elected to record at fair value certain financial instruments that contained an embedded derivative that required bifurcation from the host contract and to be accounted for separately as a derivative instrument. These hybrid financial instruments included certain medium-term notes (“MTNs”) and certain AFS securities. The Company elected to fair value these hybrid financial instruments given the complexity of bifurcating the embedded derivatives.
Long-term debt is carried at the principal amount outstanding plus accrued interest and net of any unamortized discounts.
The Company recognizes a liability for unearned premium revenue at the inception of financial guarantee insurance and reinsurance contracts on a contract-by-contract basis. Unearned premium revenue recognized at inception of a contract is measured at the present value of the premium due. For most financial guarantee insurance contracts, the Company receives the entire premium due at the inception of the contract, and recognizes unearned premium revenue liability at that time.
For certain other financial guarantee contracts, the Company receives premiums in installments over the term of the contract. Unearned premium revenue and a receivable for future premiums are recognized at the inception of an installment contract, and measured at the present value of premiums expected to be collected over the contract period or expected period using a risk-free discount rate. The expected period is used in the present value determination of unearned premium revenue and receivable for future premiums for contracts where (a) the insured obligation is contractually prepayable, (b) prepayments are probable, (c) the amount and timing of prepayments are reasonably estimable, and (d) a homogenous pool of assets is the underlying collateral for the insured obligation. The Company has determined that substantially all of its installment contracts meet the conditions required to be treated as expected period contracts. The receivable for future premiums is reduced as installment premiums are collected. The Company reports the accretion of the discount on installment premiums receivable as premium revenue and discloses the amount recognized in “Note 5: Insurance Premiums.” The Company assesses the receivable for future premiums for collectability each reporting period, adjusts the receivable for uncollectible amounts and recognizes any write-off as operating expense, and discloses the amount recognized in “Note 5: Insurance Premiums.” As premium revenue is recognized, the unearned premium revenue liability is reduced.
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. As of December 31, 2014, any member with a net operating loss (“NOL”) has not received any payment with respect to stand-alone tax losses contributed to the consolidated group. Each member with an NOL will receive benefits of its tax losses and credits as it is able to earn them out in the future. However, based on current facts and circumstances, MBIA Inc. has advised its subsidiaries that, its intention is not to allow any member’s NOL, capital loss or tax credit carryforward generated by any subsidiary to expire without compensation, to the extent such carryforward is used in consolidation. Such intention is independent of the tax sharing agreement which does not require any such compensation.
In June of 2014, the FASB issued ASU 2014-11, “Transfers and Servicing (Topic 860)-Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures.” The repurchase agreements and similar transactions guidance is amended by ASU 2014-11 to change the accounting for i.) repurchase-to-maturity transactions to secured borrowing accounting and ii.) linked repurchase financing transactions to secured borrowing accounting. ASU 2014-11 amends disclosure requirements for transfers accounted for as sales, and for repurchase transactions accounted for as secured borrowings. ASU 2014-11 is effective for interim and annual periods beginning January 1, 2015, and is applied on a prospective basis. The adoption of ASU 2014-11 is not expected to materially impact the Company’s consolidated financial statements.
Compensation-Stock Compensation (Topic 718)-Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (A Consensus of the FASB Emerging Issues Task Force) (ASU 2014-12)
In June of 2014, the FASB issued ASU 2014-12, “Compensation-Stock Compensation (Topic 718)-Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period.” ASU 2014-12 requires that a performance target that affects vesting of share-based payment awards and that could be achieved after an employee’s requisite service period be accounted for as a performance condition. ASU 2014-12 is effective for interim and annual periods beginning January 1, 2016 with early adoption permitted, and is applied on a prospective basis or retrospective basis. The adoption of ASU 2014-12 is not expected to materially impact the Company’s consolidated financial statements.
Consolidation (Topic 810)-Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity (ASU 2014-13)
Presentation of Financial Statements-Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (ASU 2014-15)
In February of 2015, the FASB issued ASU 2015-02, “Consolidation (Topic 810)-Amendments to the Consolidation Analysis.” ASU 2015-02 amends the accounting guidance for consolidation of legal entities including VIEs. ASU 2015-02 eliminates the specialized consolidation model and guidance for limited partnerships, amends the conditions for evaluating whether a fee paid to a decision maker or a service provider represents a variable interest in a VIE, amends the related party guidance for the determination of the primary beneficiary of a VIE, and requires certain investment funds designed as VIEs, except money market funds, to apply the amended consolidation guidance. ASU 2015-02 is effective for interim and annual periods beginning January 1, 2016 with early adoption permitted, and is applied on a retrospective or modified retrospective basis. The Company is evaluating the impact of adopting ASU 2015-02.
The Company evaluates issuer-sponsored SPEs initially to determine if an entity is a VIE, and is required to reconsider its initial determination if certain events occur. For all entities determined to be VIEs, MBIA performs an ongoing reassessment to determine whether its guarantee to provide credit protection on obligations issued by VIEs provides the Company with a controlling financial interest. Based on its ongoing reassessment of controlling financial interest, the Company determines whether a VIE is required to be consolidated or deconsolidated.
The Company’s advisory services segment provides asset management and advisory services to VIEs. During 2014, the Company consolidated three VIEs as the primary beneficiary, pursuant to this segment’s activities. As of December 31, 2014, the Company holds approximately $4 million of the subordinated notes issued by one of the VIEs. The Company has no obligation or commitment to provide additional financial support or liquidity to these VIEs. Effective January 1, 2015, the Company completed the sale of its Cutwater business and deconsolidated these VIEs. Refer to “Note 1: Business Developments and Risks and Uncertainties” for additional information about the sale of Cutwater.
The carrying amounts of assets and liabilities of consolidated VIEs were $5.0 billion and $4.8 billion, respectively, as of December 31, 2014, and $5.6 billion and $5.3 billion, respectively, as of December 31, 2013. 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. The carrying amounts of assets and liabilities of consolidated VIEs in the Company’s advisory services segment were $751 million and $754 million, respectively, as of December 31, 2014, and are presented separately in “Assets held for sale” and “Liabilities held for sale” 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. Three additional VIEs were consolidated during the year ended December 31, 2014 and no additional VIEs were consolidated during the year ended December 31, 2013. Net realized losses recorded for the year ended December 31, 2014 were $3 million related to the consolidation of VIEs.
As of December 31, 2014 and 2013, premiums receivable was $875 million and $1.1 billion, respectively, primarily related to installment policies for which premiums will be collected over the estimated term of the contracts. Premiums receivable for an installment policy is initially measured at the present value of premiums expected to be collected over the expected period or contract period of the policy using a risk-free discount rate. Premiums receivable for policies that use the expected period of risk due to expected prepayments are adjusted in subsequent measurement periods when prepayment assumptions change using the risk-free discount rate as of the remeasurement date.
As of December 31, 2014 and 2013, the risk-free rate used to discount future installment premiums was 2.8% and 2.9%, respectively, and the weighted average expected collection term of the premiums receivable was 9.18 years and 9.21 years, respectively. As of December 31, 2014 and 2013, reinsurance premiums payable was $56 million and $51 million, respectively, and is included in “Other liabilities” in the Company’s consolidated balance sheets. The reinsurance premiums payable is accreted and paid to reinsurers as premiums due to MBIA are accreted and collected.
The following tables present a roll forward of the Company’s premiums receivable for the years ended December 31, 2014 and 2013:
(1)-Primarily consists of unrealized gains (losses) due to foreign currency exchange rates.
The frequency and extent of IPM’s 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.
U.S. public finance insured transactions consist of 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. The Company estimates future losses by using probability-weighted scenarios that are customized to each insured transaction. Future loss estimates consider debt service due for each insured transaction, which includes par outstanding and interest due.
Certain local governments remain under financial and budgetary stress and a few have filed for protection under the United States Bankruptcy Code, or have entered into state statutory proceedings established to assist municipalities in managing through periods of severe fiscal stress. This could lead to an increase in defaults by such entities on the payment of their obligations and losses or impairments on a greater number of the Company’s insured transactions. The Company monitors and analyzes these situations closely, however, the overall extent and duration of such events are uncertain and the filing for protection under the United States Bankruptcy Code or entering state statutory proceedings does not result in a default or indicate that an ultimate loss will occur. As of December 31, 2014 and 2013, the Company had $98.9 billion and $124.9 billion, respectively, of gross par outstanding on general obligations, of which $152 million and $161 million, respectively, were reflected on the Company’s “Classified List.” Capital appreciation bonds are reported at the par amount at the time of issuance of the insurance policy.
As of December 31, 2014, the majority of the international and structured finance insurance segment’s case basis reserves and insurance loss recoveries recorded in accordance with GAAP were related to insured second and first-lien RMBS transactions. These reserves and recoveries do not include estimates for policies insuring credit derivatives or losses and recoveries on financial guarantee VIEs that are eliminated in consolidation. Policies insuring credit derivative contracts are accounted for as derivatives and carried at fair value under GAAP. The fair values of insured derivative contracts are influenced by a variety of market and transaction-specific factors that may be unrelated to potential future claim payments under the Company’s insurance policies. In the absence of credit impairments on insured derivative contracts or the early termination of such contracts at a loss, the cumulative unrealized losses recorded from these contracts should reverse before or at the maturity of the contracts.
The Company’s RMBS reserves and recoveries relate to financial guarantee insurance policies. The Company calculated RMBS case basis reserves as of December 31, 2014 for both second and first-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 potential losses and recoveries 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).
The Company’s second-lien RMBS case basis reserves as of December 31, 2014 relate to RMBS backed by home equity lines of credit (“HELOC”) and closed-end second mortgages (“CES”).
The Roll Rates for 30-59 day delinquent loans and 60-89 day delinquent loans are calculated on a transaction-specific basis. The Company assumes that the Roll Rate for 90+ day delinquent loans, excluding foreclosures and Real Estate Owned (“REO”) is 95%. The Roll Rates are applied to the amounts in the respective delinquency buckets based on delinquencies as of November 30, 2014 to estimate future losses from loans that are delinquent as of the current reporting period.
Roll Rates for loans that are current as of November 30, 2014 (“Current Roll to Loss”) are also calculated on a transaction-specific basis. A proportion of loans reported current as of November 30, 2014 is assumed to become delinquent every month, at a Current Roll to Loss rate that persists at current levels for a time and subsequently starts to decline. A key assumption in the model is the period of time in which the Company projects current levels of Current Roll to Loss to persist. The three different scenarios, base, stress and additional stress, differ in the period of time for which the current levels of Current Roll to Loss rates persist. Loss reserves are calculated by using a weighted average of these three scenarios, with the majority of the probability assigned to the stress and additional stress scenarios where the current levels of Current Roll to Loss rates persist for six or eighteen months before reverting to historic levels.
In addition, the Company considers borrower draw rates, voluntary prepayment rates and pool mortgage insurance, that primarily affect the excess spread generated by current loans, which offsets losses and results in reimbursements to the Company. The Company uses the twelve-month average voluntary prepayment rates and the six-month average loss severities to model its loss reserves. For HELOCs, the current three-month average draw rate is generally used to project future draws on the line. Projected cash flows are also based on an assumed constant basis spread between floating rate assets and floating rate insured debt obligations (the difference between Prime and London Interbank Offered Rate (“LIBOR”) interest rates, minus any applicable fees). For all transactions, cash flow models consider allocations and other structural aspects, including managed amortization periods, rapid amortization periods and claims against MBIA Corp.’s insurance policy consistent with such policy’s terms and conditions. The estimated net claims from the procedure above are then discounted using a risk-free rate to a net present value reflecting MBIA’s general obligation to pay claims over time and not on an accelerated basis. The above assumptions represent MBIA’s probability-weighted estimates of how transactions will perform over time.
As of December 31, 2014 and 2013, the Company established loss and LAE reserves totaling $70 million and $126 million, respectively, related to second-lien RMBS issues after the elimination of $21 million and $43 million, respectively, as a result of consolidating VIEs. For the year ended December 31, 2014, the Company incurred $70 million of losses and LAE recorded in earnings related to second-lien RMBS issues after the elimination of a $20 million expense as a result of consolidating VIEs.
As of December 31, 2014 and 2013, the Company recorded estimated recoveries of $523 million and $681 million, respectively, for the reimbursement of past and future expected claims through excess spread in insured second-lien RMBS transactions after the elimination of $137 million and $190 million, respectively, as a result of consolidating VIEs. As of December 31, 2014, $496 million and $27 million were included in “Insurance loss recoverable” and “Loss and loss adjustment expense reserves” on the Company’s consolidated balance sheets, respectively, after the elimination of $132 million and $5 million in “Insurance loss recoverable” and in “Loss and loss adjustment expense reserves”, respectively, as a result of consolidating VIEs. As of December 31, 2013, $647 million and $34 million were included in “Insurance loss recoverable” and “Loss and loss adjustment expense reserves” on the Company’s consolidated balance sheets, respectively, after the elimination of $183 million and $7 million, respectively, as a result of consolidating VIEs.
Excess spread is generated by performing loans within insured second-lien RMBS securitizations and is the difference between interest inflows on mortgage loan collateral and interest outflows on insured beneficial interests. The amount of excess spread depends on the future loss trends (which include future delinquency trends, average time to charge-off delinquent loans, and the availability of pool mortgage insurance), the future spread between Prime and LIBOR interest rates; and borrower refinancing behavior which results in voluntary prepayments. Minor deviations in loss trends and voluntary prepayments may substantially impact the amounts collected from excess spread.
Voluntary prepayment rates generally increased for the year ended December 31, 2014. The use of these average voluntary prepayment rates in the loss projections resulted in a reduction in estimated recoveries.
As of December 31, 2014 and 2013, the Company recorded estimated recoveries of $379 million and $359 million, respectively, related to its Credit Suisse put-back claims, reflected in “Loan repurchase commitments” presented under the heading “Assets of consolidated variable interest entities” on the Company’s consolidated balance sheets.
The Company believes that it will prevail in enforcing its contractual put-back rights against Credit Suisse. Based on the Company’s assessment of the strength of these claims, its prior settlements with other sellers/servicers, and success of other monolines in litigation against other sellers/servicers, the Company believes it is entitled to collect the full amount of its incurred losses, which totaled $417 million through December 31, 2014. The Company is also entitled to collect interest on amounts paid; it believes that in context of its put-back litigation, the appropriate rate should be the New York State statutory rate. However, the Company currently calculates its put-back recoveries using the contractual interest rate, which is lower than the New York State statutory rate.
The Company’s first-lien RMBS case basis reserves as of December 31, 2014, which primarily relate to RMBS backed by alternative A-paper and subprime mortgage loans, were determined using the Roll Rate Methodology. The Company assumes that the Roll Rate for loans in foreclosure, 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. The Current Roll to Loss rates stay at the November 30, 2014 level for one month before declining to 25% of this level over a 24-month period.
The Company estimates future losses by using three different probability-weighted scenarios: base; stress; and additional stress. The three scenarios differ in the Roll Rates to loss of 90+ day delinquent loans. In the base scenario, the Company uses deal-specific Roll Rates obtained from historic loan level Roll Rate data for 90+ day delinquent loans. In the stress scenario, the Company assumes a 90% Roll Rate for all 90+ day delinquent loans. In the additional stress scenario, the Roll Rates for each deal are an average of the deal-specific Roll Rate used in the base scenario and the 90% rate. The Roll Rates are applied to the amounts in each deal’s respective 90+ delinquency bucket based on delinquencies as of November 30, 2014 in order to estimate future losses from loans that are delinquent as of December 31, 2014.
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 start the projection for trends in loss severities at loan liquidation. The loss severities are reduced over time to account for reduction in the amount of foreclosure inventory, anticipated future increases in home prices, principal amortization of the loan and government foreclosure moratoriums.
1. Each transaction is evaluated for its commutation potential, which is customized by counterparty and considers historical commutation prices, the level of dialogue with the counterparty and the credit quality and payment profile of the underlying exposure.
As of December 31, 2014 and 2013, the Company established loss and LAE reserves totaling $111 million and $127 million, respectively, related to the total CDO financial guarantee insurance portfolio after the elimination of $225 million and $226 million, respectively, as a result of consolidating VIEs. For the year ended December 31, 2014, the Company incurred $33 million of losses and LAE recorded in earnings related to the total CDO financial guarantee insurance portfolio after the elimination of a $1 million benefit as a result of consolidating VIEs. In the event of further deteriorating performance of the collateral referenced or held in total CDO portfolio, the amount of losses estimated by the Company could increase substantially.
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, 2014:
The following table presents the components of the Company’s loss and LAE reserves and insurance loss recoverable as reported on the Company’s consolidated balance sheets as of December 31, 2014 and 2013 for insured obligations within MBIA’s “Classified List.” 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.
As of December 31, 2014, loss and LAE reserves include $653 million of reserves for expected future payments, partially offset by expected recoveries of such future payments of $147 million. As of December 31, 2013, loss and LAE reserves included $847 million of reserves for expected future payments, partially offset by expected recoveries of such future payments of $206 million.
As of December 31, 2014 and 2013, the insurance loss recoverable primarily related to expected future recoveries on second-lien RMBS transactions resulting from excess spread generated by performing loans in such transactions. The decrease in insurance loss recoverable was primarily due to decreases in projected collections from excess spread within insured second-lien RMBS securitizations.
The following tables present changes in the Company’s loss and LAE reserves for the years ended December 31, 2014 and 2013. Changes in the loss 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, 2014 and 2013, the weighted average risk-free rate used to discount the Company’s loss reserves (claim liability) was 1.72% and 2.37%, respectively. LAE reserves are generally 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 related to loss payments and changes in assumptions on ABS CDOs and an international road transaction. These were partially offset by increases in reserves due to changes in discount rates, primarily on ABS CDOs and insured first and second-lien RMBS issues outstanding as of December 31, 2013, and changes in assumptions related to high yield corporate CDOs.
The decrease in the Company’s gross loss and LAE reserves reflected in the preceding table was primarily related to loss payments on insured first and second-lien RMBS and U.S. public finance issues, partially offset by changes in assumptions.
The Company’s insurance loss recoverable decreased during 2013 primarily due to recoveries associated with issues outstanding as of December 31, 2012, which related to a settlement on the ineligible mortgage loans included in insured second-lien residential mortgage securitization exposures that were subject to contractual obligations by sellers/servicers to repurchase or replace such mortgages. Recoveries on unpaid losses decreased primarily due to changes in assumptions as a result of the reduction of excess spread related to first and second-lien RMBS transactions and changes in discount rates.
Fair value is a market-based measurement considered from the perspective of a market participant. Therefore, even when market assumptions are not readily available, the Company’s own assumptions are set to reflect those which it believes market participants would use in pricing an asset or liability at the measurement date. The fair value measurement of financial instruments held or issued by the Company are determined through the use of observable market data when available. Market data is obtained from a variety of third-party sources, including dealer quotes. If dealer quotes are not available for an instrument that is infrequently traded, the Company uses alternate valuation methods, including either dealer quotes for similar instruments or modeling using market data inputs.
The accounting guidance for fair value measurement establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available and reliable. Observable inputs are those the Company believes that market participants would use in pricing an asset or liability based on available market data. Unobservable inputs are those that reflect the Company’s beliefs about the assumptions market participants would use in pricing an asset or liability based on available information. The fair value hierarchy is categorized into three levels based on the observability and reliability of inputs, as follows:
Level 3-Valuations based on inputs that are unobservable and supported by little or no market activity and that are significant to the overall fair value measurement. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques where significant inputs are unobservable, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
Financial assets, excluding derivative assets, held by the Company primarily consist of investments in debt securities. Substantially all of the Company’s investments are priced by independent third parties, including pricing services and brokers. Typically, the Company receives one pricing service value or broker quote for each instrument, which represents a non-binding indication of value. The Company reviews the assumptions, inputs and methodologies used by pricing services and brokers to obtain reasonable assurance that the prices used in its valuations reflect fair value. When the Company believes a third-party quotation differs significantly from its internally developed expectation of fair value, whether higher or lower, the Company reviews its 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 its price, and the Company still does not agree with the price provided, the Company will obtain a price from another third-party provider or use an internally developed price which it believes represents the fair value of the investment. The fair values of investments for which internal prices were used were not significant to the aggregate fair value of the Company’s investment portfolio as of December 31, 2014 or 2013. All challenges to third-party prices are reviewed by staff of the Company with relevant expertise to ensure reasonableness of assumptions.
All significant financial assets and liabilities are reviewed by committees created by the Company to ensure compliance with the Company’s policies and risk procedures in the development of fair values of financial assets and liabilities. These valuation committees review, among other things, key assumptions used for internally developed prices, significant changes in sources and uses of inputs, including changes in model approaches, and any adjustments from third-party inputs or prices to internally developed inputs or prices. The committees also review any significant impairment or improvements in fair values of the financial instruments from prior periods. From time to time, these committees will consult with the Company’s valuation experts to better understand key methods and assumptions used for the determination of fair value, including understanding significant changes in fair values. These committees are comprised of senior finance team members with the relevant experience in the financial instruments their committee is responsible for. For each quarter, these committees document their agreement with the fair values developed by management of the Company as reported in the quarterly and annual financial statements.
Fixed-Maturity Securities (including short-term investments) Held as Available-For-Sale, Investments Carried at Fair Value, Investments Pledged as Collateral, Investments Held-to-Maturity, and Other Investments
Cash and Cash Equivalents, Receivable for Investments Sold, Net Cash Collateral Pledged to Swap Counterparties, Payable for Investments Purchased, Payable for Loans Purchased and Accrued Investment Income
The carrying amounts of cash and cash equivalents, receivable for investments sold, net cash collateral pledged to swap counterparties, payable for investments purchased, payable for loans purchased, and accrued investment income approximate fair values due to the short-term nature and credit worthiness of these instruments. These items are categorized in Level 1 or Level 2 of the fair value hierarchy.
The fair values of certain MTNs are based on quoted market prices provided by third-party sources, where available. When quoted market prices are not available, the Company applies a matrix pricing grid based on the quoted market prices received and the MTNs’ stated maturity and interest rate to determine fair value. Nonperformance risk is included in the quoted market prices and the matrix pricing grid. The Company has elected to record these MTNs at fair value as they contain embedded derivatives which cannot accurately be separated from the host debt instrument and fair valued separately, therefore, these MTNs are carried at fair value with changes in fair value reflected in earnings. The remaining MTNs, which are not carried at fair value, do not contain embedded derivatives. As these MTNs are illiquid and the prices reflect significant unobservable inputs, they are categorized as Level 3 of the fair value hierarchy.
The VIEs have entered into derivative transactions consisting of cross currency swaps and interest rate caps. Fair values of OTC derivatives are determined using valuation models based on observable and/or unobservable inputs. These observable and market-based inputs include interest rates and volatilities. These derivatives are categorized in Level 2 or Level 3 of the fair value hierarchy based on the input that is significant to the fair value measurement in its entirety.
The Company has policies and procedures in place regarding counterparties, including review and approval of the counterparty and the Company’s exposure limit, collateral posting requirements, collateral monitoring and margin calls on collateral. The Company manages counterparty credit risk on an individual counterparty basis through master netting agreements covering derivative transactions in the corporate segment as of December 31, 2014. These agreements allow the Company to contractually net amounts due from a counterparty with those amounts due to such counterparty when certain triggering events occur. The Company only executes swaps under master netting agreements, which typically contain mutual credit downgrade provisions that generally provide the ability to require assignment or termination in the event either the Company or the counterparty is downgraded below a specified credit rating. The netting agreements minimize the potential for losses related to credit exposure and thus serve to mitigate the Company’s nonperformance risk under these derivatives.
The derivative contracts insured by the Company cannot be legally traded and generally do not have observable market prices. The Company determines the fair values of insured credit derivatives using valuation models. The valuation models are consistently applied from period to period, with refinements to the fair value estimation approach being applied as and when the information becomes available. Negotiated settlements are also considered when determining fair value to validate the fair value estimates determined by the valuation models and to determine the best available estimate of fair value from the perspective of a market participant.
Inputs to the process of determining fair value for structured transactions using the BET Model include estimates of collateral loss, allocation of loss to separate tranches of the capital structure, and calculation of the change in value.
The model uses market-based inputs including credit spreads for underlying reference collateral, recovery rates specific to the type and credit rating of reference collateral, diversity score of the entire collateral pool, and MBIA’s CDS and derivative recovery rate level.
As of December 31, 2014, some of the model inputs were either unobservable or derived from illiquid markets which might adversely impact the model’s reliability.
Stock warrants issued by the Company are valued using the Black-Scholes model and are recorded at fair value. Inputs into the warrant valuation include the Company’s stock price, a volatility parameter, interest rates, and dividend data. As all significant inputs are market-based and observable, warrants are categorized as Level 2 of the fair value hierarchy.
In the fourth quarter of 2013, the Company approved and initiated a plan to sell its Armonk, New York facility. As a result, the facility was classified as held for sale as of December 31, 2014 and 2013 and presented within “Assets held for sale” on the Company’s consolidated balance sheets and measured at the lower of its carrying value or its fair value less cost to sell. The fair market value was estimated based on an independent third-party appraisal. This item is categorized as Level 2 of the fair value hierarchy.
The following tables provide quantitative information regarding the significant unobservable inputs used by the Company for assets and liabilities measured at fair value on a recurring basis as of December 31, 2014 and 2013. These tables exclude inputs used to measure fair value that are not developed by the Company, such as broker prices and other third-party pricing service valuations.
The significant unobservable inputs used in the fair value measurement of the Company’s loan repurchase commitments of consolidated VIEs are the recovery rates and breach rates. Recovery rates reflect the estimates of future cash flows reduced for litigation delays and risks and/or potential financial distress of the sellers/servicers. The estimated recoveries of the loan repurchase commitments may differ from the actual recoveries that may be received in the future. Breach rates represent the rate at which mortgages fail to comply with stated representations and warranties of the sellers/servicers. Significant increases or decreases in the recovery rates and the breach rates would result in significantly higher or lower fair values of the loan repurchase commitments, respectively. Additionally, changes in the legal environment and the ability of the counterparties to pay would impact the recovery rate assumptions, which could significantly impact the fair value measurement. Any significant challenges by the counterparties to the Company’s determination of breaches of representations and warranties could significantly adversely impact the fair value measurement. Recovery rates and breach rates are determined independently. Changes in one input will not necessarily have any impact on the other input.
The significant unobservable input used in the fair value measurement of the Company’s VIE notes of consolidated VIEs is the impact of the financial guarantee. The fair value of VIE notes is calculated by adding the value of the financial guarantee to the market value of VIE assets.
The value of a financial guarantee is estimated by the Company as the present value of expected cash payments under the policy. As the value of the guarantee provided by the Company to the obligations issued by the VIE increases, the credit support adds value to the liabilities of the VIE. This results in an increase in the fair value of the liabilities of the VIE.
The following tables present the fair values and carrying values of the Company’s assets and liabilities that are disclosed at fair value but not reported at fair value on the Company’s consolidated balance sheets as of December 31, 2014 and 2013:
Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Year Ended December 31, 2013
Gains and losses (realized and unrealized) included in earnings relating to Level 3 assets and liabilities for the years ended December 31, 2014 and 2013 are reported on the Company’s consolidated statements of operations as follows:
The following table presents the changes in fair value included in the Company’s consolidated statements of operations for the years ended December 31, 2014, 2013 and 2012 for financial instruments for which the fair value option was elected:
Substantially all gains and losses included in earnings during the periods ended December 31, 2014 and 2013 on loans receivable and VIE notes reported in the preceding table are attributable to credit risk. This is primarily due to the high rate of defaults on loans and the collateral supporting the VIE notes, resulting in depressed pricing of the financial instruments.
The following table presents the distribution by contractual maturity of AFS and HTM fixed-maturity securities at amortized cost and fair value as of December 31, 2014. Contractual maturity may differ from expected maturity as borrowers may have the right to call or prepay obligations.
The fair value of securities on deposit with various regulatory authorities as of December 31, 2014 and 2013 was $10 million for both periods. These deposits are required to comply with state insurance laws.
The following table presents the fair value and gross unrealized loss by credit rating category of ABS, MBS and corporate obligations included in the Company’s consolidated AFS investment portfolio as of December 31, 2014 for which fair value was less than amortized cost. The credit ratings are based on ratings from Moody’s as of December 31, 2014 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 Company concluded that it does not have the intent to sell securities in an unrealized loss position and it is more likely than not, that it would not have to sell these securities before recovery of their cost basis. In making this conclusion, the Company examined the cash flow projections for its investment portfolios, the potential sources and uses of cash in its businesses, and the cash resources available to its business other than sales of securities. It also considered the existence of any risk management or other plans as of December 31, 2014 that would require the sale of impaired securities. Impaired securities that the Company intends to sell before the expected recovery of such securities’ fair values have been written down to fair value.
In calculating credit-related losses, the Company utilizes cash flow modeling based on the type of security. The Company’s cash flow analysis considers all sources of cash, including credit enhancement, that support the payment of amounts owed by an issuer of a security.
This includes the consideration of cash expected to be provided by financial guarantors, including MBIA Corp., resulting from an actual or potential insurance policy claim. In general, any change in the amount and/or timing of cash flows received or expected to be received, whether or not such cash flows are contractually defined, is reflected in the Company’s cash flow analysis for purposes of assessing an OTTI loss on an impaired security.
ABS investments are evaluated for OTTI using historical collateral performance, deal waterfall and structural protections, credit ratings, and forward looking projections of collateral performance based on business and economic conditions specific to each collateral type and risk. The underlying collateral is evaluated to identify any specific performance concerns, and stress scenarios are considered in forecasting ultimate returns of principal. Based on this evaluation, if a principal default is projected for a security, estimated future cash flows are discounted at the security’s interest rate used to recognize interest income on the security. For CDO investments, the Company utilizes the same tools as its RMBS investments discussed below, aggregating the bond level cash flows to the CDO investment level. If the present value of cash flows is less than the Company’s amortized cost for the security, the difference is recorded as an OTTI loss.
The Company does not record OTTI related to credit concerns about issuers of securities insured by MBIA Corp. and National since investors in these securities, including MBIA, are guaranteed payment of principal and interest when due by MBIA. Securities insured by the Company, whether or not owned by the Company, are evaluated for impairment as part of its insurance surveillance process and, therefore, losses on securities insured by the Company are recorded in accordance with its loss reserving policy. Refer to “Note 2: Significant Accounting Policies” included herein for information about the Company’s loss reserving policy and “Note 6: Loss and Loss Adjustment Expense Reserves” for information about loss reserves.
The following table provides information about securities held by the Company as of December 31, 2014 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:
(1)-Represents circumstances where the Company determined in the current period that it intends to sell the security or it is more likely than not that it will be required to sell the security before recovery of the security’s amortized cost.
The Company entered into derivative instruments that it viewed as an extension of its core financial guarantee business that do not qualify for the financial guarantee scope exception and, therefore, are accounted for as derivative instruments. These insured CDS contracts, primarily referencing corporate, asset-backed, residential mortgage-backed, commercial mortgage-backed, CRE loans and CDO securities, are intended to be held for the entire term of the contract absent a negotiated settlement with the counterparty.
The Company has entered into derivative instruments primarily consisting of interest rate swaps. Interest rate swaps are entered into to manage the risks associated with fluctuations in interest rates or fair values of certain contracts.
Internal credit ratings assigned by MBIA on the underlying collateral are derived by the Company’s surveillance group. In assigning an internal rating, current status reports from issuers and trustees, as well as publicly available transaction-specific information, are reviewed. Also, where appropriate, cash flow analyses and collateral valuations are considered. The maximum potential amount of future payments (undiscounted) on CDS contracts are estimated as the notional value plus any additional debt service costs, such as interest or other amounts owing on CDS contracts. The maximum amount of future payments that MBIA may be required to make under these guarantees as of December 31, 2014 is $9.7 billion. This amount is net of $13 million of insured derivatives ceded under reinsurance agreements in which MBIA economically hedges a portion of the credit and market risk associated with its insured derivatives and offsetting agreements with a counterparty. The maximum potential amount of future payments (undiscounted) on insured swaps are estimated as the notional value of such contracts.
The fair value of amounts recognized for eligible derivative contracts executed with the same counterparty under a master netting agreement, including any cash collateral that may have been received or posted by the Company, is presented on a net basis in accordance with accounting guidance for the offsetting of fair value amounts related to derivative instruments. Insured CDSs and insured swaps are not subject to master netting agreements. VIE derivative assets and liabilities are not presented net of any master netting agreements. Counterparty netting of derivative assets and liabilities offsets balances in “Interest rate swaps” as of December 31, 2014 and 2013.
As of December 31, 2013, the total fair value of the Company’s derivative liabilities, after counterparty netting of $42 million and cash collateral posted by the Company of $123 million, was $1.2 billion which was reported within “Derivative liabilities” and “Derivative liabilities” presented under “Liabilities of consolidated variable interest entities” on the Company’s consolidated balance sheets. Embedded derivatives of $19 million were reported within “Medium-term notes” and “Other investments” on the Company’s consolidated balance sheets.
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 and posting of cash collateral, as of December 31, 2013:
The following table presents the effect of derivative instruments on the consolidated statements of operations for the year ended December 31, 2014:
The following table presents the effect of derivative instruments on the consolidated statements of operations for the year ended December 31, 2013:
The following table presents the effect of derivative instruments on the consolidated statements of operations for the year ended December 31, 2012:
The Company’s long-term debt presented in the preceding table is subject to certain restrictive covenants, none of which significantly restrict the Company’s operating activities or dividend-paying ability. As of December 31, 2014 and 2013, the Company was in compliance with all debt covenants as there was no occurrence of any event of default with respect to the above securities. Key events of default include: (i) default in the payment of any interest or principal when it becomes due and payable, (ii) default in the performance, or breach, of any covenant or warranty of MBIA, (iii) in the case of certain long-term debt, MBIA Inc.’s failure to make a payment on certain indebtedness in an amount in excess of $10 million, (iv) in the case of certain series of long-term debt, the Company’s default with respect to certain indebtedness that results in the acceleration of certain indebtedness in an amount in excess of $10 million, (v) entry by a court having jurisdiction in the premises of a decree or order for relief in respect of MBIA, or in the case of certain long-term debt, National, in an involuntary case or proceeding under any applicable federal or state bankruptcy, insolvency, reorganization or other similar law, and (vi) commencement by MBIA of a voluntary case or proceeding under any applicable federal or state bankruptcy, insolvency, reorganization or other similar law.
MTNs 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. Certain MTNs are measured at fair value in accordance with the accounting guidance for hybrid financial instruments. MTNs are issued by MBIA Global Funding, LLC (“GFL”) with either fixed or floating interest rates and in U.S. dollars and foreign currencies. During the year ended December 31, 2014, the Company retired the remaining $129 million of outstanding MTNs issued by the Company’s conduit segment at a cost of 97% of par value and completed the liquidation this business. The Company also repurchased approximately $122 million par value outstanding of GFL MTNs issued by the Company’s corporate segment at a weighted average cost of approximately 98% of par value. As of December 31, 2014, the interest rates of the MTNs ranged from 0% to 9.08% and the weighted average interest rate was 2.44%. As of December 31, 2013, the interest rates of the MTNs ranged from 0% to 8.93% and the weighted average interest rate was 2.67%. Expected principal payments due under MTN obligations based on their contractual maturity dates are as follows:
(2)-Includes discounts of $306 million, fair value adjustments of $45 million, net of accrued interest of $6 million.
The Company may buy back and extinguish debt originally issued by either MBIA Inc. or its subsidiaries. Purchase prices are generally negotiated through dealers, similar to buying or selling an asset in the open market. The Company repurchases its debt in an effort to improve its own economic position while also providing liquidity to investors of MBIA debt. In all cases, debt buybacks were executed in response to investor or dealer inquiries.
VIE notes are variable interest rate debt instruments that were issued primarily in U.S. dollars by consolidated VIEs within the Company’s international and structured finance insurance segment. These VIE notes consist of debt instruments issued by issuer-sponsored consolidated VIEs collateralized by assets held by those consolidated VIEs. In addition, as of December 31, 2014, the Company’s advisory services segment had $431 million of VIE notes that are presented separately in “Liabilities held for sale” on the Company’s consolidated balance sheets. Effective January 1, 2015, the Company completed the sale of its Cutwater business and deconsolidated these VIEs. Refer to “Note 1: Business Developments and Risks and Uncertainties” for additional information about the sale of Cutwater.
The maturity of the Company’s international and structured finance insurance segment’s VIE notes, as of December 31, 2014 is presented in the following table:
The Company establishes a valuation allowance against its deferred tax asset when it is more likely than not that all or a portion of the deferred tax asset will not be realized. All evidence, both positive and negative, needs to be identified and considered in making the determination. Future realization of the existing deferred tax asset ultimately depends, in part, on the generation of sufficient taxable income of appropriate character (for example, ordinary income versus capital gains) within the carryforward period available under the tax law.
In the fourth quarter of 2013, U.S. deferred income taxes were provided on the differences in the book and tax basis in the Company’s carrying value of MBIA UK and certain other entities since the Company no longer intends to permanently reinvest these earnings. The impact is reflected in the Company’s 2013 tax provision.
The Company’s policy is to record and disclose any change in UTB and related interest and/or penalties to income tax in the consolidated statements of operations. The Company includes interest as a component of income tax expense. All amounts below are reflected before any applicable tax benefit.
The Company’s new segment reporting structure is reflected in its reporting to its Chief Operating Decision Maker, as well as the senior management team and Board of Directors, who use this information to make key business decisions, assess performance and allocate resources to its segments. Certain prior period amounts within the corporate segment results have been retrospectively revised to reflect the changes in the Company’s reportable segments. Such revisions have no impact on total consolidated revenues, expenses, assets, liabilities, shareholders’ equity, operating cash flows, investing cash flows, or financing cash flows for all periods presented.
The Company’s conduit segment was operated through Meridian and administered through MBIA Asset Finance, LLC. Assets financed by Meridian were funded by MTNs. In 2014, the Company extinguished the remaining liabilities of this segment and liquidated Meridian.
The following tables provide the Company’s segment results for the years ended December 31, 2014, 2013 and 2012:
(2)-Represents intercompany premium income and expense, intercompany asset management fees and expenses, intercompany interest income and expense pertaining to intercompany receivables and payables and intercompany loans.
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, 2014, 2013 and 2012:
As of December 31, 2014, insurance in force, which represents principal and interest or other amounts owing on insured obligations, had an expected maturity range of 1 to 43 years. The distribution of MBIA Corp.’s and National’s combined insurance in force by geographic location, excluding $2.6 billion and $3.5 billion relating to transactions guaranteed by MBIA Corp. on behalf of various investment management services affiliated companies as of December 31, 2014 and 2013, respectively, is presented in the following table:
MBIA’s guarantees of derivative contracts have a legal maximum maturity range of 1 to 68 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, 2014 and 2013 are recorded on the consolidated balance sheets as derivative liabilities, representing gross losses, of $246 million and $1.2 billion, respectively.
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, 2014, 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 $11.1 billion and $12.7 billion as of December 31, 2014 and 2013, respectively.
MBIA Insurance Corporation and National are subject to insurance regulations and supervision of the State of New York (their state of incorporation) and all U.S. and non-U.S. jurisdictions in which they are licensed to conduct insurance business. In order to maintain their New York State financial guarantee insurance license, MBIA Insurance Corporation and National are required to maintain a minimum of $65 million of policyholders’ surplus. MBIA UK is authorized by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority in the United Kingdom. The extent of insurance regulation and supervision varies by jurisdiction, but New York and most other jurisdictions have laws and regulations prescribing minimum standards of solvency and business conduct, which must be maintained by insurance companies. Among other things, these laws prescribe permitted classes and concentrations of investments and limit both the aggregate and individual securities risks that MBIA Insurance Corporation and National may insure on a net basis based on the type of obligations insured. In addition, some insurance laws and regulations require the approval or filing of policy forms and rates. MBIA Insurance Corporation and National are required to file detailed annual financial statements with the NYSDFS and similar supervisory agencies in other jurisdictions in which it is licensed. The operations and accounts of MBIA Insurance Corporation and National are subject to examination by regulatory agencies at regular intervals.
NYIL regulates the payment of dividends by financial guarantee insurance companies and provides that such companies may not declare or distribute dividends except out of statutory earned surplus. Under the NYIL, the sum of (i) the amount of dividends declared or distributed during the preceding 12-month period and (ii) the dividend to be declared may not exceed the lesser of (a) 10% of policyholders’ surplus, as reported in the latest statutory financial statements and (b) 100% of adjusted net investment income for such 12-month period (the net investment income for such 12-month period plus the excess, if any, of net investment income over dividends declared or distributed during the two-year period preceding such 12-month period), unless the Superintendent of the NYSDFS approves a greater dividend distribution based upon a finding that the insurer will retain sufficient surplus to support its obligations.
As of December 31, 2014, MBIA Insurance Corporation was in compliance with its aggregate risk limits under the NYIL. If MBIA Insurance Corporation is not in compliance with its aggregate risk limits, the NYSDFS may prevent MBIA Insurance Corporation from transacting any new financial guarantee insurance business until it no longer exceeds the limitations. During 2013, MBIA Insurance Corporation exceeded its aggregate risk limits. In 2014 and 2013, MBIA Insurance Corporation reported additional overages to the NYSDFS with respect to its single risk limits due to changes in its statutory capital.
Prior to September 30, 2012, MBIA Corp. released to surplus an aggregate of $1.1 billion of contingency reserves pursuant to approvals granted by the NYSDFS in accordance with the NYIL during 2011 and 2012. Absent these releases MBIA Corp. would have had deficits of qualifying assets to meet its contingency reserve requirements. While MBIA Insurance Corporation currently satisfies its contingency reserve requirement, it had a deficit of qualifying assets required to support its contingency reserves as of September 30, 2014. The deficit was caused by the sale of liquid assets in order to make claim payments and the failure of certain RMBS sellers/servicers to honor their contractual obligations to repurchase ineligible mortgage loans from securitizations the Company insured. The deficit may occur again in the future as MBIA Insurance Corporation depletes qualifying assets to make claims and commutation payments.
Results of operations for MBIA Insurance Corporation determined in accordance with statutory accounting practices for the years ended December 31, 2014 and 2013 were net losses of $35 million and $494 million, respectively. As of December 31, 2014, MBIA Insurance Corporation’s statutory capital was $859 million, consisting of policyholders’ surplus of $542 million and contingency reserve of $317 million. As of December 31, 2013, MBIA Insurance Corporation had statutory capital of $825 million.
In addition to the above two plans, the Company maintains a non-qualified deferred compensation plan. Contributions to the above qualified plans that exceed limitations established by federal regulations are then contributed to the non-qualified deferred compensation plan. The non-qualified pension expense for the years ended December 31, 2014, 2013 and 2012 was $2 million for each applicable year. The non-qualified profit sharing/401(k) expense for each of the years ended December 31, 2014, 2013 and 2012 was $1 million for each applicable year.
The Company maintains the MBIA Inc. 2005 Omnibus Incentive Plan (the “Omnibus Plan”). Under the Omnibus Plan a maximum of 10,000,000 shares of the Company’s common stock can be used for any type of award including stock options, performance shares, performance units, restricted stock, restricted stock units and dividend equivalents. On May 1, 2012, the Company’s shareholders approved an increase in the total number of shares of common stock reserved and available for issuance under the Omnibus Plan from 10,000,000 shares to 14,000,000. Any shares issued under the Omnibus Plan in connection with stock options shall be counted against this limit as one share covered by such option. For all awards other than stock options, any shares issued shall be counted against this limit as 1.28 shares for every share issued after the May 1, 2012 amendment and two shares for every share issued prior to the May 1, 2012 amendment.
There were 6,056,168 shares available for future grants under the Omnibus Plan as of December 31, 2014.
The fair value of the restricted shares awarded, determined on the grant date, was $39 million and $6 million, and the fair value of the restricted shares canceled were $1 million each for 2014 and 2013. Restricted shares have been recorded as unearned compensation, which is a component of paid-in capital within shareholders’ equity on the Company’s consolidated balance sheets and have been included in “Share-based compensation” on the Company’s consolidated statements of changes in shareholders’ equity. The amount of unearned compensation, net of estimated forfeitures, was $35 million as of December 31, 2014, which is expected to be recognized as expense over a weighted average period of 1.83 years. Unearned compensation is amortized to expense over the appropriate three to five-year vesting period (except for a minor portion granted to members of the MBIA Inc. Board of Directors which is amortized over a ten-year period).
A summary of the Company’s restricted shares outstanding as of December 31, 2014, 2013 and 2012, and changes during the years ended on those dates, is presented in the following table:
The Company determines the fair value for stock option awards at the date of grant and is estimated using the Black-Scholes option pricing model. This model was developed for use in estimating the fair value of traded options that have no vesting restrictions, are fully transferable, and contain both service and some performance conditions. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility.
A summary of the Company’s stock options outstanding as of December 31, 2014, 2013 and 2012, and changes during the years ended on those dates, is presented in the following tables:
During 2010, the Board of Managers of Cutwater established the Cutwater Asset Management Equity Participation Plan (“the Plan”). The purpose of the Plan is to promote the interests of Cutwater and its equity security holders and is designed to provide compensation tied to the value of Cutwater by the grant of equity participation units. Each unit represents the contractual right to receive cash payments based on the value of Cutwater. These grants have a restriction period lasting five years, after which time the awards fully vest providing the participant is continuously employed by Cutwater or one of its affiliates during that period. The maximum number of units available for grant under the Plan is 350,000. During 2014, no new units were granted and 38,000 units were canceled. As of December 31, 2014, 185,312 units vested with no value. In accordance with the accounting guidance for awards that include a cash-based settlement feature, the Plan is classified as a liability award. The original value of the award was determined on the date of grant and remeasured at each balance sheet date. A liability is accrued over the vesting period of the Plan and reflects the present value of the award as of each balance sheet date. Any change is reflected in earnings. For the years ended December 31, 2014, 2013 and 2012, no compensation cost related to the Plan was recorded as a result of the decline in the value of the awards.
Basic earnings per share excludes dilution and is computed by dividing net 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, warrants and unvested restricted stock outstanding during the period that could potentially result in the issuance of common stock.
The dilution from stock options, warrants and unvested restricted stock are calculated by applying the two-class method and using the treasury stock method. The treasury stock method assumes the proceeds from the exercise of stock options and warrants or the unrecognized compensation expense from unvested restricted stock will be used to purchase shares of the Company’s common stock at the average market price during the period. For the years ended December 31, 2014, 2013 and 2012, there were 31,907,852, 43,210,917 and 33,743,884, respectively, of stock options, warrants and unvested restricted stock outstanding that were antidilutive.
In May of 2013, MBIA Inc. issued Blue Ridge Investments, L.L.C., an affiliate of Bank of America, a five-year warrant to purchase 9.94 million shares of MBIA Inc. common stock at an exercise price of $9.59 per share.
Stock warrants 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, 2014 and 2013, the fair value of the warrants was $28 million and $59 million, respectively.
On February 1, 2007, the Company’s Board of Directors authorized the repurchase of common stock up to $1 billion under a share repurchase program. During the year ended December 31, 2014, the Company repurchased 2.1 million common shares of MBIA Inc., exhausting any remaining capacity under this share repurchase program. As of December 31, 2014, the Company had repurchased 58.8 million common shares of MBIA Inc. at an average price of $17.02 per share under this share repurchase program.
In the fourth quarter of 2014, the Company’s Board of Directors authorized the repurchase of common stock up to $200 million under a new share repurchase program. During the year ended December 31, 2014, the Company repurchased 1.2 million common shares of MBIA Inc. at an average price of $9.44 per share under this new repurchase program.
As of December 31, 2014, MBIA Insurance Corporation had 2,759 shares of preferred stock issued and outstanding with a carrying value of $28 million, including 1,444 shares held by MBIA Inc. that were purchased at a weighted average price of $10,900 per share or 10.9% of face value and 1,315 shares held by unaffiliated investors. During 2014, MBIA Inc. did not repurchase any additional shares.
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, 2014 was $340 million.
MBIA, through its subsidiaries, is responsible for providing investment advisory and certain related administrative services to the 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, 2014, 2013 and 2012.
On September 14, 2012, MBIA Insurance Corporation filed a complaint alleging fraud against J.P. Morgan Securities LLC (f/k/a Bear, Stearns & Co. Inc.) relating to Bear, Stearns & Co. Inc.’s role as lead securities underwriter on the GMAC Mortgage Corporation Home Equity Loan Trust 2006-HE4. MBIA filed its amended complaint on September 29, 2014. J.P. Morgan filed its answer to the amended complaint on October 10, 2014.
National and Assured Guaranty Municipal Corp. commenced an adversary proceeding against the City of Detroit and certain individuals employees/managers in the City of Detroit’s Chapter 9 case. The amended complaint sought a declaratory judgment that the City of Detroit and its employees comply with Michigan law in the collection, segregation and use of ad valorem tax proceeds pledged to repay several series of unlimited tax general obligation bonds as well as declaratory relief with respect to National’s and Assured Guaranty Municipal Corp.’s rights and interests in the ad valorem tax proceeds. In April of 2014, National reached a settlement with the City of Detroit regarding its enhanced Unlimited Tax General Obligation bonds, which was approved when the City of Detroit’s Eighth Amended Plan went effective on December 10, 2014.
On January 30, 2013, MBIA Insurance Corporation and National filed a petition in Texas state court seeking an order requiring the Harris County-Houston Sports Authority to impose higher taxes as well as damages for other alleged breaches of contract. On December 30, 2014, the litigation was resolved in connection with a refinancing transaction.