A wholly-owned subsidiary of National owns the 280,729 square foot office building on approximately 38 acres of property in Armonk, New York, in which the Company, National, MBIA Corp. and Cutwater Asset Management have their headquarters. The Company also has offices with approximately 38,246 square feet of rental space in New York, New York; San Francisco, California; Paris, France; Madrid, Spain; Sydney, Australia; London, England; and Mexico City, Mexico. Cutwater Asset Management has 7,607 square feet of office space in Denver, Colorado. The Company generally believes that these facilities are adequate and suitable for its current needs.
the possibility that loss reserve estimates are not adequate to cover potential claims;
the resolution of regulatory inquiries or litigation claims against the Company or legal actions initiated by the Company in connection with potential insurance loss recoveries;
the possibility of further deterioration in the economic environment and financial markets in the United States (“U.S.”) or abroad, particularly with regard to credit spreads, interest rates and foreign currency levels, and that actions of the U.S. government, Federal Reserve and other governmental and regulatory bodies will not stimulate the economy;
MBIA operates the largest financial guarantee insurance business in the industry and is a provider of asset management advisory services. These activities are managed through three business operations: U.S. public finance insurance, structured finance and international insurance, and investment advisory services. We also manage asset/liability products and conduit programs, which are in wind-down. Corporate operations include revenues and expenses that arise from general corporate activities.
Along with our new operating structure, we created a new reporting segment for our U.S. public finance business, which enhances the transparency of our financial reporting. This transparency between our distinct business lines permits issuers, investors, and rating agencies to separately assess each of our businesses.
National’s insurance portfolio principally comprises exposure assumed by National under the quota share reinsurance agreement it entered into with MBIA Insurance Corporation effective January 1, 2009 pursuant to which MBIA Insurance Corporation ceded all of its U.S. public finance exposure to National and under the assignment by MBIA Insurance Corporation of its rights and obligations with respect to the U.S. public finance business that MBIA Insurance Corporation assumed from FGIC.
MBIA’s structured finance and international insurance operations have been principally conducted through MBIA Corp. The financial guarantees issued by MBIA Corp. generally provide unconditional and irrevocable guarantees of the payment of the principal of, and interest or other amounts owing on, insured obligations when due or, in the event MBIA Corp. has the right at its discretion to accelerate insured obligations upon default or otherwise, upon MBIA Corp.’s acceleration. Certain investment agreement contracts written by MBIA Inc. are insured by MBIA Corp. If MBIA Inc. were to have insufficient assets to pay amounts due, MBIA Corp. would make such payments under its insurance policies. MBIA Corp. also insured debt obligations of other affiliates, including MBIA Global Funding LLC (“GFL”) and Meridian Funding Company LLC (“Meridian”), and provides reinsurance to its insurance subsidiaries. MBIA Corp. has also written insurance policies guaranteeing the obligations of an affiliate, LaCrosse Financial Products, LLC (“LaCrosse”) under credit default swaps (“CDS”), including termination payments that may become due upon certain events including the insolvency or payment default of the financial guarantor or the CDS issuer. MBIA Corp.’s guarantees insure structured finance and asset-backed obligations, privately issued bonds used for the financing of public purpose projects, which are primarily located outside of the U.S. and that include toll roads, bridges, airports, public transportation facilities, utilities and other types of infrastructure projects serving a substantial public purpose, and obligations of sovereign and sub-sovereign issuers. Structured finance and asset-backed securities (“ABSs”) typically are securities repayable from expected cash flows generated by a specified pool of assets, such as residential and commercial mortgages, insurance policies, consumer loans, corporate loans and bonds, trade and export receivables, leases for equipment, aircraft and real property.
In certain cases, the Company may be required to consolidate entities established as part of securitizations when it insures the assets or liabilities of those entities and in connection with remediations or renegotiations of insurance policies. These entities typically meet the definition of a variable interest entity (“VIE”) under accounting principles for the consolidation of VIE’s. We do not believe there is any difference in the risks and profitability of financial guarantees provided to VIEs compared with other financial guarantees written by the Company. Additional information relating to VIEs is contained in the “Variable Interest Entities” section included herein. Refer to “Note 3: Recent Accounting Pronouncements” in the Notes to Consolidated Financial Statements for information about new accounting guidance that will affect the consolidation of VIEs in the first quarter of 2010.
On September 28, 2009, S&P affirmed National’s insurance financial strength rating at A with a developing outlook and downgraded MBIA Insurance Corporation’s insurance financial strength rating to BB+ with a negative outlook from BBB with a negative outlook. Also on September 30, 2009, S&P downgraded MBIA Inc.’s senior debt obligations to BB- with a negative outlook from BB with a negative outlook.
Adverse rating actions by S&P and Moody’s during 2009 have impeded our ability to attract new financial guarantee business. We do not expect to write significant new business prior to an upgrade of our insurance financial strength ratings and market acceptance that such ratings will be stable in the future. The timing of any such upgrade is uncertain and subject to both quantitative and qualitative factors which are considered by the rating agencies in their evaluation process, including the resolution of pending litigation.
Our ratings downgrades and mounting concerns about monoline insurers impaired our ability to write new business in late 2007 and 2008. Pending litigation challenging the establishment of National has constrained our new business in 2009. However, we expect that once the pending litigation that challenges our Transformation is resolved we will be able to obtain the highest possible credit ratings and the market acceptance necessary to meet our stated objectives. Our ability to achieve these ratings is subject to rating agency criteria in effect at the time, and there is no assurance that we will be able to achieve such ratings.
Our consolidated book value (total shareholders’ equity) as of December 31, 2009 was $2.6 billion, increasing from $994 million as of December 31, 2008. Our consolidated book value per share as of December 31, 2009 was $12.66, increasing from $4.78 as of December 31, 2008.
Loss and loss adjustment expense (“LAE”) reserves are established by Loss Reserve Committees in each of our major operating insurance companies (National, MBIA Corp. and MBIA UK Insurance Ltd. (“MBIA UK”)) and reviewed by our executive Loss Reserve Committee, which consists of members of senior management. These reserves require the use of judgment and estimates with respect to the occurrence, timing and amount of paid losses and recoveries on insured obligations. Given that the reserves are based on such estimates and assumptions, there can be no assurance that ultimate losses will not exceed such estimates resulting in the Company recognizing additional loss and LAE in earnings. Loss and LAE reserves relate only to MBIA’s non-derivative financial guarantees.
In the initial application of the accounting principles for financial guarantee insurance contracts, a cumulative-effect adjustment was recognized to beginning retained earnings as of January 1, 2009, which included reducing our unallocated loss reserve of $232 million as of December 31, 2008 to zero, or $151 million on an after-tax basis. Refer to “Note 2: Significant Accounting Policies” and “Note 3: Recent Accounting Pronouncements” in the Notes to Consolidated Financial Statements for a description of the Company’s accounting for financial guarantee insurance losses and the impact of adopting new accounting guidance on the Company’s financial statements with respect to such losses.
In determining the RMBS case basis reserves recorded as of December 31, 2009, which relate to RMBS backed by home equity lines of credit (“HELOCs”) and closed-end second mortgages (“CES”), the Company employed a multi-step process using a database of loan level information which allowed the Company to determine borrower payment status, including delinquencies and charge-offs. The Company relied upon this database to determine the likelihood of a delinquent loan being charged off. The information was then used in conjunction with a proprietary internal cash flow model and a commercially available model to estimate expected ultimate cumulative
The following are the principal assumptions used with respect to the underlying loans to determine the expected losses on our insured RMBS transactions:
For loans that are current (not delinquent), we derived the “Current Roll to Loss” rates by multiplying the percentage of loans in the 30-59 days bucket and the Roll to Loss rates for the 30-59 days delinquency bucket. We applied this percentage to the remaining current pool balance to project future losses after a six-month period. For example, if 10% of the loans in the pool are in the 30-59 days delinquency bucket and the transaction’s performance suggests that 30% of those loans will be charged off, the Current Roll to Loss rate for the transaction is 3%. Our model assumes that 3% of the currently performing loans will be charged off after six months.
We assumed that all defaulted loans will result in a total loss of principal upon charge-off.
We monitor portfolio performance on a monthly basis against projected performance, reviewing delinquencies, roll rates, prepayment rates (including voluntary and involuntary) and default rate trends. In the event of a material deviation in actual performance from projected performance, we would increase or decrease our case basis reserves quarterly accordingly. If defaults remained at the peak levels we are modeling for six months longer than in our probability-weighted outcome, the addition to our case basis reserves would be approximately $500 million.
In 2009, we continued our review of mortgage loans in our insured transactions. As a result, we revised the expected net cash inflows based on the increasing likelihood of potential recoveries related to ineligible mortgage loans in certain insured first and second-lien residential mortgage loan securitizations where the sellers/servicers have a contractual obligation to cure, repurchase or replace ineligible mortgage loans. Our recovery outlook is principally based on the following factors:
1. the strength of our existing contract claims related to ineligible loan substitution/repurchase obligations;
2. the improvement in the financial strength of issuers due to mergers and acquisitions and/or government assistance, which will facilitate their ability to comply with required loan repurchase/substitution obligations. We are not aware of any provisions that explicitly preclude or limit the successors’ obligations to honor the obligations of the original sponsor. Any credit risk associated with these sponsors (or their successors) is reflected in our probability-weighted potential recovery scenarios;
3. evidence of loan repurchase/substitution compliance by sellers/servicers for put-back requests made by other harmed parties with respect to ineligible loans that are similar to the type of ineligible loans that have been identified in our insured HELOC and CES portfolios, including substantial amounts paid to Federal Home Loan Mortgage Corporation (“FHLMC”) for substantially similar claims;
4. the favorable outcome for MBIA on Defendants’ motions to dismiss in the actions captioned MBIA Insurance Corp. v. Countrywide Home Loans, Inc., et al, Index No. 08-602825 (N.Y. Sup. Ct.) and MBIA Insurance Corp. v. Residential Funding Co., LLC, Index No. 603552/08 (N.Y. Sup. Ct.) where the respective courts each allowed MBIA’s fraud claims against the Countrywide and RFC defendants to proceed, and the fact that the defendants have not moved to dismiss our breach of contract claims; and
Fair value is defined as an “exit price”, which is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants on a measurement date. The degree of judgment used to determine the fair values of financial instruments generally correlates to the degree to which pricing is not observable. Financial instruments in liquid markets with readily available and actively quoted prices, or with such prices for comparable instruments usually have the most pricing observability. Financial instruments rarely traded or not quoted have less observability and are usually measured by valuation models that require judgment. Pricing observability is affected by type of financial instrument, whether the instrument is well established in the market, by characteristics unique to individual transactions and by overall market conditions.
The Company’s financial assets are primarily debt and equity investments. The majority of these are accounted for in accordance with the accounting principles for certain investments in debt and equity securities. The guidance requires all debt instruments and certain equity instruments to be classified in the Company’s consolidated balance sheet according to their purpose and, depending on that classification, to be carried at either amortized cost or fair value. Most valuations of the Company’s financial assets use observable market-based inputs, including dealer quotes when available. However, since mid 2007, illiquidity in the credit markets has significantly reduced the availability of observable market data. Other financial assets that require fair value reporting or disclosures within the Company’s Notes to Consolidated Financial Statements are valued based on the estimated value of the underlying collateral or the Company’s estimate of discounted cash flows.
operations, and debt issued for general corporate purposes. Investment agreements, MTNs, and corporate debt are typically recorded at face value adjusted for premiums or discounts. The fair values of these financial instruments are generally not reported within the Company’s financial statements but disclosed in the accompanying notes. However, financial liabilities which qualify as part of fair value hedging arrangements under the provisions of derivative and hedging are reported in the Company’s consolidated balance sheet at a value that reflects changes in the risks being hedged, which offsets changes in the value of the hedging instrument. MBIA uses cash flow modeling techniques to estimate the value of its liabilities that qualify as hedged obligations, incorporating current market data. Financial liabilities that the Company has elected to fair value or that require fair value reporting or disclosures within the Company’s notes to its financial statements are valued based on either estimated value of the underlying collateral, the Company’s or a third-party’s estimate of discounted cash flows or quoted market values for similar transactions. Refer to the following “3. Derivatives” and “4. Insured Derivatives” sections for information about these financial liabilities.
MBIA has entered into derivative transactions both within its financial guarantee insurance business and in hedging risks associated with its assets and liabilities. CDS contracts are also used in the investment management services operations to replicate investments in cash assets consistent with the risk tolerance and criteria for this business. We account for derivative transactions in accordance with the accounting principles for derivatives and hedging which requires that all such transactions be recorded on the Company’s consolidated balance sheet at fair value. The fair value of derivative instruments is determined as the amount that would be received to sell the derivative when in an asset position (when the Company would be owed money under the derivative in a termination) or transfer the derivative when in a liability position (when the Company would owe money under the derivative in a termination). Changes in the fair value of derivatives, exclusive of insured derivatives, are recorded each period in current earnings within “Net gains (losses) on financial instruments at fair value and foreign exchange” or in shareholders’ equity within “Accumulated other comprehensive income (loss)” depending on whether the derivative is designated as a hedge, and if so designated, the type of hedge.
As of December 31, 2009, we had $119.2 billion of net par outstanding on insured derivatives. The majority of our derivative exposure is in the form of “credit derivative” instruments insured by MBIA Corp. In February 2008, we ceased insuring such derivative instruments except in transactions reducing our existing insured derivative exposure. As of December 31, 2009, the net par outstanding on our insured credit derivatives totaled $106.0 billion. The remaining $13.2 billion of net par outstanding on insured derivatives as of December 31, 2009 primarily related to insured “interest rate” and “inflation-linked” swaps for which we have insured counterparty credit risk.
The majority of MBIA’s insured credit derivatives reference structured pools of cash securities and CDSs. We generally insured the most senior liabilities of such transactions, and at transaction closing our exposure generally had more subordination than needed to achieve triple-A ratings from credit rating agencies (referred to as “Super Triple-A” exposure). The collateral backing our insured derivatives was cash securities and CDSs referencing primarily corporate, asset-backed, residential mortgage-backed, commercial mortgage-backed, commercial real estate (“CRE”) loans, and CDO securities.
Included in the aforementioned $27.2 billion are guarantees under principal protection fund programs. As of December 31, 2009, the net par outstanding and maximum amount of future payments that the Company would be required to make under these guarantees was $8 million. To date, we have not made any payments relating to these guarantees.
MBIA’s insured CDS contracts do not contain typical CDS market standard features as they have been designed to replicate our financial guarantee insurance policies. At inception of the transactions, our insured CDS contracts provided protection on pools of securities or CDSs with either a stated deductible or subordination beneath the MBIA-insured tranche. We are not required to post collateral in any circumstance. Payment by MBIA under an insured CDS is due after the aggregate amount of losses on the underlying reference obligations, based on actual losses as determined pursuant to the settlement procedure in each transaction, exceed the deductible or subordination in the transaction. Once such losses exceed the deductible or the subordination, the transactions are structured with the intention that MBIA is generally obligated to pay the losses, net of recoveries, if any, on any subsequent reference obligations that default. Some contracts also provide for further deferrals of payment at our option. In the event of MBIA Corp.’s failure to pay a claim under the insured CDS or the insolvency of MBIA Corp., the insured CDS contract provides that the counterparty can terminate the CDS and make a claim for the amount due, which would be based on the fair value of the insured CDS at such time. An additional difference between our CDS and typical market standard contracts is that our contracts, like our financial guarantee contracts, cannot be accelerated by the counterparty in the ordinary course of business but only upon the occurrence of certain events including the failure of LaCrosse to make a payment due under the CDS or the bankruptcy of MBIA Corp. or MBIA UK, our UK subsidiary that also insured certain CDS contracts entered into by LaCrosse. Similar to our financial guarantee insurance, all insured CDS policies are unconditional and irrevocable and our obligations thereunder cannot be transferred unless the transferees are also licensed to write financial guarantee insurance policies. Since insured CDS contracts are accounted for as derivatives under relevant accounting guidance, the Company did not defer the charges associated with underwriting the CDS policies and they were expensed at origination.
The structure of our payment obligations in these contracts is intended to prevent large one-time claims upon an event of default of underlying reference obligations and to allow for payments over time (i.e. “pay-as-you-go” basis) or at final maturity. However, the size of payments will ultimately depend on the timing and magnitude of losses. There are primarily three types of payment provisions:
(iii) payments upon settlement of individual referenced collateral losses in excess of policy-specific deductibles and subordination. The deductible or loss threshold is the amount of losses experienced with respect to the underlying or referenced collateral that would be required to occur before a claim against an MBIA insurance policy can be made.
As a result of the significant differences between market standard CDS contracts and the CDS contracts insured by MBIA, we believe there are no relevant third-party exit value market observations for our insured structured credit derivative contracts and, therefore, no principal market as described in fair value measurement and disclosures. In the absence of a principal market, we value these insured credit derivatives in a hypothetical market where market participants are assumed to be other comparably-rated primary financial guarantors. Since there are no observable transactions in the financial guarantee market that could be used to value our transactions, we generally use internal and third-party models, depending on the type and structure of the contract, to estimate the fair value of our insured derivatives.
Approximately 69% of the balance sheet fair value of insured credit derivatives as of December 31, 2009 is valued using the Binomial Expansion Technique (“BET”) model, which is a probabilistic approach to calculating expected loss on our exposure based on market variables for underlying referenced collateral. During the third quarter of 2009, the Company changed the model it used to estimate the fair value of most of its insured multi-sector CDOs. Previous to the third quarter of 2009, these transactions were valued using the BET model. Beginning with the third quarter of 2009, we valued these transactions using an internally-developed valuation model, referred to as the Direct Price Model. Approximately 31% of the balance sheet fair value of insured credit derivatives as of December 31, 2009 was valued using the Direct Price Model.
credit spreads of the underlying collateral. This is based on actual spreads or spreads on similar collateral with similar ratings, or in some cases is benchmarked;
Collateral is generally considered on an average basis rather than being modeled separately.
There is no market in which to test and verify the fair values generated by our model, and as of December 31, 2009, the model inputs were also either unobservable or highly illiquid, adversely impacting their reliability.
We use the spread hierarchy listed below in determining which source of spread information to use, with the rule being to use CDS spreads where available and cash security spreads as the next alternative. Cash spreads reflect trading activity in funded fixed-income instruments while CDS spreads reflect trading levels for non-funded derivative instruments. While both markets are driven partly by an assessment of the credit quality of the referenced security, there are factors which create significant differences, such as CDS spreads can be driven by speculative activity since the CDS market facilitates both long and short positions without ownership of the underlying security, allowing for significant leverage.
Actual collateral-specific credit spreads. If up-to-date and reliable market-based spreads are available, they are used.
Corporate spreads (Bloomberg and Risk Metrics spread tables based on rating).
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 always our objective to move to higher levels on the hierarchy, but we sometimes move to lower priority inputs because of discontinued data sources or because we consider higher priority inputs no longer representative of market spreads. This occurs when transaction volume changes such that a previously used spread index is no longer viewed to reflect current market levels, as was the case for CMBS collateral in insured CDSs beginning in 2008. Refer to section “Input Adjustments for Insured CMBS Derivatives in the Current Market” below.
The diversity score is a measure to estimate the diversification in a portfolio. The diversity score estimates the number of uncorrelated assets that are assumed to have the same loss distribution as the actual portfolio of correlated assets. For example, if a portfolio of 100 assets had a diversity score of 50, this means that the 100 correlated assets are assumed to have the same loss distribution as 50 uncorrelated assets. A lower diversity score represents higher assumed correlation, increasing the chances of a large number of defaults, and thereby increasing the risk of loss in the senior tranche. A lower diversity score will generally have a negative impact on the valuation for our senior tranche. The calculation methodology for a diversity score includes the extent to which a portfolio is diversified by industry or asset class, which is either calculated internally or reported by the trustee on a regular basis. Diversity scores are calculated at transaction origination, and adjusted as the collateral pool changes over time. MBIA’s internal modeling of the diversity score is based on Moody’s methodology but uses MBIA’s internal assumptions on default correlation, including variables such as collateral rating and amount, asset type and remaining life.
Approximately $45.3 billion gross par of MBIA’s insured derivative transactions as of December 31, 2009 include substantial amounts of CMBS and commercial mortgage collateral. Prior to 2008, we had used spreads drawn from CMBX indices and CMBS spread tables as pricing input on the underlying referenced collateral in these transactions. In 2008, as the financial markets became illiquid, we observed a significant disconnect between cumulative loss expectations of market analysts on underlying commercial mortgages and loss expectations implied by the CMBX indices and CMBS spread tables.
In addition, due to financial market uncertainty since last year, transaction volume in CMBS and trading activity in the CMBX were both dramatically lower than in prior periods. We also considered that the implied loss rates within the CMBX index were much higher than that forecast by fundamental researchers and MBIA’s internal analysis. As a result of these issues, we concluded that the CMBX indices and the CMBS spread tables were unreliable model inputs for the purpose of estimating fair value in our hypothetical market among monoline insurers.
In the third quarter of 2009, MBIA reassessed the reasonableness of CMBX inputs. CMBX levels are now quoted in price terms instead of spread. It was observed that trading activity in CMBX indices is more liquid than in recent quarters. There has also been some convergence between the loss rates implied by the CMBX index and that of fundamental analysts. During the third quarter of 2009 CMBX prices improved (implying a lower loss rate) while fundamental assessments of loss rates for CMBS increased. MBIA concluded that it was again appropriate and reasonable to use CMBX as an input for the BET model.
During the third quarter of 2009, the Company modified its inputs for RMBS collateral in insured CDO-squared transactions because an appropriate source was no longer available for RMBS collateral spreads. Previously, spread levels were provided by securities firms, however, these firms no longer provide this information. As a result, the Company assumed that all RMBS collateral defaulted and there was a recovery based on the current recovery rate assumption.
In compliance with the requirements of fair value measurement, our valuation methodology for insured credit derivative liabilities incorporates the Company’s own nonperformance risk and the nonperformance risk of its reinsurers. We calculate the fair value by discounting the market value loss estimated through the BET model at discount rates which include MBIA Corp.’s and the reinsurers’ CDS spreads (or an estimate if there is not a traded CDS contract referencing a reinsurer) as of December 31, 2009. Prior to the second quarter of 2009, MBIA used the 5-year CDS spread on MBIA Corp. to calculate nonperformance risk. This assumption was compatible with the average life of the CDS portfolio, which was approximately 5 years. In the second quarter of 2009, we refined this approach to include a full term structure for CDS spreads. Under the refined approach, the CDS spreads assigned to each deal are based on the weighted average life of the deal.
In the fourth quarter of 2009, we enhanced the calculation of nonperformance risk for certain multi-sector and corporate CDOs. MBIA previously used the weighted average life of the overall transaction to calculate nonperformance risk. For the transactions affected, the timing of potential modeled loss varies significantly by the type of collateral that generates the loss. Therefore, the nonperformance risk calculation was adjusted to reflect the potential timing of loss for each collateral type. This adjustment increased our derivative liability by $345 million.
Beginning in the first quarter of 2009, we limited the impact of MBIA’s CDS speads so that the derivative liability, after giving effect to nonperformance risk, could not be lower than MBIA’s recovery derivative price multiplied by the unadjusted derivative liability.
There is no market in which to test and verify the fair values generated by our model.
There are diverse approaches to estimating fair value of similar transactions among other financial guarantee insurance companies.
The model does not take into account potential future volatility of collateral prices. When the market value of collateral is substantially lower than insured par and there is no or little subordination left in a transaction, which is the case for most of the transactions marked with this model, the Company believes this assumption still allows a reasonable estimate of fair value.
The Company believes that it is important to apply its valuation techniques consistently. However, we may consider making changes in the valuation technique if the change results in a measurement that is equally or more representative of fair value under current circumstances.
Accounting principles for fair value measurement and disclosures establish a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. 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. The following table presents the fair values of assets and liabilities recorded on our consolidated balance sheet that are classified as Level 3 within the fair value hierarchy as of December 31, 2009 and 2008, along with a brief description of the valuation technique for each type of asset and liability. Our derivative liabilities, principally relating to insured derivatives, constitute the majority of fair values of instruments classified as Level 3.
Level 3 assets were $2.4 billion and $3.8 billion as of December 31, 2009 and 2008, respectively, and represented approximately 17% and 21%, respectively, of total assets measured at fair value. Level 3 liabilities were $4.7 billion and $6.5 billion as of December 31, 2009 and 2008, respectively, and represented approximately 99% and 97%, respectively, of total liabilities measured at fair value.
inputs, which are significant to their valuation, became observable or unobservable during the period. These inputs included spreads, prepayment speeds, default speeds, default severities, yield curves observable at commonly quoted intervals, and market corroborated inputs. Corporate obligations, CMBS and CDOs comprised the majority of the transferred instruments. For the year ended December 31, 2008, the net unrealized losses related to the transfers into Level 3 was $25 million and the net unrealized losses related to the transfers out of Level 3 was $82 million.
With respect to insured credit derivatives, we use a fair value validation process. We review the model results on a quarterly basis to assess the appropriateness of the assumptions and results in light of current market activity and conditions. This review is performed by internal staff with relevant expertise. If live market spreads are observable for similar transactions, those spreads are an integral part of the analysis. For example, new insured transactions that resemble existing (previously insured) transactions would be considered, as would negotiated settlements of existing transactions. However, there have been no new insured transactions in recent periods. There were several insured CDS transactions that MBIA commuted or were terminated during 2009. In some cases, MBIA did not make any payment to the counterparties and, in other cases, the amount of payment was lower than MBIA’s carrying value for the derivative. As a result, the termination amounts were lower than our related derivative liabilities. However, we did not use these transactions to adjust the valuation of other insured derivatives because we determined that there were unique characteristics to the terminated transactions that did not apply to the remaining portfolio. For example, these transactions were privately negotiated and did not reflect independent fair values. As a result of very limited observable activity, our recent reviews have focused more on internal consistency and relativity, as well as the reasonableness of modeled results given current market conditions.
An issuer of an insured financial obligation may retire the obligation prior to its scheduled maturity through legal defeasance in satisfaction of the obligation according to its indenture, which results in the Company’s obligation being extinguished under the financial guarantee contract. The Company recognizes any remaining unearned premium revenue on the insured obligation as premium revenue in the period the contract is extinguished to the extent the unearned premium revenue has been collected.
We performed our annual impairment test of goodwill as of January 1, 2009 and January 1, 2010. As of January 1, 2009, the fair value of insurance reporting unit exceeded its carrying value indicating that goodwill was not impaired. As of January 1, 2010, the fair value of our U.S. public finance reporting unit exceeded its carrying value indicating that goodwill is not impaired. However, the fair value of our structured finance and international insurance reporting unit did not exceed its carrying value, indicating that goodwill was impaired. Such impairment was primarily driven by continued deterioration in the performance of insured RMBS and CDO transactions. As a result, in the fourth quarter of 2009, the Company recorded an impairment loss of $46 million, representing the full amount of goodwill recorded in our structured finance and international insurance reporting unit.
In performing our impairment tests of goodwill as of January 1, 2010, we calculated the fair value of our structured finance and international insurance reporting unit and our U.S. public finance insurance reporting unit utilizing discounted cash flow modeling. The inputs to our valuation models included our estimates of market participant assumptions.
Refer to “Note 14: Income Taxes” in the Notes to Consolidated Financial Statements for additional information about the Company’s deferred income taxes.
Refer to “Note 3: Recent Accounting Pronouncements” in the Notes to Consolidated Financial Statements for a discussion about accounting guidance recently adopted by the Company, as well as other recent accounting developments relating to guidance not yet adopted by the Company.
The following table presents a summary of our consolidated financial results for the years ended December 31, 2009, 2008 and 2007:
For the year ended December 31, 2009, we recorded consolidated net income of $623 million or $2.99 per share, after adjusting for preferred stock dividends of MBIA Insurance Corporation, compared with a net loss of $2.7 billion or $12.11 per share for 2008. Weighted average shares outstanding totaled 208 million for the year ended December 31, 2009, down 6% from 2008 as a result of repurchases of common stock by the Company.
Consolidated revenues for the year ended December 31, 2009 were $3.0 billion compared with a loss of $857 million for the same period of 2008. The increase in our consolidated revenues principally reflects unrealized gains on insured derivatives and an increase in insurance fees, partially offset by a reduction in net investment income and lower realized losses from the sale of securities and other-than-temporary impairments.
Consolidated expenses for the year ended December 31, 2009 were $1.7 billion compared with expenses of $2.9 billion for 2008. The decrease in our consolidated expenses was primarily due to a decline in interest expense as a result of a reduction in outstanding debt within our investment management services operations. Additionally, losses and LAE incurred on financial guarantee insurance policies decreased due to a decline in losses incurred on our RMBS exposure.
For the year ended December 31, 2008, we recorded a consolidated net loss of $2.7 billion or $12.11 per share, compared with a net loss of $1.9 billion or $14.93 per share for 2007. Weighted average shares outstanding totaled 220 million for the year ended December 31, 2009, up 71% from 2007 as a result of issuing common stock in the fourth quarter of 2008.
As described in the previous “Business Description” section, in the first quarter of 2009 we separated our insurance operations into two segments; U.S. public finance insurance and structured finance and international insurance. However, in order to provide a basis of comparison for the years ended December 31, 2009, 2008, and 2007, we have combined the results of our U.S. public finance insurance and structured finance and international insurance segments in the discussions that follow. Where practical, we have provided information about the years ended December 31, 2008 and 2007 separately for our U.S. public finance insurance segment and our structured finance and international insurance segment. Additionally, the results presented in this section include revenues and expenses from transactions with our investment management services and corporate operations:
Net premiums earned on non-derivative financial guarantees for the years ended December 31, 2009, 2008 and 2007 are presented in the following table. Net premiums earned represent gross premiums earned net of premiums ceded to reinsurers, and include scheduled premium earnings and premium earnings from refunded issues.
In 2009, U.S. public finance net premiums earned of $563 million increased $57 million or 11% compared with 2008. The increase was attributable to an increase in scheduled premiums earned of $137 million related to premium earnings on policies assumed from FGIC in 2008. This increase was partially offset by a decrease in refunding activity of $80 million compared with 2008. The decrease is consistent with the overall decline in refundings experienced in the municipal market during 2009.
In 2008, structured finance and international net premiums earned of $374 million decreased $7 million or 2% compared with 2007. The decrease is related to a decline in U.S. structured finance business of $10 million compared with 2007 and reflects the maturity and termination of policies in the absence of new business. Partially offsetting the decrease was an increase in non-U.S. premiums earned of $3 million or 2% primarily related to non-U.S. public finance business.
CREDIT QUALITY Financial guarantee insurance companies use a variety of approaches to assess the underlying credit risk profile of their insured portfolios. MBIA uses both an internally developed credit rating
system as well as third-party rating sources in the analysis of credit quality measures of its insured portfolio. In evaluating credit risk, we obtain, when available, the underlying rating of the insured obligation before the benefit of its insurance policy from nationally recognized rating agencies, Moody’s and S&P. Other companies within the financial guarantee industry may report credit quality information based upon internal ratings that would not be comparable to our presentation.
The following table presents the credit quality distribution of MBIA’s outstanding net par insured as of December 31, 2009 and 2008. All ratings are as of the period presented and represent S&P ratings. If transactions are not rated by S&P, a Moody’s equivalent rating is used. If transactions are not rated by either S&P or Moody’s, an MBIA equivalent rating is used.
As of December 31, 2009, total structured finance and international net par outstanding rated A or above, before giving effect to MBIA’s guarantee, was 69% compared with 71% as of December 31, 2008. Adverse changes in the ratings of our structured finance and international net par outstanding was principally a result of ratings downgrades on our mortgage-related exposure. As of December 31, 2009 and 2008, 15% and 12%, respectively, of net par outstanding was rated below investment grade.
INVESTMENT INCOME Net investment income in our insurance operations for the years ended December 31, 2009, 2008 and 2007, and ending investment asset balances at amortized cost as of December 31, 2009 and 2008 are presented in the following tables:
In 2008, our insurance operation’s pre-tax net investment income, excluding net realized gains and losses, increased 2% to $584 million from $573 million in 2007. The increase in pre-tax net investment income reflects growth in average invested assets from the proceeds of our surplus notes and the Warburg Pincus equity transactions and, to a lesser extent, proceeds from our reinsurance transaction with FGIC. The effect of the increase in average invested assets was partially offset by a decrease in yields on tax-exempt and short-term investments. After-tax net investment income increased 1% in 2008 as the proportion of taxable investments increased compared with 2007.
In 2008, the decrease in VIE investment income compared with 2007 primarily resulted from a decline in floating interest rates on VIE assets. Excluding interest income related to VIEs and interest income related to Northwest Airlines’ enhanced equipment trust certificates (“EETCs”) received as part of a remediation, which the Company sold in June 2007, insurance-related net investment income decreased 4% on a pre-tax basis and 10% on an after-tax basis in 2008 compared with 2007.
FEES AND REIMBURSEMENTS For the year ended December 31, 2009, combined insurance fees and reimbursements were $113 million compared with $9 million for the same period of 2008. The increase in fees and reimbursements was primarily due to the receipt of amounts in excess of those which were contractually due to MBIA upon the termination of certain reinsurance agreements, totaling $85 million, advisory fees of $7 million on a Latin American infrastructure transaction, and an increase in waiver and consent fees related to the ongoing management of our structured finance and international insurance business. For the year ended December 31, 2008, combined insurance fees and reimbursements decreased $11 million or 54% compared with 2007 as a result of a reduction in expense reimbursements associated with loss prevention efforts. Due to the transaction-specific nature inherent in fees and reimbursements, these revenues can vary significantly period to period.
NET CHANGE IN FAIR VALUE OF INSURED DERIVATIVES MBIA has sold credit protection by insuring derivative contracts with various financial institutions. As of December 31, 2009, we had $119.2 billion of net par outstanding on insured derivatives compared with $140.3 billion as of December 31, 2008. During the year ended December 31, 2009, 23 insured credit derivative transactions, representing $15.2 billion in net par outstanding, either matured or were contractually terminated prior to maturity.
In certain cases, the Company reinsured credit derivative transactions thereby purchasing credit protection on a portion of the risk written. Substantially all of the Company’s insured derivative exposure was written by its structured finance and international insurance segment. Insured derivatives within the Company’s U.S. public finance insurance segment primarily relate to interest rate swaps that were insured with municipal debt obligations.
contracts. The following table presents the net premiums earned related to derivatives and the components of the net change in fair value of insured derivatives for the years ended December 31, 2009, 2008 and 2007:
Unrealized gains for the year ended December 31, 2009 were $1.7 billion compared with unrealized losses in 2008 of $1.8 billion. Unrealized gains in 2009 were primarily related to changes in MBIA’s CDS and recovery swaps pricing, narrower collateral spreads, and transaction terminations, partially offset by losses from enhancements to our valuation models and inputs, subordination erosion, lower estimated recovery rates on collateral and collateral rating migration. The main enhancements to our valuation models and inputs were the development of a direct pricing model for multi-sector CDOs, assumptions about ABS collateral defaults, the calculation of nonperformance risk for CDOs, and the refinement of a spread model for CMBS transactions. Enhancements to our valuation models and inputs are discussed further in the “Critical Accounting Estimates” section included herein. Unrealized losses for the year ended December 31, 2008 were primarily due to spread widening, and to a lesser extent, subordination erosion, collateral rating migration and lower recovery rates. This was significantly offset by the deterioration in MBIA’s CDS spreads. For example, MBIA’s five year CDS spread as of December 31, 2007 was 3.41% per annum. As of December 31, 2008, the cost of the CDS was 46.5% upfront plus 5% per annum; and as of December 31, 2009, MBIA Corp.’s five year CDS cost was 64.25% upfront plus 5% per annum. Our mark-to-market on insured credit derivatives at year end 2009 uses the most appropriate of the one to ten year CDS for each transaction, and those costs ranged from 17.5% upfront plus 5% per annum to 64.25% upfront plus 5% per annum.
These credit impairments, a non-GAAP measure, may differ from the fair values recorded in our financial statements. The fair value of an insured derivative contract will be influenced by a variety of market and transaction-specific factors that may be unrelated to potential future claim payments. In the absence of credit impairments or the termination of derivatives at losses, the cumulative unrealized losses recorded from fair valuing insured derivatives should reverse before or at the maturity of the contracts. Contracts also may be settled prior to maturity at amounts that may be more or less than their recorded fair values. Those settlements can result in realized gains or losses, and the reversal of unrealized losses.
The Company is not required to post collateral to counterparties of these contracts, thereby avoiding liquidity risks typical of standard credit derivative contracts. Refer to “Note 24: Commitment and Contingencies” in the Notes to Consolidated Financial Statements for information about legal actions commenced by MBIA with respect to certain CDS contracts. The outcome of such legal actions may affect the amount of realized losses ultimately incurred by the Company. Costs associated with mitigating credit impairments on insured derivatives are expensed as incurred and included within “Operating expenses” in our consolidated statements of operations. Such costs totaled $22 million, and $6 million for the years ended December 31, 2009 and 2008. The Company did not incur such costs in 2007.
NET REALIZED GAINS AND LOSSES Combined insurance net realized losses totaled $50 million for the year ended December 31, 2009 compared with net realized losses of $35 million in 2008 and net realized gains of $56 million in 2007. The net realized losses for the year ended December 31, 2009 were primarily related to impairment charges in our structured finance and international insurance segment, partially offset by net gains from sales of investment securities within our U.S. public finance insurance and our structured finance and international insurance portfolios. Net realized losses for the year ended December 31, 2008 were largely due to sales of investment securities. Net realized gains in 2007 included $32 million of gains related to the disposition of Delta and Northwest Airlines’ EETCs the Company received from insurance remediations.
INVESTMENT LOSSES RELATED TO OTHER-THAN-TEMPORARY IMPAIRMENTS Combined insurance investment losses related to other-than-temporary impairments totaled $102 million for the year ended December 31, 2009 and primarily resulted from the impairment of assets within consolidated VIEs. Refer to the “Liquidity” section included herein for additional information about impaired investments.
LOSSES AND LOSS ADJUSTMENT EXPENSES MBIA’s insured portfolio management groups within its U.S. public finance and structured finance and international insurance businesses (collectively, “IPM”) are responsible for monitoring MBIA-insured issues. The level and frequency of MBIA’s monitoring of any insured issue depends on the type, size, rating and performance of the insured issue. If IPM identifies concerns with respect to the performance of an insured issue it may designate such insured issue as “Caution List-Low,” “Caution List-Medium,” “Caution List-High,” or “Classified.”
The amounts included within this “Loss and Loss Adjustment Expenses” section exclude realized and unrealized gains and losses and estimated credit impairments on insured credit derivatives. Refer to the “Net Change in Fair
The following tables present information about our insurance reserves and recoverables as of December 31, 2009 and 2008, as well as our loss and LAE provision for the years ended December 31, 2009, 2008 and 2007:
Losses and LAE incurred in our U.S. public finance insurance segment totaled $94 million in 2009 and primarily related to an affordable housing transaction and a student loan transaction.
Losses and LAE incurred in our structured finance and international insurance segment totaled $770 million in 2009. Included in the $770 million were gross losses related to actual and expected future payments of $3.1 billion, of which $2.9 billion related to insured RMBS transactions. Offsetting these losses were actual and estimated potential recoveries of $2.3 billion and reinsurance of $46 million. Included in the $2.3 billion of estimated potential recoveries were $2.3 billion of recoveries related to our RMBS transactions. The $2.3 billion of RMBS insurance loss recoveries comprised approximately $1.6 billion related to estimates of potential recoveries resulting from ineligible mortgages included in insured second-lien residential mortgage and Alt-A securitization exposures that are subject to contractual obligations by sellers/servicers to repurchase or replace
such mortgages, and approximately $684 million related to amounts expected to be paid to MBIA from excess interest cash flows within the securitizations.
Included in the Company’s case basis reserves are both loss reserves for insured obligations for which a payment default has occurred and MBIA has already paid a claim and also for which a payment default has not yet occurred but a claim is expected in the future. As of December 31, 2009, case basis reserves consisted of the following:
MBIA also insures MBS backed by mortgages that when originally underwritten were deemed to be issued to prime and near prime borrowers, including second-lien residential mortgage securitizations (revolving HELOC loans and CES mortgages) and Alt-A transactions. In 2009, we incurred losses of $575 million related to RMBS transactions. This provision primarily reflects additions to previously established reserves on certain deals rather than a material increase in the number of transactions requiring loss reserves. Included in the $575 million were gross losses related to actual and expected future payments of $2.8 billion, net of reinsurance. Offsetting these losses were actual and estimated potential recoveries of $2.2 billion, net of reinsurance. The $2.2 billion of estimated recoveries comprised approximately $1.5 billion related to expected recoveries for ineligible mortgage loans in certain securitizations that are subject to the sellers’/servicers’ contractual obligations to repurchase or replace those loans, and approximately $667 million related to amounts expected to be recovered from excess interest cash flows within the securitizations.
We paid approximately $2.3 billion, $1.4 billion and $44 million, net of reinsurance and collections, on insured RMBS transactions in the years ended December 31, 2009, 2008, and 2007, respectively. As of December 31, 2009, the net par outstanding on insured RMBS transactions for which we have paid net claims was $12.0 billion compared with $13.7 billion as of December 31, 2008. As of December 31, 2009 we expect to pay an additional $2.0 billion (on a present value basis) on these exposures. We expect to receive a total of $1.5 billion (on a present value basis) in reimbursement of past and future expected claims through excess spread in the securitizations. Of this amount, $887 million is included in our insurance loss recoverable and $578 million is included in our loss and LAE reserves. In addition, we expect to receive $1.5 billion (on a present value basis) as sellers/servicers honor their commitments to repurchase ineligible loans in the securitizations. Of this amount, $1.3 billion is included in our insurance loss recoverable and $215 million is included in our loss and LAE reserves.
As of December 31, 2009, we had paid a cumulative total of $3.8 billion, net of reinsurance and collections, on RMBS transactions and have case basis reserves of $1.2 billion. The case basis reserves represent the present value of the difference between cash payments we expect to make on the insured transactions and the cash receipts we expect from the performing mortgages in the securitizations, reduced by potential recoveries from sellers/servicers. As payments are made, a portion of those expected future receipts is recorded within “Insurance Loss Recoverable” as discussed above. The payments that we make largely go to reduce the principal balances of the securitizations.
Since the second half of 2008, we have observed an increase in delinquencies in our insured RMBS transactions, which peaked in January 2009, and a greater than expected level of losses being realized. The largest single contributor to our losses appears to be the failure of most of the individual mortgage loans in many of our insured transactions to comply with the underwriting guidelines represented to us at origination. These breaches, combined with inadequate servicer performance and relatively few successful loan modifications, led to loss and LAE expense related to our residential mortgage exposures of $575 million in 2009.
The majority of expected recoveries from RMBS transactions recorded in 2009 arise from a forensic review of defaulted mortgage loans in 30 insured first and second-lien mortgage loan securitizations. The representations and warranties in each insured RMBS securitization contractually obligate the seller to repurchase these ineligible loans at a price equal to their outstanding principal balance plus accrued interest or to replace them with eligible mortgage loans. While the Company believes that these mortgage loans are subject to repurchase or replacement obligations by the sellers/servicers, successful challenges of such determinations by the sellers/servicers could result in the Company recovering less than the amount of its estimated recoveries. The Company is continuing to review and evaluate additional mortgage loans in its insured RMBS pools and expects that there will be additional mortgages in these or in other transactions that are subject to a repurchase or replacement obligation by the seller/servicer. In addition, recoveries and damages from legal actions that MBIA has filed against certain of the seller-servicers could result in recoveries that are substantially higher than the amount currently recognized as recoveries. As previously discussed, we also recorded recoveries during 2009 based on expected receipts of excess interest in securitizations. Refer to the “Critical Accounting Estimates” section included herein for additional information about assumptions used to estimate recoveries on our RMBS exposure.
The following table provides a listing of second-lien residential mortgage securitization and Alt-A transactions included in MBIA’s insured portfolio for which it has made claim payments as of December 31, 2009:
MBIA continues to closely monitor the manufactured housing sector, which has experienced stress during the last several years. MBIA ceased writing business in this sector, other than through certain CDO transactions, in 2000. As of December 31, 2009, the Company had $20 million in case basis reserves, net of reinsurance, covering net insured par outstanding of $104 million on three credits within the manufactured housing sector. The Company had additional manufactured housing net insured par outstanding of $1.5 billion as of December 31, 2009, of which approximately 21% was reported as “Caution List-Medium” and “Caution List-High.”
In the fourth quarter of 2008, the Company took remediation action on an international infrastructure financing transaction for which the performance trends had increased the risk of future losses. The project’s revenue was below original projections and the issuer’s debt was trading at a significant discount. In the fourth quarter of 2008, we purchased approximately 62% of the outstanding debt of the issuer at a discount to par. As a consequence, the Company consolidated the issuer as a VIE. In 2009, the Company purchased an additional 13% of the outstanding debt of the issuer at a discount to par. The asset of the consolidated VIE is the loan to the project’s operator. The Company has recognized a $41 million realized loss on this asset.
As of December 31, 2009, the aggregate amount of insured par outstanding ceded by MBIA to reinsurers under reinsurance agreements was $43.6 billion compared with $54.9 billion as of December 31, 2008. Of the $43.6 billion of ceded par outstanding as of December 31, 2009, $14.1 billion was ceded from our U.S. public finance insurance segment and $29.5 billion was ceded from our structured finance and international insurance segment.
In February of 2010, the Company reassumed business ceded to one of its remaining reinsurers.
Gross expenses in our U.S. public finance insurance segment for the year ended December 31, 2009 totaled $59 million and gross expenses in our structured finance and international insurance segment totaled $189 million. Combined gross expenses of $228 million increased 16% for the year ended December 31, 2009 from $198 million for the same period of 2008. The increase was primarily due to higher legal costs associated with litigation, loss prevention expenses related to insured credit derivatives, higher consulting costs related to changes in the legal entity structure of our subsidiaries, and the reversal of long-term incentive award accruals in 2008, partially offset by lower overall compensation as a result of a reduction in staffing, and a reduction in fees related to the termination of a credit facility. For the year ended December 31, 2008, combined gross expenses of $198 million decreased 20% from $248 million for 2007. The decrease was primarily due to a decrease in compensation costs related to the reversal of prior year bonus and long-term incentive award accruals.
The amortization of deferred acquisition costs in our combined insurance operations increased 9% to $82 million from $75 million for 2008. The increase in the amortization of deferred acquisition costs was principally due to the effects of changes in amortization methods resulting from the adoption of the recently effective accounting principles for financial guarantee insurance contracts. For the year ended December 31, 2008, our combined insurance amortization of deferred acquisition costs increased 12% to $75 million from $67 million for 2007. The increase in the amortization of deferred acquisition costs was due to an increase in premiums earned during 2008 for policies to which the costs related.
(1)-Does not include multi-sector CDO-squared transactions totaling $6.6 billion and $8.3 billion net par as of December 31, 2009 and 2008, respectively.
During 2009, multi-sector CDO net par exposure reduced by approximately $8.1 billion. Of the $8.1 billion, approximately $5.3 billion of were terminated contractually without any payment from MBIA, approximately $1.2 billion was a result of negotiated commutations, and the remaining reduction was primarily due to amortization and maturity.
Since mid-2007, the multi-sector CDO portfolio has experienced stress related to the U.S. subprime mortgage crisis. As of the year ended December 31, 2009, impairment estimates are established for 19 multi-sector CDOs. Impairments have been estimated for CDOs due to the degradation of underlying RMBS and CDO of ABS collateral. As of December 31, 2009, MBIA estimated credit impairment in connection with 19 multi-sector CDO transactions, CDS and non-CDS contracts, aggregating to $1.9 billion for which MBIA expects to incur actual net claims in the future. In the event of further deteriorating performance of the collateral referenced or held in the multi-sector CDO transactions, the amount of credit impairments could increase materially.
For the multi-sector CDOs, the next four tables provide breakdowns of the collateral composition and ratings of subprime RMBS collateral, non-subprime RMBS collateral, and CDOs of ABS collateral by vintage year and rating. Years in which no exposure was insured were omitted. CDOs of ABS may contain exposure to various types of collateral, including RMBS. The collateral level detail presented for each year insured was calculated using a weighted average of the total collateral as of December 31, 2009 for deals closed for the insured year. The range of subordination represents the minimum and maximum subordination for deals written in that year. MBIA calculates subordination as the amount of the current non-defaulted collateral face value and cash in excess of the amount of the senior insured tranche outstanding. In general, this calculation produces subordination ranges that are lower than methods used by other market participants. We also present the net derivative asset/ (liability) related to CDS deals written in that year. Not all insurance contracts included in the following tables are accounted for as derivatives. Refer to “Note 5: Fair Value of Financial Instruments” and “Note 8: Derivative Instruments” in the Notes to Consolidated Financial Statements for information about the Company’s derivatives (including CDS on CDOs). The tables do not provide collateral level detail on 42 CDOs totaling $1.7 billion of net par. Three deals, with $0.6 billion of net par, contain European Mezzanine ABS assets including 55% RMBS, 22% CDO, 17% CMBS and 6% other, and were closed in 2004, 2005 and 2006. In addition, 39 deals represent insurance sold to investors for CDO tranches in their portfolios (secondary market insurance executions). These deals total $1.1 billion of par and were all insured prior to 2005. Lastly, below investment grade (“BIG”) denotes collateral credit ratings of below BBB-.
The multi-sector CDO portfolio is comprised of transactions that rely on underlying collateral originally rated single-A or above (CDOs of high-grade U.S. ABS) and transactions that rely on collateral primarily originally rated triple-B (CDOs of Mezzanine U.S. ABS). The multi-sector CDO portfolio is also comprised of CDOs of multi-sector high-grade collateral (also referred to as CDO-squared transactions), which are diversified CDOs primarily comprised of collateral
originally rated single-A and above. The collateral in MBIA’s insured CDO-squared transactions comprises primarily tranches of CLOs, CDOs of ABS, and RMBS.
MBIA’s multi-sector CDOs originally benefited from two sources of credit enhancement. First, the subordination in the underlying securities collateralizing the MBIA wrapped tranche must be fully eroded and second, the subordination below MBIA’s insurance coverage in the CDO transaction must be fully eroded before MBIA’s insured interest is subject to a claim. The original subordination levels and those as of December 31, 2009 are detailed in the above table. MBIA’s payment obligations after a default vary by deal and by insurance type. There are three policy payment types: (i) where MBIA insures current interest and ultimate principal; (ii) where MBIA insures ultimate principal only; and (iii) where MBIA insures payments upon settlement of individual collateral losses as they occur after the complete erosion of deal deductibles, such payment profiles are referred to as Asset Coverage with a Deductible. The totals may not sum due to rounding.
As of December 31, 2009, the majority of insurance protection provided by MBIA for its Investment Grade Corporate CDO exposure attached at a super senior level. The Company’s net par exposure to Investment Grade Corporate CDOs represents 32% of MBIA Corp.’s CDO exposure and approximately 18% of MBIA Corp.’s total net par insured. MBIA Corp.’s Investment Grade Corporate CDO exposure references pools of predominantly investment grade corporate credits; some of these pools may also include limited exposure to other asset classes, including structured finance securities (including RMBS and CDO collateral). Most of MBIA Corp.’s Investment Grade Corporate CDO policies guarantee coverage of losses on collateral assets once subordination in the form of a deductible has been eroded, and are generally highly customized structures. As presented in the following table, several of the Company’s insured Investment Grade Corporate CDOs have experienced subordination erosion due to the default of underlying referenced corporate obligors as well as certain structured finance securities.
Of MBIA Corp.’s $36.0 billion net par Investment Grade CDO portfolio as of December 31, 2009, the collateral composition, underlying credit ratings of the collateral that support the subprime RMBS, Non-subprime RMBS, and CDOs of ABS exposures along with their vintage are presented in the following tables. The collateral level detail for each year insured was calculated using a weighted average of the total collateral for deals closed for the insured year. The total collateral amount of the portfolio exceeds the net par written as a result of credit enhancement (such as over-collateralization and subordination) and reinsurance.
(1) Years contain deals with allowances for synthetic tranches of leveraged investment grade corporate debt. In such transactions, MBIA’s insured Investment Grade Corporate CDOs include, among direct corporate or structured credit reference risks, a monotranche or single layer of credit risk referencing a diverse pool of assets or obligors with a specific attachment and a specific detachment point. The reference monotranches in such CDOs are typically rated double-A and each reference monotranche will typically be sized to approximately 3% of the overall reference risk pool. The inner referenced monotranches are not subject to acceleration and do not give control rights to a senior investor. These transactions also may contain RMBS securities within limits ranging from 0% to 20% with one exception at 34%.
Investment Grade Corporate CDO Portfolio: Vintage and Collateral Ratings of CDOs Containing Subprime RMBS
The following table presents the collateral composition, original and current subordination for the High Yield Corporate CDOs, as well as the net derivative asset/(liability) for each year insured. The collateral level detail for each year insured was calculated using a weighted average of the net par written for deals closed for the insured year. The total collateral amount of the portfolio exceeds the net par written as a result of credit enhancement (such as over-collateralization and subordination) and reinsurance. The table does not provide collateral level detail on 23 High Yield Corporate CDOs totaling $0.5 billion of net par. These deals were insured in the secondary market prior to 2004.
The Structured CMBS Pools and CRE CDO portfolio is a diversified global portfolio of highly-rated structured transactions primarily supported by collateral from the CRE sector. This portfolio can be sub-divided into two distinct pools: Structured CMBS Pools and CRE CDOs.
MBIA Corp.’s CRE CDO exposure comprised approximately 9% or $9.6 billion of MBIA Corp.’s CDO exposure and 5% of the Company’s total insured net par as of December 31, 2009. CRE CDOs are managed pools of CMBS, CRE whole loans, B-Notes, mezzanine loans, REIT debt and other securities (including, in some instances, buckets for RMBS and CRE CDOs) that allow for reinvestment during a defined time period. The structures benefit from typical CDO structural protections such as cash diversion triggers, collateral quality tests and manager replacement provisions. MBIA guarantees timely interest and ultimate principal on these CDOs. As with the Company’s other CDOs, these transactions are generally structured with triple-A, or a multiple of triple-A credit support protection below the Company’s guarantee.
The Company’s $44.7 billion net par Structured CMBS Pools and CRE CDO portfolio as of December 31, 2009 did not contain any CDOs of ABS exposures, and the Structured CMBS Pools did not contain any Subprime and Non-subprime RMBS exposures. The underlying credit ratings of the collateral that support the Subprime RMBS, Non-subprime RMBS exposures along with their vintage are presented for the CRE CDO portfolio in the following tables:
While we have observed continued stress in the CMBS market, including a substantial rise in loan delinquencies by borrowers, we have not recognized impairments on these transactions. Our structured CMBS pool portfolio comprises over 54,000 loans and is well diversified geographically and by property type in keeping with the industry as a whole. The current weighted average debt service coverage ratio (“DSCR”) of underlying mortgages
in the CMBS pools is 1.56 based on net operating income derived from the most recent property level financial statements. The weighted average loan-to-value ratio is 71%. Virtually all of the loans are long-term and fixed-rate in nature. Approximately 30% of the loans will mature within the next five years; however, the weighted average DSCR of these loans is significantly higher at 1.71. These factors, combined with MBIA deal attachment points ranging from 5% to 80% depending upon collateral composition provide substantial protection against losses. Additionally, underlying bond collateral loss coverage in our pools generally ranges from 2% to 30% providing further protection against losses.
Delinquencies of underlying commercial mortgages continue to rise, albeit from historically low levels. As of December 31, 2009, 30-day and over delinquencies continued to increase in the fixed rate, conduit CMBS market to 5.45% and in MBIA’s insured portfolio 5.62%, primarily due to MBIA’s concentration in the 2006 vintage. MBIA believes delinquencies will continue to increase throughout 2010 and perhaps longer depending on the economic recovery. However, initial delinquencies are not “rolling to loss” at a predictable rate. Since most CMBS-eligible loans are on income producing property, the proportion of seriously delinquent loans that restructured or extended may be much higher than that which we observe in the residential market. Very few of the 2006-2007 vintage loans that comprise most or our CMBS exposure have been foreclosed and liquidated at this time.
During 2009, all three major rating agencies announced and/or executed plans to review and downgrade recent vintage CMBS collateral. Moreover, they continue to change their fundamental rating methodologies for this sector. Many of our positions have been downgraded by one or more of the agencies. Given the recent increase in delinquencies we have also downgraded many of our positions internally. Given these additional stresses, some of the Company’s insured positions may be further downgraded. In addition, we believe there continues to be a risk of a severe and prolonged recession, which could result in increased losses on CMBS collateral. In such an event, the performance of the underlying commercial mortgages in the portfolio may be materially adversely affected. In the event that loan level losses exceed the credit enhancement in our pools, the Company could incur substantial losses.
For the year ended December 31, 2009, investment management services’ revenues were $280 million compared with negative revenues of $345 million in 2008 and revenues of $1.8 billion in 2007. During 2009 and 2008, investment management services’ revenues were materially adversely affected by impairments of investments and losses from the sale of investments. Additionally, net investment income in 2009 and 2008 was materially adversely affected by the wind-down of the asset/liability products segment. For the year ended December 31, 2009, investment management services’ expenses of $370 million decreased by 63% from 2008. For the year ended December 31, 2008, investment management services’ expenses of $1.0 billion decreased by 33% from 2007. The significant decline in expenses over the past two years was primarily due to lower interest expense and program costs in the asset/liability products segment due to a reduced program size from wind-down of this business.
As of December 31, 2009, ending assets under management of $42.1 billion were $1.5 billion lower than as of December 31, 2008. Ending assets under management as of December 31, 2008 decreased $19.7 billion compared with December 31, 2007. While assets managed for third parties have increased substantially during 2009, decreases in assets under management over the past two years were predominantly due to lower outstanding balances in our asset/liability products segment as asset maturities and sales were used to retire outstanding investment agreements and MTNs upon scheduled amortizations, terminations of investment agreements due to ratings downgrades, and repurchases of MTNs by the Company. Additionally, Conduit segment assets have declined due to the maturity and scheduled amortizations of transactions and insurance assets have declined primarily due to claim payments.
The Company has issued commitments to three pooled investment programs managed or administered by Cutwater Investor Services Corp. (“Cutwater-ISC”), formerly known as MBIA Municipal Investor Service Corporation and its subsidiary. These commitments, which are accounted for as derivatives and recorded on the Company’s balance sheet at fair value, cover losses in such programs should the net asset values per share decline below specified per share values. As of December 31, 2009, the maximum amount of future payments that the Company would be required to make under these commitments was $5.9 billion. These commitments will be in effect as long as Cutwater-ISC and its subsidiary remain as manager or administrator and each program remains in compliance with its respective investment objectives and policies. Although the pools hold high-quality short-term investments, there is risk that the Company will be required to make payments or incur a loss under these guarantees in the event of material redemptions by shareholders of the pools and the need to liquidate investments held in the pools. The net unrealized gains or losses on these derivatives were losses of $5 thousand for the year ended December 31, 2009, gains of $12 thousand for the year December 31, 2008 and gains of $2 thousand for the year ended December 31, 2007. The Company has, and may in the future, purchase
For the year ended December 31, 2009, our asset/liability products segment reported a pre-tax loss of $128 million compared with $1.4 billion for 2008. The pre-tax loss for the year ended December 31, 2009 primarily resulted from realized losses of $365 million related to other-than-temporary impairments of investments, partially offset by net gains of $203 million principally from MTN liability repurchases at discounts. The pre-tax loss in 2008 resulted from $1.7 billion of net realized losses from investment securities sales and impairments, partially offset by $341 million of net gains on MTN repurchases and investment agreement terminations and by $66 million of net gains on financial instruments recorded at fair value and foreign exchange.
For the year ended December 31, 2009, net investment income in our corporate operations decreased 26% to $23 million compared with $31 million in 2008 due to a decrease in yields on invested assets and a decrease in the average balance of invested assets. The average balance of invested assets declined due to payments of interest on corporate debt and operating expenses in the absence of dividends from subsidiaries.
For the year ended December 31, 2009, net losses on financial instruments at fair value and foreign exchange included a loss of $6 million related to fair valuing outstanding warrants issued on MBIA Inc. common stock. The loss was attributable to significant fluctuations in MBIA’s stock price and volatility, which are used in the valuation of the warrants.
For the year ended December 31, 2009, corporate operating expenses decreased compared with 2008 primarily due to a decrease in legal costs of $6 million partially offset by an increase in the amount of directors’ and officers’ liability insurance expense allocated to this segment. Interest expense decreased 8% to $69 million from $75 million in 2008 as a result of repurchasing corporate debt during 2008 and 2009.
We consolidate certain third-party VIEs as a result of financial guarantees provided by our structured finance and international insurance. Additionally, the Company may consolidate VIEs when it invests in debt obligations or equity of, and/or manages the collateral for, such entities. As of December 31, 2009, the assets of consolidated VIEs primarily consisted of fixed rate and floating rate securities and loans, and the liabilities of these VIEs primarily consisted of fixed rate and floating rate notes. Any investments by MBIA in VIE notes or equity issued by consolidated VIEs are eliminated upon consolidation into MBIA’s financial statements. Refer to “Note 9: Variable Interest Entities” in the Notes to Consolidated Financial Statements for additional information about the Company’s VIEs.
The Company’s income taxes and the related effective tax rates for the twelve months ended December 31, 2009, 2008 and 2007 are as follows:
For the year ended December 31, 2007, the effective tax rate applied to our pre-tax loss was higher than the statutory tax rate of 35% primarily due to the benefit of tax-exempt interest income.
Refer to “Note 14: Income Taxes” in the Notes to Consolidated Financial Statements for a detailed analysis of the Company’s effective tax rate.
The Company is required to establish a valuation allowance against its deferred tax asset when we believe that it is more likely that we will not realize the asset than that we will. All evidence, both positive and negative, needs to be identified and considered in making the determination. Future realization of the existing deferred tax asset ultimately depends on the existence of sufficient taxable income of appropriate character (for example, ordinary income versus capital gains) within the carryforward period available under the tax law.
As of December 31, 2009, the Company reported a net deferred tax asset of $768 million which includes a valuation allowance of $490 million. The change in the valuation allowance for the year ended December 31, 2009 was an increase of $138 million which was primarily due to realized losses resulting from asset impairments offset by a reduction in the valuation allowance of $30 million as part of the adoption of an accounting guidance for recognition and presentation of other-than-temporary Impairments. As of December 31, 2008, the Company had a valuation allowance of $351 million.
Refer to “Note 3: Recent Accounting Pronouncements” and “Note 14: Income Taxes” in the Notes to the Consolidated Financial Statements for further discussions about the adoption and our deferred tax asset and valuation allowance, respectively.
Refer to “Note 14: Income Taxes” in the Notes to Consolidated Financial Statements for a further discussion.
Market deterioration in the RMBS and CDO sectors resulted in the major rating agencies reassessing the capital adequacy ratios of financial guarantors to reflect deterioration in the expected performance of transactions within the financial guarantors’ insured portfolios. During 2008 and 2009, MBIA Corp.’s financial strength ratings were downgraded by the major credit rating agencies. The rating agencies attributed their downgrades to factors that included a diminished outlook for new business generation, reduced financial flexibility, vulnerability to further stress in the residential mortgage sector, and declines in share price and CDS spreads. During 2008, we continued our comprehensive capital strengthening plan, which included the issuance of equity and debt securities, the net release of capital supporting amortizing, maturing, and terminating transactions, and the elimination of dividends to MBIA Inc. common shareholders. During 2009, we continued executing our capital strengthening plan with near-term objectives that included deleveraging our balance sheet and maximizing our liquidity position to maintain appropriate claims-paying resources.
On February 1, 2007, our Board of Directors authorized the repurchase of common stock up to $1.0 billion under a new share repurchase program, which superseded the previously authorized program. However, we decided to suspend share repurchases under the program in light of concerns and uncertainties regarding the housing markets, the structured finance sector and the U.S. economy.
As of December 31, 2009, we have repurchased 45 million common shares of MBIA Inc. under our share repurchase program at a cost of $896 million and an average price of $19.75 per share, and $104 million remained available under the program. During 2009, we repurchased 5 million shares at an average price of $3.16 per share.
From time to time, MBIA accesses the capital markets to support the growth of its businesses. As such, we filed a registration statement on Form S-3ASR with the SEC in June 2007 for an indeterminate amount which replaced and canceled remaining balances on all prior shelf registration statements filed with the SEC. This shelf registration permits us to issue an indeterminate amount of various debt and equity securities described in the prospectus filed as part of the registration statement. In February 2008, we filed amendments to our Form S-3ASR to allow the issuance of $1.15 billion of common stock as part of our capital strengthening.
As part of our liquidity risk management framework, we also evaluate and manage liquidity on both a legal entity basis and a segment basis. Legal entity liquidity is an important consideration as there are legal, regulatory and other limitations on our ability to utilize the liquidity resources within the overall enterprise. We also seek to manage segment liquidity, particularly between our corporate and asset/liability products segments as they relate to MBIA Inc. Unexpected loss payments arising from ineligible mortgages in securitizations that we have insured, dislocation in the global financial markets, the overall economic downturn in the U.S., and the loss of our triple-A insurance financial strength ratings in 2008 significantly increased the liquidity needs and decreased the financial flexibility in our segments and legal entities. We continued to satisfy all of our payment obligations and we believe that we have adequate resources to meet our ongoing liquidity needs in both the short-term and the long-term.
Our U.S. public finance insurance segment’s financial guarantee contracts cannot be accelerated, thereby mitigating liquidity risk. However, defaults, credit impairments and adverse capital markets conditions such as we are currently experiencing, can create payment requirements as a result of our irrevocable pledges to pay principal and interest, or other amounts owing on insured obligations, when due. Additionally, our U.S. public finance insurance segment requires cash for the payment of operating expenses. Finally, National also provides liquid assets to our asset/liability products segment through matched repurchase and reverse repurchase agreements to support its business operations and liquidity position, as described below.
Since inception, National, the entity from which we conduct our U.S. public finance insurance business, has exhibited robust cash flows from operations, and relatively stable and predictable cash outflows. National held cash and short-term investments of $316 million as of December 31, 2009, and maintained a highly liquid investment portfolio consisting predominately of highly rated municipal bonds.
Liquidity risk arises in our structured finance and international insurance segment when claims on insured exposures result in payment obligations, when operating cash inflows fall due to depressed new business writings, lower investment income, or unanticipated expenses, or when invested assets experience credit defaults or significant declines in fair value.
Since the first quarter of 2008, MBIA Corp. has paid $3.9 billion of claims, before reinsurance, on policies insuring second-lien mortgage securitizations. We believe these payments were driven primarily by tens of thousands of ineligible mortgages being placed in the securitizations in violation of the representations and warranties of the sellers/servicers. As a result, payments have been far in excess of the level that might be expected in an economic downturn. We believe the current liquidity position of MBIA Corp. is adequate to make expected future payments on these exposures, but the degree of loss within these transactions has been unprecedented, and continued elevated levels of payments will cause additional stress on our liquidity position.
MBIA UK. Obligor defaults, credit impairments, and adverse capital markets conditions such as we are currently experiencing, can create payment requirements as a result of our irrevocable pledges to pay principal and interest, or other amounts owing on insured obligations, when due. Additionally, our structured finance and international insurance segment requires cash for the payment of operating expenses, as well as principal and interest related to its surplus notes and preferred stock issuance. MBIA Corp. also provides guarantees to the holders of our asset/liability products debt obligations. If our asset/liability products segment or MBIA Inc. were unable to service the principal and interest payments on its debt and investment agreements, the holders of the insured liabilities would make a claim under the MBIA Corp. insurance policies. MBIA Corp. has lent $2.0 billion to the asset/liability products segment on a secured basis for the purpose of minimizing the risk that such claim would be made. The loan matures in the fourth quarter of 2011. During the fourth quarter of 2009, a total of $400 million of the secured loan was repaid and an additional $75 million was repaid in January 2010. The Company expects that the loan will be fully repaid, however, the timing of the ultimate repayment may be affected by the performance of assets in the asset/liability products segment’s investment portfolio and by MBIA Inc.’s requirements to post collateral against guaranteed investment contracts, swap contracts, and internal and external borrowing facilities.
The Company manages the liquidity of its structured finance and international segment with the goal of maintaining cash and liquid securities in an amount in excess of all projected stress scenario payment requirements. To the extent our liquidity resources fall short of our target liquidity cushions under the stress-loss scenario testing, the Company will seek to increase its cash holdings position, by selling or financing assets in its investment portfolio or drawing upon one or more of its contingent sources of liquidity. As of December 31, 2009, MBIA Corp. had unencumbered cash and available-for-sale investments of $3.3 billion, of which $1.1 billion comprised cash and highly liquid assets of MBIA Insurance Corporation (the NY-regulated entity). We believe that MBIA Corp. has sufficient cash on hand, liquid assets and future cash receipts to satisfy expected claims payments.
In order to monitor liquidity risk and maintain appropriate liquidity resources for near-term cash and collateral requirements within our asset/liability products segment, the Company calculates monthly forecasts of asset and liability maturities, as well as collateral posting requirements. Cash availability at the low point of our 12-month forecasted cash flows is measured against liquidity needs using stress-scenario testing of each of the potential liquidity needs described above. To the extent there is a shortfall in our liquidity coverage, the Company proactively manages its cash position and liquidity resources with a goal of maintaining an adequate cushion to the stress scenario. These resources include the sale of unpledged assets, the use of free cash within the asset/liability products segment and at the corporate segment level, and potentially increased securities borrowings from National.
The asset/liability products segment, through MBIA Inc., maintained simultaneous repurchase and reverse repurchase agreements (“Asset Swap”) with National for up to $2.0 billion based on the fair value of securities borrowed. As of December 31, 2009, the fair value of security borrowings under these agreements totaled $1.8 billion. The asset/liability products segment has collateralized these security borrowings with assets rated A or better and having an aggregate fair value in excess of the securities borrowed. The NYSID approved the Asset Swap in connection with the re-domestication of National to New York. National has agreed to use good faith efforts to reduce the amount of the Asset Swap to no more than 10% of its admitted assets by no later than December 2011.
Other liquidity support outstanding as of December 31, 2009 included a $600 million advance from our corporate segment to our asset/liability products segment and a secured loan between MBIA Inc. and MBIA Insurance Corporation for up to $2.0 billion, under which $1.6 billion was borrowed. As of December 31, 2009, including the $2.2 billion of intercompany resources, the asset/liability products segment had cash and investments of $5.3 billion and receivables for securities sold net of payables for securities purchased of $37 million.
Following the Moody’s downgrade of MBIA Corp. to Baa1 in November 2008, most outstanding investment agreements were terminated in accordance with their terms. As of December 31, 2009, we had $5.5 billion in remaining liabilities related to our asset/liability products business, of which $2.7 billion were investment agreements. All of the investment agreements were collateralized by cash or high-grade securities. The asset/liability products program has adequate cash and highly liquid securities to retire all remaining investment agreements where holders have a right to terminate. The remaining $2.8 billion in liabilities consist of MTNs issued by MBIA Global Funding, LLC and term repurchase agreements. No additional collateral or termination provisions would be triggered in the event of a further downgrade of MBIA Corp.’s credit rating. Payments and additional collateral requirements on the liabilities in the asset/liability products segment are expected to be met without the need for additional asset sales in the current stressed credit environment but rather from cash flows from investments and the intercompany facilities described above.
Liquidity needs in our corporate segment are highly predictable and comprise principal and interest payments on corporate debt and operating expenses. Liquidity risk is associated primarily with the dividend capacity of our
insurance subsidiaries, National and MBIA Insurance Corporation, dividends from asset management subsidiaries, investment income and our ability to issue equity and debt. Neither MBIA Corp. nor National is expected to be able to pay dividends following its year end 2009 statutory financial statement filing due to a projected earned surplus deficit as of December 31, 2009. Additionally, the corporate segment maintains excess cash and investments to ensure it is able to meet its ongoing cash requirements over a multi-year period in the event that cash becomes unavailable from one or more sources.
For the year ended December 31, 2009, net cash used by operating activities totaled $2.2 billion compared with $156 million for the year ended December 31, 2008. The Company’s net use of cash in 2009 was largely related to loss payments on financial guarantee insurance policies insuring RMBS exposure. Cash from operating activities were also adversely impacted by a decrease in net investment income and premium collections. Net cash used by operating activities in 2008 resulted from loss payments related to financial guarantee insurance policies and insured CDSs, as well as a decrease in net investment income, which more than offset an increase in premium collections. We believe that we have sufficient cash on hand, liquid assets and future cash receipts to satisfy expected claims payments and other expenses in the future.
For the year ended December 31, 2009, net cash used by financing activities was $4.3 billion compared with $15.9 billion for the year ended December 31, 2008. Net cash used by financing activities in 2009 principally related to withdrawals and terminations of investment agreements and maturities and repurchases of MTNs within our asset/liability products segment. Net cash used by financing activities in 2008 also related to withdrawals and terminations of investment agreements and maturities and repurchases of MTNs within our asset/liability products segment, partially offset by proceeds received from our capital issuance and surplus notes transactions.
Under New York State insurance law, without prior approval of the Superintendent of the NYSID, financial guarantee insurance companies can pay dividends from earned surplus subject to retaining a minimum capital
requirement. The payment of regular dividends in any 12-month period are limited to the lesser of (i) 10% of policyholders’ surplus as reported in the latest filed statutory financial statements and (ii) 100% of adjusted net investment income. Neither MBIA Corp. nor National is expected to be able to pay dividends, including, in the case of MBIA Corp., dividends on its preferred stock, following its year end 2009 statutory financial statement filing due to a projected earned surplus deficit as of December 31, 2009.
MBIA maintained a revolving credit facility totaling $500 million with a group of highly rated global banks. MBIA elected to terminate the facility effective February 27, 2009 in accordance with its rights under the credit facility. As of the termination date, neither MBIA Inc. nor MBIA Corp. had outstanding borrowings under the facility, and there were no early termination fees or premiums paid as a result of terminating the facility.
Triple-A One, an MBIA-administered multi-seller conduit consolidated in the Company’s conduit segment, historically issued commercial paper to fund assets, which were insured by MBIA Corp. Triple-A One also maintained backstop liquidity facilities covering 100% of the face amount of commercial paper outstanding. During 2008, conditions in the asset-backed commercial paper market deteriorated making it increasingly difficult for Triple-A One to issue new commercial paper at commercially acceptable rates to repay maturing obligations. Accordingly, Triple-A One borrowed under its liquidity facilities to repay maturing commercial paper. The financial guarantee policies issued by MBIA Corp. to insure the assets of Triple-A One cannot be accelerated to repay borrowings under the liquidity facilities and only guarantee ultimate payments over time relating to the assets. By September 2008, these facilities were drawn in full and Triple-A One ceased issuing commercial paper. As of December 31, 2009 borrowings under liquidity facilities totaled $433 million and will be repaid as the assets purchased by Triple-A One mature.
The credit quality distribution of the Company’s fixed-income investment portfolios, excluding short-term investments, based on ratings from Moody’s as of December 31, 2009 is presented in the following table. Alternate ratings sources, such as S&P, have been used for a small percentage of securities that are not rated by Moody’s.
MBIA’s consolidated investment portfolio includes investments that are insured by various financial guarantee insurers (“Insured Investments”), including investments insured by MBIA Corp. and National (“Company-Insured Investments”). As of December 31, 2009, Insured Investments at fair value represented $4.3 billion or 26% of consolidated investments, of which $2.9 billion or 18% of consolidated investments were insured by MBIA Corp. and National. This includes conduit investments of $1.7 billion at fair value, or 10% of consolidated investments, which were all insured by MBIA Corp.
As of December 31, 2009, based on the actual or estimated underlying ratings of our consolidated investment portfolio, without giving effect to financial guarantees, the weighted average rating of the consolidated investment portfolio would be in the Aa range, the weighted average rating of only the Insured Investments in the investment portfolio would be in the A range, and 4% of the total investment portfolio would be rated below investment grade.
The distribution of the Company’s Insured Investments by financial guarantee insurer as of December 31, 2009 is presented in the following table:
The underlying ratings of the Company-Insured Investments as of December 31, 2009 are reflected in the following table. Amounts represent the fair value of such investments including the benefit of the MBIA guarantee. The ratings in the following table are based on ratings from Moody’s. Alternate ratings sources, such as S&P, have been used for a small percentage of securities that are not rated by Moody’s.
Without giving effect to the MBIA guarantee of the Company-Insured Investments in the consolidated investment portfolio, as of December 31, 2009, based on actual or estimated underlying ratings, the weighted average rating
of the consolidated investment portfolio was in the A range, the weighted average rating of only the Company-Insured Investments was in the Baa range, and 7% of the consolidated investment portfolio was rated below investment grade.
Conduit programs involve the use of rating agencies in assessing the quality of asset purchases and in assigning ratings to the various programs funded through the conduits. All transactions currently funded in the conduits had an underlying rating of at least investment grade by Moody’s and S&P prior to funding. MBIA estimates that the current weighted average underlying rating of all outstanding conduit transactions was BBB+ by S&P and Baa1 by Moody’s as of December 31, 2009.
Investments for which the Company has recorded unrealized losses are tested quarterly for other-than-temporary impairment. For each security that meets the threshold of either 20% impaired at the time of review or 5% impaired at the time of review with a fair value below amortized cost for a consecutive 12-month period, a further analysis of the security is performed to assess if the impairment is other than temporary. As of December 31, 2009, the Company had a gross unrealized loss of $1.6 billion related to its consolidated available-for-sale investment portfolio. The consolidated gross unrealized loss of $1.6 billion included $656 million related to the asset-backed sector, $497 million related to mortgage-backed securities, and $232 million related to corporate obligations.
Seventy-five percent of our investments in ABS reported in the preceding table were rated investment grade with 41% rated Aaa. Of the $1.3 billion of ABS investments reported in the preceding table, $351 million include the benefit of guarantees provided by third-party financial guarantors and $335 million include the benefit of guarantees provided by MBIA Corp. The average credit rating of all guaranteed ABS investments using the higher of the guarantors’ ratings or the underlying bond ratings was A1 and the average underlying credit rating of guaranteed ABS investments, without giving effect to the guarantees, was Baa1. Without giving effect to the benefit of guarantees provided by financial guarantors, including MBIA Corp., $363 million or 27% of the securities included in the preceding table were rated below investment grade.
For the three months ended March 31, 2009 and all preceding periods, whenever we believed that we would not recover an amount equal to the amortized cost of a security over its remaining expected holding period, including maturity, we recorded the difference between the amortized cost and the fair value in earnings as an other-than-temporary impairment loss. Under recently issued accounting principles for the recognition and presentation of other-than temporary impairments, which we adopted beginning with the three months ended June 30, 2009, we record the difference between the fair value and the amount we expect to ultimately recover, based on our best estimate of cash flows discounted at the prescribed rate, in earnings as a reduction to other-than-temporary impairment losses. The credit loss component recognized in earnings is identified as the amount of cash flows not expected to be received over the remaining term of the security as projected using the Company’s cash flow projections and base assumptions. Had this accounting guidance been in effect for prior periods, the total net investment losses related to other-than-temporary impairments would have been less by the amount of the non-credit related losses expected on those investments during the respective periods. We believe that, over time, our impaired investments will recover to fair values at least equal to their current amortized costs through improvements in market conditions and the repayment of principal. As we do not intend to sell these securities and it is more likely than not that we would not be required to sell these securities prior to repayment or until such a recovery in value, we have not realized additional losses on the remainder of our investment portfolio through current earnings. However, if the creditworthiness of these investments or our intent to hold them were to change, we may take additional impairments on these securities through earnings in the future.
The following table summarizes the Company’s future estimated cash payments relating to contractual obligations as of December 31, 2009. Estimating these payments requires management to make estimates and assumptions regarding these obligations. The estimates and assumptions used by management are described below. Since these estimates and assumptions are subjective, actual payments in future periods may vary from those reported in the following table. Refer to “Note 16: Net Insurance In Force” in the Notes to Consolidated Financial Statements for information about the Company’s exposure under insurance contracts.
As of December 31, 2009, the Company held ABS with a fair value of $307 million purchased under TALF that are recorded as available-for-sale investments and had $277 million of secured financings from the Federal Reserve related to the purchase of these securities that are recorded in “Long-term debt” on the Company’s consolidated balance sheet.
In the fourth quarter of 2009, we settled a financial guarantee contract related to a VIE in exchange for a payment by MBIA Corp. of $65 million, net of reinsurance, and deconsolidated the VIE as of December 31, 2009. The settlement payment eliminated potentially significant future performance volatility and relieved us from any further obligation under our insurance contract and is excluded from contractual obligations.
MBIA issued insurance policies insuring payments due on structured credit derivative contracts and directly entered into credit derivative contracts, which are marked-to-market through earnings under the accounting principles for derivatives and hedging activities. All these transactions were insured by the Company’s structured finance and international insurance operations. The majority of these structured CDSs related to structured finance transactions with underlying reference obligations of cash securities and CDSs referencing liabilities of corporations or of other structured finance securitizations. The asset classes of the underlying reference obligations included corporate, asset-backed, residential mortgage-backed and commercial mortgage-backed securities. These transactions were usually underwritten at or above a triple-A credit rating level. As of December 31, 2009, approximately 30% of the tranches insured by the Company were rated triple-A. Additionally, MBIA’s investment management services operations enter into single-name CDSs as part of its asset management activities. In 2009, the value of the Company’s credit derivative contracts were affected predominantly by changes in credit spreads and prices of the underlying reference obligations’ collateral, changes in recovery rate assumptions, erosion of subordination, ratings downgrades of securities backing CDOs and the effect of the Company’s own credit risk on the portfolio. As those risk factors change, the values of credit derivative contracts will change and the resulting gains or losses will be recorded within net income.
Since December 31, 2006, the Company’s portfolio of insured structured CDSs has become increasingly concentrated in transactions where the underlying reference obligations comprise CMBS and asset-backed collateral including RMBS, in addition to corporate securities. As a result, the portfolio is more sensitive to changes in credit spreads in those sectors. Beginning in the second half of 2007, credit spreads in those sectors increased significantly, resulting in a substantial decrease in the fair value of the Company’s portfolio of structured CDSs. Refer to the discussion of the attribution of 2009 unrealized gains included in the “Results of Operations” section.
Recovery rates on defaulted collateral are an input into the Company’s valuation model. Sensitivity to changes in the recovery rate assumptions used by the Company can be estimated by projecting a hypothetical change in these assumptions. The following table presents the estimated pre-tax change in fair value and the cumulative estimated net fair value of the Company’s insurance credit derivatives portfolio of a 10% and 20% change in the
Accounting principles for fair value measurements and disclosures require the Company to incorporate its own nonperformance risk in its valuation methodology. Sensitivity to changes in the Company’s credit spreads can be estimated by projecting a hypothetical change in this assumption. The following table presents the estimated pre-tax change in fair value and the cumulative estimated net fair value of the Company’s insurance credit derivative portfolio using upfront credit spreads of 0%, an increase of 15%, and a decrease of 30%. The actual upfront spread used in the valuation at December 31, 2009 ranged from 17.5% to 64.25% based on the tenor of each transaction. The below amounts include an additional annual running credit spread of 5%.
MBIA’s insurance and certain investment management services programs have historically relied upon triple-A credit ratings. The loss of those ratings in the second quarter of 2008 resulted in a dramatic reduction in the Company’s business activities. As of December 31, 2009, National was rated A with a developing outlook by Standard & Poor’s Corporation (“S&P”) and Baa1 with a developing outlook by Moody’s Investors Service, Inc. (“Moody’s”). As of December 31, 2009, MBIA Insurance Corporation was rated BB+ with a negative outlook by S&P and B3 with a negative outlook by Moody’s.
MBIA’s structured finance and international insurance operations have been conducted through MBIA Corp. The financial guarantees issued by MBIA Corp. generally provide unconditional and irrevocable guarantees of the payment of the principal of, and interest or other amounts owing on, insured obligations when due, or in the event MBIA Corp. has the right at its discretion to accelerate insured obligations upon default or otherwise, upon MBIA Corp.’s acceleration. Certain investment agreement contracts written by MBIA Inc. are insured by MBIA Corp. If MBIA Inc. were to have insufficient assets to pay amounts due, MBIA Corp. would make such payments under its insurance policies. MBIA Corp. also insured debt obligations of other affiliates, including MBIA Global Funding LLC (“GFL”) and Meridian Funding Company LLC (“Meridian”), and provides reinsurance to its insurance
The Company also operates an asset/liability products business in which it has issued debt and investment agreements, which are insured by MBIA Corp., to capital markets and municipal investors and then initially purchased assets that largely matched the duration of those liabilities, and a conduit business in which the Company has funded transactions by issuing debt, which is insured by MBIA Corp. The ratings downgrades of MBIA Corp. have resulted in the termination and collateralization of certain investment agreements and, together with the rising cost and declining availability of funding and illiquidity of many asset classes, have caused the Company to begin winding down its asset/liability products and conduit businesses.
As a financial services company, MBIA is materially affected by conditions in global financial markets. Current conditions and events in these markets have created substantial liquidity risk for the Company.
Liquidity risk arises in the Company’s U.S. public finance insurance segment when claims on insured exposures result in payment obligations, when operating cash inflows fall due to depressed new business writings, lower investment income, unanticipated expenses, or when invested assets experience credit defaults or significant declines in fair value.
Liquidity risk arises in the Company’s structured finance and international insurance segment when claims on insured exposures result in payment obligations, when operating cash inflows fall due to depressed new business writings, lower investment income, or unanticipated expenses, or when invested assets experience credit defaults or significant declines in fair value.
In order to monitor liquidity risk and maintain appropriate liquidity resources for payments associated with the Company’s residential mortgage-related exposures, MBIA employs a stress scenario-based liquidity model using the same “Roll Rate Default Methodology” as it uses in its loss reserving. Using this methodology, the Company estimates the level of payments that would be required to be made under stress-level default assumptions of the underlying collateral taking into account MBIA’s obligation to cover such defaults under the Company’s insurance policies. These estimated payments, together with all other significant operating, financing and investing cash flows are forecasted over the next 24-month period on a monthly basis and then annually thereafter to the final maturity of the longest dated outstanding insured obligation. The stress-loss scenarios and cash flow forecasts are frequently updated to account for changes in risk factors and to reconcile differences between forecasted and actual payments.
The Company manages liquidity of its structured finance and international segment with the goal of maintaining cash and liquid securities in an amount in excess of all projected stress scenario payment requirements. To the extent the Company’s liquidity resources fall short of its target liquidity cushions under the stress-loss scenario testing, the Company will seek to increase its cash holdings position by selling or financing assets in its investment portfolio or drawing upon one or more of its contingent sources of liquidity.
Within MBIA’s investment management services operations, the asset/liability products segment is subject to material liquidity risk. Cash needs in the asset/liability products segment are primarily for the payment of principal and interest on investment agreements and medium-term notes (“MTNs”), and for posting collateral under repurchase agreements, derivatives and investment agreements, as well as for the payment of operating expenses. The primary sources of cash within the asset/liability products segment used to meet its liquidity needs include scheduled principal and interest on assets held in the segment’s investment portfolio and dedicated capital held within the investment management services operations. If needed, assets held within the segment can be sold or used in secured repurchase agreement borrowings to raise cash. However, the Company’s ability to sell assets or borrow against non-U.S. government securities in the fixed-income markets decreased dramatically and the cost of such transactions increased dramatically over the last two years due to the impact of the credit crisis on the willingness of investors to purchase or lend against even very high-quality assets. In addition, negative net interest spread between asset and liability positions resulted from the need to hold cash as collateral against terminable investment agreement contracts and reduced the cash flow historically provided by net investment income.
The asset/liability products segment, through MBIA Inc., maintained simultaneous repurchase and reverse repurchase agreements (“Asset Swap”) with National for up to $2.0 billion for the purpose of borrowing
Liquidity needs in MBIA’s corporate segment are highly predictable and comprise principal and interest payments on corporate debt and operating expenses. Liquidity risk is associated primarily with the dividend capacity of National and MBIA Corp., dividends from asset management subsidiaries, investment income and the Company’s ability to issue equity and debt. Additionally, the corporate segment maintains excess cash and investments to ensure it is able to meet its ongoing cash requirements over a multi-year period in the event that cash becomes unavailable from one or more sources.
VIEs are entities that lack one or more of the characteristics of a voting interest entity. A controlling financial interest in a VIE is present when an enterprise has a variable interest, or a combination of variable interests, that will absorb a majority of the VIE’s expected losses, receive a majority of the VIE’s expected residual returns, or both. The enterprise with a controlling financial interest, known as the primary beneficiary, consolidates the VIE. The Company consolidates all VIEs in which it is the primary beneficiary.
The Company classifies its fixed-maturity investments as either available-for-sale, held-to-maturity, or trading. Available-for-sale investments are reported in the consolidated balance sheets at fair value, with unrealized gains and losses, net of deferred taxes, reflected in accumulated other comprehensive income (loss) in shareholders’ equity. Bond discounts and premiums are amortized using the effective yield method over the remaining term of the securities. For bonds purchased at a price above par value that also have call features, premiums are amortized to the call date that produces the lowest yield. For mortgage-backed securities (“MBS”) and ABS, discounts and premiums are adjusted quarterly for the effects of actual and expected prepayments on a retrospective basis. For pre-refunded bonds, the remaining term is determined based on the contractual refunding date. Investment income is recorded as earned. Realized gains or losses on the sale of investments are determined by utilizing the first-in, first-out method to identify the investments sold and are included as a separate component of revenues.
The Company’s consolidated statement of operations reflects the full impairment (the difference between a security’s amortized cost basis and fair value) on debt securities that the Company intends to sell or would more likely than not be required to sell before the expected recovery of the amortized cost basis. For available-for-sale and held-to-maturity debt securities that management has no intent to sell and believes that it is more likely than not such securities will not be required to be sold prior to recovery, only the credit loss component of the impairment is recognized in earnings, while the rest of the fair value loss is recognized in accumulated other comprehensive income.
The Company’s investment portfolios containing all of its securities are reviewed no less than quarterly in order to determine whether a credit loss exists. The majority of the Company’s investments are available-for-sale securities, for which an impairment evaluation is subject to, but not limited by, the following criteria:
Deferred acquisition costs include those expenses that relate primarily to, and vary with, the acquisition of new insurance business. The Company periodically conducts a study to determine which operating costs have been incurred to acquire new insurance business and qualify for deferral. For business produced directly by National or MBIA Corp., such costs include compensation of employees involved in underwriting and deferred issuance functions, certain rating agency fees, state premium taxes and certain other underwriting expenses, reduced by ceding commission income on premiums ceded to reinsurers. Deferred acquisition costs also include ceding
Property, leasehold improvements and equipment are tested for potential impairment whenever events or changes in circumstances suggest that an asset’s or asset group’s carrying value may not be fully recoverable. An impairment loss, calculated as the difference between the estimated fair value and the carrying value of an asset or asset group, is recognized if the sum of the expected undiscounted cash flows relating to the asset or group of assets is less than the corresponding carrying value.
MBIA Corp. has entered into derivative transactions as an additional form of financial guarantee and for purposes of hedging risks associated with existing assets and liabilities. All derivative instruments are recognized at fair value on the balance sheet as either assets or liabilities depending on the rights or obligations under the contract. The recognition of changes in the fair value of a derivative within the statement of operations will depend on the intended use of the derivative. If the derivative does not qualify as part of a hedging relationship or is not designated as such, the gain or loss on the derivative is recognized in the statement of operations as net gains (losses) on financial instruments at fair value and foreign exchange or change in fair value of insured derivatives, depending on the nature of the derivative.
fair value attributable to the hedged risk during the period that the hedge is designated. The Company tests all fair value hedges to ensure that they are highly effective at least quarterly. The Company considers a hedge to be highly effective if the changes in the fair value of the derivative provide offset of at least 80% and not more than 125% of the changes in fair value of the hedged item. For derivatives that qualify as fair value hedges, the gain or loss on the hedging instrument is recognized in earnings and the gain or loss on the hedged item attributable to the hedged risk shall adjust the carrying amount of the hedged item and be recognized currently in earnings. Any portion of the total change in fair value of the hedging instrument that is ineffective in offsetting designated changes in the fair value of the hedged item are recognized in earnings as net gains (losses) on financial instruments at fair value and foreign exchange. The Company does not have a material amount of derivatives classified as cash flow hedges.
Financial guarantee contracts which have any of the following would not qualify for the financial guarantee scope exception:
Approximately 85% of the Company’s financial guarantee contracts qualify for the scope exception defined above and, therefore, are accounted for as financial guarantee insurance contracts. The remaining contracts do not meet the scope exception, primarily because the guaranteed party is not exposed to the risk of nonpayment both at inception of the financial guarantee contract and throughout its term. These contracts are accounted for as derivatives and reported on the Company’s balance sheet as either assets or liabilities, depending on the rights or obligations under the contract, at fair value. The Company refers to these contracts as insured CDS contracts.
Refer to “Note 8: Derivative Instruments” for a further discussion of the Company’s use of derivatives and their impact on the Company’s financial statements and “Note 5: Fair Value of Financial Instruments” for derivative valuation techniques and fair value disclosures.
Level 2-Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly. Level 2 assets include debt securities with quoted prices that are traded less frequently than exchange-traded instruments, securities which are priced using observable inputs and derivative contracts whose values are determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. Assets and liabilities utilizing Level 2 inputs include: U.S. government and agency MBS; most over-the-counter (“OTC”) derivatives; corporate and municipal bonds; and certain other MBSs or ABSs.
The availability of observable inputs can vary from product to product and period to period and is affected by a wide variety of factors, including, for example, the type of product, whether the product is new and not yet established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for instruments categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety.
The Company previously elected to record at fair value certain financial instruments that contained an embedded derivative requiring bifurcation in accordance with the accounting guidance for hybrid financial instruments. These instruments included certain medium-term notes and certain available-for-sale securities. Management elected to fair value hybrid instruments in those instances where the host contract and the embedded derivative were not separately subject to a hedging relationship.
Subsequent changes to the measurement of the claim liability are recognized as claim expense in the period of change. Measurement and recognition of claim liability is reported gross of any reinsurance. The Company estimates the likelihood of possible claims payments and possible recoveries using probability-weighted expected cash flows based on information available as of the measurement date, including market information. Accretion of the discount on a claim liability is included in claim expense.
Investment agreements and medium-term notes are recorded on the balance sheet at the time such agreements are executed. The liabilities for investment agreements and medium-term notes are carried at their face value, adjusted for any premiums or discounts, plus accrued interest. Interest expense is accrued at the contractual interest rate. Premiums and discounts related to investment agreements and medium-term notes are amortized on a constant yield basis as an adjustment to interest expense.
Securities sold under agreements to repurchase represent collateralized transactions and are carried on the consolidated balance sheets at their contractual amounts plus accrued interest.
The Company recognizes and measures premium revenue over the period of the contract in proportion to the amount of insurance protection provided. Premium revenue is measured by applying a constant rate to the
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.
Financial statement assets and liabilities denominated in foreign currencies are translated into U.S. dollars generally using rates of exchange prevailing at the balance sheet date. Operating results are translated at average rates of exchange prevailing during the year. Unrealized gains or losses, net of deferred taxes, resulting from translation of the financial statements of a non-U.S. operation, when the functional currency is other than U.S. dollars, are included in accumulated other comprehensive income (loss) in shareholders’ equity. Foreign currency remeasurement gains and losses resulting from transactions in non-functional currencies are recorded in current earnings. Exchange gains and losses resulting from foreign currency transactions are recorded in current earnings.
MBIA Inc. and its eligible U.S. subsidiaries file a consolidated Federal income tax return. The U.S. income taxes, which represent a majority of the taxes paid by the Company, are allocated based on the provisions of the Company’s tax sharing agreement which governs the intercompany settlement of tax obligations and benefits. The method of allocation between the members is generally based upon separate-company calculation as if each member filed a separate tax return on its own.
Investments in Certain Entities that Calculate Net Asset Value per Share (ASU 2009-12)
In July 2009, the FASB launched the FASB Accounting Standards Codification (“ASC”) as the single source of GAAP. While the Codification did not change GAAP, it introduced a new structure to the accounting literature and changed references to accounting standards and other authoritative accounting guidance. The Company adopted this guidance as of the third quarter of 2009 and all references to authoritative GAAP literature in the Company’s consolidated financial statements have been updated to reflect new Codification references.
In April 2009, the FASB issued amended accounting guidance related to the recognition and presentation of other-than-temporary impairments. These amended principles prescribe that only the portion of an other-than-temporary impairment on a debt security related to credit loss is recognized in current period earnings, with the remainder recognized in other comprehensive income, if the holder does not intend to sell the security and it is more likely than not that the holder will not be required to sell the security prior to recovery. Previously, the entire other-than-temporary impairment was recognized in current period earnings. The Company adopted this standard as of the second quarter of 2009. Upon adoption and implementation of the standard, the Company recorded a cumulative-effect adjustment to reclassify the non-credit component of previously recognized other-than-temporary impairments from retained earnings to accumulated other comprehensive income. The cumulative-effect adjustment resulted in an increase in retained earnings of $86 million and an increase in accumulated other comprehensive loss of $56 million, net of deferred taxes of $30 million. Refer to “Note 7: Investment Income and Gains and Losses” for further information on the Company’s investment securities and other-than-temporary impairments.
In May 2008, the FASB issued accounting guidance for financial guarantee insurance and reinsurance contracts effective prospectively as of January 1, 2009. This accounting guidance amends accounting and reporting by insurance enterprises to clarify how existing guidance applies to financial guarantee insurance and reinsurance contracts. The accounting guidance amends the recognition and measurement of premium revenue and claim liabilities, and expands disclosure requirements. Recognition and measurement of unearned premium revenue and receivable for future premiums are also amended. The accounting guidance does not apply to financial
Upon the adoption and implementation of the accounting guidance for financial guarantee insurance and reinsurance contracts, the Company recognized a cumulative transition adjustment of $55 million net of tax, $83 million pre-tax, as an increase to its beginning retained earnings balance as of January 1, 2009. The cumulative transition adjustment represents the recognized changes in assets and liabilities resulting from the adoption. The following table summarizes the adjustments made to the Company’s consolidated assets and liabilities as of January 1, 2009 on a pre-tax basis:
In December 2008, the FASB issued accounting guidance that requires enhanced disclosures about transfers of financial assets and involvement with VIEs. The Company adopted this guidance for financial statements prepared as of December 31, 2008. Since the guidance only requires additional disclosures concerning transfers of financial assets and interests in VIEs, the adoption did not affect the Company’s consolidated balance sheets, results of operations or cash flows. Refer to “Note 9: Variable Interest Entities” for mandated disclosures.
In March 2008, the FASB issued accounting guidance that expands the disclosure requirements about an entity’s derivative instruments and hedging activities. The Company adopted the disclosure provisions on January 1, 2009. Since these amended principles require only additional disclosures concerning derivatives and hedging activities, adoption of the accounting guidance did not affect the Company’s consolidated balance sheets, results of operations or cash flows. Refer to “Note 8: Derivative Instruments” for mandated disclosures.
In February 2008, the FASB issued accounting guidance that delayed the effective date for fair value measurements and disclosures to fiscal years beginning after November 15, 2008, for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The adoption on January 1, 2009 did not have a material impact on the Company’s consolidated balance sheets, results of operations or cash flows.
In December 2007, the FASB issued accounting guidance for noncontrolling interests in consolidated financial statements which requires reporting entities to present noncontrolling (minority) interest as equity, rather than as a liability or mezzanine equity. The Company adopted the prescribed guidance on January 1, 2009 which resulted in preferred stock issued by a subsidiary to be reclassified from minority interest to a separate component of equity. The adoption did not have a material impact on the Company’s consolidated results of operations or cash flows.
In December 2009, the FASB issued ASU 2009-17, “Consolidations (Topic 810)-Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities,” to require the holder of a variable interest(s) in a VIE to determine whether it holds a controlling financial interest in a VIE. A holder of a variable interest (or combination of variable interests) that has a controlling financial interest in a VIE is considered the primary beneficiary and is required to consolidate the VIE. The accounting guidance deems controlling financial interest as both (a) the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and (b) the obligation to absorb losses or the rights to receive benefits of the VIE that could potentially be significant to the VIE. This accounting guidance eliminates the more quantitative approach for determining the primary beneficiary of a VIE. The accounting guidance will require an ongoing reassessment of whether a holder of a variable interest is the primary beneficiary of a VIE and is effective for the Company as of January 1, 2010. The Company is currently evaluating the potential impact of adopting this guidance and, at this time, expects that the adoption of this standard will have a material impact on its consolidated assets and liabilities. The Company believes that the adoption of this accounting standard will not have an impact on its liquidity.
As of December 31, 2009, the Company reported reinsurance premiums payable of $239 million, which represents the portion of the Company’s premiums receivable that is due to reinsurers. The reinsurance premiums payable is accreted and paid to reinsurers as premiums due to MBIA are accreted and collected.
The following table presents the unearned premium revenue balance and the future expected premiums earned revenue as of and for the periods presented:
Foreign governments-The fair value of foreign government obligations is generally based on quoted prices in active markets and, as such, these bonds are classified in Level 1 of the fair value hierarchy. When quoted prices are not available, fair value is determined based on a valuation model that has as inputs interest rate yield curves, cross-currency basis index spreads, and country credit spreads for structures similar to the bond in terms of issuer, maturity and
seniority. These bonds are generally categorized in Level 2 of the fair value hierarchy. Bonds that contain significant inputs that are not observable are categorized as Level 3.
Mortgage-backed securities and asset-backed securities-MBSs and ABSs are valued based on recently executed prices. When position-specific external price data is not observable, the valuation is based on prices of comparable securities. In the absence of market prices, MBSs and ABSs are valued as a function of cash flow models with observable market-based inputs (e.g. yield curves, spreads, prepayments and volatilities). MBSs and ABSs are categorized in Level 3 if significant inputs are unobservable, otherwise they are categorized in Level 2 of the fair value hierarchy.
The fair value of investments held-to-maturity is obtained using recently executed transactions or market price quotations where observable. When position-specific external price data is not observable, the valuation is based on prices of comparable securities. When observable price quotations are not available, fair value is determined based on internal cash flow models with yield curves and bond spreads of comparable entities as key inputs.
Other investments also include premium tax credit investments that are carried at amortized cost. The carrying value of these investments approximates fair value.
The carrying amounts of cash and cash equivalents, receivable for investments sold and payable for investments purchased approximate their fair values as they are short-term in nature.
The fair values of investment agreements are estimated using discounted cash flow calculations based upon interest rates currently being offered for similar agreements with maturities consistent with those remaining for the investment agreements being valued. These agreements contain collateralization and termination agreements that substantially mitigate the nonperformance risk of the Company.
The Company has elected to record at fair value for four medium-term notes. Fair value of such notes is derived using quoted market prices or an internal cash flow model. Significant inputs into the valuation include yield curves and spreads to the swap curve. As these notes are not actively traded, certain significant inputs (e.g. spreads to the swap curve) are unobservable. These notes are categorized as Level 3 of the fair value hierarchy.
The fair value is estimated using discounted cash flow calculations based upon interest rates currently being offered for similar agreements. Securities sold under agreements to repurchase include term reverse repurchase agreements that contain credit enhancement provisions via over-collateralization agreements to sufficiently mitigate the nonperformance risk of the Company.
Long-term debt consists of long-term notes, debentures, surplus notes, Federal Reserve term asset-backed securities loan facility (“TALF”) and floating rate liquidity loans. The fair value of long-term notes, debentures, TALF and surplus notes are estimated based on quoted market prices for the same or similar securities. The fair value for floating rate liquidity loans in Triple-A One Funding Corporation (“Triple-A One”) are estimated using discounted cash flow calculations based upon the underlying collateral pledged to the specific loans, as these loans are non-recourse and fully backed by a pool of underlying assets.
In compliance with the requirements of fair value measurements and disclosures, the Company considers its own credit risk and that of counterparties when valuing derivative assets and liabilities. The Company has policies and
The derivative contracts that the Company insures cannot be legally traded and generally do not have observable market prices. In the cases with no active price quote, the Company uses a combination of internal and third-party models to estimate the fair value of these contracts. Most insured CDSs are valued using an enhanced Binomial Expansion Technique (“BET”) model (originally developed by Moody’s). Significant inputs include collateral spreads, diversity scores and recovery rates. For a limited number of other insured derivatives, the Company uses industry standard models as well as proprietary models such as Black-Scholes option models and dual-default models, depending on the type and structure of the contract. The valuation of these derivatives includes the impact of its own credit standing and the credit standing of its reinsurers. All of these derivatives are categorized as Level 3 of the fair value hierarchy as a significant percentage of their value is derived from unobservable inputs. For insured swaps (other than CDSs), the Company uses internally and vendor developed models with market-based inputs (e.g. interest rate, foreign exchange rate, spreads), and are classified as Level 2 within the fair value hierarchy.
The majority of the Company’s derivative exposure is in the form of credit derivative instruments insured by MBIA Corp. Prior to 2008, MBIA Corp. insured CDSs entered into by LaCrosse, an entity that is consolidated into MBIA’s financial statements. In February 2008, the Company ceased insuring such derivative instruments except in transactions reducing its existing insured derivative exposure.
As of December 31, 2009, the Company had $119.2 billion of net par outstanding on insured derivatives. The majority of MBIA’s insured derivatives are “credit derivatives” that reference structured pools of cash securities
and CDSs. The Company generally insured the most senior liabilities of such transactions, and at transaction closing the Company’s exposure generally had more subordination than needed to achieve triple-A ratings from credit rating agencies (referred to as “Super Triple-A” exposure). The collateral backing the Company’s insured derivatives was cash securities and CDSs referencing primarily corporate, asset-backed, residential mortgage-backed, commercial mortgage-backed, commercial real estate (“CRE”) loans, and CDO securities. As of December 31, 2009, the net par outstanding of such transactions totaled $106.0 billion. The remaining $13.2 billion of net par outstanding on insured derivatives as of December 31, 2009 primarily related to insured “interest rate” and “inflation-linked” swaps for which the Company has insured counterparty credit risk.
Most of MBIA’s insured CDS contracts require that MBIA make payments for losses of the principal outstanding under the contracts when losses on the underlying referenced collateral exceed a predetermined deductible. MBIA’s net par outstanding and maximum payment obligation under these contracts as of December 31, 2009 was $78.8 billion. The underlying referenced collateral for contracts executed in this manner largely consist of investment grade corporate debt, structured commercial mortgage-backed securities (“CMBS”) pools and, to a lesser extent, corporate and multi-sector CDOs (in CDO-squared transactions). MBIA’s multi-sector and CDO-squared transactions contain substantial RMBS-related collateral. As of December 31, 2009, MBIA also had $27.2 billion of net par outstanding on insured CDS contracts that require MBIA to make timely interest and ultimate principal payments.
Included in the aforementioned $27.2 billion are guarantees under principal protection fund programs. As of December 31, 2009, the net par outstanding and maximum amount of future payments that the Company would be required to make under these guarantees was $8 million. To date, the Company has not made any payments relating to these guarantees.
The Company does not trade its insured derivatives, nor do similar contracts trade in derivative markets. In determining fair value, the Company’s valuation approach uses observable market prices if available and reliable. Market prices are generally available for traded securities and market standard CDSs but are less available or accurate for highly customized CDSs. Most of the derivative contracts the Company insures are the latter as they are non-traded structured credit derivative transactions. In contrast, typical market CDSs are standardized, liquid instruments that reference tradable securities such as corporate bonds that themselves have observable prices. These market standard CDSs also involve collateral posting, and upon a default of the underlying reference obligation, can be settled in cash.
All of the contracts with settlement based on ultimate principal only at final maturity have been terminated under the terms of the agreements. MBIA had transferred some of the risk of loss on insured CDS transactions using reinsurance to other financial guarantee insurance and reinsurance companies. The fair value of the transfer under the reinsurance contract with the reinsurers is accounted for as a derivative asset. These derivative assets are valued consistently with the Company’s valuation policies.
There were four factors that led to the development of the Direct Price Model. (1) Market spreads for RMBS and ABS CDO collateral were no longer available. RMBS and ABS CDO collateral comprised the majority of the collateral for the multi-sector CDOs that were transitioned to a new marking model. Although market prices were available for the collateral, the BET model requires a spread input and the conversion from price to spread can be subjective for securities that trade substantially below par, which was the case for most of the collateral in these transactions. (2) The BET model contemplates a multi-tranche structure and allocates potential losses to each tranche. Many of the multi-sector CDOs insured by MBIA have experienced collateral erosion to the extent that there is no market value to the subordinated tranches. As a result this key feature of the BET model is no longer relevant. (3) The BET model requires a recovery rate assumption. This is not readily observable on all the collateral. As the market-implied probability of default of collateral has increased the recovery rate assumption has become increasingly important, which has gradually increased the relative importance in the model of internal assumptions as opposed to observable market inputs. (4) For all insured transactions that have been transitioned to a Direct Price Model, MBIA has an option to defer losses on principal to the legal final maturity, which is typically decades in the future. As a result of increased actual and market-implied future potential losses, as well as the significant widening of CDS spreads for MBIA, the value of this deferral option has increased. It currently has a very significant effect on the estimated fair value of MBIA’s guarantee so it was appropriate to use a model that explicitly valued that deferral option.
The model takes account of transaction structure and key drivers of market value. The transaction structure includes par insured, weighted average life, level of deductible or subordination (if any) and composition of collateral.
There is no market in which to test and verify the fair values generated by the Company’s model, and as of December 31, 2009, the model inputs were also either unobservable or highly illiquid, adversely impacting their reliability.
As of December 31, 2009, actual collateral credit spreads were used in one transaction. Sector-specific spreads were used in 12% of the transactions valued using the BET model. Corporate spreads were used in 28% of the transactions and spreads benchmarked from the most relevant spread source were used for 59% of the transactions. When determining the percentages above, there were some transactions where MBIA incorporated multiple levels within the hierarchy. For example, for some transactions MBIA used actual collateral-specific credit spreads in combination with a calculated spread based on an assumed relationship. In those cases, MBIA classified the transaction as being benchmarked from the most relevant spread source even though the majority of the average spread was from actual collateral-specific spreads. The spread source can also be identified by whether or not it is based on collateral WARF. No Level 1 spreads are based on WARF, all Level 2 and 3 spreads are based on WARF and some Level 4 spreads are based on WARF. WARF-sourced and/or ratings-sourced credit spread was used for 72% of the transactions.
The diversity score is a measure to estimate the diversification in a portfolio. The diversity score estimates the number of uncorrelated assets that are assumed to have the same loss distribution as the actual portfolio of correlated assets. For example, if a portfolio of 100 assets had a diversity score of 50, this means that the 100 correlated assets are assumed to have the same loss distribution as 50 uncorrelated assets. A lower diversity score represents higher assumed correlation, increasing the chances of a large number of defaults, and thereby increasing the risk of loss in the senior tranche. A lower diversity score will generally have a negative impact on the valuation for the Company’s senior tranche. The calculation methodology for a diversity score includes the extent to which a portfolio is diversified by industry or asset class, which is either calculated internally or reported by the trustee on a regular basis. Diversity scores are calculated at transaction origination, and adjusted as the collateral pool changes over time. MBIA’s internal modeling of the diversity score is based on Moody’s methodology but uses MBIA’s internal assumptions on default correlation, including variables such as collateral rating and amount, asset type and remaining life.
Approximately $45.3 billion gross par of MBIA’s insured derivative transactions as of December 31, 2009 include substantial amounts of CMBS and commercial mortgage collateral. Prior to 2008, the Company had used spreads drawn from CMBX indices and CMBS spread tables as pricing input on the underlying referenced collateral in these transactions. In 2008, as the financial markets became illiquid, the Company observed a significant disconnect between cumulative loss expectations of market analysts on underlying
In compliance with the requirements of fair value measurement, the Company’s valuation methodology for insured credit derivative liabilities incorporates the Company’s own nonperformance risk and the nonperformance risk of its reinsurers. 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 and the reinsurers’ CDS spreads (or an estimate if there is not a traded CDS contract referencing a reinsurer) as of December 31, 2009. Prior to the second quarter of 2009, MBIA used the 5-year CDS spread on MBIA Corp. to calculate nonperformance risk. This assumption was compatible with the average life of the CDS portfolio, which was
approximately 5 years. In the second quarter of 2009, the Company refined this approach to include a full term structure for CDS spreads. Under the refined approach, the CDS spreads assigned to each deal are based on the weighted average life of the deal.
In the fourth quarter of 2009, the Company enhanced the calculation of nonperformance risk for certain multi-sector and corporate CDOs. MBIA previously used the weighted average life of the overall transaction to calculate nonperformance risk. For the transactions affected, the timing of potential modeled loss varies significantly by the type of collateral that generates the loss. Therefore, the nonperformance risk calculation was adjusted to reflect the potential timing of loss for each collateral type. This adjustment increased our derivative liability by $345 million.
Beginning in the first quarter of 2009, the Company limited the impact of MBIA’s CDS spreads so that the derivative liability, after giving effect to nonperformance risk, could not be lower than MBIA’s recovery derivative price multiplied by the unadjusted derivative liability.
Prior to the third quarter of 2008, the Company did not apply nonperformance risk to the excess (if any) of insured par over the par value of remaining collateral (such excess referred to as “burn-through”) within CDS transactions. Most obligations insured by MBIA do not have burn-through. However, an increasing number of multi-sector CDOs insured by MBIA had developed burn-through. As a result, in the third quarter of 2008 the Company began applying its nonperformance calculation to burn-through, which resulted in a reduction of the fair value of its derivative liability by $683 million. Most of the insured transactions with burn-through are now valued using the Direct Price Model.
There is no market in which to test and verify the fair values generated by the Company’s model.
As of December 31, 2009, the Company’s net insured derivative liability of $3.8 billion comprised the fair values of insured derivatives included in “Derivative assets” and “Derivative liabilities” on its consolidated balance sheet of $756 million and $4.6 billion, respectively, based on the results of the aforementioned pricing models. In the current environment the most significant driver of changes in fair value is nonperformance risk. In aggregate, the nonperformance calculation results in a pre-tax net insured derivative liability which is $14.8 billion lower than the net liability that would have been estimated if the Company did not include nonperformance risk in its valuation. Nonperformance risk is a fair value concept and does not contradict the Company’s internal view, based on fundamental credit analysis of the Company’s economic condition, that the Company will be able to pay all claims when due.
The Company reviews the model results on a quarterly basis to assess the appropriateness of the assumptions and results in light of current market activity and conditions. This review is performed by internal staff with relevant expertise. If live market spreads are observable for similar transactions, those spreads are an integral part of the analysis. For example, new insured transactions that resemble existing (previously insured) transactions would be considered, as would negotiated settlements of existing transactions. This data has been scarce or non-existent in recent periods, but MBIA Corp. did negotiate settlements of two insured CDS transactions in the fourth quarter of 2009. In assessing the reasonableness of the fair value estimate for insured CDS, the Company considered the executed prices for those transactions as well as a review of internal consistency and relativity.
The Company believes that it is important to apply its valuation techniques consistently. However, the Company may consider making changes in the valuation technique if the change results in a measurement that is equally or more representative of fair value under current circumstances.
Gross Financial Guarantees-The Company estimates the fair value of its gross financial guarantee liability using a discounted cash flow model with significant inputs that include (i) an assumption of expected loss on financial guarantee policies for which case basis reserves have not been established, (ii) the amount of loss expected on
The following fair value hierarchy tables present information about the Company’s assets (including short-term investments) and liabilities measured at fair value on a recurring basis as of December 31, 2009 and 2008:
Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Year Ended December 31, 2009
Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Year Ended December 31, 2008
Transfers into and out of Level 3 were $1.2 million and $959 million, respectively, for the year ended December 31, 2008. These transfers were principally for available-for-sale securities where inputs, which are significant to their valuation, became unobservable or observable during the year. These inputs included spreads, prepayment speeds, default speeds, default severities, yield curves observable at commonly quoted intervals, and market corroborated inputs. CDOs, RMBSs and other asset-backed securities comprised the majority of the transferred instruments. For the year ended December 31, 2008, the net unrealized losses related to the transfers into Level 3 was $25 million and the net unrealized gains related to the transfers out of Level 3 was $82 million.
For the year ended December 31, 2009, the fair value of hybrid financial assets increased $5 million on a pre-tax basis and $3 million on an after-tax basis. For the year ended December 31, 2009, the fair value of hybrid financial liabilities, which related to four medium-term notes, decreased $66 million on a pre-tax basis and $43 million on an after-tax basis. Contractual interest coupon payments related to these medium-term notes are recorded within “Interest expense” on the Company’s consolidated statements of operations.
For the year ended December 31, 2008, the fair value of hybrid financial assets decreased $4 million on a pre-tax basis and $3 million on an after-tax basis and the fair value of hybrid financial liabilities, which related to four medium-term notes, decreased $149 million on a pre-tax basis and $97 million on an after-tax basis.
The Company’s fixed-maturity portfolio consists of high-quality (average rating double-A) taxable and tax-exempt investments of diversified maturities. Other investments primarily comprise equity investments, including those accounted for under the equity method and highly rated perpetual securities that bear interest and are callable by the issuer. The following tables present the amortized cost, fair value and other-than-temporary impairments of available-for-sale fixed-maturity and other investments included in the consolidated investment portfolio of the Company as of December 31, 2009 and 2008:
MBIA Corp., through a consolidated VIE, held fixed-maturity securities for trading with a fair value of $128 million as of December 31, 2009. As of December 31, 2008, MBIA Corp. held no fixed-maturity securities for trading.
The following table presents the distribution by contractual maturity of available-for-sale fixed-maturity investments at amortized cost and fair value as of December 31, 2009. Contractual maturity may differ from expected maturity because borrowers may have the right to call or prepay obligations.
Included in the preceding tables are investments that have been insured by MBIA Corp. and National (“Company-Insured Investments”). As of December 31, 2009, the Company-Insured Investments at fair value represented $2.9 billion or 18% of the consolidated investment portfolio. Conduit segment investments represented $1.7 billion or 10% of the consolidated investment portfolio and were all insured by MBIA Corp. Without giving effect to the MBIA guarantee of the Company-Insured Investments, the underlying ratings (those given to an investment without the benefit of MBIA’s guarantee) of the Company-Insured Investments as of December 31, 2009 are reflected in the following table. Amounts represent the fair value of such investments including the benefit of MBIA Corp.’s and National’s guarantee. The ratings in the following table are based on ratings from Moody’s. Alternate rating sources, such as S&P, have been used for a small percentage of securities that are not rated by Moody’s. When an external underlying rating is not available, the underlying rating is based on the Company’s best estimate of the rating of such investment.
It is MBIA’s policy to obtain an underlying rating from both Moody’s and S&P for each new transaction funded through the Company’s conduit segment prior to the execution of such transactions. All transactions currently funded in the conduit segment had an underlying rating of investment grade by Moody’s and S&P prior to funding. MBIA estimates that the weighted average underlying rating of all outstanding conduit segment transactions was Baa1 by Moody’s and BBB+ by S&P as of December 31, 2009.
As of December 31, 2009 and 2008, the Company recorded net unrealized losses of $1.4 billion and $2.5 billion, respectively, on available-for-sale fixed-maturity and other investments, which included $1.6 billion and $2.7 billion, respectively, of gross unrealized losses. The following tables present the gross unrealized losses included in accumulated other comprehensive income (loss) as of December 31, 2009 and 2008 related to available-for-sale fixed-maturity and other investments. These tables segregate investments that have been in a continuous unrealized loss position for less than twelve months from those that have been in a continuous unrealized loss position for twelve months or longer.
As of December 31, 2009 and 2008, the Company’s available-for-sale fixed-maturity, equity and held-to-maturity investment portfolios’ gross unrealized losses totaled $1.9 billion and $2.8 billion, respectively. The weighted average contractual maturity of securities in an unrealized loss position as of December 31, 2009 and 2008 was
19 years and 16 years, respectively. As of December 31, 2009, there were 619 securities that were in an unrealized loss position for a continuous twelve-month period or longer with aggregate unrealized losses of $1.3 billion. Within the 619 securities, the book value of 497 securities exceeded market value by more than 5% as presented in the following table:
As of December 31, 2008, there were 570 securities that were in an unrealized loss position for a continuous twelve-month period or longer with aggregate unrealized losses of $1.9 billion. Within the 570 securities, the book value of 486 securities exceeded market value by more than 5%.
MBIA has evaluated whether the unrealized losses in its investment portfolios were other-than-temporary considering the circumstances that gave rise to the unrealized losses, and whether MBIA has the intent to sell the securities or more likely than not will be required to sell the securities before their anticipated recovery. Based on its evaluation, the Company realized other-than-temporary impairments of $467 million primarily related to RMBS, CDOs, and perpetual securities for the year ended December 31, 2009. MBIA determined that the unrealized losses on the remaining securities were temporary in nature because its impairment analysis, including projected future cash flows, indicated that the Company would be able to recover the amortized cost of impaired assets. The Company also concluded that it does not have the intent to sell these securities and it is more likely than not that it will 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 availability to its business other than sales of securities. It also considered the existence of any risk management or other plans as of December 31, 2009 that would require the sale of impaired securities. On a quarterly basis, MBIA will re-evaluate the unrealized losses in its investment portfolios and determine whether an impairment loss should be realized in current earnings. Refer to “Note 7: Investment Income and Gains and Losses” for information on realized losses due to other-than-temporary impairments. Additionally, refer to “Note 2: Significant Accounting Policies” for a description of the process used by the Company to determine other-than-temporary impairments.
Net realized losses from fixed-maturity investments for 2009 included net realized gains of $10 million from trading securities, of which $8 million was due to an increase in the fair value of the trading securities portfolio and $2 million was due to sales of securities. The Company did not own any trading securities in 2008 and 2007.
Other net realized losses for 2009 of $28 million were primarily due to impairment losses of $112 million on assets, partially offset by gains principally related to swap terminations and reinsurance activity. Total impairment losses of $112 million comprised a $46 million write-off of MBIA Corp.’s goodwill, a $41 impairment of a receivable held by one of our consolidated VIEs, and a $25 million impairment of real estate owned by MBIA Corp. For 2008, other net realized losses of $94 million resulted from interest rate swap terminations in a loss position.
As discussed in “Note 2: Significant Accounting Policies,” a portion of other-than-temporary impairment losses on fixed-maturity securities is recognized in accumulated other comprehensive income (loss). The following table presents the amount of credit loss impairments on fixed-maturity securities held by MBIA as of the dates indicated, for which a portion of the other-than-temporary impairment losses was recognized in accumulated other comprehensive income (loss), and the corresponding changes in such amounts.
For ABS (e.g., RMBSs and CDOs), the Company estimated expected future cash flows of each security by estimating the expected future cash flows of the underlying collateral and applying those collateral cash flows, together with any credit enhancements such as subordination interests owned by third parties, to the security. The expected future cash flows of the underlying collateral are determined using the remaining contractual cash flows adjusted for future expected credit losses (which consider current delinquencies and nonperforming assets, future expected default rates and collateral value by vintage and geographic region) and prepayments. The expected cash flows of the security are then discounted at the interest rate used to recognize interest income on the security to arrive at a present value amount. The following table presents a summary of the significant inputs considered in determining the measurement of the credit loss component recognized in earnings for each significant class of asset-backed securities for the 12 months ended December 31, 2009.
(3)-Calculated by weighting the relevant input/assumption for each individual security by current outstanding amortized cost basis of the security.
(4)-Represents current level of credit protection (subordination) for the securities, expressed as a percentage of total current underlying loan balance.
Net unrealized gains (losses), including the portion of other-than-temporary impairments included in other comprehensive loss, reported within shareholders’ equity consisted of:
The change in net unrealized gains (losses) presented in the table above consisted of:
Changes in the fair value of derivatives, excluding insured derivatives, are recorded each period in current earnings within “Net gains (losses) on financial instruments at fair value and foreign exchange” or in shareholders’ equity within “Accumulated other comprehensive income (loss),” depending on whether the derivative is designated as a hedge, and if so designated, the type of hedge. Changes in the fair value of insured derivatives are recorded in “Net change in fair value of insured derivatives.” The net change in the fair value of the Company’s insured derivatives has two primary components; (i) realized gains (losses) and other settlements on
insured derivatives and (ii) unrealized gains (losses) on insured derivatives. “Realized gains (losses) and other settlements on insured derivatives” include (i) premiums received and receivable on written CDS contracts, (ii) premiums paid and payable to reinsurers in respect of CDS contracts, (iii) net amounts received or paid on reinsurance commutations, (iv) losses paid and payable to CDS contract counterparties due to the occurrence of a credit event or settlement agreement, (v) losses recovered and recoverable on purchased CDS contracts due to the occurrence of a credit event or settlement agreement and (vi) fees relating to CDS contracts. The “Unrealized gains (losses) on insured derivatives” include all other changes in fair value of the insured derivative contracts.
The Company entered into derivative transactions that it viewed as an extension of its core financial guarantee business but which do not qualify for the financial guarantee scope exception and, therefore, must be recorded at fair value on the Company’s balance sheet. The Company’s structured finance and international insurance operations, which insured the majority of the Company’s notional derivative exposure, have insured derivatives primarily consisting of structured pools of CDSs that the Company intends to hold for the entire term of the contract absent a negotiated settlement with the counterparty. The Company’s structured finance and international insurance operations have also provided guarantees on the value of certain structured closed-end funds, which meet the definition of a derivative. The Company reduces risks embedded in its insured portfolio through the use of reinsurance and by entering into derivative transactions. This includes cessions of insured derivatives under reinsurance agreements and capital markets transactions in which the Company economically hedges a portion of the credit and market risk associated with its insured credit derivative portfolio. Such arrangements are also accounted for as derivatives and recorded in the Company’s financial statements at fair value.
The corporate operations have entered into a cross currency swap to hedge foreign exchange risks related to the issuance of certain MBIA long-term debt in accordance with the Company’s risk management policies. The cross currency swap has been designated as a cash flow hedge and hedges the variability arising from currency exchange rate movements on the foreign denominated fixed rate debt. Changes in the fair value of the cross currency swap are recorded in accumulated other comprehensive income (loss). As the debt is revalued at the spot exchange rate in accordance with accounting principles for foreign currency matters, an amount that will offset the related transaction gain or loss arising from the revaluation will migrate each period from accumulated other comprehensive income (loss) into earnings. This cash flow hedge was 100% effective during 2009.
Referenced credit ratings assigned by MBIA to insured credit derivatives are derived by the Company’s surveillance group in conjunction with representatives from its new business and risk divisions. In assigning an internal rating, current status reports from issuers and trustees, as well as publicly available transaction-specific information, are reviewed. Also, where appropriate, cash flow analyses and collateral valuations are considered. The maximum potential amount of future payments (undiscounted) on CDSs are estimated as the notional value plus any additional debt service costs, such as interest or other amounts owing on CDSs. Refer to “Note 16: Net Insurance in Force” for further information about the Company’s sold credit derivatives, including the maximum potential undiscounted payments, recourse provisions and collateral arrangements. The maximum potential amount of future payments (undiscounted) on insured swaps, total return swaps and credit linked notes sold are estimated as the notional value of such contracts.
The maximum potential amount of future payments (undiscounted) on derivatives presented in the preceding table are estimated as the notional value of such contracts.
As of December 31, 2009, the total fair value of the Company’s derivative assets, before counterparty netting, was $987 million and the total fair value of the Company’s derivative liabilities, before counterparty netting, was $4.9 billion. The following table presents the total fair value of the Company’s derivative assets and liabilities by instrument and balance sheet location, before counterparty netting, as of December 31, 2009:
The following tables show the effect of derivative instruments on the consolidated statement of operations for the year ended December 31, 2009:
The amount of gains recognized in other comprehensive income (loss) on derivatives designated as cash flow hedges was $195 thousand for interest rate swaps and $2 million for cross currency swaps. The amount of losses reclassified from other comprehensive income (loss) into net gains (losses) on financial instruments at fair value and foreign exchange was $109 thousand for interest rate swaps and $498 thousand for the cross currency swaps. The Company expects that approximately $37 thousand of unrealized losses (including foreign exchange
The Company manages counterparty credit risk on an individual counterparty basis through master netting agreements covering derivative transactions in the investment management services and corporate operations. 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 MBIA or the counterparty is downgraded below a specified credit rating.
In certain non-insurance derivative contracts, the Company also manages credit risk through collateral agreements that give the Company the right to hold or the obligation to provide collateral when the current market value of certain derivative contracts exceeds an exposure threshold. Under these arrangements, the Company may receive or provide U.S. Treasury and other highly rated securities or cash to secure counterparties’ exposure to the Company or its exposure to counterparties, respectively. Such collateral is available to the holder to pay for replacing the counterparty in the event that the counterparty defaults. As of December 31, 2009 and 2008, the Company did not hold cash collateral from derivative counterparties but posted cash collateral to derivative counterparties of $163 million and $66 million, respectively. These amounts are included in “Derivative liabilities” on the Company’s consolidated balance sheets. As of December 31, 2009 and 2008, the Company had securities with a fair value of $20 million and $284 million, respectively, posted to derivative counterparties.
As of December 31, 2008, the fair value was positive on four CSAs which govern collateral posting requirements between MBIA and its derivative counterparties. The aggregate positive fair value for these four CSAs was $128 million for which the Company did not receive collateral because the Company’s credit rating was below the CSA minimum credit ratings level for holding counterparty collateral. The lowest rated of the four counterparties was Aa3 by Moody’s and A+ by S&P.
The Company evaluates issuer-sponsored SPEs to determine if the entity is a VIE. For all entities determined to be VIEs, at inception and when reconsideration events occur, MBIA evaluates whether its guarantee to provide credit protection on obligations issued by VIEs will absorb the majority of the expected losses of the VIE.
As of December 31, 2009, consolidated VIE assets and liabilities were $2.2 billion and $1.8 billion, respectively, based on the consolidation of six VIEs. As of December 31, 2008, consolidated VIE assets and liabilities were $2.3 billion and $8.0 billion, respectively, based on the consolidation of six VIEs. As of December 31, 2008, consolidated VIEs included an entity sponsored and formed by the Company, LaCrosse, designed to provide credit protection to counterparties in the form of credit derivative instruments. The Company provides credit support and issues financial guarantee insurance policies that insure all LaCrosse credit protection obligations. In 2009, the Company acquired 100% of the ownership interest in LaCrosse and subsequently acquired additional equity investment in LaCrosse. LaCrosse is no longer considered a VIE as a result of the controlling financial interest held by MBIA.
In 2009, the Company formed MBIA Capital Management Institutional Investor Trust to invest in fixed-income securities and financial instruments for income and capital appreciation, and has invested in the equity of this entity. The entity’s equity at risk does not meet all the conditions of a controlling financial interest and is deemed a VIE. Since the Company holds the majority of the equity of the VIE and is considered the primary beneficiary, it has consolidated this entity. The Company also increased its interest in one consolidated VIE, which has outstanding obligations insured by MBIA.
The following tables present the total assets of nonconsolidated VIEs in which the Company holds a significant variable interest as of December 31, 2009 and 2008. The tables also present the Company’s maximum exposure to loss in comparison to the carrying value of liabilities resulting from financial guarantees and insured CDSs and loss and LAE reserves as of December 31, 2009 and 2008. The Company has aggregated nonconsolidated VIEs based on the underlying credit exposure of the insured obligation. Refer to “Note 8: Derivative Instruments” for information about the Company’s valuation of insured derivatives. Additionally, as the majority of the Company’s loss and LAE reserves relate to guarantees of VIEs, refer to “Note 12: Loss and Loss Adjustment Expense Reserves” for information about the Company’s loss and LAE activity.
The maximum exposure to losses as a result of the Company’s variable interest in the VIE is represented by net insurance in force. Net insurance in force is the maximum future payments of principal and interest, net of cessions to reinsurers, which may be required under commitments to make payments on insured obligations issued by nonconsolidated VIEs, assuming a full credit event occurs. The maximum exposure to losses presented in the preceding table is included in and not incremental to the net insurance in force presented in “Note 16: Net Insurance in Force.” The Company adopted the accounting principles for financial guarantee insurance contracts effective and applied prospectively beginning January 1, 2009, which requires unearned premium revenue to be recognized and measured based on the present value, using the risk-free discount rate, of premiums due or expected to be collected in installments. Therefore, “Unearned Premium Revenue” presented under “Carrying Value of Liabilities” in the preceding nonconsolidated VIEs tables as of December 31, 2009 and 2008, are based on different accounting estimates due to the change in accounting principle.
In its investment management services operations, the Company invests in obligations issued by issuer-sponsored SPEs which are included in fixed-maturity securities held as available-for-sale and investments held-to-maturity. The Company evaluates issuer-sponsored SPEs to determine if the entity is a VIE. For all entities determined to be VIEs, the Company evaluates whether its investment will absorb the majority of the expected losses of the VIE, receive the majority of the expected returns of the VIE, or both, as of the date of initial purchase and as of any subsequent date of additional acquisitions of interests in the VIE. MBIA is not the primary beneficiary of any VIEs and does not hold any significant variable interests in issuers considered VIEs based on its assessment of the investment portfolio.
As of December 31, 2009 and 2008, a Company sponsored nonconsolidated funding conduit held no material assets and had no obligations outstanding. The Company has no liquidity obligation to fund nonconsolidated funding conduits.
In the conduit segment of its investment management services operations, the Company manages and administers two multi-seller conduit SPEs, Triple-A One and Meridian (collectively, the “Conduits”). The Conduits invest in various types of financial instruments, such as debt securities, loans, lease receivables, trade receivables, and obligations issued by SPEs, and fund the investments through the issuance of medium-term notes and long-term debt. The assets and liabilities of the Conduits are supported by credit enhancement provided through MBIA Corp. The Conduits are designed to provide issuers an efficient source of funding for issued obligations, and to provide an opportunity for MBIA Corp. to issue financial guarantee insurance policies.
The Conduits are VIEs and are consolidated by the Company as the primary beneficiary. MBIA has included on its balance sheet the assets and liabilities of each Conduit, which consist primarily of various types of investments funded by medium-term notes and liquidity loans, and has included in its statement of operations the operating revenues and expenses of the Conduits. Certain of MBIA’s consolidated subsidiaries have invested in Conduit debt obligations or have received compensation for services provided to the Conduits. As such, MBIA has eliminated intercompany transactions with the Conduits from its balance sheet and statement of operations. After the elimination of such intercompany assets and liabilities, total assets and liabilities of the Conduits were $2.0 billion and $1.8 billion, respectively, as of December 31, 2009 and $2.5 billion and $2.5 billion, respectively, as of December 31, 2008. Creditors of the Conduits do not have recourse to the general assets of MBIA outside of financial guarantee policies provided on obligations issued by the Conduits.
Under certain non-insurance derivative contracts entered into by the Company, collateral postings are required by either MBIA or the counterparty when the aggregate market value of derivative contracts entered into with the same counterparty exceeds a predefined threshold. Cash or securities may be posted as collateral at the option
of the party posting the collateral. As of December 31, 2009 and 2008, the Company did not hold cash collateral from derivative counterparties but posted cash collateral to derivative counterparties of $193 million and $92 million, respectively. The 2009 amount reflects $30 million of cash collateral posted on a notional basis swap which is included in “Other liabilities” on the Company’s consolidated balance sheet. As of December 31, 2009 and 2008, the Company had securities with a fair value of $20 million and $284 million posted to derivative counterparties. Refer to “Note 8: Derivative Instruments” for a further discussion on collateralized derivative transactions.
The Company’s long-term debt presented in the preceding table is subject to certain restrictive covenants, none of which significantly restrict the Company’s operating activities or dividend-paying ability. At December 31, 2009 and 2008, the Company was in compliance with all debt covenants as there was no occurrence of any event of default with respect to the above securities. Key events of default include (i) default in the payment of any interest or principal when it becomes due and payable, (ii) default in the performance, or breach, of any covenant or warranty of MBIA, (iii) events of default with respect to the Company’s indebtedness, other than its debt securities
On January 16, 2008, MBIA Corp. issued $1.0 billion of 14% fixed-to-floating rate surplus notes due January 15, 2033. As of December 31, 2009 and 2008, the par amount outstanding was $945 million and $953 million, respectively. The surplus notes have an initial interest rate of 14% until January 15, 2013 and thereafter at an interest rate of three-month LIBOR plus 11.26%. Interest and principal payments on the surplus notes are subject to prior approval by the Superintendent of the NYSID. The surplus notes are callable at par at MBIA Corp.’s option on the fifth anniversary of the date of issuance and every fifth anniversary thereafter, subject to prior approval by the Superintendent and other restrictions. The cash received from the issuance of surplus notes was used for general business purposes and the deferred debt issuance costs are being amortized over the term of the surplus notes. During the first quarter of 2009, MBIA Inc. repurchased $7 million par value of surplus notes issued by MBIA Corp. at a price of $31.02. Net gains from repurchasing the surplus notes in 2009 totaled $5 million, which is only reflected in the consolidated accounts of the Company. During the third quarter of 2008, MBIA Corp. repurchased $47 million par value outstanding of its surplus notes at a weighted average price of $77.08. Net gains from repurchasing the surplus notes in 2008 totaled $10 million.
Liquidity loans presented in the preceding table represent borrowings under liquidity facilities. Under private placement offerings, Triple-A One issued commercial paper to fund the purchase of assets from structured finance clients with maturities of up to 270 days. Assets purchased by Triple-A One are insured by MBIA Corp. Historically, Triple-A One maintained backstop liquidity facilities for each transaction, covering 100% of the face amount of commercial paper outstanding. These liquidity facilities were designed to allow Triple-A One to repay investors in the event of a market disruption in which Triple-A One would be unable to issue new commercial paper to replace maturing commercial paper. The financial guarantee policies issued by MBIA to insure the assets of Triple-A One cannot be accelerated to repay maturing commercial paper or borrowings under liquidity facilities and only guarantee ultimate payments over time relating to the assets. As a result of the deteriorating market environment, Triple-A One fully drew on its liquidity facilities in September 2008 and ceased issuing commercial paper. All commercial paper holders have been repaid in full and borrowings under liquidity facilities, which totaled $433 million as of December 31, 2009, will be repaid as the assets purchased by Triple-A One mature. The Company expects that the facilities will be fully repaid by 2037. The interest rate applicable to $352 million of borrowings is one-month LIBOR plus 0.75% and the interest rate applicable to $81 million of borrowings is one-month LIBOR plus 0.425%. Given the fully drawn position of its liquidity facilities and no expectation of issuing commercial paper in the foreseeable future, Triple-A One ratings were withdrawn by Moody’s and S&P at the request of Triple-A One.
The aggregate maturity of debt obligations, excluding accrued interest and premiums or discounts, as of December 31, 2009 for each of the next five years and thereafter commencing in 2010 was:
Investment agreements have been issued with either fixed or floating interest rates in both U.S. dollars and foreign currencies. As of December 31, 2009, the annual interest rates on these agreements ranged from 0% to 7.38% and the weighted average interest rate was 3.62%. As of December 31, 2008, the annual interest rates on these agreements ranged from 0.17% to 7.93% and the weighted average interest rate was 4.41%. Principal payments due under these investment agreements in each of the next five years ending December 31 and thereafter, based upon expected withdrawal dates, are as follows:
The Company may buyback and extinguish debt originally issued by either MBIA Inc. or its subsidiaries. Purchase prices are generally negotiated through dealers, similar to buying or selling an asset in the open market. The Company repurchases its debt at discounted prices in an effort to improve its own economic position while also providing liquidity to investors of MBIA debt. In all cases, debt buybacks were executed in response to investor or dealer inquiries. During 2009, the Company recognized gains associated with medium-term note repurchases, net of losses associated with investment agreement terminations, of $247 million.
Total paid activity, net of reinsurance and collections, for the year ended December 31, 2009 was $2.6 billion and included $2.3 billion of payments for insured RMBS transactions. For the year ended December 31, 2009, estimated recoveries on paid losses totaled $2.0 billion and were primarily related to insured RMBS transactions.
In 2009, the Company continued its review of mortgage loans in the Company’s insured transactions. As a result, the expected net cash flows were revised based on increasing likelihood of potential recoveries related to ineligible mortgage loans in certain insured first and second-lien residential mortgage loan securitizations where the sellers/servicers have a contractual obligation to cure, repurchase or replace ineligible mortgage loans. The Company’s recovery outlook is principally based on the following factors:
2. the improvement in the financial strength of issuers due to mergers and acquisitions and/or government assistance, which will facilitate their ability to comply with required loan repurchase/substitution obligations. The Company is not aware of any provisions that explicitly preclude or limit the successors’ obligations to honor the obligations of the original sponsor. Any credit risk associated with these sponsors (or their successors) is reflected in the Company’s probability-weighted potential recovery scenarios;
3. evidence of loan repurchase/substitution compliance by sellers/servicers for put-back requests made by other harmed parties with respect to ineligible loans that are similar to the type of ineligible loans that have been identified in our insured home equity lines of credit (“HELOCs”) and closed-end second mortgages (“CES”) portfolio, including substantial amounts paid to Federal Home Loan Mortgage Corporation (“FHLMC”) for substantially similar claims;
4. the favorable outcome for MBIA on Defendants’ motions to dismiss in the actions captioned MBIA Insurance Corp. v. Countrywide Home Loans, Inc., et al, Index No. 08-602825 (N.Y. Sup. Ct.) and MBIA Insurance Corp. v. Residential Funding Co., LLC, Index No. 603552/08 (N.Y. Sup. Ct.) where the respective courts each allowed MBIA’s fraud claims against the Countrywide and RFC defendants to proceed; and
5. reserves the Company believes have been established by certain sellers/servicers to cover such obligations.
Beginning in the first quarter of 2008, MBIA engaged loan level forensic review consultants to re-underwrite/review a sample of the mortgage loan files underlying MBIA’s HELOCs, CES and Alt-A insured transactions. Certain transactions that exhibited exceptionally poor performance were chosen for a re-underwriting review. Factors MBIA believes to be indicative of this poor performance include (i) a material increase in early and late stage delinquencies; (ii) material increases in charged-off loans; (iii) significant decreases in credit enhancement; and/or (iv) policy payments. During 2008 and 2009, in coordination with our forensic review consultants, the Company reviewed over 33,000 mortgage loans within 30 first and second-lien mortgage loan securitizations. MBIA’s forensic loan review determined that there were significant breaches of mortgage loan representations and material deviations from underwriting guidelines. Accordingly, the Company has determined that thousands of loans were contractually ineligible for inclusion in the
securitized trusts insured by MBIA. In turn, MBIA has submitted thousands of ineligible loans for repurchase/substitution to the sponsors or sellers/servicers. The unsatisfactory resolution of these contractual matters, in addition to the pervasive misrepresentations made by the certain sellers/servicers in inducing MBIA Corp. to write insurance of the transactions, has led MBIA to pursue litigation with these sellers/servicers seeking to enforce the sellers/servicers obligation to repurchase or replace ineligible mortgage loans, and seeking damages for both breaches of contractual obligations and fraud. MBIA’s forensic examination of loan repurchase/substitution requirements for various issuers remains ongoing.
To date, sellers/servicers have not substituted loans which MBIA has put back. However, if a loan were to be substituted, the original loan would be removed from the trust by the seller/servicer and all proceeds associated with the original loan would belong to the seller/servicer. The seller/servicer would then be required to place a new loan into the transaction and all future payments associated with the new loan would belong to the trust. Therefore, any defaults on the original loan would be recovered upon substitution.
The Company believes that, on a contractual basis, the sellers/servicers in MBIA-insured mortgage transactions are obligated to cure, replace, or repurchase all the deficient loans for which the Company has recorded potential recoveries. To date, only a nominal amount of the loans for which MBIA has incurred losses and put back have been repurchased. The unsatisfactory resolution of these put-backs has caused MBIA to initiate litigation with three of the sellers to enforce their obligations. The Company has alleged several causes of action in its complaints, including breach of contract, fraudulent inducement and indemnification. MBIA’s $1.5 billion of estimated potential recoveries do not include damages from causes of action other than breach of contract for failure to repurchase specific loans. While two of the sellers/servicers of MBIA’s transactions filed motions to dismiss MBIA’s fraudulent inducement, indemnification, and certain other claims, they have not moved to dismiss the Company’s breach of contract claims. Furthermore, the sellers’/servicers’ motions to dismiss the Company’s fraud claims have been denied.
The Company will continue to assess the level of expected recoveries based on additional forensic reviews on additional loans, developments in the pending litigation proceedings or in any new litigation that we file and other factors that could influence the amount of the recoveries. As a result the factors described above the Company’s estimate of recoveries could change materially in the future.
The Company does not establish any case basis reserves for insured obligations that are assigned to “Caution List - Low,” “Caution List - Medium,” or “Caution List - High.” In the event MBIA expects to pay a claim in excess of the unearned premium revenue with respect to an insured transaction, it places the insured transaction on its “Classified List” and establishes a case basis reserve. The following provides a description of each surveillance category:
“Classified List”-Includes all insured obligations where MBIA has paid a claim or where a claim payment is expected to exceed its unearned premium revenue. Generally, IPM is actively remediating these credits where possible, including restructurings through legal proceedings, usually with the assistance of specialist counsel and advisors.
The following table presents changes in the Company’s loss and LAE reserve for the year ended December 31, 2009. Changes in the loss and LAE reserve attributable to the accretion of the discount on the loss reserve, changes in discount rates, and changes in the timing and amounts of estimated payments and recoveries are recorded in “Losses and loss adjustment expenses” in the Company’s statement of operations. LAE reserves are expected to be settled within a one year period and are not discounted. As of December 31, 2009, the weighted average risk-free rate used to discount the claim liability was 3.14%.
As a result of the establishment of National in the first quarter of 2009, the Company changed the composition of the insurance reporting unit. Accordingly, the goodwill of the Company’s insurance operations was allocated between its U.S public finance insurance and structured finance and international insurance reporting units based on the relative fair value of each reporting unit as of January 1, 2009.
As of January 1, 2010, the fair value of MBIA’s structured finance and international insurance reporting unit, while substantial, did not exceed its carrying value, indicating that goodwill was impaired. Such impairment was primarily driven by continued deterioration in the performance of insured transactions within the Company’s structured finance and international insurance business. Further analysis indicated that there was no remaining implied value attributable to the Company’s structured finance and international insurance segment’s goodwill. Therefore, in the fourth quarter of 2009, the Company wrote off all of its $46 million of goodwill in its structured finance and international insurance segment. The fair value of the Company’s reporting unit was estimated using discounted cash flow modeling. The inputs to the Company’s valuation model included its estimates of market participant assumptions.
Goodwill within the Company’s investment management services segment was related to Cutwater-ISC. As of January 1, 2009, the fair value of this reporting unit was less than its carrying value indicating that goodwill was impaired. As a result, in the fourth quarter of 2008, the Company recorded an impairment loss for the full amount of goodwill in its investment management services operations. In performing the goodwill assessment, the Company used a market approach and other factors as the best evidence of the fair value of its reporting unit.
The provision for income tax expense (benefit) gives effect to permanent differences between financial and taxable income. Accordingly, the Company’s effective income tax rate differs from the statutory rate due to the tax effect of the following permanent differences: