• the level of activity within the national and international credit markets;
MBIA is a leading provider of financial guarantee insurance, investment management services and municipal services to public finance clients and financial institutions around the world. During 2003, the Company continued to grow its global franchise resulting in record levels of business production and reported earnings. MBIA’s consistently solid performance is accomplished through its dedication to the foundation principles that guide its operations. They are: Maintain the Strongest Team, which recognizes the Company’s commitment to individual and organizational growth as well as its focus on
The Company’s insurance operations experienced significant growth in both its United States (U.S.) and non-United States (non-U.S.) operations in 2003. The investment management services operations demonstrated an improving trend in the third and fourth quarters of 2003 resulting from a strong performance in the Company’s fixed-income businesses. The Company believes it is well positioned to take advantage of favorable growth prospects both inside and outside of the U.S. in all of its businesses except for the equity component of its investment management business, which has not recovered from turbulence in the U.S. equity markets.
LOSSES AND LOSS ADJUSTMENT EXPENSES Loss and loss adjustment expense (LAE) reserves are established in an amount equal to the Company’s estimate of unallocated losses and identified or case basis reserves, including costs of settlement and other loss mitigation expenses, on obligations it has insured. The unallocated loss and loss adjustment expense reserves and specific case basis reserves are established by the Company’s Loss Reserve Committee, which is comprised of members of senior management.
Although the Company has had an excellent history in estimating its loss reserving needs, its total loss reserves of $560 million represent a small fraction of the net debt service insured of $836 billion. Management believes that the reserves are adequate to cover ultimate net losses; however, because the reserves are based on estimates, there can be no assurance that the ultimate liability will not exceed such estimates. Various methodologies are
UPFRONT PREMIUM REVENUE RECOGNITION Upfront premiums are earned in proportion to the expiration of the related risk while installment premiums are earned over each installment period, generally one year or less. Therefore, for transactions in which the premium is received upfront, premium earnings are greater in the earlier periods when there is a higher amount of exposure outstanding. The upfront premiums are apportioned to individual sinking fund payments of a bond issue according to an amortization schedule. After the premiums are allocated to each scheduled sinking fund payment, they are earned on a straight-line basis over the period of that sinking fund payment. When an insured issue is retired early, is called by the issuer, or is in substance paid in advance through a refunding accomplished by placing U.S. Government securities in escrow, the remaining deferred premium revenue is earned at that time. If other than U.S. Government securities are placed in escrow, the Company remains contingently liable for the outstanding debt service. Accordingly, deferred premium revenue represents the portion of premiums written that is applicable to the unexpired risk of insured bonds and notes.
VALUATION OF FINANCIAL INSTRUMENTS The fair market values of financial instruments held or issued by the Company are determined through the use of available market data and widely accepted valuation methods. Market data is retrieved from a variety of third-party data sources for input into the Company’s valuation systems. Valuation systems are determined based on the
The Company’s financial instruments categorized as assets are mainly comprised of investments in debt and equity instruments. The majority of the Company’s debt and equity investments are accounted for in accordance with Statement of Financial Accounting Standards (SFAS) 115, “Accounting for Certain Investments in Debt and Equity Securities.” SFAS 115 requires that all debt instruments and certain equity instruments be classified in the Company’s balance sheet according to their purpose and, depending on that classification, be carried at either amortized cost or fair market value. Quoted market prices are generally available for these investments. However, if a quoted market price is not available, a price is derived from internally developed models which use available market data. Equity investments outside the scope of SFAS 115 are accounted for under cost or equity method accounting principles. Other financial assets that require fair value reporting or disclosures within the Company’s financial notes are valued based on underlying collateral or the Company’s estimate of discounted cash flows.
MBIA regularly monitors its investments in which fair value is less than amortized cost in order to assess whether such a decline in value is other than temporary and, therefore, should be reflected as a realized loss in net income. Such an assessment requires the Company to determine the cause of the decline and whether the Company possesses both the ability and intent to hold the investment to maturity or until the value recovers to an amount at least equal to amortized cost. As of December 31, 2003, MBIA determined that unrealized losses on its investments were temporary in nature because there was no material indication of credit deterioration and the Company has the ability and intent to hold the investments to maturity or until the fair value increases to an amount equal to amortized cost. This assessment requires management to exercise judgment as to whether an investment is impaired based on market conditions and trends and the availability of relevant data.
MBIA expects to hold all derivative instruments to their contractual maturity. Upon maturity of a contract, the unrealized value recorded in the Company’s financial statements will be zero. However, if circumstances or
GOODWILL Effective January 1, 2002 the Company adopted SFAS 142, “Goodwill and Other Intangible Assets.” SFAS 142, which supersedes Accounting Principles Board Opinion No. (APB) 17, “Intangible Assets,” requires that goodwill and intangible assets with indefinite lives are no longer amortized but instead tested for impairment at least annually. The standard includes a two-step process aimed at determining the amount, if any, by which the carrying value of a reporting unit exceeds its fair value. Other intangible assets are amortized over their useful lives.
The municipal services segment had goodwill of $7.7 million as of January 1, 2002. The fair value of the reporting segment was based on net assets. In comparing fair value to carrying value, it was determined that goodwill was potentially impaired. In performing step two of the impairment testing the implied fair value of goodwill was calculated by subtracting the fair value of the net assets from the fair value of the reporting segment. In comparing the implied fair value of goodwill to the carrying amount of goodwill, it was determined that the entire amount was impaired and was therefore written off as of January 1, 2002 and reported as a cumulative effect of accounting change. The per share effect of the cumulative effect of accounting change was to reduce 2002’s net income per share by five cents.
Consolidated revenues for 2003 were $1.9 billion compared with $1.5 billion in 2002, a 28% increase. The increase in consolidated revenues was primarily due to an increase in insurance premium and fee revenues, net gains on insured credit derivative instruments, and net realized gains on the Company’s investment portfolio. Consolidated expenses for 2003 were $720 million compared with $671 million in 2002, a 7% increase. This increase was primarily due to an increase in insurance operations expenses and, to a lesser extent, an increase in investment management services operating expenses and interest expense from additional debt issued in the third quarter of 2002. Somewhat offsetting these increases were decreases in interest expense related to investment management services debt obligations and corporate expenses. Net income for 2003 increased 40% while net income per share increased 43%. The difference between the growth in net income and the growth in net income per share was principally the result of common stock repurchases by the Company.
Consolidated revenues for 2002 and 2001 remained flat at $1.5 billion. Insurance revenues increased 10% resulting from growth in premiums, fees and investment income, offset by net losses on insured credit derivative instruments and decreases in investment management services revenues. Consolidated expenses for 2002 were $671 million compared with $666 million in 2001, a 1% increase. The 2002 increase in consolidated expenses was due to an increase in insurance operations expenses, with smaller offsetting decreases in investment management services expenses and municipal services expenses. Net income for 2002 increased 2% while net income per share increased 3%. The difference between the growth in net income and the growth in net income per share was principally the result of common stock repurchases by the Company.
The Company’s book value at December 31, 2003 was $43.50 per share, up 15% from $37.95 at December 31, 2002. The increase was largely driven by income from operations and the increase in the unrealized appreciation of the Company’s investment portfolio. Book value per share has shown substantial growth over the past three years with a three-year compound average growth rate of 15%. The low interest rate environment had a positive effect on this growth rate.
MBIA evaluates the premium rates it receives for insurance guarantees through the use of internal and external rating agency quantitative models. These models assess the Company’s premium rates and return on capital results on a risk adjusted basis. In addition, market research data is used to evaluate pricing levels across the financial guarantee industry for comparable risks. The Company’s 2003 pricing levels indicate continued positive trends in overall portfolio profitability, and the Company believes the pricing charged for its insurance products produces results that meet its long-term return on capital targets.
revenues from insurance operations were $1.230 billion compared with $1.072 billion in 2002, a 15% increase. The growth in insurance revenues was driven by a 25% increase in premiums earned and an 18% increase in advisory fee revenues. Net scheduled premiums earned, which exclude refundings, were $607 million in 2003, up 18% from 2002. The growth in net scheduled premiums earned in 2003 reflects the increase in new business written during the last two years, as well as a lower reinsurance cession rate. Refunded premiums earned increased 69% this year when compared with last year as municipalities took advantage of the continued low interest rate environment to refinance their debt.
The Company’s gross premiums written (GPW), net premiums written (NPW) and scheduled premiums earned for the last three years are presented in the following table:
In 2002, insurance operations revenues increased 10% compared with 2001. The growth in revenues was due to increases in premiums earned, net investment income and advisory fees. Insurance expenses increased 10% in 2002, which is in line with the increase in insurance revenues for the same period. In 2002, GPW grew by 10% compared with 2001, reflecting strong growth in U.S. business slightly offset by a decrease in non-U.S. business. NPW grew 20% compared with 2001, resulting from increases in both U.S. and non-U.S. business. The increase in 2002 NPW relative to the increase in 2002 GPW is due to a decrease in cession rates to reinsurers.
The credit quality of global public finance business written by the Company remained high for the past three years. Insured credits rated A or above before the Company’s guarantee accounted for 88% of the 2003 and 2002 global public finance business, while credits rated A or above in 2001 were 85%. At year-end 2003, 81% of the outstanding global public finance book of business was rated A or above before the Company’s guarantee.
Global structured finance worldwide securitization volume increased 27% over the prior year with most of the growth concentrated in U.S. public asset-backed and mortgage-backed securities.
In 2002, GPW increased 21% due to increases in installment business written in the U.S. and outside the U.S. NPW increased 22%, in line with the growth in GPW due to a relatively stable cession rate. The 11% growth in net scheduled premiums earned reflects increases in both U.S. and non-U.S. business.
In 2002, insurance-related net investment income was up 5% over 2001. The modest growth in 2002 was due to the low-yield environment despite a 9% growth in invested assets at cost. After-tax net investment income increased 6% in 2002, as the portfolio had significant tax-exempt investments.
In 2003, advisory fee revenues increased 18% to $59.7 million, from $50.7 million in 2002. This increase was driven by the Company’s emphasis on work fees for increasingly complex insurance transactions and waiver and consent fees related to the surveillance and remedial activities of the Company’s
statutory loss ratio only includes case losses incurred, while the GAAP loss ratio includes case losses incurred and a provision for unallocated losses. Both the GAAP and statutory loss ratios have remained relatively consistent over the last three years.
In the event MBIA determines that it expects to pay a claim with respect to an insured issue, it places the issue on its “classified list” and establishes a case basis reserve for that insured issue. As of December 31, 2003, MBIA had 48 open case basis issues on its classified list that had $201 million in aggregate case reserves. Of the 48 issues on its classified list, 17 issues with an aggregate outstanding net insured par of approximately $831 million had case basis reserves of $278 million for expected future claims. In addition, 21 issues with an aggregate outstanding net insured par of approximately $1.8 billion had negative case basis reserves for which no further claims are expected but for which the Company expects to receive future salvage and recoveries totaling $77 million. The Company does not expect to incur losses, net of salvage and recoveries, on the remaining 10 issues, which had an aggregate outstanding net insured par of approximately $359 million. The Company has not established any case basis reserves for issues that are listed as “Caution List-Low,” “Caution List-Medium” or “Caution List-High.”
restructured only three insured bond issues, with an aggregate insured par amount of $352 million, two of which involved the extension of the term of the insured bonds by three and eight years, respectively. In no case was the principal amount of the insured bond issue increased or decreased or the interest rate reduced. The restructuring of an insured issue will generally not affect the amount of the Company’s case basis reserves established for the restructured issue, if any, except if as a result of such restructuring the Company’s estimate of the amount of its ultimate loss for such policy changes. MBIA has a case basis reserve with respect to one of the insured issues that it has restructured.
REINSURANCE Reinsurance enables the Company to cede exposure for purposes of increasing its capacity to write new business while complying with its single risk and credit guidelines. The rating agencies continuously review reinsurers providing coverage to the financial guarantee industry. Many of MBIA’s reinsurers have been downgraded over the past two years, and others remain under review. As of December 31, 2002, reinsurers rated Double-A and above represented 90% of MBIA’s ceded par. As a result of downgrades during 2003, this percentage as of December 31, 2003 was 56%. When a reinsurer is downgraded, less capital credit is given to MBIA under rating agency models. The reduced capital credit has not and is not expected to have a material adverse effect on the Company. The Company generally retains the right to reassume the business ceded to reinsurers under certain circumstances, including the downgrade of the reinsurers. The Company remains liable on a primary basis for all reinsured risks, and although the Company believes that its reinsurers remain capable of meeting their obligations, there can be no assurance that the reinsurers will be able to meet these obligations.
As of December 31, 2003, the aggregate amount of insured par ceded by MBIA to reinsurers was $110.2 billion. The following table shows the percentage ceded to and reinsurance recoverable from reinsurers by S&P rating levels.
MBIA will recognize a premium deficiency if the sum of expected loss and loss adjustment expenses, maintenance costs and unamortized policy acquisition costs exceed the related unearned premiums. If MBIA were to have a premium deficiency that is greater than unamortized acquisition costs, the unamortized acquisition costs would be reduced by a charge to expense, and a liability (if necessary) would be established for any remaining deficiency. Although GAAP
Operating expenses increased 24% from $87 million in 2002 to $108 million in 2003, reflecting higher compensation costs that are primarily the result of a one-time cost related to the replacement of split-dollar life insurance policies, expenses in the second quarter of 2003 to establish TRF and a reallocation of expenses between business operations. The 9% increase in operating expenses in 2002 compared with 2001 primarily reflects the Company’s decision to expense the fair value of stock options, totaling $7 million, in accordance with the modified prospective transition method of SFAS 148, “Accounting for Stock-Based Compensation - Transition and Disclosure.” The pro forma stock option expense not included in 2001 in accordance with the modified prospective method of adoption is not materially different from the expense recognized in 2002.
Financial guarantee insurance companies use the statutory expense ratio (expenses divided by net premiums written) as a measure of expense management. The Company’s 2003 statutory expense ratio of 12.8% is below the 2002 ratio of 16.8% and the 2001 ratio of 13.4%. The decrease in the ratio from 2002 is due
to a significant increase in net premiums written. If stock option expenses had been included in the 2001 calculation, the statutory expense ratio for 2001 would have been 16.7%. The statutory expense ratios for the past three years have been considerably better than the Company’s long-term goal of 20%.
Under the provisions of FIN 46, MBIA must determine whether it has a variable interest in a VIE and if so, whether that variable interest would cause MBIA to be the primary beneficiary. The primary beneficiary is the entity that will absorb the majority of the expected losses, receive the majority of the expected residual returns or both of the VIE and is required to consolidate the VIE. VIEs are used in a variety of structures insured or managed by MBIA. Under FIN 46, MBIA’s guarantee of the assets or liabilities of a VIE constitute a variable interest and require MBIA to assess whether it is the primary beneficiary. Additionally, the Company’s management of VIEs under asset management agreements may subject the Company to consolidation of such entities. Consolidation of such VIEs does not increase MBIA’s exposure above that already committed to in its insurance policies. Additionally, VIE assets and liabilities that are consolidated within MBIA’s financial statements may represent amounts above MBIA’s guarantee, although such excess amounts would ultimately have no impact on MBIA’s net income. VIE assets and liabilities consolidated in the Company’s financial statements at December 31, 2003 are reported in “Variable interest entity assets” and “Variable interest entity liabilities”, respectively, on the face of the Company’s balance sheet and totaled $600.3 million.
The following provides a summary of each of the asset management businesses:
GFL was formed in 2002 as an extension of the Company’s investment management business. GFL raises funds through the issuance of medium-term notes with varying maturities (GFL MTNs), which are in turn guaranteed by MBIA Insurance Corporation (MBIA Corp.). GFL lends the proceeds of these GFL MTN issuances to the Company (GFL Loans). Under an agreement between the Company and MBIA Corp., the Company invests the proceeds of the GFL Loans in eligible investments (the GFL Investments), which consist of securities with a minimum Double-A quality. The GFL Investments are pledged to MBIA Corp.
At December 31, 2003, principal and accrued interest outstanding on IMC, GFL and EAAL investment agreements and medium-term note obligations and securities sold under agreements to repurchase totaled $9.3 billion, compared with $7.8 billion at December 31, 2002. Assets supporting these agreements had market values of $9.4 billion and $8.1 billion at December 31, 2003 and December 31, 2002, respectively. These assets are comprised of high-quality securities with an average credit quality rating of Double-A.
1838 is a full-service asset management firm with an institutional focus. It manages equity, fixed-income and balanced portfolios for a client base comprised of municipalities, endowments, foundations, corporate employee benefit plans and high-net-worth individuals. 1838’s results were significantly impacted by, and have not recovered from, turbulence in the U.S. equity markets. A considerable decline in operating revenues was slightly mitigated by a reduction in operating costs. Assets under management at year-end 2003 were $3.7 billion, a decline of 31% from year-end 2002 assets of $5.4 billion.
It is MBIA’s policy to obtain a shadow rating from both Moody’s and S&P for each new transaction prior to the execution of such transactions within the Conduits. A shadow rating is the implied rating for the transaction without giving consideration to the MBIA guarantee. All transactions currently funded in the Conduits were shadow-rated at least investment grade by Moody’s and S&P prior to funding. The weighted average shadow rating for transactions currently funded in the Conduits was A by S&P and A2 by Moody’s at the time such transactions were
funded. MBIA estimates that the current weighted average shadow rating of all outstanding Conduit transactions was A- by S&P and A3 by Moody’s as of December 31, 2003.
As a result of having to adhere to MBIA’s underwriting standards and criteria, Conduit transactions have, in general, the same underlying shadow ratings that similar non-Conduit transactions guaranteed by MBIA have at the time they are closed. Like all credits underwritten by MBIA, the shadow ratings on Conduit transactions may be downgraded by either one or more rating agencies after they are closed. In general, the underlying shadow ratings on Conduit transactions have been downgraded no more frequently than similar non-Conduit transactions guaranteed by MBIA.
For 2003, the municipal services operations reported operating income of $957 thousand, compared with operating income of $402 thousand in 2002. Revenues grew slightly more than expenses, with 8% and 6% growth rates. Municipal contracts and contingency fee billings were the main drivers behind the increase in municipal services revenues.
amount in connection with these securitizations was approximately $179 million compared with $201 million at December 31, 2002. MBIA Corp. has established case reserves related to these policies based on the amount of redemptive balances of those tax liens underlying such policies that Capital Asset has written off for a variety of reasons. MBIA will continue to evaluate the performance of the tax lien portfolio and establish reserves as and when necessary based on the same methodology. Since the ultimate collectability of tax liens is difficult to estimate, there can be no assurance that the case reserves established to date would be sufficient to cover all future claims under these policies.
INTEREST EXPENSE The Company incurred $68 million of interest expense compared with $58 million last year. The 17% increase is the result of the additional $200 million of debt issued during the third quarter of 2002.
NET REALIZED GAINS Net realized gains were $81 million in 2003, consisting of gross realized gains of $130 million and gross realized losses of $49 million. The increase in 2003’s net realized gains primarily resulted from the Company’s sale of long-term assets to reduce the duration of its investment
MBIA’s tax policy is to optimize after-tax income by maintaining the appropriate mix of taxable and tax-exempt investments. However, the tax rate fluctuates from time to time as the Company manages its investment portfolio on an after-tax total return basis. In addition, the tax rate for 2003 has increased due to the net gains on derivative instruments and foreign exchange. The effective tax rate for 2003 increased to 29.2% from 26.0% in 2002 and 26.3% in 2001.
The Company carefully manages its capital resources to minimize its cost of capital while maintaining appropriate claims-paying resources to sustain its Triple-A claims-paying ratings. At year-end 2003, total claims-paying resources for MBIA Corp. stood at $12.6 billion, a 15% increase over year-end
(1) At March 31, June 30, September 30 and December 31, 2003 the discount rates were 5.6%, 5.3%, 5.1% and 4.7%, respectively, while 2002 was discounted at 9.0%.
Total shareholders’ equity at December 31, 2003 was $6.3 billion, with total long-term debt at $1.0 billion. The Company uses debt financing to lower its overall cost of capital. MBIA maintains debt at levels it considers to be prudent based on its cash flow and total capital. The following table shows the Company’s long-term debt and the ratio used to measure it:
In July of 1999, the board of directors authorized the repurchase of 11.25 million shares of common stock of the Company after adjusting for the 2001 stock split. The Company began the repurchase program in the fourth quarter of 1999. As of year-end 2003, the Company had repurchased a total of 9.5 million shares at an average price of $41.71 per share.
In addition, the Company has various soft capital facilities, such as lines of credit, stop-loss facilities and other equity-based facilities at its disposal, which increase its claims-paying resources.
coverage due to the rating downgrades of the stop-loss providers. In addition, at the end of 2003, MBIA Corp. elected not to renew the remaining $35.7 million of stop-loss reinsurance coverage effective January 1, 2004, also due to the rating downgrade of the stop loss reinsurer.
MBIA Corp. has access to $400 million of Money Market Committed Preferred Custodial Trust securities (CPS securities) issued by eight Trusts which were created for the primary purpose of issuing CPS securities and investing the proceeds in high quality commercial paper or short-term U.S. government obligations. MBIA Corp. has a put option to sell to the Trusts the perpetual preferred stock of MBIA Corp. If MBIA Corp. exercises its put option, the Trusts will transfer the proceeds to MBIA Corp. in exchange for the preferred stock that will be held by the Trusts. The Trusts are vehicles for providing MBIA Corp. the opportunity to access new capital at its sole discretion through the exercise of the put options. The Trusts are rated AA/Aa2 by S&P and Moody’s, respectively. To date, MBIA Corp. has not exercised its put options under any of these arrangements.
Cash flow needs at the parent company level are primarily for dividends to its shareholders and interest payments on its debt. Liquidity and operating cash requirements of the Company are met by its cash flows generated from operations, which were more than adequate in 2003. Management of the Company believes that cash flows from operations will be sufficient to meet the
Cash requirements have historically been met by upstreaming dividend payments from MBIA Corp., which generates substantial cash flow from premium writings and investment income. In 2003, the Company’s operating cash flow totaled $979 million compared with $873 million in 2002 and $722 million in 2001. The majority of net cash provided by operating activities is generated from the Company’s insurance operations.
Under New York State insurance law, without prior approval of the superintendent of the state insurance department, financial guarantee insurance companies can pay dividends from earned surplus subject to retaining a minimum capital requirement. In MBIA Corp.’s case, dividends in any 12-month period cannot be greater than 10% of policyholders’ surplus as shown on MBIA Corp.’s latest filed statutory financial statements. In 2003, MBIA Corp. declared and paid dividends of $240 million to MBIA Inc. Based upon the filing of its year-end 2003 statutory financial statement, MBIA Corp. has dividend capacity of $131.5 million for the first quarter of 2004 without special regulatory approval. Based on the projected future earnings of MBIA Corp., the Company believes MBIA Corp.’s dividend capacity will continue to be replenished each quarter. Management expects the dividend capacity of MBIA Corp. to be comparable to the current level for the foreseeable future.
The Company has significant liquidity supporting its businesses. At the end of 2003, cash equivalents and short-term investments totaled $1.2 billion. If, for any reason, significant cash flow reductions occur in any of its businesses, MBIA has alternatives for meeting ongoing cash requirements. They include selling or pledging its fixed-income investments in its investment portfolio, tapping existing liquidity facilities and new borrowings.
In addition, the Company has substantial external borrowing capacity. It maintains two short-term bank lines totaling $675 million with a group of highly rated global banks; a $225 million facility with a term of 364 days and a $450 million facility with a four-year term. At year-end 2003, there were no balances outstanding under these agreements.
The investment portfolio provides a high degree of liquidity since it is comprised of readily marketable high-quality fixed-income securities and short-term investments. At year-end 2003, the fair value of the consolidated investment portfolio was $27.7 billion, as shown below:
The increase in insurance-related investments in 2003 was the result of positive cash flow from operations. The fair value of investments related to the investment agreement and medium-term note businesses increased to $9.4 billion from $8.1 billion at December 31, 2002. This increase was a result of growth in the GFL medium-term note program. The TRF investment portfolio and the consolidation of the Conduits at year-end 2003 contributed an additional $8.4 billion in investments.
When the Company holds investments to maturity, unrealized gains or losses currently recorded in accumulated other comprehensive income in the shareholders’ equity section of the balance sheet will decrease over time as the investments approach maturity. As a result, the Company expects to realize a value substantially equal to amortized cost. The Conduit portfolios are considered held-to-maturity, as the Company has the ability and intent to hold these investments to their contractual maturity. Therefore, these portfolios are reported at amortized cost and are not adjusted to reflect unrealized changes in fair value.
MBIA’s consolidated investment portfolio, excluding conduit investments (the Investment Portfolio), includes investments that are insured by MBIA Corp. (MBIA Insured Investments). As of December 31, 2003, the Investment Portfolio was approximately $19.3 billion, of which approximately $4.3 billion, or 22%, consisted of MBIA Insured Investments. Without giving effect to the MBIA guarantee of the MBIA Insured Investments in the Investment Portfolio, as of December 31, 2003, based on the actual or estimated underlying ratings (i) the weighted average rating of the Investment Portfolio would be in the Double-A range, (ii) the average weighted rating of just the MBIA Insured Investments in the Investment Portfolio would be in the Single-A range and (iii) approximately 1.6% of the Investment Portfolio would be rated below investment grade. See the “Investment Management Services” section for additional disclosure on Conduit investment credit ratings.
The following table summarizes the Company’s contractual obligations as of December 31, 2003. For information on the Company’s financial guarantee exposure see Footnote 20 in the Notes to Consolidated Financial Statements.
The Company generates significant liquidity from its operations. Because of its risk management policies and procedures, diversification and reinsurance, the Company believes that the occurrence of an event that would significantly adversely affect liquidity is unlikely.
Since the Company is able and primarily expects to hold its fixed-maturity securities and derivative transactions to maturity, it does not expect to recognize any adverse impact to income or cash flows under the above scenarios.
The board of directors exercises its responsibility for these financial statements through its Audit Committee, which consists entirely of independent non-management board members. The Audit Committee meets periodically with the Company’s independent auditors, both privately and with management present, to review accounting, auditing, internal controls and financial reporting matters.
The Company also provides municipal services through its municipal services operations’ subsidiaries, which are wholly owned by MBIA MuniServices Company (MBIA MuniServices) formed in 1996. Municipal Resources Consultants (MRC) is a revenue audit and information services firm and also provides tax compliance services to state and local governments. Municipal Tax Collection Bureau Inc. (MTB) provides tax compliance services to state and local governments. MTB’s activities have been transferred to MBIA MuniServices and MRC and, as of December 31, 2003, only one service contract remained in MTB. Capital Asset Holdings, Inc. and subsidiaries (Capital Asset) service and manage delinquent municipal tax liens.
TRS Funding Corporation (TRS) was formed in September 1997 to provide clients with structured financing solutions involving the use of total return swaps and credit derivatives. While MBIA does not have a direct ownership interest in TRS, it is consolidated in the financial statements of the Company on the basis that TRS is controlled by MBIA and substantially all risks and rewards are borne by MBIA. In October 2002, all remaining investments and debt obligations of TRS matured. As of December 31, 2003, TRS had two derivative contracts outstanding.
MBIA Asset Finance, LLC (Asset Finance) was formed as a wholly owned subsidiary of the Company in April 2002 as a holding company for the purpose of consolidating MBIA-owned special purpose vehicles. As of September, 2003, it became a wholly owned subsidiary of MBIA-AMC. Assurance Funding Limited (Assurance Funding) was formed in September 2002 and is 99% owned by Asset Finance and 1% owned by MBIA Assurance. Assurance Funding was created as a special purpose vehicle to provide structured funding and credit enhancement services to global structured finance clients. Assurance Funding remained inactive as of December 31, 2003.
Meridian, formed in July 1997, issues medium-term notes in an unlimited number of series of undetermined amounts not to exceed an aggregate principal amount of $8 billion. Proceeds from the issuance of such notes are used to fund the purchase of permitted investments. Such investments primarily consist of asset-backed loans and securities issued by major global structured finance clients. Meridian may enter into various types of derivative agreements for non-trading purposes designed to hedge its exposure to interest rate and foreign currency fluctuations.
CONSOLIDATION The consolidated financial statements include the accounts of the Company, its subsidiaries and entities under its control for which the Company retains substantially all the risks and rewards. All significant intercompany balances have been eliminated. Certain amounts have been reclassified in prior years’ financial statements to conform to the current presentation. The reclassifications had no effect on net income and shareholders’ equity as previously reported.
MBIA regularly monitors its investments in which fair value is less than amortized cost in order to assess whether such a decline in value is other than temporary and, therefore, should be reflected as a realized loss in net income. Such an assessment requires the Company to determine the cause of the decline and whether the Company possesses both the ability and intent to hold the investment to maturity or until the value recovers to an amount at least equal to amortized cost. This assessment requires management to
exercise judgment as to whether an investment is impaired based on market conditions and trends and the availability of relevant data.
PROPERTY AND EQUIPMENT Property and equipment consists of land and buildings, furniture and fixtures, computer equipment and software, and leasehold improvements. All property and equipment is recorded at cost and depreciated over the appropriate useful life of the asset using the straight-line method. The useful lives of each class of assets are as follows:
DERIVATIVES The FASB issued, then subsequently amended, SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” which became effective for the Company on January 1, 2001. Under SFAS 133, as amended, all derivative instruments are recognized on the balance sheet at their fair value, and changes in fair value are recognized immediately in earnings unless the derivatives qualify as hedges. If the derivatives qualify as hedges, depending on the nature of the hedge, changes in the fair value of the derivatives are either offset against the change in fair value of assets, liabilities, or firm commitments through earnings, or recognized in accumulated other comprehensive income until the hedged item is recognized in earnings. Any ineffective portion of a derivative’s change in fair value is recognized immediately in earnings.
Beginning in 2002, the Company made a modification to the methodology it uses to record the amount of loss charged to earnings each period (losses incurred). The Company began recording losses incurred based upon a percentage of scheduled net earned premiums instead of a percentage of net debt service written. The reason for the change in methodology was that during the quarter the premiums were written, losses incurred were being recognized in advance of the related earned premium since the premium was essentially all deferred and recognized as revenue in future periods. The intent of the change was to better match the recognition of incurred losses with the related premium revenue.
MBIA establishes new case basis reserves with respect to an insurance policy when its Loss Reserve Committee determines that (i) a claim has been made or is likely to be made in the future with respect to such policy and (ii) the amount of the ultimate loss that MBIA will incur under such policy can be reasonably estimated. The amount of the case basis reserve with respect to any policy is based on the net present value of the expected ultimate losses and loss adjustment expense payments that the Company expects
to pay with respect to such policy, net of expected recoveries under salvage and subrogation rights. The amount of the expected loss is discounted based on a discount rate equal to the actual yield of the Company’s fixed-income portfolio at the end of the preceding fiscal quarter. Various variables are taken into account in establishing specific case basis reserves for individual policies that depend primarily on the nature of the underlying insured obligation. These variables include the nature and creditworthiness of the underlying issuer of the insured obligations, whether the obligation is secured or unsecured and the expected recovery rates on the insured obligations, the projected cash flow or market value of any assets that support the insured obligation and the historical and projected loss rates on such assets. Factors that may affect the actual ultimate realized losses for any policy include the state of the economy, changes in interest rates, rates of inflation and the salvage values of specific collateral. MBIA believes that reasonably likely changes in any of these factors are not likely to have a material impact on its recorded level of reserves, financial results or financial position, or liquidity.
Management believes that the reserves are adequate to cover the ultimate net cost of claims. However, because the reserves are based on estimates, there can be no assurance that the ultimate liability will not exceed such estimates.
Compensation - Transition and Disclosure,” compensation cost recognized in 2002 is the same as that which would have been recognized had the recognition provisions of SFAS 123 been applied from its original effective date. The following table illustrates the pro forma effect on net income and earnings per share if the fair value method had been applied to all outstanding and unvested awards in each period:
INVESTMENT MANAGEMENT SERVICES OPERATIONS Investment management services results are comprised of the net investment income, fee income, and expenses of MBIA-AMC, MBIA-MISC, IMC, GFL, CMC, 1838, EAAL and the Conduits.
GAINS AND LOSSES Net realized gains and losses are primarily generated as a result of sales of investments as part of the ongoing active total return management of the investment portfolio. Net gains and losses on derivative instruments and foreign exchange are the result of fair valuing the derivative assets and liabilities reported on the balance sheet and gains and losses resulting from related transactions in foreign currencies.
INCOME TAXES Deferred income taxes are provided with respect to the temporary differences between the tax bases of assets and liabilities and the reported amounts in the financial statements that will result in deductible or taxable amounts in future years when the reported amount of the asset or liability is recovered or settled. Such temporary differences relate principally to premium revenue recognition, deferred acquisition costs, unrealized appreciation or depreciation of investments and derivatives, and the contingency reserve.
FOREIGN CURRENCY TRANSLATION Assets and liabilities denominated in foreign currencies are translated at year-end exchange rates. Operating results are translated at average rates of exchange prevailing during the year. Unrealized gains or losses, net of deferred taxes, resulting from translation are included in accumulated other comprehensive income in shareholders’ equity. Gains and losses resulting from transactions in foreign currencies are recorded in current income.
NET INCOME PER COMMON SHARE Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding during the period. Diluted earnings per share shows the dilutive effect of all stock options and other items outstanding during the period that could potentially result in the issuance of common stock. As of December 31, 2003, 2002 and 2001 there were 5,606,205, 5,584,810, and 4,035,843 stock options, respectively, that were not included in the diluted earnings per share calculation because they were antidilutive. A reconciliation of the denominators of the basic and diluted earnings per share for the years ended December 31, 2003, 2002 and 2001 is as follows:
projects dealing with financial instruments and in connection with implementation issues raised in relation to the application of the definition of a derivative. SFAS 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The Company’s financial position and results of operations did not change as a result of the adoption of SFAS 149.
In January 2003, the FASB issued FIN 46, as revised December 2003, as an interpretation of Accounting Research Bulletin No. (ARB) 51, “Consolidated Financial Statements.” FIN 46 addresses consolidation of VIEs by business enterprises. An entity is considered a VIE subject to consolidation if the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support or if the equity investors lack one of three characteristics of a controlling financial interest. First, the equity investors lack the ability to make decisions about the entity’s activities through voting rights or similar rights. Second, they do not bear the obligation to absorb the expected losses of the entity if they occur. Lastly, they do not claim the right to receive expected returns of the entity if they occur, which is the compensation for the risk of absorbing the expected losses. MBIA determined that FIN 46 applies to entities which it sponsors and, in certain cases, unaffiliated entities that it guarantees. See Note 5 for a further discussion on the impact of adoption on the Company’s financial statements.
On December 31, 2002 the FASB issued SFAS 148, which is effective for companies with fiscal years ending after December 15, 2002 and was adopted by the Company as of January 1, 2002. This statement amends SFAS 123. SFAS 148 provides three alternative methods of transition to SFAS 123’s fair value method of accounting for stock-based compensation. The Prospective Method, originally required under SFAS 123, requires that expense be recognized in the year of adoption only for grants made in that year. In subsequent years, expense is recognized for the current year’s grant and for grants made in the years since adoption. Years prior to adoption are not restated. The Modified Prospective Method requires that stock options be expensed as if SFAS 123 had been adopted as of January 1, 1995. Thus, the fair value of any options vesting in the current year that were granted subsequent to January 1, 1995 will be included in expense. However, restatement of prior years is not required. The Retroactive Restatement Method is identical to the Modified Prospective Method in that the fair value of all options vesting in the current year for grants made after January 1, 1995 is included in
The Company completed its transitional impairment testing on its existing goodwill as of January 1, 2002 in accordance with SFAS 142.
As of January 1, 2002, goodwill in the insurance segment totaled $76.9 million. SFAS 142 requires a two-step approach in determining any impairment in goodwill. Step one entails evaluating whether the fair value of a reporting segment exceeds its carrying value. In performing this evaluation the Company determined that the best measure of the fair value of the insurance reporting segment is its book value adjusted for the after-tax effects of net deferred premium revenue less deferred acquisition costs, and the present value of installment premiums to arrive at adjusted book value. Adjusted book value is a common measure used by analysts to determine the value of financial guarantee companies. As of January 1, 2002, the insurance reporting segment’s adjusted book value significantly exceeded its carrying value, and thus there was no impairment of its existing goodwill.
Total goodwill for the segments within the investment management services operations was $13.1 million as of January 1, 2002. In performing step one of the impairment testing, the fair values of the reporting segments were determined using a multiple of earnings before income tax, depreciation and amortization (EBITDA), as this is a common measure of fair value in the investment management industry. The multiple was determined based on a review of current industry valuation practices. As of January 1, 2002, the fair value of the investment management services’ reporting segments significantly exceeded its carrying value indicating that goodwill was not impaired.
The municipal services segment had goodwill of $7.7 million as of January 1, 2002. The fair value of the reporting segment was based on net assets. In comparing fair value to carrying value, it was determined that goodwill was potentially impaired. In performing step two of the impairment testing
Under the provisions of FIN 46, an entity is considered a VIE subject to consolidation if the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support or if the equity investors lack one of three characteristics of a controlling financial interest. First, the equity investors lack the ability to make decisions about the entity’s activities through voting rights or similar rights. Second, they do not bear the obligation to absorb the expected losses of the entity if they occur. Lastly, they do not claim the right to receive expected returns of the entity if they occur, which is the compensation for the risk of absorbing the expected losses. A VIE is consolidated with its primary beneficiary, which is defined as the entity that will absorb the majority of the expected losses, receive the majority of the expected residual returns or both of the VIE.
In May 2003, the Company sponsored the formation of TRF, a public company incorporated in Ireland under the Irish Companies Act. TRF is a conduit established to acquire a loan participation related to the financing of an Italian toll road and, at December 31, 2003, had $1.5 billion of debt outstanding. Assets supporting the repayment of the debt were comprised of the loan participation and high-quality, liquid investments. Assets and liabilities of TRF are included within “Conduit investments held-to-maturity” and “Conduit debt obligations,” respectively, on the Company’s balance sheet. TRF is a variable interest entity, of which MBIA is the primary beneficiary. Therefore, while MBIA does not have a direct ownership interest in TRF, it is consolidated in the financial statements of the Company in accordance with FIN 46.
The Conduits enter into derivative instruments primarily to hedge against interest rate and currency risks. It is expected that any change in the market value of the derivative instruments will be offset by a change in the market value of the hedged assets or liabilities. However, since the investments are accounted for as held-to-maturity, no change in market value, with the exception of the change in value of foreign currency assets due to changes in foreign currency rates, is recorded in the financial statements. Derivative instruments entered into by the Conduits are not accounted for as hedges under SFAS 133 and, therefore, changes in market value are recorded as gains or losses in MBIA’s consolidated income statement.
It is MBIA’s policy to obtain a shadow rating from both Moody’s Investors Service (Moody’s) and Standard & Poor’s (S&P) for each new transaction prior to the execution of such transactions within the Conduits. A shadow rating is the implied rating for the transaction without giving consideration to the MBIA guarantee. All transactions currently funded in the Conduits were shadow-rated at least investment grade by Moody’s and S&P prior to funding. The weighted-average shadow rating for transactions currently funded in the Conduits was A by S&P and A2 by Moody’s at the time such transactions were funded.
With respect to third-party SPVs guaranteed or managed by the Company, MBIA must determine whether it has a variable interest in a VIE and if so, whether that variable interest would cause MBIA to be the primary beneficiary and,
therefore, consolidate the VIE. VIEs are used in a variety of structures insured by MBIA. Under FIN 46, MBIA’s guarantee of the assets or liabilities of a VIE constitute a variable interest and require MBIA to assess whether it is the primary beneficiary. VIEs managed by MBIA represent collateralized debt obligations whereby CMC has been contracted as asset manager and whereby the Company may own a subordinated interest. Consolidation of such VIEs does not increase MBIA’s exposure above that already committed to in its insurance policies or investments. Additionally, VIE assets and liabilities that are consolidated within MBIA’s financial statements may represent amounts above MBIA’s guarantee, although such excess amounts would ultimately have no impact on MBIA’s net income. VIE assets and liabilities consolidated in the Company’s financial statements at December 31, 2003 are related to the Company’s guarantee of a VIE. Such assets and liabilities are reported in “Variable interest entity assets” and “Variable interest entity liabilities,” respectively, on the face of the Company’s balance sheet and totaled $600.3 million.
INSURANCE The Company has entered into derivative transactions that it views as an extension of its core financial guarantee business but which do not qualify for the financial guarantee scope exception under SFAS 133 and, therefore, must be stated at fair value. The insurance operations, which represent the majority of the Company’s derivative exposure, have insured derivatives primarily consisting of pools of credit default swaps, which the Company intends to hold for the entire term of the contract. The insurance operations have also provided guarantees on the value of certain closed-end equity funds, which meet the definition of a derivative under SFAS 133. Changes in fair values of these transactions are recorded through the income statement within net gains (losses) on derivative instruments and foreign exchange.
The Conduits enter into interest rate and foreign currency swaps primarily as economic hedges against interest rate and currency risks. The cross currency swaps qualify as fair value hedges of foreign currency risk under SFAS 133. The Company recognizes the earnings impact of cross currency swaps designated as fair value hedges upon the recognition of the foreign exchange
Cash flow hedges for the IMS operations resulted in an aggregate unrealized loss balance of $4.3 million (net of deferred taxes) remaining in accumulated other comprehensive income at December 31, 2003. The Company expects that approximately $1.8 million (net of tax) will migrate from accumulated other comprehensive income into earnings during 2004 and the remaining amount over the term of the contracts.
CORPORATE The corporate operations have entered into derivatives to hedge foreign exchange risks related to the issuance of certain MBIA long-term debt in accordance with the Company’s risk management policies. As of December 31, 2003, there was one cross currency swap outstanding.
The cross currency swap designated as a cash flow hedge resulted in an aggregate unrealized loss balance of $2.4 million (net of deferred taxes) remaining in accumulated other comprehensive income at December 31, 2003. The Company expects that approximately $1.3 million (net of tax) will migrate
The notional values of the derivative instruments by business operations for the years ended December 31, 2003 and 2002 are as follows:
During 2003, an $11.0 million after-tax increase in the fair value of the cash flow hedges was recorded in other comprehensive income while $0.7 million of after-tax expense was transferred to earnings as a result of scheduled payments and receipts on the cash flow hedges. This resulted in an
ending loss position related to the cash flow hedges in other comprehensive income of $6.7 million as of December 31, 2003. At December 31, 2003, the maximum term of derivative instruments that hedge forecasted transactions was approximately 7 years.
NOTE 7: TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES
It is the Company’s policy to take possession of securities borrowed. These contracts are primarily for MBIA’s collateralized investment and repurchase agreement activity and are only transacted with high-quality dealer firms.
The Company minimizes the credit risk that counterparties to transactions might be unable to fulfill their contractual obligations by monitoring customer credit exposure and collateral value and requiring additional collateral to be deposited with the Company when deemed necessary.
In September 1999, Capital Asset sold substantially all of its remaining tax lien portfolio through a securitization. This securitization was the third in a series of such securitizations. Proceeds from this transaction were used to extinguish an existing warehouse financing facility that had been guaranteed by the Company. MBIA Corp. has insured the notes issued in connection with the securitizations. Consequently, the Company recorded a servicing liability which represents the fair value of such liability based
• upfront premiums are earned as the related risk expires rather than over the period of the risk;
• fixed-maturity securities are reported at amortized cost rather than fair value;
• a contingency reserve is computed on the basis of statutory requirements, and reserves for losses and LAE are established at present value for specific insured issues that are identified as currently or likely to be in default. Under GAAP, reserves are established based on the Company’s reasonable estimate of the identified and unallocated losses and LAE on the insured obligations it has written;
• goodwill under GAAP represents the excess of the cost of acquisitions over the fair value of the net assets acquired, while on a statutory basis, the acquisitions of MBIA Corp. and MBIA Illinois were recorded at statutory book value. Therefore no goodwill was recorded;
• derivative assets and liabilities exclude insurance guarantees, while under GAAP, guarantees that do not qualify for the financial guarantee scope exception under SFAS 133 are recorded at fair value; and
• certain assets designated as “non-admitted assets” are charged directly against surplus but are reflected as assets under GAAP.
The New York State Insurance Department adopted the Codification guidance effective January 1, 2001. However, the New York State Insurance Department did not adopt the Codification rules on deferred taxes until December 31, 2002. The deferred tax effect of adoption on the statutory surplus of MBIA Corp. and its subsidiaries reduced surplus by $10.8 million.
The Company’s investment objective, excluding the Conduit programs which are managed separately, is to optimize long-term, after-tax returns while emphasizing the preservation of capital through maintenance of high quality investments with adequate liquidity. The Company’s investment policies limit the amount of credit exposure to any one issuer. The fixed-maturity portfolio is comprised of high quality (average rating Double-A) taxable and tax-exempt investments of diversified maturities.
The following tables set forth the amortized cost and fair value of the available-for-sale fixed-maturity and short-term investments included in the consolidated investment portfolio of the Company as of December 31, 2003 and 2002:
Fixed-maturity investments carried at fair value of $13.9 million and $13.7 million as of December 31, 2003 and 2002, respectively, were on deposit with various regulatory authorities to comply with insurance laws.
The investments of the Conduits along with the investments of TRF are classified as held-to-maturity and are reported on the balance sheet at amortized cost, net of any unamortized discount and unamortized premium. These investments are primarily asset-backed securities and loans issued by major national and international corporations and other structured finance clients. The following table sets forth the distribution of the Conduit and TRF investments by contractual maturity at amortized cost at December 31, 2003.
ongoing management of all the Company’s investment portfolios. However, 2003 net realized gains were mainly the result of the Company selling securities to shorten the duration of its fixed-maturity portfolio.
The deferred income taxes are reflected in other accumulated comprehensive income in shareholders’ equity.
The Company recognizes deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect on tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The tax effects of temporary differences that give rise to deferred tax assets and liabilities at December 31, 2003 and 2002 are presented in the following table:
MBIA Inc., through its subsidiaries, is a leading provider of financial guarantee products and specialized financial services. MBIA provides innovative and cost-effective products and services that meet the credit enhancement, financial and investment needs of its public- and private-sector clients, domestically and internationally. MBIA manages its activities primarily through three principal business operations: insurance, investment management services and municipal services. The Company has defined reportable segments within its business operations based on the way management assesses the performance and resource requirements of such operations.
The insurance operations provide an unconditional and irrevocable guarantee of the payment of principal and interest on insured obligations when due. The Company views its insurance operations as a reportable segment. This segment includes all activities related to global credit enhancement services provided principally by MBIA Corp. and its subsidiaries.
The Company’s municipal services operations provide revenue enhancement services and products to public-sector clients nationwide, consisting of discovery, audit, collections/recovery, enforcement and information services through MBIA MuniServices and its wholly owned subsidiaries. The Company views its municipal services operations as a reportable segment.
Reportable segment results are presented net of material intersegment transactions. The following table summarizes the Company’s operations for the years ended December 31, 2003, 2002 and 2001:
An increasingly significant portion of premiums reported within the insurance segment are generated outside the United States. The following table summarizes net premiums earned by geographic location of risk for years ended December 31, 2003, 2002 and 2001.
On March 15, 2001 the Company’s board of directors approved a three-for-two stock split. The three-for-two stock split was accomplished through a stock dividend distributed on April 20, 2001 to shareholders of record on April 2, 2001. All references to the number of common shares, except shares authorized, and to the per share information in the consolidated financial statements and related notes, have been adjusted to reflect the stock split on a retroactive basis.
Under New York State insurance law, without prior approval of the superintendent of the state insurance department, financial guarantee insurance companies can pay dividends from earned surplus subject to retaining a minimum capital requirement. In the Company’s case, dividends in any 12-month period cannot be greater than 10% of policyholders’ surplus as shown on MBIA Corp.’s latest filed statutory financial statements. In 2003, MBIA Corp. declared and paid dividends of $240.0 million and, based upon the filing of its year-end 2003 statutory financial statement, has dividend capacity of $131.5 million for the first quarter of 2004 without special regulatory approval. During 2004, a similar calculation will be performed each quarter to determine the amount of dividend capacity for MBIA Corp.
The insurance departments of New York State and certain other statutory insurance regulatory authorities, and the agencies that rate the bonds insured by MBIA Corp. and its subsidiaries, have various requirements relating to the maintenance of certain minimum ratios of statutory capital and reserves to net insurance in force. MBIA Corp. and its subsidiaries were in compliance with these requirements as of December 31, 2003 and 2002.
* These notes bear interest at three-month LIBOR plus a fixed spread. The current interest rate in effect is 1.943%.
The Company’s long-term debt is subject to certain covenants, none of which significantly restricts the Company’s operating activities or dividend-paying ability.
In August of 2002, the Company completed a $300 million debt offering of 20-year senior notes, which carry a coupon rate of 6.4%. Part of the proceeds from this offering were used to redeem the Company’s $100 million 8.2% debentures due October 1, 2022. This redemption occurred on October 1, 2002. The remainder of the proceeds was used for general corporate purposes.
At January 1, 2003, the Company maintained $211 million of stop loss reinsurance coverage with three reinsurers. At the end of the third quarter, the Company elected not to renew two of the facilities with $175 million of coverage due to the rating downgrade of the stop loss providers. In addition, at the end of 2003, MBIA Corp. elected not to renew the remaining $35.7 million of stop loss reinsurance coverage effective January 1, 2004, also due to the rating downgrade of the stop loss reinsurer.
The Company also maintained two ten-year stop loss reinsurance facilities maturing in 2011 and 2012 for $100 million and $50 million, respectively. These facilities allowed the Company to issue subordinated securities and could be drawn upon if the Company incurred cumulative losses (net of any recoveries) above an annually adjusted attachment point, which was $1.76 billion for 2003. The $50 million facility was not renewed in the fourth quarter due to a rating downgrade of the related provider, with the remaining $100 million facility remaining in effect as of December 31, 2003.
The Company and MBIA Corp. maintain two short-term bank liquidity facilities totaling $675 million; a $225 million facility with a term of 364 days and a $450 million facility with a four-year term. As of December 31, 2003, there were no borrowings outstanding under these agreements.
remaining assets, liabilities and derivative contracts of TRS matured. As of December 31, 2003, TRS remains inactive.
The Company has $19.8 million of outstanding letters of credit for MBIA-MISC that are intended to support the net asset value of certain investment pools managed by MBIA-MISC. These letters can be drawn upon in the event that the liquidation of such assets is required and the proceeds are less than the cost. In addition, the Company has issued commitments to three pooled investment programs managed or administered by MBIA-MISC and its subsidiary. These commitments cover losses in such programs should the net asset values per share decline below specified per share values. At December 31, 2003, the maximum amount of future payments that the Company would be required to make under these commitments was $2.9 billion. These commitments shall be in effect so long as MBIA-MISC and its subsidiary remain as manager or administrator and each program remains in compliance with its respective investment objectives and policies.
Conduit debt obligations, including TRF, are recorded as liabilities on the balance sheet based upon proceeds received, net of unamortized discount and unamortized premium plus unpaid accrued interest. These obligations include long-term, medium-term and commercial paper note obligations. The long-term note obligation had an interest rate of 1.6%. The rates of the medium-term note obligations are indexed to LIBOR and as of December 31, 2003 range from 1.24% to 4.31%. The commercial paper note obligations had interest rates ranging from 1.03% to 1.30% as of December 31, 2003. The weighted-average interest rate of all Conduit obligations was 2.0%.
Included above in the obligations maturing in 2004 are Triple-A commercial paper note obligations of $2.6 billion, which mature January 2004. Triple-A enters into 364-day or shorter term credit facilities with multiple independent third-party credit support providers as a source of liquidity in the event of a commercial paper market disruption.
The insurance operations have entered into certain guarantees of derivative contracts, included in the preceding tables, which do not qualify for the financial guarantee scope exception under SFAS 133. These contracts are discussed further in Note 6. The maximum amount of future payments that MBIA Corp. may be required to make under these guarantees, should a full default occur, is $68.3 billion. This amount is net of cessions to reinsurers of $15.2 billion. MBIA Corp.’s guarantees of derivative contracts have a legal maximum range of maturity of 1 - 75 years. A small number of guaranteed credit derivative contracts have long maturities to satisfy regulatory requirements imposed on MBIA’s counterparties. However, the expected maturities of such contracts are much shorter due to amortizations and prepayments in the underlying collateral pools. In accordance with SFAS 133, the fair values of these guarantees at December 31, 2003 are recorded on the balance sheet as assets and liabilities, representing gross gains and losses, of $55.8 million and $49.6 million, respectively.
MBIA Corp. may hold recourse provisions with third parties in these transactions through both reinsurance and subrogation rights. MBIA Corp.’s reinsurance arrangements provide that should MBIA Corp. pay a claim under a guarantee of a derivative contract, then MBIA Corp. can collect amounts from any reinsurers that have reinsured the guarantee on either a proportional or non-proportional basis depending upon the underlying reinsurance agreement. MBIA Corp. may also have recourse through subrogation rights whereby if MBIA Corp. makes a claim payment, it is entitled to any rights of the insured counterparty, including the right to any assets held as collateral.
MBIA Corp. has also issued guarantees of certain obligations issued by its investment management affiliates that are not included in the previous tables. These guarantees take the form of insurance policies issued by MBIA Corp. on behalf of the investment management affiliates. Should one of these affiliates default on their insured obligations, MBIA Corp. will be required to pay all scheduled principal and interest amounts outstanding. As of December 31, 2003, the maximum amount of future payments that MBIA Corp. could be required to make under these guarantees, should a full default occur, is $9.7 billion. These guarantees have a maximum range of maturity of 1 - 42 years. These guarantees were entered into on an arm’s length basis and are fully collateralized by marketable securities. MBIA Corp. has both direct recourse provisions and subrogation rights in these transactions. If MBIA Corp. is required to make a payment under any of these affiliate guarantees, it would have the right to seek reimbursement from such affiliate and to
MBIA Corp. reinsures exposure to other insurance companies under various treaty and facultative reinsurance contracts, both on a pro-rata and non-proportional basis. In the event that any or all of the reinsurers were unable to meet their obligations, MBIA Corp. would be liable for such defaulted amounts.
As part of the Company’s portfolio shaping activity in 1998, the Company entered into reinsurance agreements with highly rated reinsurers that obligate the Company to cede future premiums to the reinsurers through October 1, 2004.
The Company has a non-contributory, defined contribution pension plan to which the Company contributes 10% of each eligible employee’s annual compensation. Annual compensation consists of base salary, bonus and commissions, as applicable, for determining such contributions. Pension benefits vest over a five-year period with 60% vesting after three years and 20% in years four and five. Pension expense for the years ended December 31, 2003, 2002 and 2001 was $10.1 million, $10.1 million, and $7.4 million, respectively.
The Company also has a profit-sharing/401(k) plan. The plan is a voluntary contributory plan that allows eligible employees to defer compensation for federal income tax purposes under Section 401(k) of the Internal Revenue Code of 1986, as amended. Employees may contribute through payroll deductions up to 10% of eligible compensation. The Company matches employee contributions up to the first 5% of such compensation with MBIA common stock. The benefit of the Company’s contributions vests over five years with 60% vesting after three years and then 20% in years four and five. Generally, a participating employee is entitled to distributions from the plan upon termination of
employment, retirement, death or disability. Participants who qualify for distribution may receive a single lump sum, transfer the assets to another qualified plan or individual retirement account, or receive a series of specified installment payments. Company contributions to the profit-sharing/401(k) plan aggregated $5.1 million, $3.4 million, and $3.1 million for the years ended December 31, 2003, 2002 and 2001, respectively.
Amounts relating to the above plans that exceed limitations established by federal regulations are contributed to a non-qualified deferred compensation plan. These non-qualified contributions are included in the above stated pension and profit-sharing/401(k) match amounts and totaled $3.4 million, $3.9 million, and $3.0 million for the pension plan, and $1.7 million, $1.5 million, and $1.8 million for the profit-sharing/401(k) plan for the years ending December 31, 2003, 2002 and 2001, respectively.
On May 11, 2000, the Company’s shareholders approved the 2000 Stock Option Plan (the 2000 plan). The 2000 plan superseded the Company’s 1987 stock option plan (the 1987 plan), and shares available for grant under the 1987 plan were canceled and are no longer available for grant. Options previously granted under the 1987 plan remain outstanding in accordance with their terms and with the terms of the 1987 plan. The 2000 plan enables key employees of the Company and its subsidiaries to acquire shares of common stock of the Company or to benefit from appreciation in the price of the common stock of the Company. Options granted will either be Incentive Stock Options (ISOs), where they qualify under Section 422(a) of the Internal Revenue Code, or Non-Qualified Stock Options (NQSOs).
In December 1995, the Company adopted a restricted stock program whereby certain employees are granted restricted shares of the Company’s common stock. These stock awards may only be sold three, four or five years from the date of grant, at which time the awards fully vest.
In 2003 and 2002, respectively, 247,543 and 124,815 restricted shares (net of canceled shares) of the Company’s common stock were granted to certain employees and directors of the Company. The fair value of the shares awarded (net of cancellations) in 2003 and 2002, determined on the grant date, was $9.0 million and $6.7 million, respectively, which has been recorded as “Unearned compensation-restricted stock” and is shown as a separate component of shareholders’ equity. Unearned compensation is amortized to expense over the appropriate three- to five-year vesting period (except for a minor portion granted to members of the MBIA Inc. board of directors which are
amortized over a ten-year period). Compensation expense related to the restricted stock was $6.3 million, $5.4 million, and $2.9 million for the years ended December 31, 2003, 2002 and 2001, respectively.
Effective January 1, 2002 the Company adopted the fair value recognition provisions of SFAS 123. Under the modified prospective method of adoption selected by the Company under the provisions of SFAS 148, compensation cost recognized in 2002 is the same as that which would have been recognized had the recognition provisions of SFAS 123 been applied from its original effective date. Results for prior years have not been restated. Employee stock compensation expense for the years ended December 31, 2003 and 2002 totaled $26.4 million and $23.9 million, respectively.
The following table summarizes information about the plan’s stock options at December 31, 2003:
• Affiliates of the Company: An affiliate is a party that directly or indirectly controls, is controlled by or is under common control with the Company. Control is defined as having, either directly or
• Principal owners of the Company defined as owners of record or known beneficial owners of more than 10 percent of the voting interests of the Company.
• Management of the Company which includes persons who are responsible for achieving the objectives of the Company and who have the authority to establish policies and make decisions by which those objectives are to be pursued. Management normally includes members of the board of directors, the chief executive officer, chief operating officer, vice president in charge of principal business functions and other persons who perform similar policymaking functions.
• Other parties with which the Company may deal if one party controls or can significantly influence the management or policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests.
From time to time the Company may enter into transactions with related parties that the Company deems immaterial or which occur in the normal course of business and are transacted at “arms length.” Since 1989, MBIA Corp. has executed five surety bonds to guarantee the payment obligations of the members of the Association that had their S&P claims-paying rating downgraded from Triple-A on their previously issued Association policies. In the event
that they do not meet their Association policy payment obligations, MBIA Corp. will pay the required amounts directly to the paying agent. The aggregate outstanding exposure on these surety bonds as of December 31, 2003 is $340 million.
MBIA Inc., through its subsidiaries, is responsible for providing investment advisory and certain related administrative services to the MBIA Capital/Claymore Managed Duration Investment Grade Municipal Fund, the 1838 Bond-Debenture Trading Fund and the 1838 Investment Advisors Funds (collectively, the “Funds”). Additionally, MBIA, Inc., through its subsidiaries, earned investment management, accounting, administration and service fees related to the Funds, which aggregated $1.4 million and $1.7 million, for the years ended December 31, 2003 and 2002, respectively, and are included in revenues in the accompanying Consolidated Statements of Income.
The Company had no loans outstanding with any executive officers or directors during 2003, with the exception of split-dollar life insurance policies. As the Company believes such policies fall within the prohibitions on loans to executives imposed under the Sarbanes-Oxley Act, such policies were terminated in the fourth quarter of 2003.
The estimated fair value amounts of financial instruments shown in the following table have been determined by the Company using available market information and appropriate valuation methodologies. However, in certain cases considerable judgment was required to interpret market data in order to develop estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amount the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
FIXED-MATURITY SECURITIES-The fair value of fixed-maturity securities available-for-sale is based upon quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES-The carrying amount is composed of the present value of the expected cash flows for specifically identified
claims combined with an estimate for unidentified claims. Therefore, the carrying amount is a reasonable estimate of the fair value of the reserve.
INVESTMENT AGREEMENTS AND MEDIUM-TERM NOTES-The fair values of investment agreements and medium-term notes 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 agreements being valued.
LONG-TERM DEBT-The fair value is estimated based on the quoted market prices for the same or similar securities.
DERIVATIVES-The fair value derived from market information and appropriate valuation methodologies reflects the estimated amounts that the Company would receive or pay to terminate the transaction at the reporting date.
VARIABLE INTEREST ENTITY LIABILITIES-Variable interest entity liabilities consist of floating rate securities and related accrued interest. The carrying values of variable interest entity liabilities approximate their fair values due to the term of the applicable interest rates.
INSTALLMENT PREMIUMS-The fair value is derived by calculating the present value of the estimated future cash flow streams. The discount rate used is the actual yield of the Company’s insurance-related investment portfolio at the end of the preceding fiscal quarter. At March 31, June 30, September 30 and December 31, 2003 the discount rates were 5.6%, 5.3%, 5.1% and 4.7%, respectively, while 2002 was at 9.0%.