Prior to 2015, MBIA managed two other operating segments, advisory services and conduit. Our advisory services segment was operated primarily through Cutwater Holdings, LLC and its subsidiaries (“Cutwater”). Effective on January 1, 2015, we exited our advisory business through the sale of Cutwater. In the second quarter of 2014, we exited our conduit business through the liquidation of Meridian Funding Company, LLC (“Meridian”).
a restructuring agreement, the implementation of which remains subject to certain conditions, was agreed to with the Puerto Rico Electric Power Authority (“PREPA”) addressing, among other things, the treatment of approximately $1.4 billion of PREPA bonds insured by National;
These items were accomplished while we continued to experience several challenges within our businesses. A low interest rate environment with relatively narrow spreads between insured and uninsured obligations and the competitive environment continued to suppress demand for our bond insurance. In addition, continued financial stress of some municipal bond issuers, including Puerto Rico, inhibited us from seeking to redeploy excess capital in National. Finally, MBIA Corp. continued to face liquidity and capital stress as a result of ongoing exposure to several structured finance insurance policies, including two high yield corporate collateralized debt obligations (“CDOs”), one of which we paid a claim of $149 million. Refer to the following “Results of Operations” section for a further discussion of our 2015 key developments and challenges.
National is the largest U.S. public finance-only bond insurer in the financial guarantee industry as measured by total insured gross par outstanding of $161.0 billion as of December 31, 2015. Our primary activity 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 the rating agencies. As of December 31, 2015, the rating agencies have assigned the following ratings to National: 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”).
National pursues opportunities for new business in most municipal sectors. Based on our underwriting and pricing criteria, the majority of our new business is in the general obligation, tax-backed and revenue bond sectors. In addition to the new issue market, we are pursuing opportunities in the secondary market with respect to bonds issued in recent years that were not insured and that meet our underwriting criteria.
In addition to the unsecured debt in the preceding table, MBIA Inc. and MBIA Investment Management Corp. (“IMC”) issued investment agreements to which we have pledged high-quality securities as collateral. All of our MTNs, MBIA Inc. senior notes and investment agreements are collectively managed and serviced by available liquidity. Based on MBIA Inc.’s debt service requirements and expected operating expenses, we expect that MBIA Inc. will have sufficient cash to satisfy its debt obligations and its general corporate needs over time from expected subsidiary dividends, additional anticipated releases under the MBIA group’s tax sharing agreement (the “Tax Escrow Account”), investment income and potential securities issuance; however, there can be no assurance that such sources will be adequate or that we will have access to the capital markets when needed. Refer to the “Liquidity-MBIA Inc. Liquidity” section for information on MBIA Inc.’s liquidity.
MBIA Corp.’s primary objective is to maximize the margin of safety for its policyholders and the future recoveries of its subordinate preferred stock holders and surplus note holders. We intend to execute this strategy by reducing and mitigating potential losses on MBIA Corp.’s insurance exposures and maximizing the collection of recoveries.
In the event that MBIA Corp. experiences unexpected liquidity requirements, MBIA Corp. may have insufficient resources to continue to meet its obligations and may seek to secure liquidity through financing transactions. There can be no assurance that MBIA Corp. will be successful in generating sufficient cash to meet its obligations. In particular, MBIA Corp. insures $776 million of gross par outstanding, as of February of 2016, of notes issued by Zohar II 2005-1, Limited (“Zohar II”), a high yield corporate CDO, which matures in January of 2017. If cash flows generated by Zohar II are insufficient to pay the insured amount in full, MBIA Corp. will be called upon to make the unpaid insured amount at maturity. Unless a substantial amount of the insured exposure is paid at maturity, or if we are unsuccessful at reaching an agreed upon restructuring of the insured exposure, MBIA Corp. may ultimately have insufficient resources to continue to pay claims. Such failure could cause the New York State Department of Financial Services (“NYSDFS”) to put MBIA Insurance Corporation, exclusive of MBIA UK and MBIA Mexico, into a rehabilitation or liquidation proceeding or to order MBIA Corp. to cease paying any claims under its policies. Given the separation of MBIA Inc. and MBIA Corp. as distinct legal entities, the absence of any material intercompany lending agreements or cross defaults between the entities, and the lack of reliance by MBIA Inc. on MBIA Corp. for the receipt of dividends, we do not believe that a rehabilitation or liquidation proceeding of MBIA Insurance Corporation by the NYSDFS would have any significant long-term liquidity impact on MBIA Inc. or result in a liquidation or similar proceeding of MBIA UK or MBIA Mexico. For the same reasons, we believe MBIA Corp. does not provide significant economic or shareholder value to MBIA Inc. Refer to the “Liquidity-MBIA Corp. Liquidity” section for additional information on MBIA Corp.’s liquidity position.
MBIA Corp. has significant negative statutory earned surplus and therefore no current capacity to pay dividends. In addition, since July 15, 2012, the NYSDFS has not approved any payments on MBIA Insurance Corporation’s outstanding surplus notes. MBIA Corp. has contributed to the Company’s net operating loss carryforward (“NOL”), which is used in the calculation of our consolidated income taxes. MBIA Corp. maintains a notional NOL carryforward, and as a result of its NOL, when and if MBIA Corp. is profitable, it is not expected to make any tax payments to the Tax Escrow Account. Based on MBIA Corp.’s current projected earnings and our expectation that it will not write new business for the foreseeable future, we believe it is unlikely that MBIA Corp. will generate sufficient income to fully use its NOL. Refer to the “Capital Resources-MBIA Insurance Corporation” section for additional information on MBIA Insurance Corporation’s surplus notes and statutory capital.
During 2015, certain investment funds affiliated with Warburg Pincus LLC (“Warburg”) sold all of their 45.7 million shares of MBIA Inc. common stock. At the time of each sale, Warburg was the largest holder of the Company’s common stock. In connection with the sales, National and MBIA Inc. repurchased 8 million shares and 7.6 million shares, respectively.
In May of 2015, we sold our Armonk, New York facility. Refer to “Note 1: Business Developments and Risks and Uncertainties” in the Notes to Consolidated Financial Statements for a further discussion of this transaction.
The U.S. economy grew at a modest pace during 2015 supported by strong job growth leading to an eight-year low in the unemployment rate, despite flat wage growth and a low labor force participation rate. In addition to job growth, lower energy prices have helped bolster housing and consumer spending, but growth was hindered by China’s slowing economy and the strengthening of the U.S. dollar. In December of 2015, the Federal Open Market Committee increased the federal funds rate by 25 basis points for the first time since the financial crisis; however, this increase has not had a significant impact on long-term rates.
Economic and financial market trends could impact MBIA’s business outlook and its financial results. Many states and municipalities have experienced growing tax collections and appreciation in local level assessed valuations which drive property taxes. The consistent gradual improvement of economic indicators at the state and local levels that strengthen the credit quality of the issuers of our insured municipal bonds is expected to improve the performance of our insured U.S. public finance portfolio and could reduce the amount of National’s incurred losses. A decrease in oil prices which benefits consumers could have a positive impact on certain sales taxes to the extent consumer spending increases as a result. However, some states and municipalities will experience a decrease in revenues where their economies are reliant on the oil and gas industries.
Instruments that trade infrequently and, therefore, have little or no price transparency are classified within Level 3 of the fair value hierarchy. Also included in Level 3 are financial instruments that have significant unobservable inputs deemed significant to the instrument’s overall fair value. Level 3 assets represented approximately 19% and 20% of total assets measured at fair value on a recurring basis as of December 31, 2015 and 2014, respectively. Level 3 liabilities represented approximately 52% and 35% of total liabilities measured at fair value on a recurring basis as of December 31, 2015 and 2014, respectively.
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. 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.
Consolidated total revenues for the year ended December 31, 2015 included $129 million of net gains on insured derivatives compared with $459 million and $232 million of net gains for 2014 and 2013, respectively. The net gains on insured derivatives in 2015 were principally the result of refining the credit rating of underlying collateral, partially offset by claim payments. The net gains on insured derivatives in 2014 were principally the result of commuting derivative liabilities at prices below their fair values, partially offset by settlement and claim payments. The net gains on insured derivatives in 2013 were principally the result of changes in the weighted average life of transactions, commuting derivative liabilities at prices below their fair values and favorable changes in spreads and pricing on collateral, partially offset by the favorable effects of changes in the market’s perception of MBIA Corp.’s nonperformance risk on its derivative liabilities.
Operating income (loss) and operating income (loss) per diluted common share include the combined after-tax results of our U.S. public finance insurance and corporate segments and remove the after-tax results of activities that are not part of our ongoing business strategy. This includes the activities of our international and structured finance insurance, advisory services and conduit segments (collectively, “Non-Core Segments”). We do not expect to write new business in our international and structured finance insurance segment. We exited our advisory services segment through the sale of Cutwater effective January 1, 2015, and in the second quarter of 2014, we liquidated our conduit segment.
The following table presents our combined operating income (loss) and operating income (loss) per diluted common share (both non-GAAP measures) and provides reconciliations of GAAP net income (loss) to operating income (loss) and GAAP net income (loss) per diluted common share to operating income (loss) per diluted common share for the years ended December 31, 2015, 2014 and 2013:
(2)-Primarily relates to the after-tax gain on the sale of Cutwater.
The following table presents our U.S. public finance insurance segment results for the years ended December 31, 2015, 2014 and 2013:
NET PREMIUMS EARNED Net premiums earned on financial guarantees represent gross premiums earned net of premiums ceded to reinsurers, and include scheduled premium earnings and premium earnings from refunded issues. The increase in net premiums earned for 2015 compared with 2014 resulted from an increase in refunded premiums earned of $50 million, partially offset by a decrease in scheduled premiums earned of $35 million. The decrease in net premiums earned for 2014 compared with 2013 resulted from decreases in refunded premiums earned of $39 million and scheduled premiums earned of $38 million. Scheduled premium earnings declined due to the refunding and maturity of insured issues within our U.S. public finance portfolio. Refunding activity over the past several years has accelerated premium earnings in prior periods and reduced the amount of scheduled premiums that would have been earned in the current period.
NET GAINS (LOSSES) ON FINANCIAL INSTRUMENTS AT FAIR VALUE AND FOREIGN EXCHANGE The unfavorable changes in net gains (losses) on financial instruments at fair value and foreign exchange for 2015 compared with 2014 and 2013 were principally due to decreases in net realized gains from the sales of securities from the ongoing management of our U.S. public finance insurance investment portfolio and unfavorable mark-to-market fluctuations on financial instruments.
The following table presents information about our U.S. public finance insurance loss and LAE reserves and recoverables as of December 31, 2015 and 2014:
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 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, 2015 and 2014, loss and LAE reserves comprised the following:
Amortization of deferred acquisition costs increased for the year ended December 31, 2015 compared with 2014 due to higher refunding activity in 2015. Amortization of deferred acquisition costs decreased for the year ended December 31, 2014 compared with 2013 due to lower refunding activity in 2014. We did not defer a material amount of policy acquisition costs during 2015, 2014 or 2013.
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, 2015.
(2)-As a result of debt service payments made as of January 1, 2016, National’s total Puerto Rico debt service outstanding declined by $86 million.
For many years Puerto Rico’s economy has suffered from stagnation that has led to recurring budget deficits and increased borrowing to finance such deficits. As a result of mounting debt, deteriorating credit ratings and lack of market confidence, Puerto Rico has lost access to the capital markets. Puerto Rico’s lack of liquidity and market access has led to defaults on its debt obligations, including general obligations.
The Public Corporations Debt Enforcement and Recovery Act (the “Recovery Act”), which Puerto Rico wrote to establish a bankruptcy framework for certain public corporations of Puerto Rico, was determined to be unconstitutional by the U.S. District Court in Puerto Rico, and this ruling was upheld by the First Circuit Court of Appeals. Puerto Rico has sought review of these decisions by the Supreme Court of the United States, which granted its petition for certiorari on December 4, 2015. The case is expected to be argued on March 22, 2016, with a decision expected by June 30, 2016. If the U.S. Supreme Court reverses the lower court’s ruling and if the Recovery Act is ultimately reinstated, certain issuers of Puerto Rico debt insured by National might be eligible to seek protection under the Recovery Act, which could result in significant delays in payments by such issuers and impede efforts to achieve a consensual restructuring.
In the second quarter of 2015, Puerto Rico increased its sales and use tax from 7% to 11.5% and mandated the conversion to a value added tax system in April of 2016 in an effort to raise additional general fund revenues. The Governor of Puerto Rico formed a working group to address significant, projected general fund deficits over the next several years. The working group delivered its Puerto Rico Fiscal and Economic Growth Plan (the “Plan”) in September of 2015, which was subsequently revised (the “Revised Plan”) in January of 2016. The Revised Plan indicates that, absent any meaningful fiscal and structural reforms, the government will incur a $28.0 billion cumulative deficit between fiscal year 2016 and fiscal year 2020. The Plan proposes to reduce the Commonwealth’s sizable deficits through a combination of revenue increases and spending cuts, as well as by realizing benefits from economic growth from spending initiatives. However, even with the implementation of these measures, the Revised Plan projects a $16.1 billion cumulative deficit, a $2.1 billion increase from the original plan. The Revised Plan extended the projection by another five years.
On December 23, 2015, National, Assured Guaranty, and the ad hoc group of bondholders (representing approximately $3.0 billion, or 37.0% of the power revenue bonds) entered into an Amended and Restated Restructuring Support Agreement (“RSA”) with PREPA addressing, among other things, the treatment of approximately 65% of $8.1 billion of outstanding PREPA bonds, including approximately $1.4 billion of PREPA bonds insured by National. The RSA calls for a newly formed bankruptcy remote entity (“SPE”) to issue securitized bonds including bonds that are equal in principal amount to the outstanding principal of the PREPA bonds insured by National and by another monoline insurer (“Mirror Bonds”). The Mirror Bonds will bear interest at the same rate and will amortize at the same schedule as the existing insured legacy bonds which they back. Payments on the Mirror Bonds will be used to make payment on the insured legacy bonds.
Additionally, and subject to certain market rate and rating agency conditions, the SPE may issue additional securitization bonds to refinance outstanding currently callable and non-callable insured legacy bonds (approximately $320 million of National exposure). National will issue a Surety Bond in an amount up to $344 million as partial funding of a Debt Service Reserve Fund (“DSRF”) for the securitization bonds which would be used after a $65 million cash funded DSRF. The Surety Bond will be amortized using cash from the SPE over seven years starting in the seventh year, but can amortize after the second year over nine years if PREPA does not refinance the currently callable and non-callable debt referenced above.
Finally, the monolines and the bondholders which are a party to the RSA entered into a Bond Purchase Agreement committing to purchase certain bonds of PREPA in the aggregate amount of $115 million, approximately $35 million of which will be purchased by National, subject to certain funding conditions precedent. The bonds will earn 10% interest, will mature on July 1, 2019 and will be supported by Mirror Bonds when the SPE issues its securitization bonds.
In September of 2015, National filed a petition with the Puerto Rico Energy Commission (the “PREC”) requesting (i) conclusion of a PREPA rate review within four months and (ii) an immediate 4.2 cent per kWh temporary increase in PREPA’s base electricity rate. The PREC denied National’s request, citing insufficient information regarding’s PREPA’s operations and financial performance necessary to conduct a rate review. In October of 2015, National filed an appeal of this decision with the Puerto Rico Court of Appeals. As a condition to the RSA, National and PREPA agreed to stay this litigation so long as the RSA is in effect. Also in October of 2015, National and Assured Guaranty filed a petition to intervene into the ongoing proceeding in which PREC is evaluating the Integrated Resource Plan (“IRP”) that PREPA submitted in final form in September of 2015. In December of 2015, the PREC announced that PREPA had not presented a sufficiently complete proposal for its IRP and has until early March of 2016 to respond.
With regard to PRHTA, legislation was passed in the first quarter of 2015 that provides for (i) an increase in the aggregate petroleum products tax from $9.25 per barrel to $15.50 per barrel, and (ii) the reallocation of a portion of the petroleum products tax from PRHTA to another entity upon the occurrence of certain events including the transfer of certain PRHTA debt obligations to another entity for repayment. While the tax increase has become effective, the transfer of certain debt obligations has not occurred.
Other than Inter American University of Puerto Rico Inc., S&P, Fitch Ratings and/or Moody’s have downgraded the ratings of all Puerto Rico issuers to below investment grade with a negative outlook due to narrowing liquidity, sluggish economic growth and persistent structural deficits. Although we have downgraded our internal rating for certain Puerto Rico insured debt, including that of the Commonwealth, PREPA and PRHTA, to below investment grade, all of the insured obligations included in the preceding table are presently current on debt service payments (with PREPA using debt service reserve funds to pay its July 1, 2014, January 1, 2015, and a portion of its July 1, 2015 debt service payments). In addition, the table below reflects the cancellation of certain bonds previously purchased by the PRHTA that reduces total debt service outstanding by $333 million.
Scheduled gross debt service due on our Puerto Rico exposures as of December 31, 2015 and each of the subsequent five years ending December 31 and thereafter are presented in the following table:
FEES The decreases in fees for 2015 compared with 2014 and 2013 were primarily due to decreases in fees paid by our conduit segment for administrative and other services. During the second quarter of 2014, we completed the winding down of 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 2015 compared with 2014 was primarily due to gains from the termination of derivatives, partially offset by a decrease in foreign exchange gains on Euro denominated liabilities, an increase in losses from mark-to-market changes of our interest rate swaps and a decrease in gains from the changes in the fair value of the outstanding warrants issued on MBIA Inc. common stock. The changes in the fair value of outstanding warrants were primarily attributable to a decrease in MBIA Inc.’s common stock price, partially offset by an increase in volatility, which are used in the valuation of the warrants. 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, an increase in realized gains from asset sales and changes in fair value of outstanding warrants issued on MBIA Inc. common stock, due to decreases in MBIA Inc.’s common stock price and volatility.
OTHER NET REALIZED GAINS (LOSSES) The increase in other net realized gains for 2015 compared with 2014 was primarily due to the gain from the sale of Cutwater.
REVENUES OF CONSOLIDATED VIEs For 2014 and 2013, total revenues of consolidated variable interest entities (“VIEs”) related to net losses as a result of the deconsolidation of VIEs.
MBIA Corp. insures non-U.S. public finance and global structured finance, including asset-backed obligations. MBIA Corp. has insured sovereign-related and sub-sovereign bonds, utilities, privately issued bonds used for the financing of utilities, toll roads, bridges, airports, public transportation facilities, and other types of infrastructure projects serving a substantial public purpose. Global structured finance and asset-backed obligations typically are securities repayable from cash flows generated by a specified pool of assets, such as residential and commercial mortgages, insurance policies, consumer loans, corporate loans and bonds, trade and export receivables, and leases for equipment, aircraft and real estate property. We no longer insure new credit derivative contracts except for transactions related to the restructuring or reduction of existing derivative exposure.
The following table presents our international and structured finance insurance segment results for the years ended December 31, 2015, 2014, and 2013:
NET PREMIUMS EARNED Our international and structured finance insurance segment generates net premiums from insurance policies accounted for as financial guarantee contracts. Certain premiums may be eliminated in our consolidated financial statements as a result of the Company consolidating VIEs. In addition, we generate net premiums from insured credit derivatives that are included in “Realized gains (losses) and other settlements on insured derivatives” on our consolidated statements of operations. The following table provides net premiums earned from our financial guarantee contracts for the years ended December 31, 2015, 2014 and 2013:
Net premiums earned represent gross premiums earned net of premiums ceded to reinsurers, and include scheduled premium earnings and premium earnings from refunded issues. Net premiums earned decreased for 2015 compared with 2014 primarily due to a decrease in scheduled premiums earned from the maturity and early settlement of insured transactions with no writings of new insurance policies. Consolidated VIEs elimination increased for 2015 compared with 2014 primarily due to additional premiums of $36 million related to events that occurred resulting in increased cash flows related to certain VIEs. In addition, 2014 included significant refunded premiums earned from the termination of a policy.
FEES AND REIMBURSEMENTS The decrease in fees and reimbursements for 2015 compared with 2014 was primarily due to a decrease in termination and waiver and consent fees, partially offset by an increase in ceding commission income due to higher refunding activity. Due to the transaction-specific nature inherent in fees and reimbursements, these revenues can vary significantly from period to period.
The Company no longer insures new credit derivative contracts except in transactions related to the restructuring or reduction of existing derivative exposure. Premiums earned related to insured credit derivatives will decrease over time as a result of settlements prior to maturity and scheduled amortizations. For 2015, realized losses on insured derivatives resulted from claim payments on commercial mortgage-backed securities (“CMBS”). For 2014, realized losses on insured derivatives resulted primarily from settlements and claim payments on CMBS. For 2013, realized losses on insured derivatives resulted primarily from settlements and claim payments on CMBS and asset-backed securities (“ABS”).
For the year ended December 31, 2015, unrealized gains on insured derivatives were principally the result of refining the credit rating of underlying collateral. For the year ended December 31, 2014, unrealized gains on insured derivatives were principally associated with the reversal of unrealized losses from commutations. For the year ended December 31, 2013, unrealized gains on insured derivatives were principally associated with the reversal of unrealized losses from commutations, a decline in the weighted average life on transactions and favorable changes in spread/prices on the underlying collateral, partially offset by the effects of MBIA’s nonperformance risk on its derivative liabilities.
As of December 31, 2015, the cost of five year CDS referencing MBIA Corp. was 42.95% upfront plus 5% per annum compared with 16.71% upfront plus 5% per annum and 13.63% upfront plus 5% per annum as of December 31, 2014 and 2013, respectively. As of December 31, 2015 and 2014, the fair value of MBIA Corp.’s insured CDS liability was $85 million and $244 million, respectively. Our mark-to-market on insured credit derivatives uses the most appropriate of the one to ten year CDS cost for each transaction, and those costs ranged from 26.24% upfront plus 5% per annum to 44.55% upfront plus 5% per annum as of December 31, 2015. As of December 31, 2014, those costs ranged from 3.68% upfront plus 5% per annum to 18.98% upfront plus 5% per annum. As of December 31, 2013, those costs ranged from 2.00% upfront plus 5% per annum to 19.25% upfront plus 5% per annum.
As of December 31, 2015, MBIA Corp. had $3.2 billion of gross par outstanding on insured credit derivatives compared with $9.5 billion as of December 31, 2014. During the year ended December 31, 2015, eight insured issues matured or terminated that totaled $5.9 billion in gross par outstanding. As of December 31, 2015, 11 insured issues remained, of which one insured issue with total gross par outstanding of $1.2 billion is scheduled to mature by the end of 2016.
OTHER NET REALIZED GAINS (LOSSES) Other net realized gains (losses) for the year ended December 31, 2014 primarily related to an insurance recovery received on an errors and omissions liability policy.
The following table presents information about our financial guarantee insurance losses and LAE recorded in accordance with GAAP for the years ended December 31, 2015, 2014 and 2013:
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 the London Interbank Offered Rate (“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 we collect from excess spread.
For the years ended December 31, 2015, 2014 and 2013, losses and LAE incurred included the elimination of a $3 million expense, a $20 million expense and a $56 million benefit, respectively, as a result of the consolidation of VIEs. The $3 million expense elimination for the year ended December 31, 2015 included gross recoveries of expected payments of $4 million, partially offset by gross losses related to expected payments of $1 million. The $20 million expense elimination for the year ended December 31, 2014 included gross losses related to expected payments of $21 million, partially offset by gross recoveries of expected payments of $1 million. The $56 million benefit for the year ended December 31, 2013 included gross recoveries of expected payments of $98 million, partially offset by gross losses related to expected payments of $42 million.
The Company’s insurance loss recoverable represents expected potential recoveries of paid claims based on probability-weighted net cash inflows discounted at applicable risk-free rates as of the measurement date. The loss and LAE reserves represent the present value of the difference between cash payments we expect to make on the insured transactions and the excess spread we expect from the performing mortgage loans in the securitizations. As payments are made, a portion of those expected future receipts is recorded within “Insurance loss recoverable” on our consolidated balance sheets. The payments that we make virtually all go to reduce the principal balances of the insured transactions. The following table presents information about our insurance loss recoverable and reserves as of December 31, 2015 and 2014.
Uncertainties regarding European sovereign debt have affected the global economy. Outside the U.S., financial guarantee insurance has been used by issuers of sovereign-related and sub-sovereign bonds, structured finance securities, utilities and providers of public purpose projects, among others. MBIA does not insure any direct European sovereign debt. However, we do insure both structured finance and public finance obligations in select international markets. MBIA’s indirect European sovereign insured debt exposure totaled $6.3 billion as of December 31, 2015 and included obligations of sovereign-related and sub-sovereign issuers, such as regions, departments, and sovereign-owned and private entities that are supported by a sovereign state, region or department. Sovereign-related includes Private Finance Initiative transactions that involve private entities that receive contractual payments for providing services to public sector entities. Of the $6.3 billion of insured gross par outstanding, $480 million and $198 million were related to Spain and Ireland, respectively. The remaining $5.6 billion was related to the United Kingdom (“UK”). We do not insure any sovereign or sub-sovereign debt from Greece and our remaining exposure in Portugal matured in the third quarter of 2015. We closely monitor our existing insured European portfolios on an ongoing basis. We consider country risk, including economic and political factors, the type and quality of local regulatory oversight, the strength of the legal framework in each country and the stability of the local institutional framework. We also monitor local accounting, regulatory and legal requirements, local financial market developments, the impact of exchange rates and local demand dynamics. A default by one or more sovereign issuers could have an adverse effect on our insured debt exposures. The Company has an immaterial amount of European sovereign debt holdings, with no Greece sovereign debt holdings included in its investment portfolios.
The following is a summary of selected significant exposures within the insured portfolio of our international and structured finance insurance segment. Many of these sectors are and have been considered volatile over the past several years. We may experience considerable incurred losses and future expected payments in certain of these sectors. There can be no assurance that the loss reserves described below will be sufficient or that we will not experience losses on transactions on which we currently have no loss reserves, in particular if the economy deteriorates.
MBIA Corp. insures mortgage-backed securities (“MBS”) backed by residential mortgage loans, including second-lien RMBS transactions (revolving home equity lines of credit (“HELOC”) loans and closed-end second mortgages (“CES”)). MBIA Corp. also insures MBS backed by first-lien alternative A-paper (“Alt-A”) and subprime mortgage loans directly through RMBS securitizations. There was considerable stress and deterioration in the mortgage market since 2008 reflected by heightened delinquencies and losses, particularly related to Alt-A and subprime mortgage loans originated during 2005, 2006 and 2007.
(1)-Includes international exposure of $449 million and $511 million as of December 31, 2015 and 2014, respectively.
As of December 31, 2015, MBIA Corp.’s $6.0 billion CDO portfolio represented 14% of its total insured gross par outstanding of $41.6 billion. 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. In addition to the below table, MBIA Corp. insures approximately $454 million in commercial real estate (“CRE”) loan pools, comprising both European and domestic assets. The distribution of our insured CDO and related instruments portfolio by collateral type is presented in the following table:
We may seek to purchase, directly or indirectly, obligations guaranteed by MBIA or seek to commute policies. The amount of insurance exposure reduced, if any, and the nature of any such actions will depend on market conditions, pricing levels from time to time, and other considerations. In some cases, these activities may result in a reduction of loss reserves, but in all cases they are intended to limit our ultimate losses and reduce the future volatility in loss development on the related policies. Our ability to purchase guaranteed obligations and to commute policies will depend on management’s assessment of available liquidity.
Our asset management advisory business was conducted through Cutwater. Cutwater offered advisory services, including cash management, discretionary asset management and structured products on a fee-for-service basis. Cutwater offered these services to public, not-for-profit, corporate and financial services clients, including MBIA Inc. and its other subsidiaries. In October of 2014, the Company entered into an agreement to sell Cutwater to a subsidiary of The Bank of New York Mellon Corporation. Effective with the January 1, 2015 sale of Cutwater, MBIA has no business activities within its advisory services segment.
The following table summarizes the results and assets under management of our advisory services segment for the years ended December 31, 2014 and 2013. These results include revenues and expenses from transactions with the Company’s insurance, corporate, and conduit segments.
In 2014, the Company’s conduit segment was operated through Meridian and administered through MBIA Asset Finance, LLC. Assets held 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 following table presents the results of our conduit segment for the years ended December 31, 2014 and 2013. These results include revenues and expenses from transactions with the Company’s other segments.
For 2015, 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 nondeductible equity-based compensation expense.
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). At that time, 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 $5.2 billion and $5.4 billion as of December 31, 2015 and 2014, respectively. MBIA Inc. uses its capital resources to support the business activities of its subsidiaries. As of December 31, 2015, MBIA Inc.’s investments in subsidiaries totaled $4.1 billion.
The Company’s share repurchases for the years ended December 31, 2015, 2014 and 2013 are presented in the following table:
On October 28, 2015, the Company’s Board of Directors authorized the repurchase by the Company or its subsidiaries of up to $100 million of its outstanding shares under a new share repurchase authorization. During the fourth quarter of 2015, the Company repurchased 965,736 common shares of MBIA Inc. at an average share price of $6.50. Subsequent to December 31, 2015, we exhausted all of the remaining capacity under the October 28, 2015 repurchase program by repurchasing an additional 14.9 million common shares of MBIA Inc. at an average share price of $6.30.
During the year ended December 31, 2015, we repurchased $40 million par value outstanding of GFL MTNs issued by our corporate segment at a weighted average cost of approximately 100% of par value. Also, we repurchased $10 million par value outstanding of the 7.00% Debentures due 2025 issued by our corporate segment at a cost of 105% of par value.
Under statutory accounting and NYIL, National’s purchase of 8 million shares of MBIA Inc. common stock in the second quarter of 2015 is recorded as an investment and measured at fair value. However, the value of the investment that can be admitted is subject to limitation. As of December 31, 2015, the fair value and admitted value of the MBIA Inc. common shares owned by National were $35 million and $12 million, respectively.
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. As of December 31, 2015 National was in compliance with its aggregate and single risk limits. As of December 31, 2014, National was not in compliance with certain of its single risk limits but was in compliance with its aggregate risk limits.
National’s CPR and components thereto, as of December 31, 2015 and 2014 are presented in the following table:
(1)-Calculated using a discount rate of 3.04% and 2.90% as of December 31, 2015 and 2014, respectively.
As of December 31, 2015, the par amount outstanding of MBIA Insurance Corporation’s 14% Fixed-to-Floating Rate Surplus Notes due January 15, 2033 (the “Surplus Notes”) was $953 million. Section 1307 of the Insurance Law and the Fiscal Agency Agreement governing the surplus notes (the “Fiscal Agency Agreement”), which was approved as it relates to Section 1307 by the NYSDFS in connection with the issuance of the Surplus Notes, each impose restrictions on the payments of principal and interest (or the redemption price or any make-whole premium) on the Surplus Notes (“Surplus Note Payments”). Section 1307 of the Insurance Law provides that any payments on surplus notes issued by an insurer “shall be repaid only out of free and divisible surplus of such insurer with the approval of the Superintendent whenever, in his/her judgment, the financial condition of such insurer warrants.” The Superintendent has broad discretion in determining whether to allow us to make Surplus Note Payments. We are not aware of any guidelines or interpretations that govern the exercise of the Superintendent’s discretion under Section 1307 in determining whether the financial condition of an insurer warrants the making of such payments. The Fiscal Agency Agreement provides that (a) Surplus Note Payments may be made only with the prior approval of the Superintendent, whenever, in his/her judgment, the financial condition of MBIA Insurance Corporation warrants, and (b) any such Surplus Note Payments may only be made to the extent MBIA Insurance Corporation has sufficient “Eligible Surplus” to make such payment. The Fiscal Agency Agreement defines “Eligible Surplus” as MBIA Insurance Corporation “surplus as regards policyholders,” less the sum of its “common capital stock” and “preferred capital stock”, as shown on its annual and quarterly statements filed with state insurance regulatory authorities. While the insurance law does not explicitly set forth the calculation of “free and divisible surplus”, MBIA believes that the calculation of Eligible Surplus, as set forth in the Fiscal Agency Agreement and as accepted by the NYSDFS, is the appropriate calculation of “free and divisible surplus”. MBIA Insurance Corporation’s “free and divisible” surplus, determined as set forth above, was $318 million as of December 31, 2015 representing an increase of $68 million from December 31, 2014. The increase in MBIA Insurance Corporation’s “free and divisible” surplus during 2015 primarily resulted from a release of $41 million of contingency reserves associated with policies that matured or were contractually terminated during 2015 and a change in the non-admitted amount related to investments in subsidiaries of $31 million. MBIA Insurance Corporation is required to seek the Superintendent’s approval to make payments of interest and principal when scheduled on the Surplus Notes. There is no assurance the Superintendent will approve Surplus Note Payments. Notwithstanding the sufficiency of MBIA Insurance Corporation’s Eligible Surplus available for the payment of Surplus Note Payments, the NYSDFS may deny approval of any Surplus Note Payments if the Superintendent concludes that MBIA Insurance Corporation’s financial condition does not warrant such approval.
MBIA Corp.’s CPR and components thereto, as of December 31, 2015 and 2014 are presented in the following table:
(1)-Calculated using a discount rate of 5.18% and 5.17% as of December 31, 2015 and 2014, respectively.
available cash and liquid assets not subject to collateral posting requirements;
collateral requirements under investment agreements, the Asset Swap and derivative arrangements;
Based on our projections of National’s and MBIA Corp.’s future earnings and losses, we expect that for the foreseeable future National will be the primary source of dividends and tax sharing agreement payments to MBIA Inc. There can be no assurance as to the amount and timing of any such dividends or payments under the tax sharing agreement. During the year ended December 31, 2015, National declared and paid a dividend of $114 million to its ultimate parent, MBIA Inc. For the foreseeable future, we expect the declared and paid dividend amounts from National to be limited to prior year net investment income and similar to the 2015 dividend payment. Refer to the “Capital Resources-Insurance Statutory Capital” section for additional information on payments of dividends. In addition, we do not expect MBIA Inc. to receive distributions from MBIA Corp. for the foreseeable future.
As of December 31, 2015 and 2014, the liquidity positions of MBIA Inc. comprising cash and liquid assets for general corporate purposes, excluding the amounts held in escrow under its tax sharing agreement, were $416 million and $498 million, respectively.
payments of principal and interest related to its surplus notes, to the extent approved by the NYSDFS. Refer to “Capital Resources-Insurance Statutory Capital” for a discussion on the non-approval of requests to the NYSDFS to pay interest on its surplus notes.
Over the last several years, the liquidity position of MBIA Corp. has been stressed by payments related to: RMBS exposures, both first and second-lien; remaining CMBS exposures; commutations of insured transactions that reduces exposure and potential loss volatility; and a high yield corporate CDO exposure. Depending on the amount of actual future claims, including claims on insured exposures that in some cases may require large bullet payments, and the amount of future cash inflows, in particular in excess spread and put-back recoveries, MBIA Corp. may not have sufficient liquid assets to pay its claims. In the event that we experience other unexpected liquidity requirements, we may have insufficient resources to meet our obligations or insufficient qualifying assets to support our surplus and reserves, and may seek to increase liquidity through financing transactions. There can be no assurance that we will be successful in generating sufficient cash to meet our obligations. In particular, MBIA Corp. insures $776 million of gross par outstanding, as of February of 2016, of notes issued by Zohar II which matures in January of 2017. If cash flows generated by Zohar II are insufficient to pay the insured amount in full, MBIA Corp. will be called upon to make the unpaid insured amount at maturity. Unless a substantial amount of the insured exposure is paid at maturity, or if we are unsuccessful at reaching an agreed upon restructuring of the insured exposure, MBIA Corp. may ultimately have insufficient resources to continue to pay claims. Such failure could cause the NYSDFS to put MBIA Insurance Corporation into a rehabilitation or liquidation proceeding or to order MBIA Corp. to cease paying any claims under its policies. Given the separation of MBIA Inc. and MBIA Corp. as distinct legal entities, the absence of any material intercompany lending agreements or cross defaults between the entities, and the lack of reliance by MBIA Inc. on MBIA Corp. for the receipt of dividends, we do not believe that a rehabilitation or liquidation proceeding of MBIA Insurance Corporation by the NYSDFS would have any significant long-term liquidity impact on MBIA Inc. or result in a liquidation or similar proceeding of MBIA UK or MBIA Mexico.
As of December 31, 2015, MBIA Corp. held cash and investments of $997 million, of which $264 million comprised cash and highly liquid assets that were immediately available to MBIA Insurance Corporation. Included in the $997 million was $642 million of cash and investments held by MBIA Insurance Corporation’s subsidiaries. As of December 31, 2014, MBIA Corp. held cash and investments of $1.2 billion, of which $443 million comprised cash and highly liquid assets that were immediately available to MBIA Insurance Corporation. Included in the $1.2 billion was $701 million of cash and investments held by MBIA Insurance Corporation’s subsidiaries. Currently, MBIA UK can only pay dividends to MBIA Insurance Corporation with the approval of the PRA; however, there is no certainty as to when such consent would be provided.
Information about our consolidated cash flows by category is presented on our consolidated statements of cash flows. The following table summarizes our consolidated cash flows for the years ended December 31, 2015, 2014 and 2013:
Net cash used by operating activities decreased for the year ended December 31, 2015 compared with 2014 primarily due to decreases in insured derivative commutations and loss payments of $390 million and operating and employee related expenses of $108 million, partially offset by decreases in premiums, fees and reimbursements and investment income received of $164 million. 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 investing activities increased slightly for the year ended December 31, 2015 compared with 2014 primarily due to increases in net proceeds from purchases, sales, paydowns and maturities of investments and loans of $316 million and increases in the proceeds from derivative settlements, the sale of Cutwater and the sale of our Armonk, New York facility of $86 million. These increases were partially offset by a decrease in cash acquired from consolidated VIEs of $214 million and an increase in collateral posting of $175 million. Net cash provided by investing activities increased for the year ended December 31, 2014 compared with 2013 primarily due to increases in net proceeds from purchases, sales, paydowns and maturities of investments and loans of $513 million and an increase in cash due to the consolidation of a VIE of $221 million.
The following discussion of investments, including references to consolidated investments, excludes investments reported under “Assets of consolidated variable interest entities” on our consolidated balance sheets. Investments of VIEs support the repayment of VIE obligations and are not available to settle obligations of MBIA. Our AFS investments comprise high-quality fixed-income securities and short-term investments. The following table presents our investment portfolio as of December 31, 2015 and 2014:
MBIA’s consolidated investment portfolio includes investments that are insured by various financial guarantee insurers (“Insured Investments”), including investments insured by National and MBIA Corp. (“Company-Insured Investments”). As of December 31, 2015, Insured Investments at fair value represented $569 million or 9% of consolidated investments, of which $401 million or 6% of consolidated investments were Company-Insured Investments. As of December 31, 2015, based on the actual or estimated underlying ratings of our consolidated investment portfolio, without giving effect to financial guarantees, the weighted average rating of only the Insured Investments in the investment portfolio would be in the Baa range.
In purchasing Insured Investments, the Company’s third-party portfolio manager independently assesses the underlying credit quality, structure and liquidity of each investment, in addition to the creditworthiness of the insurer. Insured Investments are diverse by sector, issuer and size of holding. The third-party portfolio manager assigns underlying ratings to Insured Investments without giving effect to financial guarantees based on the lower of underlying ratings assigned by Moody’s or S&P. When a Moody’s or S&P underlying rating is not available, the underlying rating is based on the portfolio manager’s best estimate of the rating of such investment. A downgrade of a financial guarantee insurer has historically had an adverse effect on the fair value of investments insured by the downgraded financial guarantee insurer. If the Company determines that declines in the fair values of Insured Investments are other-than-temporary, the Company will record a realized loss through earnings.
The underlying ratings of the Company-Insured Investments as of December 31, 2015 are reflected in the following table. Amounts represent the fair value of such investments including the benefit of the MBIA guarantee. The ratings in the following table are based on ratings from Moody’s. Alternate ratings sources, such as S&P, have been used for a small percentage of securities that are not rated by Moody’s.
Without giving effect to the National and MBIA Corp. guarantees of the Company-Insured Investments in the consolidated investment portfolio, as of December 31, 2015, 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 4% of the total consolidated investment portfolio.
As of December 31, 2015 and 2014, we held impaired AFS investments (investments for which fair value was less than amortized cost) with a fair value of $2.8 billion and $2.1 billion, respectively.
Surplus notes, investment agreements, MTNs, and long-term debt include principal and interest and exclude premiums or discounts. Liabilities issued at discounts reflect principal due at maturity. Interest payments on floating rate obligations are estimated using applicable forward rates. Principal and interest on callable obligations or obligations that allow investors to withdraw funds prior to legal maturity are based on the expected call or withdrawal dates of such obligations. Liabilities denominated in foreign currencies are presented in U.S. dollars using applicable exchange rates as of December 31, 2015.
Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2015, 2014 and
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of comprehensive income (loss), of changes in shareholders’ equity and of cash flows present fairly, in all material respects, the financial position of MBIA Inc. and its subsidiaries at December 31, 2015 and 2014, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2015 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 15(a)(2), present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Prior to 2015, MBIA managed two other operating segments, advisory services and conduit. The advisory services segment was primarily operated through Cutwater Holdings, LLC and its subsidiaries (“Cutwater”). Effective on January 1, 2015, the Company exited its advisory services business through the sale of Cutwater. During the second quarter of 2014, the Company dissolved its conduit segment through the liquidation of Meridian Funding Company, LLC (“Meridian”). Refer to “Note 12: Business Segments” for further information about the Company’s operating segments.
MBIA Corp.’s primary focus is the collection of excess spread and put-back recoveries and loss mitigation, primarily through remediation of stressed credits including through commutations of insurance policies.
During the fourth quarter of 2015, the Company identified and recorded errors related to the years ended December 31, 2009 through 2014. These errors primarily related to adjustments to premiums due on behalf of certain consolidated variable interest entities (“VIEs”). The Company evaluated the materiality of these errors in accordance with Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 99, Materiality, and SEC Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements, and concluded that these errors, individually and in the aggregate, were immaterial to the year ended December 31, 2015 and all prior periods to which these errors relate. For the year ended December 31, 2015, the Company’s consolidated financial statements included an increase in net income of $17 million as a result of the correction of these errors.
The Company’s consolidated statements of operations reflect the full impairment (the difference between a security’s amortized cost basis and fair value) on debt securities that the Company intends to sell or would more likely than not be required to sell before the expected recovery of the amortized cost basis. For AFS and HTM debt securities that management has no intent to sell and believes that it is more likely than not such securities will not be required to be sold prior to recovery, only the credit loss component of the impairment is recognized in earnings. For AFS securities, the remaining fair value loss is recognized in AOCI, net of applicable deferred income taxes.
The Company presents the fair value amounts recognized for eligible derivative contracts executed with the same counterparty on a net basis in the consolidated balance sheets. Accrued receivables and accrued payables which meet the offsetting criteria are netted separately from the derivative amounts and reported in “Other assets” or “Other liabilities.” Cash collateral is offset against amounts recognized as derivative liabilities and the related accrued interest for eligible derivative contracts. Refer to “Note 9: Derivative Instruments” for the impact of offsetting eligible derivative contracts executed with the same counterparty on the consolidated balance sheets.
Level 1-Valuations based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. Assets utilizing Level 1 inputs generally include U.S. Treasuries, foreign government bonds, money market securities and certain corporate obligations that are highly liquid and actively traded.
The Company collects insurance related fees for services performed in connection with certain transactions. In addition, the Company may be entitled to reimbursement of third-party insurance expenses that it incurs in connection with certain transactions. Depending upon the type of fee received and whether it is related to an insurance policy, the fee is either earned when it is received or deferred and earned over the life of the related transaction. Work, waiver and consent, termination, administrative and management fees are earned when the related services are completed and the fee is received. Fees related to investment management services are recognized in earnings over the period that the related services are provided. Asset management fees are typically based on the net asset values of assets under management.
MBIA Inc. and its eligible U.S. subsidiaries file a consolidated federal income tax return. The U.S. income taxes 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, 2015, 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 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 adopted ASU 2015-02 in the second quarter of 2015, and deconsolidated a VIE upon adoption. The adoption of ASU 2015-02 did not materially impact the Company’s consolidated financial statements.
In May of 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606).” ASU 2014-09 amends the accounting guidance for recognizing revenue for the transfer of goods or services from contracts with customers unless those contracts are within the scope of other accounting standards. ASU 2014-09 does not apply to financial guarantee insurance contracts within the scope of Topic 944, “Financial Services-Insurance.” In August of 2015, the FASB issued ASU 2015-14, “Revenue from Contracts with Customers (Topic 606)-Deferral of the Effective Date.” ASU 2015-14 defers the effective date of ASU 2014-09 to interim and annual periods beginning January 1, 2018, and is applied on a retrospective or modified retrospective basis. The adoption of ASU 2014-09 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)
In February of 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)” that amends the accounting guidance for leasing transactions. ASU 2016-02 requires a lessee to classify lease contracts as finance or operating leases, and to recognize assets and liabilities for the rights and obligations created by leasing transactions with lease terms more than twelve months. ASU 2016-02 substantially retains the criteria for classifying leasing transactions as finance or operating leases. For finance leases, a lessee recognizes a right-of-use asset and a lease liability initially measured at the present value of the lease payments, and recognizes interest expense on the lease liability separately from the amortization of the right-of-use asset. For operating leases, a lessee recognizes a right-of-use asset and a lease liability initially measured at the present value of the lease payments, and recognizes lease expense on a straight-line basis. ASU 2016-02 is effective for interim and annual periods beginning January 1, 2019 with early adoption permitted, and is applied on a modified retrospective basis. The Company is evaluating the impact of adopting ASU 2016-02.
The following tables present the total assets of nonconsolidated VIEs in which the Company holds a variable interest as of December 31, 2015 and 2014, through its insurance operations. The following tables also present the Company’s maximum exposure to loss for nonconsolidated VIEs and carrying values of the assets and liabilities for its interests in these VIEs as of December 31, 2015 and 2014. The Company has aggregated nonconsolidated VIEs based on the underlying credit exposure of the insured obligation. The nature of the Company’s variable interests in nonconsolidated VIEs is related to financial guarantees, insured CDS contracts and any investments in obligations issued by nonconsolidated VIEs.
The maximum exposure to loss as a result of MBIA’s variable interests in VIEs is represented by insurance in force. Insurance in force is the maximum future payments of principal and interest which may be required under commitments to make payments on insured obligations issued by nonconsolidated VIEs.
As of December 31, 2015 and 2014, premiums receivable was $792 million and $875 million, 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. Premiums receivable also includes the current amount of premiums due from installment policies insuring consolidated VIEs when the premiums are payable by third-parties on behalf of the consolidated VIEs.
The Company evaluates whether any premiums receivable are uncollectible at each balance sheet date. If the Company determines that premiums are uncollectible, it records a write-off of such amounts in current earnings. The majority of the Company’s premiums receivable consists of the present values of future installment premiums that are not yet billed or due, primarily from structured finance transactions. Given that premiums due to MBIA typically have priority over most other payment obligations of structured finance transactions, the Company determined that the amount of uncollectible premiums as of December 31, 2015 and 2014 was insignificant.
As of December 31, 2015 and 2014, the risk-free rate used to discount future installment premiums was 2.7% and 2.8%, respectively, and the weighted average expected collection term of the premiums receivable was 9.08 years and 9.18 years, respectively. As of December 31, 2015 and 2014, reinsurance premiums payable was $38 million and $56 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, 2015 and 2014:
(1)-Includes premiums from third-parties on behalf of consolidated VIEs, offset by net unrealized losses due to changes in foreign currency exchange rates.
U.S. public finance insured transactions consist of municipal bonds, including tax-exempt and taxable indebtedness of U.S. political subdivisions, as well as utilities, 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.
In addition, for second-lien RMBS, the Company considers pool mortgage insurance and assumes a constant basis spread between Prime and LIBOR interest rates.
To date, MBIA has settled the majority of the Company’s put-back claims. Only its claims against Credit Suisse remain outstanding. Settlement amounts have been consistent with the put-back recoveries previously included in the Company’s financial statements.
The contract claim remaining with Credit Suisse is related to the inclusion of ineligible mortgage loans in the 2007-2 Home Equity Mortgage Trust securitization. Credit Suisse has challenged the Company’s assessment of the ineligibility of individual mortgage loans and the dispute is the subject of litigation for which there is no assurance that the Company will prevail.
As of December 31, 2015 and 2014, the Company recorded estimated recoveries of $396 million and $379 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.
Based on the Company’s assessment of the strength of its contractual put-back rights against Credit Suisse, which it is pursuing through litigation claims, as well as on its prior settlements with other sellers/servicers and success of other monolines in litigation against other sellers/servicers, the Company believes it will prevail in enforcing its contractual rights and that it is entitled to collect the full amount of its incurred losses, which totaled $424 million through December 31, 2015. 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.
Notwithstanding the foregoing, uncertainty remains with respect to the ultimate outcome of the litigation with Credit Suisse, which is contemplated in the scenario based-modeling the Company uses. The Credit Suisse recovery scenarios are based on the amount of incurred losses measured against certain probabilities of ultimate resolution of the dispute with Credit Suisse. Most of the probability weight is assigned to partial recovery scenarios and are discounted using the current risk-free discount rates associated with the underlying transaction’s cash flows.
The Company continues to consider all relevant facts and circumstances in developing its assumptions on expected cash inflows, probability of potential recoveries (including the outcome of litigation) and recovery period. The estimated amount and likelihood of potential recoveries are expected to be revised and supplemented to the extent there are developments in the pending litigation and/or changes to the financial condition of Credit Suisse. While the Company believes it will be successful in realizing its recoveries from its contract claims against Credit Suisse, the ultimate amounts recovered may be materially different from those recorded by the Company given the inherent uncertainty of the manner of resolving the claims (e.g., litigation) and the assumptions used in the required estimation process for accounting purposes which are based, in part, on judgments and other information that are not easily corroborated by historical data or other relevant benchmarks.
The Company’s first-lien RMBS case basis reserves as of December 31, 2015, which primarily relate to RMBS backed by alternative A-paper and subprime mortgage loans, were determined using the Roll Rate Methodology. As of December 31, 2015 and 2014, the Company’s loss and LAE reserves were $277 million and $263 million, respectively, related to first-lien RMBS issues after the elimination of $5 million, as of December 31, 2015, as a result of consolidating VIEs.
As of December 31, 2015 and 2014, the Company’s loss and LAE reserves were $133 million and $111 million, respectively, related to the total CDO financial guarantee insurance portfolio after the elimination of $190 million and $225 million, respectively, as a result of consolidating VIEs. For the year ended December 31, 2015, the Company incurred $29 million of losses and LAE recorded in earnings related to the total CDO financial guarantee insurance portfolio after the elimination of $35 million of benefit as a result of consolidating VIEs. In the event of further deteriorating performance of the collateral referenced or held in the total CDO portfolio, the amount of losses estimated by the Company could increase substantially.
The gross claim liability in the preceding tables represents the Company’s estimate of undiscounted probability-weighted future claim payments. As of December 31, 2015, the gross claim liability primarily related to insured first-lien RMBS issues. As of December 31, 2014, the gross claim liability primarily related to insured first and second-lien RMBS issues, CDOs and an international road transaction.
The gross potential recoveries represent the Company’s estimate of undiscounted probability-weighted recoveries of actual claim payments and recoveries of estimated future claim payments. As of December 31, 2015, the gross potential recoveries principally related to insured second-lien RMBS. As of December 31, 2014, the gross potential recoveries principally related to insured second-lien RMBS and U.S. public finance issues. The Company’s recoveries have been, and remain based on either salvage rights, the rights conferred to MBIA through the transactional documents (inclusive of the insurance agreement), or subrogation rights embedded within financial guarantee insurance policies. Expected salvage and subrogation recoveries, as well as recoveries from other remediation efforts, reduce the Company’s claim liability. Once a claim payment has been made, the claim liability has been satisfied and MBIA’s right to recovery is no longer considered an offset to future expected claim payments, it is recorded as a salvage asset. The amount of recoveries recorded by the Company is limited to paid claims plus the present value of projected future claim payments. As claim payments are made, the recorded amount of potential recoveries may exceed the remaining amount of the claim liability for a given policy. The gross claim liability and gross potential recoveries reflect the elimination of claim liabilities and potential recoveries related to VIEs consolidated by the Company.
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, 2015 and 2014 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, 2015 and 2014, 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 increase in 2015 was primarily due to an increase in expected future recoveries on CDOs, partially offset by actual collections from excess spread within insured second-lien RMBS securitizations.
The decrease in the Company’s insurance loss recoverable and recoveries on unpaid losses during 2014 was primarily due to actual collections, changes in assumptions due to lower LIBOR forward rates on second-lien RMBS issues and changes in assumptions on an international road transaction and U.S. public finance issues.
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 use of alternate valuation methods generally requires considerable judgment in the application of estimates and assumptions and changes to such estimates and assumptions may produce materially different fair values.
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, along with its third-party portfolio manager, 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 and its third-party portfolio manager believe 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, its third-party portfolio manager 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, 2015 or 2014. All challenges to third-party prices are reviewed by staff of the Company as well as its third-party portfolio manager with relevant expertise to ensure reasonableness of assumptions. A pricing analysis is reviewed and approved by the Company’s Valuation Committee.
Financial liabilities, excluding derivative liabilities, issued by the Company primarily consist of debt issued for general corporate purposes within its corporate segment, MTNs, investment agreements, debt issued by consolidated VIEs and warrants. Investment agreements, MTNs, and corporate debt are typically recorded at face value adjusted for premiums or discounts. The majority of the financial liabilities that the Company has elected to fair value or that require fair value reporting or disclosures are valued based on the estimated value of the underlying collateral, the Company’s or a third-party’s estimate of discounted cash flow model estimates, or quoted market values for similar products. These valuations include adjustments for expected nonperformance risk of the Company.
The Company’s insured credit derivative contracts are non-traded structured credit derivative transactions. Since insured derivatives are highly customized and there is generally no observable market for these derivatives, the Company estimates their fair values in a hypothetical market based on internal and third-party models simulating what a similar company would charge to assume the Company’s position in the transaction at the measurement date. This pricing would be based on the expected loss of the exposure. The Company reviews its valuation model results on a quarterly basis to assess the appropriateness of the assumptions and results in light of current market activity and conditions. This review is performed by internal staff with relevant expertise. If live market spreads or securities prices are observable for similar transactions, those spreads are an integral part of the analysis. New insured transactions that resemble existing (previously insured) transactions, if any, would be considered, as well as negotiated settlements of existing transactions.
All significant financial assets and liabilities are reviewed by a committee 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. This valuation committee reviews, 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 committee also reviews any significant impairment or improvements in fair values of the financial instruments from prior periods. The committee is comprised of senior finance team members with relevant experience in the financial instruments their committee is responsible for. For each quarter, the committee documents their agreement with the fair values developed by management of the Company as reported in the quarterly and annual financial statements.
Loan repurchase commitments are obligations owed by the sellers/servicers of mortgage loans to either MBIA as reimbursement of paid claims or to the RMBS trusts as defined in the transaction documents. Loan repurchase commitments are assets of the consolidated VIEs. This asset represents the rights of MBIA against the sellers/servicers for breaches of representations and warranties that the securitized residential mortgage loans sold to the trust to comply with stated underwriting guidelines and for the sellers/servicers to cure, replace, or repurchase mortgage loans. Fair value measurements of loan repurchase commitments represent the amounts owed by the sellers/servicers to MBIA as reimbursement of paid claims. Loan repurchase commitments are not securities and no quoted prices or comparable market transaction information are observable or available. Loan repurchase commitments at fair value are categorized in Level 3 of the fair value hierarchy. Fair values of loan repurchase commitments are determined using discounted cash flow techniques based on inputs including:
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. 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.
Approximately 88% of the balance sheet fair value of insured credit derivatives as of December 31, 2015 was valued based on the Binomial Expansion Technique (“BET”) Model. Approximately 12% of the balance sheet fair value of insured credit derivatives as of December 31, 2015 was valued based on the internally developed Direct Price Model and the Dual Default model. The valuation of insured derivatives includes the impact of its credit standing. All of these derivatives are categorized as Level 3 of the fair value hierarchy as their fair value is derived using significant unobservable inputs.
Over time, the data inputs change as new sources become available, existing sources are discontinued or are no longer considered to be reliable or the most appropriate. It is the Company’s preference to use more observable spread inputs defined above. However, the Company may on occasion move to less observable spread inputs due to the discontinuation of data sources or due to the Company considering certain spread inputs no longer representative of market spreads.
The recovery rate represents the percentage of par expected to be recovered after an asset defaults, indicating the severity of a potential loss. MBIA generally uses rating agency recovery assumptions which may be adjusted to account for differences between the collateral used by the rating agencies and the actual collateral in MBIA-insured transactions. The Company may also adjust rating agency assumptions based on the performance of the collateral manager and on empirical market data.
The Company’s valuation methodology for insured credit derivative liabilities incorporates MBIA Corp.’s own nonperformance risk. The Company calculates the fair value by discounting the market value loss estimated through the BET Model at discount rates which include MBIA Corp.’s CDS spreads as of December 31, 2015. The CDS spreads assigned to each deal are based on the weighted average life of the deal. The Company limits the nonperformance impact so that the derivative liability could not be lower than MBIA Corp.’s recovery derivative price multiplied by the unadjusted derivative liability.
As of December 31, 2015 and 2014, the Company’s net insured CDS derivative liability was $85 million and $244 million, respectively, based on the results of the aforementioned models. A significant driver of changes in fair value is MBIA Corp.’s nonperformance risk. In aggregate, the nonperformance calculation resulted in a pre-tax net insured derivative liability that was $99 million and $92 million lower than the net liability that would have been estimated if MBIA Corp. excluded nonperformance risk in its valuation as of December 31, 2015 and 2014, respectively. Nonperformance risk is a fair value concept and does not contradict MBIA Corp.’s internal view, based on fundamental credit analysis of MBIA Corp.’s economic condition, that MBIA Corp. will be able to pay all claims when due.
In the fourth quarter of 2013, the Company approved and initiated a plan to sell its Armonk, New York facility and classified it as held for sale as of December 31, 2014. In May of 2015, the Company completed the sale of this facility. As of December 31, 2014, 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 present the fair value of the Company’s assets (including short-term investments) and liabilities measured and reported at fair value on a recurring basis as of December 31, 2015 and 2014:
Level 3 assets at fair value as of December 31, 2015 and 2014 represented approximately 19% and 20%, respectively, of total assets measured at fair value. Level 3 liabilities at fair value as of December 31, 2015 and 2014 represented approximately 52% and 35%, respectively, of total liabilities measured at fair value.
The following tables present information about changes in Level 3 assets (including short-term investments) and liabilities measured at fair value on a recurring basis for the years ended December 31, 2015 and 2014:
Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Year Ended December 31, 2015
Transfers into and out of Level 3 were $43 million and $126 million, respectively, for the year ended December 31, 2015. Transfers into and out of Level 2 were $126 million and $43 million, respectively, for the year ended December 31, 2015. Transfers into Level 3 were principally related to corporate obligations and other ABS, where inputs, which are significant to their valuation, became unobservable during the period. Corporate obligations, other ABS and CDOs comprised the majority of the instruments transferred out of Level 3 where inputs, which are significant to their valuation, became observable during the period. These inputs included spreads, prepayment speeds, default speeds, default severities, yield curves observable at commonly quoted intervals, and market corroborated inputs. There were no transfers into or out of Level 1.
The following table presents the changes in fair value included in the Company’s consolidated statements of operations for the years ended December 31, 2015, 2014 and 2013 for financial instruments for which the fair value option was elected:
The following table reflects the difference between the aggregate fair value and the aggregate remaining contractual principal balance outstanding as of December 31, 2015 and 2014 for loans and notes for which the fair value option was elected:
Investments, excluding those elected under the fair value option, include debt and equity securities classified as either AFS or HTM. Other AFS investments primarily comprised money market funds.
The following tables present the amortized cost, fair value, corresponding gross unrealized gains and losses and other-than-temporary impairments (“OTTI”) for AFS and HTM investments in the Company’s consolidated investment portfolio as of December 31, 2015 and 2014:
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, 2015. Contractual maturity may differ from expected maturity as borrowers may have the right to call or prepay obligations.
The following tables present the gross unrealized losses related to AFS and HTM investments as of December 31, 2015 and 2014:
With the weighting applied on the fair value of each security relative to the total fair value, the weighted average contractual maturity of securities in an unrealized loss position as of December 31, 2015 and 2014 was 17 and 13 years, respectively. As of December 31, 2015 and 2014, there were 65 and 143 securities, respectively, that were in an unrealized loss position for a continuous twelve-month period or longer, of which, fair values of 22 and 23 securities, respectively, were below book value by more than 5%.
The following table presents the distribution of securities in an unrealized loss position for a continuous twelve-month period or longer where fair value was below book value by more than 5% as of December 31, 2015:
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, 2015 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.
Gross realized gains and losses are recorded within “Net gains (losses) on financial instruments at fair value and foreign exchange” on the Company’s consolidated statements of operations. The proceeds and the gross realized gains and losses from sales of fixed-maturity securities held as AFS for the years ended December 31, 2015, 2014 and 2013 are as follows:
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 obligations, ABS, RMBS, CMBS, CRE loans and CDOs, are intended to be held for the entire term of the contract absent a negotiated settlement with the counterparty. The Company’s derivative exposure within its international and structured finance insurance segment also includes insured interest rate and inflation-linked swaps related to insured debt issues.
The Company has also entered into a derivative contract as a result of a commutation occurring in 2014. Changes in the fair value of the Company’s non-insured derivative are included in “Net gains (losses) on financial instruments at fair value and foreign exchange” on the Company’s consolidated statements of operations.
The following tables present information about credit derivatives sold by the Company’s insurance operations that were outstanding as of December 31, 2015 and 2014. Credit ratings represent the lower of underlying ratings assigned to the collateral by Moody’s, S&P or MBIA.
As of December 31, 2015 and 2014, the fair value on one Credit Support Annex (“CSA”) was $3 million and $2 million, respectively. This CSA governs collateral posting requirements between MBIA and its derivative counterparties. The Company did not receive collateral due to the Company’s credit rating, which was below the CSA minimum credit ratings level for holding counterparty collateral. As of December 31, 2015 and 2014, the counterparty was rated A2 by Moody’s and A by S&P.
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 CDS 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, 2015 and 2014.
As of December 31, 2015, the total fair value of the Company’s derivative liabilities, after counterparty netting of $1 million and cash collateral posted by the company of $31 million, was $374 million, of which $359 million 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 $15 million were reported within “Medium-term notes” on the Company’s consolidated balance sheets.
As of December 31, 2014, the total fair value of the Company’s derivative liabilities, after counterparty netting of $81 million was $456 million, of which $437 million 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, 2014:
(2)-Callable anytime at the greater of 100.00 or the present value of the remaining scheduled payments of principal and interest.
In addition to the preceding table, as of December 31, 2015, National owned $136 million principal amount of the 5.700% Senior Notes due 2034 that are eliminated on a consolidated basis.
(2)-Includes discounts of $296 million, fair value adjustments of $56 million, net of accrued interest of $4 million.
The Company files a consolidated tax return that includes all of its U.S. subsidiaries and foreign branches. The Company also files tax returns in the United Kingdom, France, Spain, and various state and local jurisdictions. Income tax expense (benefit) on income (loss) and shareholders’ equity consisted of:
A reconciliation of the U.S. federal statutory tax rate of 35% to the Company’s effective income tax rate for the years ended December 31, 2015, 2014 and 2013 is presented in the following table:
In accordance with accounting guidance for income taxes, the netting of deferred taxes between different taxpaying jurisdictions is not permitted. As of December 31, 2015, there was also a non-U.S. deferred tax liability of $12 million included in “Other liabilities” on the Company’s consolidated balance sheet.
The Company has a tax sharing agreement among its members 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”). Refer to “Note 2: Significant Accounting Policies” for further discussion on the Company’s tax sharing agreement.
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. As of December 31, 2015 and 2014, the Company had no UTB outstanding.
The tax authorities in the United Kingdom have audited MBIA UK for tax years 2005 through 2012. In April of 2015, MBIA UK received correspondence from the HM Revenue & Customs closing the audit for the years under examination with no change in taxable income.
The Company manages its businesses across three operating segments: 1) U.S. public finance insurance; 2) international and structured finance insurance; and 3) corporate. The Company’s U.S. public finance insurance business is operated through National and its international and structured finance insurance business is operated through MBIA Corp. Prior to 2015, the Company managed two other operating segments, advisory services and conduit. During 2014, the Company dissolved its conduit segment by extinguishing the remaining liabilities of the segment and liquidating the Company’s remaining conduit, Meridian, and effective January 1, 2015, the Company exited its advisory services business with the completed sale of Cutwater to a subsidiary of The Bank of New York Mellon Corporation.
The advisory services segment primarily consisted of the operations of Cutwater Investor Services Corp. and Cutwater Asset Management Corp. and was a fee-for-service investment management business focused on fixed-income markets. Effective with the January 1, 2015 sale of Cutwater, MBIA has no business activities within its advisory services segment.
(3)-Consists of intercompany deferred income taxes, reinsurance balances and repurchase agreements.
(3)-Represents the gain on the debt received as consideration in connection with the settlement with Bank of America.
As of December 31, 2015, insurance in force, which represents principal and interest or other amounts owing on insured obligations, had an expected maturity range of 1 to 42 years. The distribution of MBIA Corp.’s and National’s combined insurance in force by geographic location, excluding $2.2 billion and $2.6 billion relating to debt obligations guaranteed by MBIA Corp. on behalf of affiliated companies as of December 31, 2015 and 2014, respectively, is presented in the following table:
Investment agreement contracts and MTNs issued by the Company’s corporate segment are insured by MBIA Corp. and are not included in the previous tables. If MBIA Inc. or these subsidiaries were to have insufficient assets to pay amounts due, MBIA Corp. would be obligated to make such payments under its insurance policies. As of December 31, 2015, the maximum amount of future payments that MBIA Corp. could be required to make under these guarantees is $2.2 billion. These guarantees, which have a maximum maturity range of 1 to 24 years, were entered into on an arm’s length basis. MBIA Corp. has both direct recourse provisions and subrogation rights in these transactions. If MBIA Corp. is required to make a payment under any of these affiliate guarantees, it would have the right to seek reimbursement from such affiliate and to liquidate any collateral to recover amounts paid under the guarantee.
Reinsurance enables the Company to cede exposure for purposes of syndicating risk and increasing its capacity to write new business while complying with its single risk and credit guidelines. When a reinsurer is downgraded by one or more of the rating agencies, less capital credit is given to MBIA under rating agency models and the overall value of the reinsurance to MBIA is reduced. The Company generally retains the right to reassume the business ceded to reinsurers under certain circumstances, including a reinsurer’s rating downgrade below specified thresholds. As of December 31, 2015, 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.
MBIA requires certain unauthorized reinsurers to maintain bank letters of credit or establish trust accounts to cover liabilities ceded to such reinsurers under reinsurance contracts. As of December 31, 2015, the total amount available under these letters of credit and trust arrangements was $33 million. The Company remains liable on a primary basis for all reinsured risk, and although MBIA believes that its reinsurers remain capable of meeting their obligations, there can be no assurance of such in the future.
National and MBIA Insurance Corporation 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, National and MBIA Insurance Corporation are required to maintain a minimum of $65 million of policyholders’ surplus. MBIA UK is authorized by the Prudential Regulation Authority (“PRA”) and regulated by the Financial Conduct Authority (“FCA”) and the PRA in the United Kingdom. MBIA Mexico is regulated by the Comision Nacional de Seguros y Fianzas in Mexico. 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 National and MBIA Insurance Corporation 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. National and MBIA Insurance Corporation are required to file detailed annual financial statements with the NYSDFS and MBIA UK is required to file annual regulatory returns with the PRA and the FCA. The operations and accounts of National and MBIA Insurance Corporation are subject to examination by regulatory agencies at regular intervals.
For the years ended December 31, 2015 and 2014, National had statutory net income of $284 million and $238 million, respectively. As of December 31, 2015, National’s statutory capital was $3.4 billion, consisting of policyholders’ surplus of $2.5 billion and contingency reserves of $910 million. As of December 31, 2014, National had statutory capital of $3.3 billion.
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 Insurance Corporation 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. As of December 31, 2015, the notional amount of the Asset Swap was below 5% of National’s admitted assets. In 2015 and 2014, National declared and paid dividends of $114 million and $220 million, respectively, to its ultimate parent, MBIA Inc.
As a result of the establishment of National, National and MBIA Insurance Corporation exceeded, as of the closing date, certain single and aggregate risk limits under the NYIL. These insurers obtained waivers from the NYSDFS of such limits. In connection with the waivers, they submitted a plan to the NYSDFS to achieve compliance with the applicable regulatory limits. Under the plans, they agreed not to write new financial guarantee insurance for certain issuers, and in MBIA Insurance Corporation’s case, in certain categories of business, until they were in compliance with their single risk limits and agreed to take commercially reasonable steps, including considering reinsurance, the addition of capital and other risk mitigation strategies, in order to comply with the regulatory single and aggregate risk limits. As a condition to granting the waiver, the NYSDFS required that, in addition to complying with these plans, upon written notice from the NYSDFS, MBIA Insurance Corporation and National, as applicable, would cease writing new financial guarantee insurance if it were not in compliance with the aggregate risk limitation requirements by December 31, 2009, which National came into compliance with its aggregate risk limits in 2011. As of December 31, 2015, National was in compliance with its single risk limits under the NYIL.
As of December 31, 2015 and 2014, MBIA Insurance Corporation was in compliance with its aggregate risk limits under the NYIL, but was not in compliance with certain of its single risk limits. In 2015 and 2014, MBIA Insurance Corporation reported additional overages to the NYSDFS with respect to its single risk limits. If MBIA Insurance Corporation is not in compliance with its aggregate risk and its single risk limits, the NYSDFS may prevent MBIA Insurance Corporation from transacting any new financial guarantee insurance business until it no longer exceeds these limitations.
As of 2015, MBIA Insurance Corporation’s policyholders’ surplus was negatively impacted by $75 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 primarily caused by a decrease in MBIA Insurance Corporation’s policyholders’ surplus due to insured losses in the past. MBIA Insurance Corporation’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.
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, 2015, 2014 and 2013 was $1 million, $2 million, and $2 million, respectively. The non-qualified profit sharing/401(k) expense for each of the years ended December 31, 2015, 2014 and 2013 was $1 million for each applicable year.
There were 5,663,974 shares available for future grants under the Omnibus Plan as of December 31, 2015.
Compensation expense related to the restricted shares, net of estimated forfeitures, was $20 million, $18 million and $11 million for the years ended December 31, 2015, 2014 and 2013, respectively. The tax charge related to the restricted shares awards during 2015 was $2 million. The tax benefit related to the restricted share awards during 2014 and 2013 was $2 million and $1 million, respectively.
Employee stock option compensation expense, net of estimated forfeitures, for the years ended December 31, 2015 and 2014 was immaterial. Employee stock option compensation expense, net of estimated forfeitures, for the year ended December 31, 2013 totaled $2 million. During 2015, 2014, and 2013, there were no stock option awards granted. During 2015, the company expensed a deferred tax asset of $2 million related to the stock option awards as a charge through the income statement. During 2014 and 2013, the Company expensed deferred tax assets of $4 million and $5 million, respectively, related to the stock option awards as a charge to paid-in capital. As of December 31, 2015, there was an immaterial amount of total unrecognized compensation cost related to non-vested stock options.
The following table summarizes information about outstanding stock options as of December 31, 2015:
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, 2015, 2014 and 2013 there were 17,967,871, 31,907,852 and 43,210,917, respectively, of stock options, warrants and unvested restricted stock outstanding that were antidilutive.
The following table presents the computation of basic and diluted earnings per share for the years ended December 31, 2015, 2014 and 2013:
(1) Includes 617,909, 412,769 and 629,896 of participating securities that met the service condition and were eligible to receive nonforfeitable dividends or dividend equivalents for the years ended December 31, 2015, 2014 and 2013, respectively.
In August of 2013, pursuant to the anti-dilution provisions of warrants issued by MBIA to Warburg, the terms of the warrants issued to Warburg in 2008 were amended, which resulted in (a) Warburg’s warrant to purchase 11.5 million shares exercisable at $30.25 per share was revised to 11.8 million shares at $29.44 per share; (b) Warburg’s B warrant to purchase 9.8 million shares exercisable at $30.25 per share was revised to 10.1 million shares at $29.44 per share; and (c) Warburg’s B2 warrant to purchase 4 million shares exercisable at $16.20 per share was revised to 4,004,945 shares at $16.18 per share. In addition, under the agreement, Warburg has certain gross up rights that are triggered in connection with the offering by the Company of any equity securities. As such, MBIA issued Warburg a five-year warrant to purchase 1.91 million shares of MBIA common stock at an exercise price of $9.59 per share.
In February of 2015, the Company reported the expiration of the Warburg’s warrant to purchase 11.8 million shares at $29.44 per share, the Warburg’s B warrant to purchase 10.1 million shares at $29.44 per share and the Warburg’s B2 warrant to purchase 4,004,945 shares at $16.18 per share.
The following table provides information about the Company’s share repurchases for the years ended December 31, 2015, 2014 and 2013:
Subsequent to December 31, 2015, the Company exhausted all of the remaining capacity under the October 28, 2015 program by repurchasing an additional 14.9 million common shares of MBIA Inc. at an average share price of $6.30.
As of December 31, 2015, 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 2015, MBIA Inc. did not repurchase any additional shares.
The following table presents the changes in the components of AOCI for the years ended December 31, 2015, 2014, and 2013:
On December 14, 2009, MBIA Corp. commenced an action in New York State Supreme Court, New York County, against Credit Suisse. The complaint seeks damages for fraud and breach of contractual obligations in connection with the procurement of financial guarantee insurance on the Home Equity Mortgage Trust Series 2007-2 securitization. On January 30, 2013, MBIA Corp. filed an amended complaint. The amended complaint alleges, among other claims, that Credit Suisse falsely represented: (i) the attributes of the securitized loans; (ii) that the loans complied with the governing underwriting guidelines; and (iii) that Credit Suisse had conducted extensive due diligence on and quality control reviews of the securitized loans to ensure compliance with the underwriting guidelines. The complaint further alleges that the defendants breached their contractual obligations to cure or repurchase loans found to be in breach of the representations and warranties applicable thereto and denied MBIA the requisite access to all records and documents regarding the securitized loans. Expert discovery is scheduled to conclude by March of 2016.
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. On September 9, 2014, the court granted in part MBIA Corp.’s motion to file an amended complaint. MBIA filed its amended complaint on September 29, 2014. J.P. Morgan filed its answer to the amended complaint on October 10, 2014. The parties each cross-appealed the September 9, 2014 decision and those appeals were fully submitted as of June 8, 2015. J.P. Morgan’s motion for summary judgment was argued in December of 2015 and is awaiting a ruling from the court.
Refer to “Note 21: Commitments and Contingencies” for information about legal proceedings that occurred after December 31, 2015.