A wholly-owned subsidiary of National owns the office building in Armonk, New York, in which the Company, National, MBIA Corp., Cutwater and Optinuity have their headquarters. The Company also leases office space in New York, New York; San Francisco, California; Paris, France; Mexico City, Mexico; and London, England. Cutwater leases office space in Denver, Colorado. The Company is seeking to sell its headquarters property and relocate in order to reduce operating costs, but otherwise generally believes that these facilities are adequate and suitable for its current needs.
(1)-Amounts were revised. Refer to “Note: 17 Earnings Per Share” in the Notes to Consolidated Financial Statements of MBIA Inc. and Subsidiaries in Part II, Item 8 of this Form 10-K for additional information.
National seeks to generate shareholder value through appropriate risk adjusted pricing; however, current market conditions and the competitive landscape may limit National’s new business opportunities and its ability to price and underwrite risk with attractive returns. An increase in interest rates and issuances of new municipal debt in 2014 would present new business opportunities for National in the U.S. public finance market.
In August of 2013, the novation agreement between Financial Guaranty Insurance Corporation (“FGIC”) and National, whereby FGIC transferred, by novation, to National all the rights and liabilities under each of the policies covered under a reinsurance agreement with FGIC, became effective. This novation agreement included covered policies that previously benefited from the reinsurance agreement and second-to-pay policies entered into by MBIA Insurance Corporation in 2008 that were subsequently assigned to and reinsured by National in 2009. As a result of this novation, National is now the primary insurer under these policies.
In May of 2013, the Company executed the BofA Settlement Agreement which resulted in MBIA Corp. repaying the remaining balance and accrued interest on the National Secured Loan. Refer to “Note 1: Business Developments and Risks and Uncertainties” in the Notes to Consolidated Financial Statements for a discussion of the BofA Settlement Agreement.
During 2013, MBIA Corp’s liquidity position has been substantially strengthened as a result of the BofA Settlement Agreement and the sale of the ResCap Claims. MBIA Corp. continues to manage liquidity risk and satisfy all contractual payment obligations. Our expected liquidity and capital forecasts for MBIA Corp. and projected collections of excess spread and the remaining put-back recoverable reflect more than adequate resources to pay expected claims. However, there are risks to these forecasts, as the amount and timing of potential claims from our remaining insured CMBS pools and RMBS exposures are potentially volatile, as are the projected collections of excess spread and the remaining put-back recoverable. If MBIA Corp. experiences higher than expected claim payments or is unable to commute the remaining insurance exposures that represent substantial risk to the Company, MBIA Corp. may ultimately have insufficient resources to continue to pay claims, which could cause the New York State Department of Financial Services (“NYSDFS”) to put MBIA Insurance Corporation into a rehabilitation or liquidation proceeding. Refer to the “Liquidity-MBIA Corp. Liquidity” section for additional information on MBIA Corp.’s liquidity position.
The U.S. economy steadily improved during 2013 aided by stabilization in the housing and automobile sectors. In addition, the unemployment rate dropped in the fourth quarter of 2013 to its lowest level in five years. On the heels of these improving signs in the U.S. economy, in January of 2014 the Federal Reserve began tapering their quantitative easing programs and reaffirmed their intention to keep short-term interest rates low. Information concerning our interest rate sensitivity appears in Part II, Item 7A, “Quantitative and Qualitative Disclosures about Market Risk.” The continued improvement in the labor market should help to increase personal incomes, and the passing of the federal budget and extension of the debt ceiling by Congress should reduce both the possibility of a government shutdown and any default of its debt until 2015. However, the ultimate outcome on the continued implementation of the Affordable Care Act will add uncertainty to the business and consumer segments of our economy. We believe confidence in the U.S. economy should continue to expand in 2014, however, sustained job growth and resolution of fiscal policies in Washington are paramount to a complete recovery. While Europe continues to display signs of recovering from its recession and enters 2014 with more positive sentiment than a year ago, such signs are still inconclusive and unemployment rates there are still high. Prolonged debt and budget issues and related austerity programs suggest that it may be some time before Europe shows sustained growth and a robust recovery. MBIA’s business outlook should be viewed against this backdrop since these are some of the key economic conditions which, together with the volatility of gains and losses on our insured credit derivatives, significantly impact our financial results.
For the year ended December 31, 2013, we recorded consolidated net income of $250 million, or $1.29 per diluted share, compared with consolidated net income of $1.2 billion, or $6.33 per diluted share, for 2012 and a consolidated net loss of $1.3 billion, or $6.85 per diluted share, for 2011.
For the year ended December 31, 2013, consolidated adjusted pre-tax loss was $452 million compared with adjusted pre-tax losses of $708 million and $497 million for 2012 and 2011, respectively.
Our consolidated shareholders’ equity increased slightly to $3.3 billion as of December 31, 2013 compared with $3.2 billion as of December 31, 2012. Our consolidated book value per share as of December 31, 2013 was $17.05 compared with $16.22 as of December 31, 2012.
Loss and loss adjustment expense (“LAE”) reserves are established by loss reserve committees in each of our major operating insurance companies (National, MBIA Insurance Corporation, and MBIA UK Insurance Limited) and reviewed by our executive Loss Reserve Committee, which consists of members of senior management. Loss and LAE reserves include case basis reserves and accruals for LAE incurred with respect to non-derivative financial guarantees. Case basis reserves represent our estimate of expected losses to be paid under insurance contracts, net of potential recoveries, on insured obligations that have defaulted or are expected to default. 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 the actual ultimate losses will not be greater than or less than such estimates resulting in the Company recognizing additional or reversing excess loss and LAE reserves through earnings.
We have categorized our financial instruments measured at fair value into the three-level hierarchy according to accounting guidance for fair value measurements and disclosures based on the significance of pricing inputs to the measurement in its entirety. Fair value measurements of financial instruments that use quoted prices in active markets for identical assets or liabilities are generally categorized as Level 1, and fair value measurements of financial instruments where significant inputs are not observable are generally categorized as Level 3. We categorize our financial instruments based on the lowest level category at which we can generate reliable fair values. The determination of reliability requires management to exercise judgment. The degree of judgment used to determine the fair values of financial instruments generally correlates to the degree that pricing is not observable.
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. Refer to “Note 7: Fair Value of Financial Instruments” in the Notes to Consolidated Financial Statements for additional information about assets and liabilities classified as Level 3.
The following table presents the fair values of assets and liabilities measured and reported at fair value on a recurring basis on our consolidated balance sheets that are classified as Level 3 within the fair value hierarchy as of December 31, 2013 and 2012:
For the year ended December 31, 2013, our consolidated adjusted pre-tax loss decreased when compared with 2012 primarily as a result of decreases in impairments on insured credit derivatives and insurance losses and LAE, and the absence of net investment losses related to other-than-temporary impairments (“OTTI”). These changes were partially offset by lower premiums earned and lower net investment income. In addition, our consolidated adjusted pre-tax loss for the year ended December 31, 2013 includes expenses of approximately $97 million related to settlement, consulting and legal expenses associated with the resolution of litigation matters and settlements.
NET PREMIUMS EARNED Net premiums earned on non-derivative financial guarantees represent gross premiums earned net of premiums ceded to reinsurers, and include scheduled premium earnings and premium earnings from refunded issues. The decrease in net premiums earned for the year ended December 31, 2013 compared with 2012 resulted from a decrease in refunded premiums earned of $102 million and a decrease of $24 million in scheduled premiums earned. The increase in net premiums earned for the year ended December 31, 2012 compared with 2011 resulted from an increase in refunded premiums earned of $99 million, partially offset by a decrease in scheduled premiums earned of $61 million. Scheduled premium earnings in 2013 and 2012 declined due to the refunding and maturity of insured issues within our U.S. public finance portfolio with no material new insurance writings. Refunding activity over the past several years has accelerated premium earnings in prior periods and reduced the amount of scheduled premiums that would have been earned in the current period. Refundings have experienced a decline when compared to the prior periods due to an overall decrease in municipal market issuance.
Investment asset balances at amortized cost as of December 31, 2013 and 2012 are presented in the following table:
OTHER NET REALIZED GAINS (LOSSES) Other net realized gains (losses) for the year ended December 31, 2013 related to an impairment charge of $29 million for our Armonk, New York facility. Other net realized gains (losses) for the year ended December 31, 2011 related to an impairment loss of $31 million, representing the full write-off of goodwill held by National.
Losses and LAE for the year ended December 31, 2013 primarily related to certain general obligation bonds and the loss related to the difference in the value of the salvage receivable recorded and the fair market value of the marketable securities received in connection with the restructuring of a gaming revenue transaction. We expect to recover the full value of the original salvage receivable in the future from the securities received as a result of this restructuring. Under U.S. STAT, which differs from GAAP in certain respects, the salvage receivable for the gaming revenue transaction continues to be reflected as a component of National’s loss reserves. Refer to “Note 11: Statutory Accounting Practices” in the Notes to Consolidated Financial Statements of National within exhibit 99.1 of this annual report on Form 10-K for an explanation of the differences between U.S. STAT and GAAP. For the year ended December 31, 2012, losses and LAE primarily related to certain general obligation bonds and lease transactions. For the year ended December 31, 2011, losses and LAE primarily related to two tax-backed transactions, a toll road transaction and a housing transaction.
Certain local governments remain under extreme financial and budgetary stress and several have filed for protection under the United States Bankruptcy Code, or have entered into state statutory proceedings established to assist municipalities in managing through periods of severe fiscal stress. This could lead to an increase in defaults by such entities on the payment of their obligations and losses or impairments on a greater number of our insured transactions. We continue to monitor and analyze these situations very closely, however the overall extent and duration of these events is uncertain.
Loss and LAE reserves as of December 31, 2013 decreased when compared with December 31, 2012 primarily as a result of the Allegheny Health, Education and Research Foundation transaction discussed below, partially offset by increases in certain general obligation bonds reserves.
Insurance loss recoverable as of December 31, 2013 decreased when compared with December 31, 2012 primarily as a result of the receipt of salvage in connection with the restructuring of a gaming revenue transaction and collections of other recoverables.
Gross expenses represent total insurance expenses before the deferral of any policy acquisition costs. Gross expenses decreased for the year ended December 31, 2013 compared with 2012 primarily due to a decrease in legal and litigation related costs. Gross expenses increased for the year ended December 31, 2012 compared with 2011 primarily due to an increase in legal and litigation related costs.
The following table presents the credit quality distribution of MBIA’s U.S. public finance outstanding gross par insured as of December 31, 2013 and 2012. Capital appreciation bonds (“CABs”) are reported at the par amount at the time of issuance of the insurance policy. All ratings are as of the period presented and represent S&P ratings. If transactions are not rated by S&P, a Moody’s equivalent rating is used. If transactions are not rated by either S&P or Moody’s, an internal equivalent rating is used. The credit quality distribution of our U.S. public finance insurance exposure as of December 31, 2013 remained relatively consistent with December 31, 2012.
The following is a summary of exposures within the insured portfolio of our U.S. public finance insurance segment related to the Commonwealth of Puerto Rico or certain of its instrumentalities in that territory as of December 31, 2013. S&P ratings are as of February 4, 2014.
The loss of investment grade ratings across certain Puerto Rico issuers could trigger acceleration of principal and interest payments on a portion of its debt including certain derivatives. In addition, these rating actions will constrain traditional market access for Puerto Rico and certain of its instrumentalities, further straining liquidity. While Puerto Rico and certain of its instrumentalities are experiencing fiscal stress that could lead to defaults on its debt obligations, it has taken pro-active actions to address its significant financial challenges including its intention to issue bonds in early 2014. We will be reviewing the execution and resulting application of proceeds from these bond issuances carefully to determine Puerto Rico’s ability to meet its near term obligations while its recently enacted financial reforms take effect. At this time, we do not expect a default by Puerto Rico or certain of its instrumentalities in that territory. All of the insured obligations included in the preceding table are presently current on debt service payments.
Adjusted pre-tax loss for the year ended December 31, 2012 increased when compared with 2011 principally due to a decrease in premiums earned, an increase in insurance losses and LAE, an increase in interest expense from the National Secured Loan that was established in December of 2011, and a decrease on net gains from asset sales, partially offset by decreased impairments on insured credit derivatives.
The following table presents the adjusted pre-tax income (loss) of our structured finance and international insurance segment, and a reconciliation of adjusted pre-tax income (loss) to GAAP pre-tax income (loss) for the years ended December 31, 2013, 2012 and 2011:
(1)-Premiums related to insured derivatives are included in “Realized gains (losses) and other settlements on insured derivatives” on our consolidated statements of operations.
NET CHANGE IN FAIR VALUE OF INSURED DERIVATIVES The following table presents the net premiums and fees earned related to derivatives and the components of the net change in fair value of insured derivatives for the years ended December 31, 2013, 2012 and 2011:
The Company no longer insures new credit derivative contracts except in transactions related to the restructuring or reduction of existing derivative exposure. Premiums earned related to insured credit derivatives will decrease over time as a result of settlements prior to maturity and scheduled amortizations. For the years ended December 31, 2013 and 2012, realized losses on insured derivatives resulted primarily from settlements and claim payments on CMBS and ABS transactions. For 2011, realized losses on insured derivatives resulted primarily from settlements and claim payments on multi-sector CDOs and CMBS transactions.
For the year ended December 31, 2013, unrealized gains on insured derivatives were principally associated with the reversal of unrealized losses from commutations, a decline in the weighted average life on transactions and favorable changes in spreads/prices on the underlying collateral, partially offset by the effects of MBIA Corp.’s nonperformance risk on its derivative liabilities. For the year ended December 31, 2012, unrealized gains on insured derivatives were principally associated with the reversal of unrealized losses from commutations, the effects of MBIA Corp.’s nonperformance risk on its derivative liabilities and the result of favorable movements in spreads and pricing on collateral within transactions, partially offset by collateral erosion. For the year ended December 31, 2011, unrealized losses on insured derivatives were principally the result of favorable changes in the market perception of MBIA Corp.’s nonperformance risk on its derivative liability, reduced collateral pricing and collateral erosion, partially offset by the reversal of unrealized losses from settlements of contracts prior to maturity and terminations.
As of December 31, 2013, we had $24.0 billion of gross par outstanding on insured credit derivatives compared with $47.5 billion as of December 31, 2012. The decrease in gross par outstanding was primarily due to contractual terminations, amortizations and maturities. During the year ended December 31, 2013, 38 insured issues, representing $22.5 billion in gross par outstanding, either matured or contractually settled prior to maturity.
Costs associated with mitigating credit impairments on insured derivatives are expensed as incurred and included within “Operating expense” in our consolidated statements of operations. These costs totaled $5 million, $7 million and $12 million for the years ended December 31, 2013, 2012 and 2011, respectively.
NET GAINS (LOSSES) ON FINANCIAL INSTRUMENTS AT FAIR VALUE AND FOREIGN EXCHANGE The decreases in net gains (losses) on financial instruments at fair value and foreign exchange in 2013 and 2012 were primarily due to decreases in net realized gains from the sales of securities.
LOSS AND LOSS ADJUSTMENT EXPENSES MBIA’s insured portfolio management group within its structured finance and international insurance business is responsible for monitoring structured finance and international insured obligations. The level and frequency of monitoring of any insured issue depends on the type, size, rating and performance of the insured issue. If we identify concerns with respect to the performance of an insured issue we may designate such insured issue as “Caution List-Low,” “Caution List-Medium,” “Caution List-High,” or “Classified” depending on the likelihood of a loss. We establish case basis reserves in connection with insured issues designated as Classified credits.
The impact of insured exposures on the Company’s liquidity position is best understood by assessing the ultimate amount of payments that the Company will be required to make with respect to these exposures. In this regard, the Company discloses the discounted expected future net cash flows to be made under all insurance contracts, irrespective of the legal form of the guarantee (i.e., financial guarantee insurance policy or insured derivative contract) or the GAAP accounting basis.
All amounts presented in the following aggregate losses and LAE tables are calculated in accordance with GAAP, with the exception of those related to insured credit derivative impairments. The amounts reported for insured credit derivative impairments are calculated in accordance with U.S. STAT because GAAP does not contain a comparable measurement basis for these contracts. All losses and recoverables reported in the following tables are measured using discounted probability-weighted cash flows. Losses and recoverables on VIEs that are eliminated in consolidation are included because the consolidation of these VIEs does not impact whether or not we will be required to make payments under our insurance contracts. As a result of the different accounting bases of amounts included in the following tables, the total provided in each table represents a non-GAAP measure.
The following tables present the aggregate loss and LAE reserves and insurance loss recoverables as of December 31, 2013 and 2012, and the aggregate change in the discounted values of net payments expected to be made on all insurance contracts for the years ended December 31, 2013, 2012 and 2011:
(1)-Included in “Losses and loss adjustment,” “Loss and loss adjustment expense reserves,” and “Insurance loss recoverable” on the Company’s consolidated financial statements.
(4)-Represents “Losses and loss adjustment,” “Loss and loss adjustment expense reserves” and “Insurance loss recoverable” on the Company’s consolidated financial statements that are ceded to third-party reinsurers under insurance contracts. As of December 31, 2013 and 2012, there was a $2 million and $1 million receivable, respectively, related to insured credit derivative impairments and LAE reinsurance.
Aggregate Losses and LAE (change in discounted values of net payments)
The decrease in total aggregate losses and LAE for 2013 compared with 2012 was primarily due to lower increases in expected future payments on CMBS and first and second-lien RMBS exposures. Partially offsetting these decreases were changes in actual and expected salvage primarily related to lower expected recoveries resulting from excess spread (the difference between interest inflows on mortgage loan collateral and interest outflows on insured beneficial interests) within the RMBS securitizations.
The increase in total aggregate losses and LAE for 2012 compared with 2011 was primarily due to reduced future expected recoveries on second-lien RMBS exposures. In addition, during the year ended December 31, 2011, commutation settlements of ABS policies below established reserves were partially offset by commutation settlements for CMBS polices in excess of established reserves.
In addition to the information presented above, the following tables present aggregate losses and LAE for the years ended December 31, 2013, 2012 and 2011 by insurance type:
(2)-Primarily represents high yield corporate CDOs and an international road transaction.
For 2011, the loss and LAE related to actual and expected future payments of $323 million included $163 million related to insured second-lien RMBS transactions, $94 million related to insured first-lien RMBS transactions and $66 million related to other activity. Included in the recoveries of actual and expected future payments of $405 million were recoveries related to second-lien RMBS transactions, resulting from ineligible mortgage loans included in insured exposures that were subject to contractual obligations by sellers/servicers to repurchase or replace such mortgage loans of $448 million and $25 million related to other recovery activity. This was partially offset by a $68 million reduction in excess spread within the securitizations.
For the years ended December 31, 2013, 2012 and 2011, losses and LAE incurred included the elimination of a $56 million benefit, a $140 million expense and a $90 million benefit, respectively, as a result of the consolidation of VIEs. The $56 million benefit for the year ended December 31, 2013 included gross recoveries of actual and expected payments of $98 million, partially offset by gross losses related to actual and expected future payments of $42 million. The $140 million expense for the year ended December 31, 2012 included gross losses related to actual and expected future payments of $100 million and recoveries of actual and expected payments of $40 million. The $90 million benefit for the year ended December 31, 2011 included recoveries of actual and expected payments of $351 million, partially offset by gross losses related to actual and expected future payments of $261 million.
Included in the Company’s loss and LAE reserves are both reserves for insured obligations for which a payment default has occurred and MBIA Corp. has already paid a claim and also for which a payment default has not yet occurred but a claim is expected in the future. The following table includes LAE reserves as of December 31, 2013 and 2012 for one and four issues, respectively, that had no expected future claim payments or par outstanding, but for which the Company was obligated to pay LAE incurred in prior periods. As of December 31, 2013 and 2012, loss and LAE reserves comprised the following:
MBIA reports expected potential recoveries of certain paid claims within “Insurance loss recoverable” and the corresponding estimated recovery amounts due to reinsurers within “Other liabilities” on the Company’s consolidated balance sheets. As of December 31, 2013 and 2012, our insurance loss recoverable in our structured finance and international insurance segment was $681 million and $3.4 billion, respectively. The decrease in our insurance loss recoverable primarily resulted from the collections of previously established recoveries related to the BofA Settlement Agreement related to insured second-lien RMBS securitizations. As of December 31, 2013 and 2012, our insurance loss recoverable included estimated recoveries of $647 million and $780 million, respectively, primarily from excess spread within insured second-lien RMBS securitizations. Insurance loss recoverables due to reinsurers totaled $5 million and $6 million as of December 31, 2013 and 2012, respectively, and are only paid to reinsurers upon receipt of such amounts by MBIA.
MBIA Corp. insures mortgage-backed securities (“MBS”) backed by residential mortgage loans, including second-lien RMBS transactions (revolving HELOC loans and CES). For the year ended December 31, 2013, we recorded a $2 million benefit in losses and LAE related to insured second-lien RMBS transactions. The $2 million benefit was due to gross recoveries of actual and expected payments of $110 million, partially offset by gross losses and LAE of actual and expected payments of $108 million.
MBIA Corp. also insures MBS backed by first-lien subprime mortgage loans directly through RMBS securitizations. There has been considerable stress and continued deterioration in the subprime mortgage market since 2008 reflected by increased delinquencies and losses, particularly related to subprime mortgage loans originated during 2005, 2006 and 2007. As of December 31, 2013 and 2012, the Company had $1.1 billion and $2.2 billion, respectively, of gross par outstanding from direct exposure to subprime mortgage loans. While subprime transactions directly guaranteed by MBIA Corp. include collateral comprising mortgage loans that originated during 2005, 2006, and 2007, we currently do not expect ultimate material losses on these transactions given the amount of subordination below MBIA Corp.’s insured portion of such transactions available to absorb losses from collateral defaults. As of December 31, 2013, the Company had $59 million of gross par outstanding in two insured direct subprime mortgage transactions with 2005 or 2006 subprime mortgage collateral appearing on the Company’s Classified or Caution Lists.
The gross par outstanding on insured second-lien RMBS transactions decreased from $2.2 billion as of December 31, 2012 to $1.7 billion as of December 31, 2013. As of December 31, 2013, we expect to pay an additional $51 million (on a present value basis) on these transactions and expect to receive a total of $189 million (on a present value basis) in reimbursement of past and future expected claims through excess spread in these transactions. In addition, we expect to receive $359 million (on a present value basis) as of December 31, 2013 with respect to Credit Suisse Securities (USA) LLC’s (“Credit Suisse”) obligation to repurchase ineligible mortgage loans, which is reported in “Loan repurchase commitments” under “Assets of consolidated variable interest entities” on the consolidated balance sheets.
Refer to “Note 6: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements for additional information about assumptions used to estimate reserves and recoveries on our RMBS exposure.
Gross expenses represent total insurance expenses before the deferral of any policy acquisition costs. Gross expenses decreased for the year ended December 31, 2013 compared with 2012 primarily due to a decrease in legal and litigation related costs. Gross expenses decreased for the year ended December 31, 2012 compared with 2011 due to reductions in compensation and other administrative expenses.
INTEREST EXPENSE Interest expense incurred by our structured finance and international insurance segment decreased for the year ended December 31, 2013 when compared with 2012 primarily due to the repayment of the National Secured Loan in May of 2013. In addition, during 2013, the interest rate on MBIA Corp.’s surplus notes decreased as a result of the conversion to a floating rate. Interest expense for the year ended December 31, 2012 increased when compared with 2011 due to the National Secured Loan that was established in December of 2011.
The following is a summary of selected significant exposures within the insured portfolio of our structured finance and international insurance segment. The Company has large exposures to many of these sectors. Moreover, many of these sectors are and have been considered volatile over the past several years. As described below, considerable incurred losses and future expected payments are attributable to many of these sectors.
As of December 31, 2013, our gross par exposure to multi-sector CDOs of $1.5 billion represented 5% of MBIA Corp.’s total gross par insured. Total gross par exposure in our multi-sector CDO portfolio was $37.3 billion as of December 31, 2007. Since the end of 2007 through December 31, 2013, our multi-sector CDO gross par exposure has decreased by approximately $35.8 billion primarily from negotiated commutations of $23.6 billion and contractual terminations without any payment from MBIA Corp. of $5.4 billion. The remaining reduction in gross par was due to the amortization and maturity of transactions.
Our gross par exposure to investment grade CDOs of $15.6 billion represents 53% of MBIA Corp.’s CDO exposure and 19% of MBIA Corp.’s total gross par insured. The portfolio is comprised of 11 investment grade corporate CDO exposures insured in 2006 and 2007 reference pools of predominantly investment grade corporate credits. Three of these pools include limited exposure to other asset classes, including structured finance securities (such as RMBS and CDOs). Our investment grade corporate CDO policies guarantee coverage of losses on collateral assets once a deductible has been eroded, and are highly customized structures. The Company’s insured investment grade corporate CDOs have experienced erosion of subordination due to the default of underlying referenced corporate and structured finance securities, but we currently do not expect losses on MBIA Corp.’s insured tranches. As of December 31, 2013, the collateral amount in the portfolio exceeds the gross par outstanding as a result of credit enhancement. Original subordination levels for eight of the investment grade corporate CDO policies referencing only direct corporate credit ranged from 15% to 30%. Current subordination levels for these eight policies are between 11% and 28%.
Our gross par exposure to insured investment grade corporate CDOs includes $7.3 billion across three transactions that were structured to include buckets (typically 30% to 35% of the overall CDO) of references to specific tranches of other investment grade corporate CDOs (monotranches). In such transactions, MBIA Corp.’s insured investment grade corporate CDOs include direct corporate or structured credit reference risks, and monotranche or single layer credit risk referencing a diverse pool of corporate assets or obligors with a specific attachment and a specific detachment point. The referenced monotranches in such CDOs were typically rated double-A and sized to approximately 3% of the overall reference risk pool. The inner referenced monotranches are not subject to acceleration and do not give control rights to a senior investor. The inner referenced monotranches have also experienced erosion of subordination due to defaults in their referenced corporate assets. These transactions had original subordination of 25% and current subordination ranges from 15% to 18%.
Our high yield corporate CDO portfolio, totaling $4.3 billion of gross par exposure, largely comprises middle-market/special- opportunity corporate loan transactions. Our gross par exposure to high yield corporate CDOs represents 14% of MBIA Corp.’s CDO exposure and 5% of MBIA Corp.’s total gross par insured as of December 31, 2013. Original subordination for our high yield corporate portfolio ranged from 22% to 33%. Current subordination is between 10% and 36%. Declines in subordination levels result from defaults in underlying collateral, as well as sales of underlying collateral at discounted prices. Subordination within CDOs may decline further over time as a result of additional collateral deterioration. We do not expect insured losses on our high yield corporate CDO portfolio. Accordingly, as of December 31, 2013, there is no loss reserve established for this portfolio. However, there can be no assurance that the Company will not incur losses as a result of further deterioration in subordination.
MBIA Corp.’s guarantee generally is in the form of a CDS referencing the static pooled transactions. MBIA Corp. would have a payment obligation if the volume of collateral losses exceeds the deductible level in the transaction. Loss payments on these transactions are generally due upon settlement of individual collateral losses as they occur after any deductible or subordination has been exhausted. Each pool comprising CMBS bonds is ultimately backed by the commercial mortgage loans securitized within each CMBS trust. The same CMBS bonds may be referenced in multiple pools. The Company’s structured CMBS pools are static, meaning that the collateral pool of securitizations cannot be and has not been changed since the origination of the policy. Most transactions comprised similarly rated underlying tranches at inception. The deductible for each transaction varies according to the ratings of the underlying collateral. For example, a transaction which comprised originally BBB rated underlying CMBS bonds would typically include a 30-35% deductible to MBIA Corp.’s position whereas a transaction comprising all originally AAA rated underlying CMBS bonds would typically have required a 5-10% deductible.
As of December 31, 2013, our gross par exposure to CRE CDOs totaled $1.2 billion and represented approximately 2% of MBIA Corp.’s total gross par insured. 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. These transactions benefit from typical CDO structural features such as cash diversion triggers, collateral quality tests, and manager replacement provisions. MBIA Corp. guarantees timely interest and ultimate principal of these CDOs. As with our other insured CDOs, these transactions were structured with credit protection originally rated triple-A, or a multiple of triple-A, below our guarantee. As of December 31, 2013, our CRE CDO insured portfolio did not contain any CDOs of ABS exposures. Some of the CRE CDO transactions do contain some RMBS collateral, but overall this comprises less than 1% of the collateral in the CRE CDO portfolio. To the extent losses do occur on these transactions, the payments are due at the maturity date, which range from the years 2036 through 2056. Current subordination levels are between 0% and 61%.
Reinsurance enables the Company to cede exposure for purposes of syndicating risk and increasing its capacity to write new business while complying with its single risk and credit guidelines. When a reinsurer is downgraded by one or more of the rating agencies, less capital credit is given to MBIA under rating agency models and the overall value of the reinsurance to MBIA is reduced. The Company generally retains the right to reassume the business ceded to reinsurers under certain circumstances, including a reinsurer’s rating downgrade below specified thresholds. The following table presents information about our reinsurance agreements as of December 31, 2013 for our U.S. public finance and structured finance and international insurance operations:
As of December 31, 2013, the aggregate amount of insured par outstanding ceded by MBIA to reinsurers under reinsurance agreements was $7.1 billion compared with $3.4 billion as of December 31, 2012. As of December 31, 2013, $5.7 billion of the ceded par outstanding was ceded from our U.S. public finance insurance segment and $1.4 billion was ceded from our structured finance and international insurance segment. Under National’s reinsurance agreement with MBIA Corp., if a reinsurer of MBIA Corp. is unable to pay claims ceded by MBIA Corp. on U.S. public finance exposure, National will assume liability for such ceded claim payments. As of December 31, 2013, the total amount for which National would be liable in the event that the reinsurers of MBIA Corp. were unable to meet their obligations was $1.4 billion.
Our asset management advisory business is primarily conducted through Cutwater. Cutwater offers advisory services, including cash management, discretionary asset management and structured products on a fee-for-service basis. Cutwater offers these services to public, not-for-profit, corporate and financial services clients, including MBIA Inc. and its other subsidiaries. In 2013, management substantially exited the advisory and asset management business in the European Union.
The following table summarizes the results and assets under management of our advisory services segment for the years ended December 31, 2013, 2012 and 2011. These results include revenues and expenses from transactions with the Company’s insurance, corporate, and wind-down operations.
For the year ended December 31, 2013, the unfavorable change in pre-tax income (loss) compared with 2012 was primarily driven by a decrease in fees due to declines in asset balances managed for third parties and our other segments.
Average third-party assets under management for the years ended December 31, 2013, 2012 and 2011 were $15.9 billion, $19.1 billion and $24.9 billion, respectively. These decreases were principally due to declines in our pool products and CDO management business.
FEES Fees are generated from support services provided to business units within the Company on a fee-for-service basis. The changes in fees for the periods presented were primarily related to differences in fees paid by our conduit segment for administrative and other services. For the years ended December 31, 2013, 2012, and 2011, these fees were $25 million, $95 million, and $66 million, respectively. Such fees may vary significantly from period to period.
OTHER NET REALIZED GAINS (LOSSES) Other net realized gains and losses for the years ended December 31, 2012 and 2011, consisted of insurance recoveries received from our directors’ and officers’ insurance policy. These insurance recoveries reimbursed the Company for a portion of the expenses incurred by the Company related to private securities litigation.
OPERATING EXPENSES Operating expenses for the year ended December 31, 2013 increased compared with 2012 due to an increase in compensation expense related to severance and expenses related to the BofA Settlement Agreement.
The following table presents the results of our asset/liability products segment for the years ended December 31, 2013, 2012 and 2011. These results include revenues and expenses from transactions with the Company’s other segments.
NET INVESTMENT INCOME The decreases in net investment income for the year ended December 31, 2013 compared with 2012 and 2011 were primarily due to lower average asset balances as investments were sold to generate liquidity and repay liabilities.
The following table presents the results of our conduit segment for the years ended December 31, 2013, 2012 and 2011. These results include revenues and expenses from transactions with the Company’s insurance and corporate operations.
The Company’s income taxes and the related effective tax rates for the years ended December 31, 2013, 2012 and 2011 are presented in the following table:
For the year ended December 31, 2013, our effective tax rate applied to our pre-tax income was higher than the U.S. statutory tax rate of 35% primarily due to the provision for deferred taxes on a basis difference created by unremitted earnings of certain foreign subsidiaries, non-deductibility of warrants issued by the Company, and other taxes. These items are partially offset by a benefit for the reduction in our valuation allowance against our deferred tax asset.
For the year ended December 31, 2012, our effective tax rate applied to our pre-tax income was lower than the U.S. statutory tax rate of 35% primarily due to a reversal of a portion of the Company’s valuation allowance against its deferred tax asset and a net tax benefit related to an out-of-period adjustment. Refer to “Note 11: Income Taxes” in the Notes to Consolidated Financial Statements for a discussion of the out-of-period adjustment.
The Company manages its capital resources to minimize its cost of capital while maintaining appropriate claims-paying resources (“CPR”) for National and MBIA Corp. The Company’s capital resources consist of total shareholders’ equity, total debt issued by MBIA Inc. for general corporate purposes, and surplus notes issued by MBIA Insurance Corporation. Total capital resources were $4.8 billion as of December 31, 2013 and 2012. MBIA Inc. utilizes its capital resources to support the business activities of its subsidiaries. As of December 31, 2013, MBIA Inc.’s investments in subsidiaries totaled $3.9 billion.
In addition, MBIA Inc. also supports the MTN and investment agreement obligations originally issued by our asset/liability products segment. MBIA Inc. seeks to maintain sufficient liquidity and capital resources to meet its general corporate needs, including those of its asset/liability products segment, which are in wind-down. As of December 31, 2013 and 2012, the combined net debt of MBIA Inc.’s corporate segment and asset/liability products segment, which primarily comprised long-term debt, MTNs, investment agreements and derivative liabilities net of cash and investments at amortized cost and a tax receivable from subsidiaries, totaled $1.1 billion and $1.2 billion, respectively. The Company expects that MBIA Inc. will generate sufficient cash to satisfy its net debt and its general corporate needs over time from distributions from its operating subsidiaries. In addition, the Company may also consider raising third-party capital. There can be no assurance that the aforementioned factors will generate sufficient cash to satisfy its net debt. Refer to the following “Liquidity-MBIA Inc. Liquidity” section for additional information about MBIA Inc.’s liquidity.
Repurchases of debt and common stock may be made from time to time in the open market or in private transactions as permitted by securities laws and other legal requirements. We may also choose to redeem debt obligations where permitted by the relevant agreements. We believe that debt and share repurchases and redemptions can be an appropriate deployment of capital in excess of amounts needed to support our liquidity while maintaining the CPR of MBIA Insurance Corporation and National as well as other business needs.
MBIA Inc. or its subsidiaries may repurchase or redeem their outstanding debt at prices that we deem to be economically advantageous. During 2013, we redeemed $506 million par value outstanding of MTNs issued by our conduit segment at a cost of approximately 100% of par value. In addition, we also repurchased approximately $192 million par value outstanding of GFL MTNs issued by our asset/liability segment at a weighted average cost of approximately 91% of par value.
National and MBIA Insurance Corporation are incorporated and licensed in, and are subject to primary insurance regulation and supervision by, the State of New York. MBIA UK Insurance Limited is authorized by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority in the United Kingdom. National and MBIA Insurance Corporation each are required to file detailed annual financial statements, as well as interim financial statements, with the NYSDFS and similar supervisory agencies in each of the other jurisdictions in which it is licensed. These financial statements are prepared in accordance with New York State and the National Association of Insurance Commissioners’ statements of U.S. STAT and assist our regulators in evaluating minimum standards of solvency, including minimum capital requirements, and business conduct. U.S. STAT differs from GAAP in a number of ways. Refer to the statutory accounting practices note to consolidated financial statements of National and MBIA Corp. within exhibits 99.1 and 99.2, respectively, of this annual report on Form 10-K for an explanation of the differences between U.S. STAT and GAAP.
National reported total statutory capital of $3.3 billion as of December 31, 2013 compared with $3.2 billion as of December 31, 2012. As of December 31, 2013, statutory capital comprised $1.2 billion of contingency reserves and $2.1 billion of policyholders’ surplus. The increase in National’s statutory capital is primarily due to statutory net income of $256 million for the year ended December 31, 2013. Consistent with our plan to transform our insurance business, the Company received approval from the NYSDFS to reset National’s unassigned surplus to zero, which was effective January 1, 2010. As of December 31, 2013, National’s unassigned surplus was $1.5 billion. In October of 2010, the plaintiffs in the litigation challenging the establishment of National initiated a court proceeding challenging the approval of the surplus reset. Subsequent to the BofA Settlement Agreement and the Societe Generale settlement, all litigation brought originally by the group of eighteen domestic and international financial institutions, related to the establishment of National, has been resolved.
In order to maintain its New York State financial guarantee insurance license, National is required to maintain a minimum of $65 million of policyholders’ surplus. National is also required to maintain contingency reserves to provide protection to policyholders in the event of extreme losses in adverse economic events. Refer to the following “MBIA Insurance Corporation-Capital and Surplus” section for additional information about contingency reserves under the New York Insurance Law (“NYIL”). National’s policyholders’ surplus would grow over time from the recognition of unearned premiums and investment income and the expected release of the contingency reserves. Conversely, dividends and incurred losses would reduce policyholders’ surplus. As of December 31, 2013 and 2012, National was not in compliance with its single risk limits requirements but was in compliance with its aggregate risk limits.
National’s statutory policyholders’ surplus was lower than its GAAP shareholder’s equity by $1.6 billion as of December 31, 2013. U.S. STAT differs from GAAP in certain respects. Refer to “Note 11: Statutory Accounting Practices” in the Notes to Consolidated Financial Statements of National within exhibit 99.1 of this annual report on Form 10-K for an explanation of the differences between U.S. STAT and GAAP.
(1)-Calculated using a discount rate of 3.14% and 4.54% as of December 31, 2013 and 2012, respectively.
As of December 31, 2013, MBIA Insurance Corporation recognized estimated recoveries of $227 million, net of reinsurance and income taxes at a rate of 35%, on a statutory basis related to put-backs of ineligible mortgage loans in its insured transactions and $770 million related to excess spread recoveries. These expected insurance recoveries represented 108% of MBIA Insurance Corporation’s statutory capital as of December 31, 2013. There can be no assurance that we will be successful or that we will not be delayed in realizing these recoveries. Refer to “Executive Overview-MBIA Corp.” included herein for factors that may influence MBIA Corp.’s ability to realize these recoveries.
In order to maintain its New York State financial guarantee insurance license, MBIA Insurance Corporation is required to maintain a minimum of $65 million of policyholders’ surplus. MBIA Insurance Corporation’s policyholders’ surplus would grow over time from the recognition of unearned premiums and investment income and the expected release of the contingency reserves. In addition, MBIA Insurance Corporation’s policyholders’ surplus could be enhanced by the settlement, commutation or repurchase of insured transactions at prices less than its statutory loss reserves for such transactions. Conversely, dividends or incurred losses or an inability to collect on our excess spread recoveries or ineligible mortgage loan put-back claims would reduce policyholders’ surplus.
As of December 31, 2013, MBIA Insurance Corporation exceeded its aggregate risk limits under the NYIL by $233 million. The overage was caused by the decrease in statutory capital described above. MBIA Insurance Corporation plans to notify the NYSDFS of the overage and submit a plan to achieve compliance with the limits in accordance with the NYIL. If MBIA Insurance Corporation is not in compliance with its aggregate risk limits, the NYSDFS may prevent MBIA Insurance Corporation from transacting any new financial guarantee insurance business until it no longer exceeds the limitations. In 2013 and 2012, MBIA Insurance Corporation reported additional overages to the NYSDFS with respect to its single risk limits due to changes in its statutory capital.
(1)-Calculated using a discount rate of 5.09% and 5.72% as of December 31, 2013 and 2012, respectively.
(3)-This amount primarily consists of expected recoveries related to the Company’s put-back claims.
Below is a description of certain intercompany and third-party lending agreements.
National maintains the Asset Swap with MBIA Inc. which was amended in 2009 to replace MBIA Insurance Corporation with National. The Asset Swap provides MBIA Inc. with eligible assets to pledge under investment agreements and derivative contracts in the asset/liability products business. As of December 31, 2013, the notional amount utilized under each of these agreements was $447 million and the fair value of collateral pledged by National and MBIA Inc. under these agreements was $465 million and $473 million, respectively. The net average interest rate on these transactions was 0.24%, 0.44% and 0.34% for the years ended December 31, 2013, 2012 and 2011, respectively.
Investment agreements: bankruptcy of MBIA Inc. or the filing of an insolvency proceeding with respect to MBIA Insurance Corporation, and in certain circumstances bankruptcy of MBIA Inc. and the filing of an insolvency proceeding with respect to MBIA Insurance Corporation;
GFL MTNs: bankruptcy of GFL or the filing of an insolvency proceeding with respect to MBIA Insurance Corporation; and
MBIA Inc. is subject to material liquidity risks and uncertainty. To mitigate these risks, we seek to maintain cash and liquidity resources that we believe will be sufficient to make all payments due on our obligations and to meet other financial requirements, such as posting collateral.
MBIA Inc. has a net debt, which comprised long-term debt, MTNs, investment agreements and derivative liabilities net of cash and investments at amortized cost and a tax receivable from subsidiaries, of $1.1 billion as of December 31, 2013. There is uncertainty of the timing and amount of cash inflows from dividends and tax sharing agreement payments paid by MBIA’s principal operating subsidiaries to service these liabilities. Refer to the “Capital Resources-Insurance Statutory Capital” section for a discussion on our insurance subsidiaries’ dividend restrictions.
Because most of MBIA Inc.’s assets are pledged against the obligations described above, the widening of credit spreads would have an adverse impact on the market value of these assets and increase collateralization requirements for the portfolio. The following table presents the estimated pre-tax change in the aggregate fair value of the asset/liability products business’ assets as of December 31, 2013 from instantaneous shifts in credit spread curves. This table assumes that all credit spreads move by the same amount; however, it is more likely that the actual changes in credit spreads will vary by investment sector and individual security. The table presents hypothetical increases and decreases in credit spreads of 50 and 200 basis points. Because downward movements of these amounts in some cases would result in negative spreads, a floor was assumed for minimum spreads.
As of December 31, 2013, the liquidity position of MBIA Inc., which consists of the liquidity positions of its corporate and asset/liability products activities, was $359 million and comprised cash and liquid assets of $307 million available for general corporate liquidity purposes, excluding the amounts held in escrow under its tax sharing agreement, and $52 million not pledged directly as collateral for its asset/liability products activities. As of December 31, 2012, MBIA Inc. had $239 million of cash and liquid assets comprising $170 million available for general corporate liquidity purposes, excluding the amounts held in escrow under its tax sharing agreement, and $69 million not pledged directly as collateral for its asset/liability products activities. We believe this liquidity position provides MBIA Inc. with sufficient funds to cover expected obligations at least through the next twelve months.
Liquidity available in the structured finance and international insurance segment is affected by our ability to collect on recoveries associated with loss payments, the persistency of installment premiums, investment results, the payment of claims on insured exposures, payments made to commute insured exposures, the repayment of outstanding borrowings, any unanticipated expenses, or the impairment or a significant decline in the fair value of invested assets. We may also experience liquidity constraints as a result of NYIL requirements that we maintain specified, high quality assets to back our reserves and surplus.
Our structured finance and international insurance segment also requires cash for the payment of operating expenses, as well as principal and interest related to its surplus notes. Refer to “Note 10: Debt” in the Notes to Consolidated Financial Statements for a discussion on the denied requests from the NYSDFS to pay interest on its surplus notes.
Despite continued adverse macroeconomic conditions in the U.S., the incidence of default among U.S. public finance issuers remains extremely low and we believe that the liquidity position of our U.S. public finance insurance segment is sufficient to meet cash requirements in the ordinary course of business.
National has entered into certain intercompany transactions to support the liquidity needs of its affiliates. One of these transactions includes the Asset Swap through which National exchanges liquid assets with MBIA Inc. As a result of this transaction, National is subject to repayment risk, which may adversely affect its liquidity. In addition, changes in the market value of securities sold to National under its Asset Swap with the asset/liability products business may adversely affect its liquidity position if MBIA Inc. were unable to pledge additional eligible assets in order to meet minimum required collateral amounts.
As of December 31, 2013, National held cash and short-term investments of $665 million, of which $627 million was highly liquid and comprised highly rated commercial paper, money market funds and municipal, U.S. agency and corporate bonds. As of December 31, 2012, National held cash and short-term investments of $470 million, of which $419 million was highly liquid and comprised commercial paper, money market funds, and highly rated municipal, U.S. agency and corporate bonds.
Net cash used by financing activities decreased in 2013 compared with 2012 primarily due to decreases in payments of long-term debt related to our conduit segment of $537 million, drawdowns of investment agreements of $403 million and securities sold under agreements to repurchase of $287 million. Net cash used by financing activities increased in 2012 compared with 2011 primarily due to increases in the paydown of long-term debt related to our conduit segment of $475 million, drawdowns of investment agreements of $164 million and principal paydowns of debt related to financial guarantee VIEs of $129 million.
Our AFS investments comprise high-quality fixed-income securities and short-term investments. As of December 31, 2013 and 2012, the fair values of our consolidated AFS investments were $6.6 billion and $5.6 billion, respectively, as presented in the following table. Additionally, consolidated cash and cash equivalents as of December 31, 2013 and 2012 were $1.2 billion and $814 million, respectively.
As of December 31, 2013, 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 3% of the total investment portfolio would be rated below investment grade in the Insured Investments.
The distribution of our Insured Investments by financial guarantee insurer as of December 31, 2013 is presented in the following table:
As of December 31, 2013 and 2012, we held impaired AFS investments (investments for which fair value was less than amortized cost) with a fair value of $3.5 billion and $1.3 billion, respectively.
Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2013, 2012 and
Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2013, 2012 and
MBIA Inc., together with its consolidated subsidiaries, (collectively, “MBIA” or the “Company”) operates one of the largest financial guarantee insurance businesses in the industry and is a provider of asset management and advisory services. These activities are managed through three business segments: United States (“U.S.”) public finance insurance; structured finance and international insurance; and advisory services. The Company’s U.S. public finance insurance business is primarily operated through National Public Finance Guarantee Corporation and its subsidiaries (“National”), its structured finance and international insurance business is primarily operated through MBIA Insurance Corporation and its subsidiaries (“MBIA Corp.”), and its asset management and advisory services business is primarily operated through Cutwater Holdings, LLC and its subsidiaries (“Cutwater”). MBIA Inc. and certain of its subsidiaries also manage certain other business activities, the results of which are reported in the corporate, asset/liability products, and conduit segments. The corporate segment includes revenues and expenses that arise from general corporate activities. While the asset/liability products and conduit businesses represent separate business segments, they may be referred to collectively as “wind-down operations” as the funding programs managed through those businesses are in wind-down. Refer to “Note 12: Business Segments” for further information about the Company’s reporting segments.
National seeks to generate shareholder value through appropriate risk adjusted pricing; however, current market conditions and the competitive landscape may limit National’s new business opportunities and its abilities to price and underwrite risk with attractive returns. Refer to “Risks and Uncertainties” below for a discussion of business risks related to National’s strategy.
As of December 31, 2013, the liquidity position of MBIA Inc., which consists of the liquidity positions of its corporate and asset/liability products segments, was $359 million and comprised cash and liquid assets of $307 million available for general liquidity purposes, excluding the amounts held in escrow under its tax sharing agreement, and $52 million not pledged directly as collateral for its asset/liability products segment. As of December 31, 2012, MBIA Inc. had $239 million of cash and liquid assets comprising $170 million available for general corporate liquidity purposes, excluding the amounts held in escrow under its tax sharing agreement, and $69 million not pledged directly as collateral for its asset/liability products segment. MBIA Inc.’s liquidity position has substantially improved during 2013 due to a dividend of $214 million declared and paid by National to MBIA Inc. and the release of $115 million from the Tax Escrow Account. Subsequent to December 31, 2013, an additional $160 million was released to MBIA Inc. from the Tax Escrow Account. The Company expects that MBIA Inc. will generate sufficient cash to satisfy its debt obligations and its general corporate needs over time from expected subsidiary dividends, additional anticipated releases from the Tax Escrow Account and by raising third-party capital.
Under the terms of the BofA Settlement Agreement, Blue Ridge Investments, L.L.C. (“Blue Ridge”), an affiliate of Bank of America, received a five-year warrant to purchase 9.94 million shares of MBIA common stock at a price of $9.59 per share. Bank of America also agreed to dismiss the litigation between the parties concerning the restructuring transactions announced by MBIA on February 18, 2009 (the “Transformation”) and the litigation between the parties concerning the senior debt consent solicitation completed by MBIA in the fourth quarter of 2012. In addition, Bank of America agreed to withdraw the purported “notice of default” it sent in connection with such consent solicitation.
Under the terms of the BofA Settlement Agreement, the dismissals of the litigations referenced above were initially filed on a “without prejudice” basis. The parties will refile such dismissals on a “with prejudice” basis provided that, within the one-year period following execution of the BofA Settlement Agreement, none of the claims released pursuant to the BofA Settlement Agreement are reinstated and neither party is required to make a payment on any such released claims. The Company views the likelihood of such an event as remote, and thus expects that the litigation dismissals will be filed on a “with prejudice” basis at the expiration of such one-year period.
MBIA Corp.’s policies insuring the RMBS securitizations originated by Countrywide will continue to be in full force and effect, and MBIA Corp. will continue to make payments of principal and interest if there are shortfalls when due under such policies. Bank of America will have no further representation and warranty liability with respect to the origination of the mortgage loans in the MBIA-insured Countrywide and certain other securitizations. MBIA Corp. also will retain the rights under its insurance policies to any excess spread (the difference between interest inflows on assets and interest outflows on liabilities) collected under these policies.
In December of 2013, MBIA Insurance Corporation sold its claims and certain related rights (the “Claims”), as an unsecured creditor, against the bankruptcy estates of Residential Funding Company, LLC (“RFC”), GMAC Mortgage LLC (“GMAC”) and ResCap for an amount that modestly exceeds the recoveries recorded in respect to the Claims on MBIA Corp.’s balance sheet as of September 30, 2013. As previously disclosed, MBIA Corp. had asserted contract claims (referred to as “put-back” claims) against RFC, GMAC and ResCap related to mortgage loans whose inclusion in insured securitizations failed to comply with representations and warranties. ResCap and its wholly-owned subsidiary companies, RFC and GMAC, each filed for bankruptcy protection in May of 2012. During the fourth quarter of 2013, ResCap settled litigation with its Junior Secured Noteholders and a reorganization plan was approved in bankruptcy court. MBIA Corp.’s policies insuring the RMBS securitizations originated by ResCap will continue to be in full force and effect, and MBIA Corp. will continue to make payments of principal and interest if there are shortfalls when due under such policies. MBIA Corp. also will retain the rights under its insurance policies to any excess spread collected under these policies.
In May of 2013, the Company entered into an agreement with Societe Generale pursuant to which the Company commuted $4.2 billion of gross insured exposure comprising ABS CDOs, structured CMBS pools and CRE CDOs. The amount MBIA paid to Societe Generale in consideration of commuting its insured exposure is consistent with MBIA Corp.’s December 31, 2012 aggregate statutory loss reserves for the exposures commuted. Also, pursuant to the agreement, Societe Generale agreed to dismiss the litigation between the parties concerning the Transformation, which includes any appeals of the decision denying the Article 78 petition and the plenary case.
The absence of higher ratings from S&P and Moody’s continues to adversely impact National’s ability to write new insurance business. In order to write new business in the U.S. public finance market, the Company is seeking rating upgrades from the rating agencies because the Company believes the current ratings of National do not fully represent the financial strength of National when compared with other companies in its industry. The Company expects to achieve higher stable ratings for National that it believes are necessary to support writing new business in accordance with its business plan, however, there is no assurance that it will be able to achieve such ratings and the timing of such ratings upgrades is uncertain. The Company is also considering obtaining ratings for National from additional rating agencies. The Company expects National will gain market acceptance and become a competitive financial guarantor once its ratings are further upgraded.
The majority of National’s new business is expected to be in the general obligation, tax-backed and revenue bond sectors. In recent years there have been significant amounts of insurable bonds that have been issued on an unwrapped basis, which present attractive secondary market opportunities and are within the Company’s underwriting criteria. Nonetheless, as a result of intense competition and the diminished use of financial guarantee insurance in the municipal finance market, among other factors, there can be no assurance that National will be able to write business that generates attractive returns, even if it obtains its target ratings.
While MBIA Inc.’s liquidity position improved during 2013 and management believes that MBIA Inc. has sufficient liquidity resources to meet all of its obligations for the foreseeable future, MBIA Inc. continues to have liquidity risk. If invested asset performance deteriorates or the flow of dividends from subsidiaries is interrupted and/or access to the capital markets is impaired, its liquidity position could be eroded over time. While the Company expects that MBIA Inc. will generate sufficient cash to satisfy its debt obligations and its general corporate needs over time from distributions from its operating subsidiaries and by raising third-party capital, there can be no assurance that such sources will generate sufficient cash. In addition, a failure by MBIA Inc. to settle liabilities that are also insured by MBIA Corp. could result in claims on MBIA Corp.
Prior period basic earnings per share was revised to correct an error in the allocation of net income to participating securities under the two-class method and prior period diluted earnings per share was revised to correct an error in the application of the treasury stock method for certain liability-classified warrants. Refer to “Note 17: Earnings Per Share” for a discussion and impact of this revision.
The consolidated statements of comprehensive income (loss) for the years ended December 31, 2012 and 2011 were revised to correct an error in the classification of certain foreign currency translation gains included in other comprehensive income. For the year ended December 31, 2012, “Unrealized gains (losses) arising during the period” of $176 million were previously reported as $217 million and “Foreign currency translation gains (losses)” of $24 million were previously reported as ($17 million). For the year ended December 31, 2011, “Unrealized gains (losses) arising during the period” of $277 million were previously reported as $298 million and “Foreign currency translation gains (losses)” of ($13 million) were previously reported as ($34 million). These revisions had no impact on total other comprehensive income, total comprehensive income, total assets, total liabilities, or total equity for the respective periods. As such and in accordance with Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 99, Materiality, and SEC Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements, the Company evaluated these revisions and concluded that they were immaterial to the affected prior periods individually and in the aggregate.
The Company classifies its fixed-maturity investments as available-for-sale (“AFS”), held-to-maturity (“HTM”), or trading. AFS investments are reported in the consolidated balance sheets at fair value with unrealized gains and losses, net of applicable deferred income taxes, reflected in accumulated other comprehensive income (loss) (“AOCI”) in shareholders’ equity. Bond discounts and premiums are accreted and amortized using the effective yield method over the remaining term of the securities. For mortgage-backed securities (“MBS”) and ABS, discounts and premiums are amortized using the retrospective method. For pre-refunded bonds, the remaining term is determined based on the contractual refunding date. Investment income is recorded as earned. Realized gains and losses represent the difference between the amortized cost value and the sale proceeds. The first-in, first-out method is used to identify the investments sold and the resulting realized gains and losses are included as a separate component of revenues.
Property and equipment consists of land, buildings, leasehold improvements, furniture, fixtures and equipment and software owned by the Company. All property and equipment held for use is recorded at cost and, except for land, is depreciated over the appropriate useful life of the asset using the straight-line method. Leasehold improvements are amortized over the useful life of the improvement or the remaining term of the lease, whichever is shorter. The cost and related accumulated depreciation applicable to assets sold or retired are removed from the Company’s balance sheet and any gain or loss on disposition is recognized in earnings as a component of “Other net realized gains (losses).” Maintenance and repairs are charged to current earnings as incurred.
In the fourth quarter of 2013, the Company approved and initiated a plan to actively market the Armonk, New York facility with the expectation that the facility will be sold prior to the end of 2014. As a result, it has been classified as held for sale as of December 31, 2013, and is presented within “Assets held for sale” on the Company’s consolidated balance sheet and measured at the lower of its cost basis or its fair value less cost to sell. The Company no longer recognizes depreciation expense on the facility because it is classified as held for sale.
Certain of the Company’s financial guarantees that meet the definition of a derivative are subject to a financial guarantee scope exception, as defined by the accounting guidance for derivative instruments and hedging activities. This scope exception provides that these financial guarantee contracts are not subject to accounting guidance for derivative instruments and should be accounted for as financial guarantee insurance contracts only if:
the guaranteed party is, as a precondition in the contract (or in the back-to-back arrangement, if applicable) for receiving payment of any claim under the guarantee, exposed to the risk of nonpayment both at inception of the financial guarantee contract and throughout its term either through direct legal ownership of the guaranteed obligation or through a back-to-back arrangement with another party that is required, by the back-to-back arrangement, to maintain direct ownership of the guaranteed obligation.
price quotes among dealers do not vary significantly over time; and
The Company recognizes a liability for unearned premium revenue at the inception of financial guarantee insurance and reinsurance contracts on a contract-by-contract basis. Unearned premium revenue recognized at inception of a contract is measured at the present value of the premium due. For most financial guarantee insurance contracts, the Company receives the entire premium due at the inception of the contract, and recognizes unearned premium revenue liability at that time. For certain other financial guarantee contracts, the Company receives premiums in installments over the term of the contract. Unearned premium revenue and a receivable for future premiums are recognized at the inception of an installment contract, and measured at the present value of premiums expected to be collected over the contract period or expected period using a risk-free discount rate. The expected period is used in the present value determination of unearned premium revenue and receivable for future premiums for contracts where (a) the insured obligation is contractually prepayable, (b) prepayments are probable, (c) the amount and timing of prepayments are reasonably estimable, and (d) a homogenous pool of assets is the underlying collateral for the insured obligation. The Company has determined that substantially all of its installment contracts meet the conditions required to be treated as expected period contracts. The receivable for future premiums is reduced as installment premiums are collected. The Company reports the accretion of the discount on installment premiums receivable as premium revenue and discloses the amount recognized in “Note 5: Insurance Premiums.” The Company assesses the receivable for future premiums for collectability each reporting period, adjusts the receivable for uncollectible amounts and recognizes any write-off as operating expense, and discloses the amount recognized in “Note 5: Insurance Premiums.” As premium revenue is recognized, the unearned premium revenue liability is reduced.
Financial statement assets and liabilities denominated in foreign currencies are translated into U.S. dollars generally using rates of exchange prevailing as of 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 the U.S. dollar, 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.
Deferred income taxes are recorded with respect to loss carryforwards and temporary differences between the tax bases of assets and liabilities and the reported amounts in the Company’s financial statements that will result in deductible or taxable amounts in future years when the reported amounts of assets and liabilities are recovered or settled. Such temporary differences relate principally to premium revenue recognition, deferred acquisition costs, unrealized gains or losses on investments and insured derivatives, asset impairments, cancellation of indebtedness income, and net operating losses. Valuation allowances are established to reduce deferred tax assets to the amount that more likely than not will be realized. Deferred tax assets and liabilities are adjusted for the effect of changes in tax laws and rates in the period in which changes are approved by the relevant authority.
In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-02, “Comprehensive Income (Topic 220)-Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income” that requires an entity to present information about the amounts reclassified out of AOCI by component and to present significant amounts reclassified out of AOCI by the respective line items of net income. The amendment only affects the Company’s disclosures and does not affect the Company’s consolidated balance sheets, results of operations, or cash flows. The Company adopted this standard in the first quarter of 2013.
In December 2011, the FASB issued ASU 2011-11, “Balance Sheet (Topic 210)-Disclosures about Offsetting Assets and Liabilities.” ASU 2011-11 creates new disclosure requirements about the nature of the Company’s rights of setoff and related arrangements associated with its financial instruments and derivative instruments. This amendment does not change the existing offsetting eligibility criteria or the permitted balance sheet presentation for those instruments that meet the eligibility criteria. The disclosure requirement was effective for the Company beginning in the first quarter of 2013. In January 2013, the FASB issued ASU 2013-01, “Balance Sheet (Topic 210)-Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.” ASU 2013-01 clarifies that ASU 2011-11 applies only to derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with specific criteria contained in the FASB Accounting Standards Codification or subject to a master netting arrangement or similar agreement. These standards only affect the Company’s disclosures and do not affect the Company’s consolidated balance sheets, results of operations, or cash flows. The Company adopted this standard in the first quarter of 2013.
Through MBIA’s structured finance and international insurance segment, the Company provides credit protection to issuers of obligations that may involve issuer-sponsored special purpose entities (“SPEs”). An SPE may be considered a VIE to the extent the SPE’s total equity at risk is not sufficient to permit the SPE to finance its activities without additional subordinated financial support or its equity investors lack any one of the following characteristics: (i) the power to direct the activities of the SPE that most significantly impact the entity’s economic performance or (ii) the obligation to absorb the expected losses of the entity or the right to receive the expected residual returns of the entity. A holder of a variable interest or interests in a VIE is required to assess whether it has a controlling financial interest, and thus is required to consolidate the entity as primary beneficiary. An assessment of a controlling financial interest identifies the primary beneficiary as the variable interest holder that has both of the following characteristics: (i) the power to direct the activities of the VIE that most significantly impact the entity’s economic performance and (ii) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. The primary beneficiary is required to consolidate the VIE. An ongoing reassessment of controlling financial interest is required to be performed based on any substantive changes in facts and circumstances involving the VIE and its variable interests.
In the conduit segment, the Company has managed and administered two conduits that invested primarily in debt securities and were funded through the issuance of VIE notes and long-term debt. MBIA Corp. insures the debt obligations of the conduits, and provides credit protection on certain assets held by the conduits. The conduits are VIEs and are consolidated by the Company as primary beneficiary. In 2012, all debt securities held by one of the conduits were entirely repaid, and the proceeds were used to repay all outstanding long-term debt of this conduit. The Company subsequently dissolved this conduit, and no longer provides any related credit protection.
The following tables present the total assets of nonconsolidated VIEs in which the Company holds a variable interest as of December 31, 2013 and 2012, through its insurance operations. The following tables also present the Company’s maximum exposure to loss for nonconsolidated VIEs and carrying values of the assets and liabilities for its interests in these VIEs as of December 31, 2013 and 2012. The Company has aggregated nonconsolidated VIEs based on the underlying credit exposure of the insured obligation. The nature of the Company’s variable interests in nonconsolidated VIEs is related to financial guarantees, insured CDS contracts and any investments in obligations issued by nonconsolidated VIEs.
The maximum exposure to loss as a result of MBIA’s variable interests in VIEs is represented by insurance in force. Insurance in force is the maximum future payments of principal and interest, net of cessions to reinsurers, which may be required under commitments to make payments on insured obligations issued by nonconsolidated VIEs.
As of December 31, 2013 and 2012, premiums receivable was $1.1 billion and $1.2 billion, respectively, primarily related to installment policies for which premiums will be collected over the estimated term of the contracts. Premiums receivable for an installment policy is initially measured at the present value of premiums expected to be collected over the expected period or contract period of the policy using a risk-free discount rate. Premiums receivable for policies that use the expected period of risk due to expected prepayments are adjusted in subsequent measurement periods when prepayment assumptions change using the risk-free discount rate as of the remeasurement date. As of December 31, 2013 and 2012, the weighted average risk-free rate used to discount future installment premiums was 2.9% and 2.6%, respectively, and the weighted average expected collection term of the premiums receivable was 9.21 years and 9.13 years, respectively.
The Company evaluates whether any premiums receivable are uncollectible at each balance sheet date. If the Company determines that premiums are uncollectible, it records a write-off of such amounts in current earnings. The majority of the Company’s premiums receivable consists of the present values of future installment premiums that are not yet billed or due primarily from structured finance transactions. Given that premiums due to MBIA typically have priority over most other payment obligations of structured finance transactions, the Company determined that the amount of uncollectible premiums as of December 31, 2013 and 2012 was insignificant.
The following tables present a roll forward of the Company’s premiums receivable for the years ended December 31, 2013 and 2012:
In establishing case basis loss reserves, the Company calculates the present value of probability-weighted estimated loss payments, net of estimated recoveries, using a discount rate equal to the risk-free rate applicable to the currency and the weighted average remaining life of the insurance contract as required by accounting principles for financial guarantee contracts. Yields on U.S. Treasury offerings are used to discount loss reserves denominated in U.S. dollars, which represent the majority of the loss reserves. Similarly, yields on foreign government offerings are used to discount loss reserves denominated in currencies other than the U.S. dollar. If the Company were to apply different discount rates, its case basis reserves may have been higher or lower than those established as of December 31, 2013. For example, a higher discount rate applied to expected future payments would have decreased the amount of a case basis reserve established by the Company and a lower rate would have increased the amount of a reserve established by the Company. Similarly, a higher discount rate applied to the potential future recoveries would have decreased the amount of a loss recoverable established by the Company and a lower rate would have increased the amount of a loss recoverable established by the Company.
Certain local governments remain under extreme financial and budgetary stress and some have filed for protection under the United States Bankruptcy Code, or have entered into state statutory proceedings established to assist municipalities in managing through periods of severe fiscal stress. This could lead to an increase in defaults by such entities on the payment of their obligations and losses or impairments on a greater number of the Company’s insured transactions. The Company monitors and analyzes these situations closely, however, the overall extent and duration of such events are uncertain. As of December 31, 2013, the Company had $124.9 billion of gross par outstanding on general obligations, of which $161 million was reflected on the Company’s “Classified List.” Capital appreciation bonds are reported at the par amount at the time of issuance of the insurance policy.
Notwithstanding the difference in accounting under GAAP for financial guarantee policies and the Company’s insured derivatives, insured derivatives have similar terms, conditions, risks, and economic profiles to financial guarantee insurance policies, and therefore, are evaluated by the Company for loss (referred to as credit impairment herein) and LAE periodically in a manner similar to the way that loss and LAE reserves are estimated for financial guarantee insurance policies. Credit impairments represent actual payments and collections plus the present value of estimated expected future claim payments, net of recoveries. MBIA Insurance Corporation’s expected future claim payments for insured derivatives were discounted using a rate of 5.09%, the same rate it used to calculate its statutory loss reserves as of December 31, 2013. These credit impairments, calculated in accordance with statutory accounting principles (“U.S. STAT”) differ from the fair values recorded in the Company’s consolidated financial statements. The Company considers its credit impairment estimates as critical information for investors as it provides information about loss payments the Company expects to make on insured derivative contracts. As a result, the following loss and LAE process discussion includes information about loss and LAE activity recorded in accordance with GAAP for financial guarantee insurance policies and credit impairments estimated in accordance with U.S. STAT for insured derivative contracts. Refer to “Note 7: Fair Value of Financial Instruments” included herein for additional information about the Company’s insured credit derivative contracts.
In addition, in the Company’s loss reserve models for transactions secured by HELOCs, the Company considers borrower draw and prepayment rates and factors that could affect the excess spread generated by current loans, which offsets losses and reduces payments. For HELOCs, the current three-month average draw rate is generally used to project future draws on the line. Prior to the second quarter of 2013, for HELOCs and transactions secured by fixed-rate CES, the three-month average conditional prepayment rate was generally used to start the projection for trends in voluntary principal prepayments. Beginning in the second quarter of 2013, in order to capture the effects of rising interest rates, which impact voluntary prepayments, the Company began using historical average voluntary prepayment rates to model its loss reserves. For HELOCs, projected cash flows are also based on an assumed constant basis spread between floating rate assets and floating rate insured debt obligations (the difference between prime and London Interbank Offered Rate (“LIBOR”) interest rates, minus any applicable fees). For all transactions, cash flow models consider allocations and other structural aspects, including managed amortization periods, rapid amortization periods and claims against MBIA Corp.’s insurance policy consistent with such policy’s terms and conditions. The estimated net claims from the procedure above are then discounted using a risk-free rate to a net present value reflecting MBIA’s general obligation to pay claims over time and not on an accelerated basis. The above assumptions represent MBIA’s probability-weighted estimates of how transactions will perform over time.
The Company primarily records two types of recoveries related to insured second-lien RMBS exposures: “put-back” claims related to those mortgage loans whose inclusion in insured securitizations failed to comply with representations and warranties (“ineligible loans”), and excess spread that is generated from performing loans in the insured transactions.
To date, MBIA has settled the majority of the Company’s put-back claims, with its claims against only Credit Suisse remaining as outstanding. The settlement amounts have been consistent with the put-back recoveries previously included in the Company’s financial statements. Refer to “Note 1: Business Developments and Risks and Uncertainties” included herein for a description of the BofA Settlement Agreement and the Residential Capital LLC Agreement. Additional information on the status of the litigation against Credit Suisse can be found within “Note 21: Commitments and Contingencies.”
The contract claim remaining with Credit Suisse is related to the inclusion of ineligible mortgage loans in the 2007-2 Home Equity Mortgage Trust (“HEMT”) securitization. Credit Suisse has challenged the Company’s assessment of the ineligibility of individual mortgage loans and the dispute is the subject of litigation for which there is no assurance that the Company will prevail.
As of December 31, 2013, the Company recorded estimated recoveries, gross of income taxes, of $359 million related to second-lien RMBS put-back claims on ineligible mortgage loans, reflected in “Loan repurchase commitments” presented under the heading “Assets of consolidated variable interest entities” on the Company’s consolidated balance sheets. As of December 31, 2012, the Company recorded estimated recoveries, gross of income taxes, of $3.6 billion related to second-lien RMBS put-back claims on ineligible mortgage loans, of which, $2.5 billion was included in “Insurance loss recoverable” and $1.1 billion was included in “Loan repurchase commitments” presented under the heading “Assets of consolidated variable interest entities” on the Company’s consolidated balance sheets. As of December 31, 2013 and 2012, the Company’s estimated recoveries after income taxes calculated at the federal statutory rate of 35%, were $233 million and $2.3 billion, respectively, which was 7% and 73% of the consolidated total shareholders’ equity of MBIA, excluding preferred stock of subsidiaries and noncontrolling interests, respectively.
The Company’s assessment of the remaining unsettled recoveries related to insured Credit Suisse second-lien RMBS is principally based on the following factors:
2. Assured Guaranty’s favorable court ruling in its put-back litigation against Flagstar Bank, awarding it the vast majority of the claims paid on the relevant transactions plus interest, fees and expenses, as well as their subsequent settlement with Flagstar Bank, which resolved Assured Guaranty’s put-back claims; and
As of December 31, 2013 and 2012, the Company recorded estimated recoveries of $681 million and $906 million, respectively, for the reimbursement of past and future expected claims through excess spread in insured second-lien RMBS transactions. As of December 31, 2013 and 2012, $647 million and $780 million respectively, was included in “Insurance loss recoverable” and $34 million and $126 million, respectively, was included in “Loss and loss adjustment expense reserves” on the Company’s consolidated balance sheets. Excess spread is generated by performing loans within insured RMBS securitizations and is the difference between interest inflows on mortgage loan collateral and interest outflows on insured beneficial interests. The amount of excess spread depends on the future delinquency and loss trends, future prime and LIBOR interest rates and borrower refinancing behavior, which results in voluntary prepayments.
The Company’s ABS CDOs originally benefited from two sources of credit enhancement. First, the subordination in the underlying securities collateralizing the transaction must be fully eroded and second, the subordination below the insured tranche in the CDO transaction must be fully eroded before the insured tranche is subject to a claim. The Company’s payment obligations after a default are timely interest and ultimate principal.
The last approach is based on a proprietary model developed by reviewing performance data on over 80,000 securitized CRE loans originated between 1992 and 2011. The time period covered during the performance review includes the years 2006 through 2011 because they encompass a period of extreme stress in the economy and the CRE markets. The Company found property type and the debt service coverage ratio to be the most significant determinants of a loan’s average annual default probability, and developed a model based on these factors. The Company then ran Monte Carlo simulations to estimate the timing of defaults and losses at the property level by applying property type-based Cap Rates to estimate the property’s NOI.
For the year ended December 31, 2013, the Company had a benefit of $33 million of losses and LAE recorded in earnings related to CRE CDO financial guarantee insurance policies. For the year ended December 31, 2013, additional credit impairments and LAE for insured derivatives on structured CMBS pools, CRE CDOs and CRE loan pools were estimated to be $601 million as a result of additional delinquencies and loan level liquidations, as well as continued refinements of MBIA’s assessment of various commutation possibilities. The cumulative credit impairments and LAE on structured CMBS pools, CRE CDOs and CRE loan pools were estimated to be $4.2 billion through December 31, 2013. Though the pace of increases in the delinquency rate has slowed, many loans are being modified and liquidations continue to take place. Loan level losses have ranged from 1% to 2%, to near complete losses, and in a few cases severities exceeded 100%. These liquidations led to bond level losses which reduced the level of enhancement to the individual CMBS bonds referenced by the insured structured CMBS pools and in certain cases resulted in deductible erosion. Bond level enhancement and pool level deductibles are structural features intended to mitigate losses to the Company, however, some of the transactions reference similar rated subordinate tranches of CMBS bonds. When there are broad-based declines in property performance, this leverage can result in rapid deterioration in pool performance. Beginning in the second quarter of 2013, the Company paid claims on a CMBS pool transaction that experienced deterioration such that all remaining deductible was eliminated.
The Company’s financial guarantee insurance losses and LAE for the year ended December 31, 2013 are presented in the following table:
The losses and LAE related to actual and expected payments in the preceding table primarily related to insured second-lien RMBS transactions and other issues, partially offset by a benefit in insured first-lien RMBS transactions related to previously established reserves. The second-lien RMBS losses and LAE related to actual and expected payments comprise net increases of previously established reserves. The $50 million in other issues primarily related to an international road transaction and U.S. public finance transactions, partially offset by decreases in CMBS and ABS CDO transactions.
The following table provides information about the financial guarantees and related claim liability included in each of MBIA’s surveillance categories as of December 31, 2013:
The following table presents the components of the Company’s loss and LAE reserves and insurance loss recoverable as reported on the Company’s consolidated balance sheets as of December 31, 2013 and 2012 for insured obligations within MBIA’s “Classified List.” The loss reserves (claim liability) and insurance claim loss recoverable included in the following table represent the present value of the probability-weighted future claim payments and recoveries reported in the preceding tables.
The following table presents the amounts of the Company’s second-lien RMBS exposure, gross undiscounted claim liability and potential recoveries related to non-consolidated VIEs and consolidated VIEs, included in the Company’s “Classified List,” as of December 31, 2013:
The following tables present changes in the Company’s loss and LAE reserves for the years ended December 31, 2013 and 2012. Changes in the loss and LAE reserves attributable to the accretion of the claim liability discount, changes in discount rates, changes in the timing and amounts of estimated payments and recoveries, changes in assumptions and changes in LAE reserves are recorded in “Losses and loss adjustment” expenses in the Company’s consolidated statements of operations. As of December 31, 2013 and 2012, the weighted average risk-free rate used to discount the Company’s loss reserves (claim liability) was 2.37% and 1.38%, respectively. LAE reserves are expected to be settled within a one-year period and are not discounted.
The increase in the Company’s gross loss and LAE reserves reflected in the preceding table was primarily due to changes in assumptions on insured first and second-lien RMBS issues and changes in amount and timing of payments. These were partially offset by decreases in reserves related to loss payments on insured first and second-lien RMBS issues outstanding as of December 31, 2011.
Current period changes in the Company’s estimate of potential recoveries may be recorded as an insurance loss recoverable asset, netted against the gross loss and LAE reserve liability, or both. The following tables present changes in the Company’s insurance loss recoverable and changes in recoveries on unpaid losses reported within the Company’s claim liability for the years ended December 31, 2013 and 2012. Changes in insurance loss recoverable attributable to the accretion of the discount on the recoverable, changes in discount rates, changes in the timing and amounts of estimated collections, changes in assumptions and changes in LAE recoveries are recorded in “Losses and loss adjustment” expenses in the Company’s consolidated statements of operations.
The following table presents the Company’s total estimated recoveries from ineligible mortgage loans included in certain insured second-lien mortgage loan securitizations as of December 31, 2013. The total estimated recoveries from ineligible mortgage loans of $359 million are recorded as “Loan repurchase commitments” presented under the heading “Assets of consolidated variable interest entities” on the Company’s consolidated balance sheets.
Fair value is a market-based measure considered from the perspective of a market participant. Therefore, even when market assumptions are not readily available, the Company’s own assumptions are set to reflect those which it believes market participants would use in pricing an asset or liability at the measurement date. The fair value measurements of financial instruments held or issued by the Company are determined through the use of observable market data when available. Market data is obtained from a variety of third-party sources, including dealer quotes. If dealer quotes are not available for an instrument that is infrequently traded, the Company uses alternate valuation methods, including either dealer quotes for similar instruments or modeling using market data inputs. The use of alternate valuation methods generally requires considerable judgment in the application of estimates and assumptions and changes to such estimates and assumptions may produce materially different fair values.
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 product. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the Company assigns the level in the fair value hierarchy for which the fair value measurement in its entirety falls, based on the least observable input that is significant to the fair value measurement.
Financial assets, excluding derivative assets, held by the Company primarily consist of investments in debt securities. Substantially all of the Company’s investments are priced by independent third parties, including pricing services and brokers. Typically, the Company receives one pricing service value or broker quote for each instrument, which represents a non-binding indication of value. The Company reviews the assumptions, inputs and methodologies used by pricing services and brokers to obtain reasonable assurance that the prices used in its valuations reflect fair value. When the Company believes a third-party quotation differs significantly from its internally developed expectation of fair value, whether higher or lower, the Company reviews its data or assumptions with the provider. This review includes comparing significant assumptions such as prepayment speeds, default ratios, forward yield curves, credit spreads and other significant quantitative inputs to internal assumptions, and working with the price provider to reconcile the differences. The price provider may subsequently provide an updated price. In the event that the price provider does not update its price, and the Company still does not agree with the price provided, the Company will obtain a price from another third-party provider, such as a broker, or use an internally developed price which it believes represents the fair value of the investment. The fair values of investments for which internal prices were used were not significant to the aggregate fair value of the Company’s investment portfolio as of December 31, 2013 or 2012. All challenges to third-party prices are reviewed by staff of the Company with relevant expertise to ensure reasonableness of assumptions.
In addition to challenging pricing assumptions, the Company obtains reports from the independent accountants for significant third-party pricing services attesting to the effectiveness of the controls over data provided to the Company. These reports are obtained annually and are reviewed by the Company to ensure key controls are applied by the pricing services, and that appropriate user controls are in place at the third-party pricing services organization to ensure proper measurement of the fair values of its investments. In the event that any controls in these reports are deemed as ineffective by independent accountants, the Company will take the necessary actions to ensure that internal user controls are in place to mitigate the control risks. No deficiencies were noted for significant third-party pricing services used.
Financial liabilities, excluding derivative liabilities, issued by the Company primarily consist of investment agreements and MTNs within its wind-down operations, debt issued for general corporate purposes, debt in VIEs and warrants. Investment agreements, MTNs, and corporate debt are typically recorded at face value adjusted for premiums or discounts. The majority of the financial liabilities that the Company has elected to fair value or that require fair value reporting or disclosures are valued based on the estimated value of the underlying collateral, the Company’s or a third-party’s estimate of discounted cash flow model estimates, or quoted market values for similar products. These valuations include adjustments for expected nonperformance risk of the Company.
All significant financial assets and liabilities, including derivative assets and liabilities, are reviewed by committees created by the Company to ensure compliance with the Company’s policies and risk procedures in the development of fair values of financial assets and liabilities. These valuation committees review, among other things, key assumptions used for internally developed prices, significant changes in sources and uses of inputs, including changes in model approaches, and any adjustments from third-party inputs or prices to internally developed inputs or prices. The committees also review any significant impairment or improvements in fair values of the financial instruments from prior periods. From time to time, these committees will consult with the Company’s valuation experts to better understand key methods and assumptions used for the determination of fair value, including understanding significant changes in fair values. These committees are comprised of senior finance team members with the relevant experience in the financial instruments their committee is responsible for. For each quarter, these committees document their agreement with the fair values developed by management of the Company as reported in the quarterly and annual financial statements.
Investments based on quoted market prices of identical investments in active markets are classified as Level 1 of the fair value hierarchy. Level 1 investments generally consist of U.S. Treasury and foreign government and agency investments. Quoted market prices of investments in less active markets, as well as investments which are valued based on other than quoted prices for which the inputs are observable, such as interest rate yield curves, are categorized in Level 2 of the fair value hierarchy. Investments that contain significant inputs that are not observable are categorized as Level 3.
Cash and Cash Equivalents, Receivable for Investments Sold, Net Cash Collateral Pledged to Swap Counterparties, Payable for Investments Purchased, Secured Loan and Accrued Investment Income
expectations about possible variations in the timing of collections of the cash flows; and
The fair values of investment agreements are determined using discounted cash flow techniques based on contractual cash flows and observable interest rates currently being offered for similar agreements with comparable maturity dates. Investment agreements contain collateralization and termination agreements that substantially mitigate the nonperformance risk of the Company. As the terms of the notes are private, and the timing and amount of contract cash flows are not observable, these investment agreements are categorized as Level 3 of the fair value hierarchy.
The fair values of certain MTNs are based on quoted market prices provided by third-party sources, where available. When quoted market prices are not available, the Company applies a matrix pricing grid based on the quoted market prices received and the MTNs’ stated maturity and interest rate to determine fair value. Nonperformance risk is included in the quoted market prices and the matrix pricing grid.
The VIEs have entered into derivative transactions primarily consisting of cross currency swaps, and interest rate caps. Fair values of OTC derivatives are determined using valuation models based on observable and/or unobservable inputs. These observable and market-based inputs include interest rate and volatilities. These derivatives are categorized in Level 2 or Level 3 of the fair value hierarchy based on the input that is significant to the fair value measurement in its entirety.
The asset/liability products business has entered into derivative transactions primarily consisting of interest rate swaps. Fair values of OTC derivatives are determined using valuation models based on observable inputs, nonperformance risk of the Company’s own credit and nonperformance risk of the counterparties. Observable and market-based inputs include interest rate yields, credit spreads and volatilities. These derivatives are categorized in Level 2 or Level 3 of the fair value hierarchy based on the lowest level input that is significant to the fair value measurement in its entirety.
In certain cases, 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 derivative contracts exceeds an exposure threshold. Under these arrangements, the Company may provide U.S. Treasury and other highly rated securities or cash to secure the derivative. The delivery of high-quality collateral can minimize credit exposure and mitigate the potential for nonperformance risk impacting the fair values of the derivatives.
Allocation of losses to separate tranches of the capital structure according to priority of payments in a transaction.
There were some transactions where the Company incorporated multiple levels within the hierarchy, including using 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. As of December 31, 2013, sector-specific spreads were used in 8% of the transactions valued using the BET Model. Corporate spreads were used in 48% of the transactions and spreads benchmarked from the most relevant spread source were used for 44% of the transactions. The spread source can also be identified by whether or not it is based on collateral weighted average rating factor (“WARF”). No collateral-specific spreads are based on WARF. Sector-specific spreads, corporate spreads and some benchmarked spreads are based on WARF. WARF-sourced and/or ratings-sourced credit spreads were used for 78% of the transactions.
The Company’s valuation methodology for insured credit derivative liabilities incorporates MBIA Corp.’s own nonperformance risk. The Company calculates the fair value by discounting the market value loss estimated through the BET Model at discount rates which include MBIA Corp.’s CDS spreads as of December 31, 2013. The CDS spreads assigned to each deal are based on the weighted average life of the deal. The Company limits the nonperformance impact so that the derivative liability could not be lower than MBIA Corp.’s recovery derivative price multiplied by the unadjusted derivative liability.
The significant unobservable inputs used in the fair value measurement of MBIA Corp.’s other credit derivatives, which are valued using the BET Model, are recovery rates, nonperformance risk and weighted average life. The recovery rate represents the percentage of notional expected to be recovered after an asset defaults, indicating the severity of a potential loss. The nonperformance risk is an assumption of MBIA Corp.’s own ability to pay and whether MBIA Corp. will have the necessary resources to pay the obligations as they come due. Weighted average life is based on MBIA Corp.’s estimate of when the principal of the underlying collateral will be repaid. A significant increase in weighted average life can result in an increase or decrease in the fair value of the derivative liability, depending on the discount rate and the timing of significant losses. Any significant increase or decrease in recovery rates or MBIA Corp.’s nonperformance risk would result in a decrease or increase in the fair value of the derivative liabilities, respectively. Recovery rates, nonperformance risk and weighted average lives are determined independently. Changes in one input will not necessarily have any impact on the other inputs.
The following tables present the fair value of the Company’s assets (including short-term investments) and liabilities measured and reported at fair value on a recurring basis as of December 31, 2013 and 2012:
Level 3 assets at fair value as of December 31, 2013 and 2012 represented approximately 22% and 29%, respectively, of total assets measured at fair value. Level 3 liabilities at fair value as of December 31, 2013 and 2012 represented approximately 61% and 73%, respectively, of total liabilities measured at fair value.
The following tables present the fair values and carrying values of the Company’s assets and liabilities that are disclosed at fair value but not reported at fair value on the Company’s consolidated balance sheets as of December 31, 2013 and 2012:
Transfers into and out of Level 3 were $293 million and $157 million, respectively, for the year ended December 31, 2012. Transfers into and out of Level 2 were $157 million and $293 million, respectively, for the year ended December 31, 2012. Transfers into Level 3 were principally related to state and municipal bonds, CDOs, other asset backed, RMBS non-agency and corporate obligations where inputs, which are significant to their valuation, became unobservable during the period. CDOs, RMBS non-agency, corporate obligations and other ABS comprised the majority of the transferred instruments out of Level 3 where inputs, which are significant to their valuation, became observable during the period. These inputs included spreads, prepayment speeds, default speeds, default severities, yield curves observable at commonly quoted intervals, and market corroborated inputs. There were no transfers into or out of Level 1.
Gains and losses (realized and unrealized) included in earnings relating to Level 3 assets and liabilities for the years ended December 31, 2013, 2012 and 2011 are reported on the Company’s consolidated statements of operations as follows:
Substantially all gains and losses included in earnings during the periods ended December 31, 2013 and 2012 on loans receivable and VIE notes reported in the preceding table are attributable to credit risk. This is primarily due to the high rate of defaults on loans and the collateral supporting the VIE notes, resulting in depressed pricing of the financial instruments.
The following table presents the distribution by contractual maturity of AFS and HTM fixed-maturity securities at amortized cost and fair value as of December 31, 2013. Contractual maturity may differ from expected maturity as borrowers may have the right to call or prepay obligations.
The following table presents the distribution of securities in an unrealized loss position for a continuous twelve-month period or longer by percentage of fair value below book value by more than 5% as of December 31, 2013:
The Company concluded that it does not have the intent to sell securities in an unrealized loss position and it is more likely than not, that it would not have to sell these securities before recovery of their cost basis. In making this conclusion, the Company examined the cash flow projections for its investment portfolios, the potential sources and uses of cash in its businesses, and the cash resources available to its business other than sales of securities. It also considered the existence of any risk management or other plans as of December 31, 2013 that would require the sale of impaired securities. Impaired securities that the Company intends to sell before the expected recovery of such securities’ fair values have been written down to fair value.
Gross realized gains and losses are recorded within “Net gains (losses) on financial instruments at fair value and foreign exchange” on the Company’s consolidated statements of operations. The proceeds and gross realized gains and losses from sales of AFS investments for the years ended December 31, 2013, 2012 and 2011 are as follows:
The Company entered into derivative instruments 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 balance sheet. These insured CDS contracts, primarily referencing corporate, asset-backed, residential mortgage-backed, commercial mortgage-backed, CRE loans and CDO securities, are intended to be held for the entire term of the contract absent a negotiated settlement with the counterparty.
In certain instances, the Company’s structured finance and international insurance business purchased or issued securities that contain embedded derivatives. In accordance with the accounting guidance for derivative instruments and hedging activities, the balance sheet location of the Company’s embedded derivative instruments is determined by the location of the related security.
VIEs consolidated by the Company have entered into derivative instruments consisting of interest rate swaps, interest rate caps and cross currency swaps. Interest rate swaps and caps are entered into to mitigate the risks associated with fluctuations in interest rates or fair values of certain contracts. Cross currency swaps are entered into to hedge the variability in cash flows resulting from fluctuations in foreign currency rates.
Changes in the fair value of the Company’s asset/liability products business derivatives are recorded on the Company’s consolidated statements of operations within “Net gains (losses) on financial instruments at fair value and foreign exchange”.
The following tables present information about credit derivatives sold by the Company’s insurance operations that were outstanding as of December 31, 2013 and 2012. Credit ratings represent the lower of underlying ratings assigned to the collateral by Moody’s, S&P or MBIA.
As of December 31, 2013, the total fair value of the Company’s derivative liabilities, after counterparty netting of $42 million and cash collateral posted by the Company of $123 million was $1.2 billion, which was reported within “Derivative liabilities” and “Derivative liabilities” presented under “Liabilities of consolidated variable interest entities” on the Company’s consolidated balance sheets. Embedded derivatives of $19 million were reported within “Medium-term notes” on the Company’s consolidated balance sheets.
As of December 31, 2012, the total fair value of the Company’s derivative liabilities, after counterparty netting of $90 million and cash collateral posted by the Company of $203 million, was $3.1 billion which was reported within “Derivative liabilities” and “Derivative liabilities” presented under “Liabilities of consolidated variable interest entities” on the Company’s consolidated balance sheets. Embedded derivatives of $36 million were reported within “Medium-term notes” and “Other investments” on the Company’s consolidated balance sheets.
The following table presents the total fair value of the Company’s derivative assets and liabilities by instrument and balance sheet location, before counterparty netting and posting of cash collateral, as of December 31, 2012:
As of December 31, 2013, accrued interest on the Company’s long-term debt was reported within “Long-term debt” on the Company’s consolidated balance sheets. Prior to December 31, 2013, the accrued interest on long-term debt was included in “Other liabilities” on the Company’s consolidated balance sheets. The accrued interest on long-term debt has been reclassified in the prior year’s financial statements to conform to the current presentation. This reclassification had no impact on total revenues, expenses, assets, liabilities, shareholders’ equity, operating cash flows, investing cash flows, or financing cash flows for all periods presented.
On January 16, 2008, MBIA Insurance Corporation issued $1.0 billion of 14% fixed-to-floating rate surplus notes due January 15, 2033. As of December 31, 2013 and 2012, the par amount outstanding was $940 million. The surplus notes had an initial interest rate of 14% until January 15, 2013 and thereafter have an interest rate of three-month LIBOR plus 11.26%. Interest and principal payments on the surplus notes are subject to prior approval by the Superintendent of the NYSDFS. From the January 15, 2013 interest payment to the present, MBIA Insurance Corporation’s requests for approval of the note interest payments have been denied by the NYSDFS. MBIA Insurance Corporation provided notice to the Fiscal Agent that it has not made a scheduled interest payment. The deferred interest payment will become due on the first business day on or after which MBIA Insurance Corporation obtains approval to make such payment. No interest will accrue on the deferred interest. The surplus notes were callable at par at the option of MBIA Insurance Corporation on the fifth anniversary of the date of issuance, and are callable at par on January 15, 2018 and every fifth anniversary thereafter and are callable on any other date at par plus a make-whole amount, 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. As of December 31, 2013, MBIA Inc., through its corporate segment, owned $13 million of MBIA Insurance Corporation surplus notes. To date, MBIA Insurance Corporation has repurchased a total of $47 million par value outstanding of its surplus notes at a weighted average price of $77.08.
Investment agreements have been issued with either fixed or floating interest rates in U.S. dollars. As of December 31, 2013, the annual interest rates on these agreements ranged from 0.21% to 7.38% and the weighted average interest rate was 5.10%. As of December 31, 2012, the annual interest rates on these agreements ranged from 0.28% to 7.38% and the weighted average interest rate was 5.04%. Expected principal payments due under these investment agreements in each of the next five years ending December 31 and thereafter, based upon contractual maturity dates, are as follows:
MTN obligations are recorded as liabilities on the Company’s balance sheets based upon proceeds received, net of unamortized discounts and premiums, plus unpaid accrued interest at the balance sheet date. Certain MTNs are measured at fair value in accordance with the accounting guidance for hybrid financial instruments, which was adopted on January 1, 2007. MTNs are issued by GFL as part of MBIA’s asset/liability products. MTNs have been issued with either fixed or floating interest rates and GFL has issued MTNs in U.S. dollars and foreign currencies. During the year ended December 31, 2013, the Company redeemed $506 million par value outstanding of MTNs issued by the Company’s conduit segment at a cost of 99.86% of par value. The Company also repurchased approximately $192 million par value outstanding of GFL MTNs issued by the Company’s asset/liability segment at a weighted average cost of approximately 91.35% of par value. As of December 31, 2013, the interest rates of the MTNs ranged from 0% to 8.93% and the weighted average interest rate was 2.67%. As of December 31, 2012, the interest rates of the MTNs ranged from 0% to 8.08% and the weighted average interest rate was 2.89%. Expected principal payments due under MTN obligations based on their contractual maturity dates are as follows:
(1)-Amounts reflect principal due at maturity for notes issued at a discount or premium.
VIE notes are variable interest rate debt instruments that were issued primarily in U.S. dollars by consolidated VIEs within the Company’s structured finance and international insurance and conduit segments. VIE notes within the structured finance and international insurance segment consist of debt instruments issued by issuer-sponsored consolidated VIEs collateralized by assets held by those consolidated VIEs. VIE notes related to the conduit segment consist of floating rate MTN obligations issued by a Company-sponsored conduit collateralized by assets held by the conduit. As of December 31, 2013, the interest rate of the MTN was 1.02%. As of December 31, 2012, the interest rates of the MTNs ranged from 0.55% to 1.71% and the weighted average interest rate was 1.28%. The maturity of VIE notes, by segment, as of December 31, 2013 is presented in the following table:
(1)-Includes $2.4 billion of VIE notes accounted for at fair value as of December 31, 2013.
Borrowings under the Blue Ridge Secured Loan had a variable interest rate, at MBIA Insurance Corporation’s option based on either: (i) the adjusted LIBOR plus an applicable margin (“LIBOR Loans”), or (ii) the highest between (a) Bank of America’s prime rate and (b) the sum of the federal funds effective rate plus 0.5% and (c) the adjusted LIBOR plus 1.00%, plus an applicable margin (“Base Rate Loans”). The applicable margin for the LIBOR Loans and the Base Rate Loans is 7.50% and 6.50%, respectively. With respect to any available but undrawn amounts under the Blue Ridge Secured Loan, MBIA Insurance Corporation was obligated to pay a commitment fee on such undrawn amounts of 2.00% per annum. The amount of the commitment fee and interest expense for the year ended December 31, 2013 was $7 million.
The tax effects of temporary differences that give rise to deferred tax assets and liabilities as of December 31, 2013 and 2012 are presented in the following table:
In the fourth quarter of 2013, the Internal Revenue Service contacted the Company to review the 2011 consolidated return on MBIA and its subsidiaries and for the purpose of determining whether to formally examine the tax return. To date no formal examination has been initiated.
As of December 31, 2013, the Company’s NOL is approximately $2.8 billion which will expire between tax years 2029 through 2033. As of December 31, 2013, the Company has an alternative minimum tax credit carryforward of $22 million, which does not expire. As a result of the commutation of CMBS exposure that occurred subsequent to December 31, 2013, the Company’s NOL will increase from December 31, 2013.
The Company’s U.S. public finance insurance segment is principally conducted through National. The financial guarantees issued by National provide unconditional and irrevocable guarantees of the payment of the principal of, and interest or other amounts owing on, U.S. public finance insured obligations when due. The obligations are generally not subject to acceleration, except that National may have the right, at its discretion, to accelerate insured obligations upon default or otherwise. National issues financial guarantees for municipal bonds, including tax-exempt and taxable indebtedness of U.S. political subdivisions, as well as utility districts, airports, health care institutions, higher educational facilities, student loan issuers, housing authorities and other similar agencies and obligations issued by private entities that finance projects that serve a substantial public purpose. Municipal bonds and privately issued bonds used for the financing of public purpose projects are generally supported by taxes, assessments, fees or tariffs related to the use of these projects, lease payments or other similar types of revenue streams. National has not written any meaningful amount of business since its formation in 2009.
The Company’s corporate segment is principally conducted through Optinuity Alliance Resources Corporation (“Optinuity”), which provides general support services to the corporate segment and other operating businesses. Optinuity is a reportable segment that includes revenues and expenses that arise from general corporate activities, such as fees, net investment income, net gains and losses, interest expense on MBIA Inc. debt and general corporate expenses. Employees of the service company provide various support services including management, legal, accounting, treasury, information technology, and insurance portfolio surveillance, among others, on a fee-for-service basis. The service company’s revenues and expenses are included in the results of the corporate segment.
The following tables provide the Company’s segment results for the years ended December 31, 2013, 2012 and 2011:
(3)-Consists of intercompany reinsurance balances, repurchase agreements, deferred taxes and loans.
The following tables provide the results of the segments within the wind-down operations for the years ended December 31, 2013, 2012 and 2011:
(1)-Includes investor owned utilities, industrial development and pollution control revenue bonds.
MBIA requires certain unauthorized reinsurers to maintain bank letters of credit or establish trust accounts to cover liabilities ceded to such reinsurers under reinsurance contracts. As of December 31, 2013, the total amount available under these letters of credit and trust arrangements was $32 million. The Company remains liable on a primary basis for all reinsured risk, and although MBIA believes that its reinsurers remain capable of meeting their obligations, there can be no assurance of such in the future.
For the years ended December 31, 2013, 2012 and 2011, recoveries received on claims for financial guarantee policies under reinsurance contracts totaled $4 million, $4 million and $10 million, respectively. Ceding commissions from reinsurance, before deferrals and net of returned ceding commissions, were $2 million, $3 million and $3 million for the years ended December 31, 2013, 2012, and 2011, respectively.
The New York Insurance Law (“NYIL”) regulates the payment of dividends by financial guarantee insurance companies and provides that such companies may not declare or distribute dividends except out of statutory earned surplus. Under the NYIL, the sum of (i) the amount of dividends declared or distributed during the preceding 12-month period and (ii) the dividend to be declared may not exceed the lesser of (a) 10% of policyholders’ surplus, as reported in the latest statutory financial statements and (b) 100% of adjusted net investment income for such 12-month period (the net investment income for such 12-month period plus the excess, if any, of net investment income over dividends declared or distributed during the two-year period preceding such 12-month period), unless the Superintendent of the NYSDFS approves a greater dividend distribution based upon a finding that the insurer will retain sufficient surplus to support its obligations.
For the years ended December 31, 2013 and 2012, National had statutory net income of $256 million and $416 million, respectively. As of December 31, 2013, National’s statutory capital was $3.3 billion, consisting of policyholders’ surplus of $2.1 billion and contingency reserves of $1.2 billion. As of December 31, 2012, National had statutory capital of $3.2 billion.
The Company maintains a qualified non-contributory defined contribution pension plan to which the Company contributes 10% of each eligible employee’s annual compensation. Annual compensation for determining such contributions consists of base salary, bonus and commissions, as applicable. Pension benefits vest over a five-year period with 20% vested after two years, 60% vested after three years, 80% vested after four years and 100% vested after five years. The Company funds the annual pension contribution by the following February of each applicable year. Pension expense related to the Company’s qualified pension plan for the years ended December 31, 2013, 2012 and 2011 was $4 million, $7 million, and $6 million, respectively.
The Company also maintains a qualified profit sharing/401(k) plan. The plan is a voluntary contributory plan that allows eligible employees to defer compensation for federal income tax purposes under Section 401(k) of the Internal Revenue Code of 1986, as amended. Employees may contribute, through payroll deductions, up to 25% of eligible compensation. The Company matches employee contributions up to the first 5% of such compensation. The 401(k) matching contributions are made in the form of cash, whereby participants may direct the Company match to an investment of their choice. The benefit of the Company’s contributions vest over a five-year period with 20% vested after two years, 60% vested after three years, 80% vested after four years and 100% vested after five years. Generally, a participating employee is entitled to distributions from the plans upon termination of employment, retirement, death or disability. Participants who qualify for distribution may receive a single lump sum, transfer the assets to another qualified plan or individual retirement account, or receive a series of specified installment payments. Profit sharing/401(k) expense related to the Company’s qualified plan for the years ended December 31, 2013, 2012 and 2011 was $3 million, $3 million, and $4 million, respectively.
In addition to the above two plans, the Company maintains a non-qualified deferred compensation plan. Contributions to the above qualified plans that exceed limitations established by federal regulations are then contributed to the non-qualified deferred compensation plan. The non-qualified pension expense for the years ended December 31, 2013, 2012 and 2011 was $2 million for each applicable year. The non-qualified profit sharing/401(k) expense for each of the years ended December 31, 2013, 2012 and 2011 was $1 million for each applicable year.
The Board of Directors of the Company approved restricted share grants for certain key employees in December 2012. The vesting schedules of these grants are linked to the Company’s market value performance. For further information regarding performance based awards, please refer to the “Performance Based Awards” section of this note.
In accordance with accounting guidance for share-based payments, the Company expenses the fair value of employee stock options and other forms of stock-based compensation. In addition, the guidance classifies share-based payment awards as either liability awards, which are remeasured at fair value at each balance sheet date, or equity awards, which are measured on the grant date and not subsequently remeasured. Generally, awards with cash-based settlement repurchase features or that are settled at a fixed dollar amount are classified as liability awards, and changes in fair value will be reported in earnings. Awards with net-settlement features or that permit a cashless exercise with third-party brokers are classified as equity awards and changes in fair value are not reported in earnings. The Company’s long-term incentive plans include features which result in both liability and equity awards. For liability awards, the Company remeasures these awards at each balance sheet date. In addition, the guidance requires the use of a forfeiture estimate. The Company uses historical employee termination information to estimate the forfeiture rate applied to current stock-based awards.
The Company maintains voluntary retirement benefits as discussed in “Note 15: Pension and Profit Sharing Plans.” One of the components of the retirement program for those employees that are retirement eligible is to continue to vest all performance-based stock options and restricted share awards beyond the retirement date in accordance with the original vesting terms and to immediately vest all outstanding time-based stock options and restricted share grants. The accounting guidance for share-based payment requires compensation costs for those employees to be recognized from the date of grant through the retirement eligible date, unless there is a risk of forfeiture, in which case the compensation cost is recognized in accordance with the original vesting schedule. Accelerated expense, if any, relating to this retirement benefit for both stock option awards and restricted stock awards has been included in the compensation expense amounts.
The fair value of the restricted shares awarded, determined on the grant date, was $6 million and $21 million, and the fair value of the restricted shares canceled was $1 million and $2 million for 2013 and 2012, respectively. Restricted shares have been recorded as unearned compensation, which is a component of paid-in capital within shareholders’ equity on the Company’s consolidated balance sheets and have been included in “Share-based compensation” on the Company’s consolidated statements of changes in shareholders’ equity. The amount of unearned compensation, net of estimated forfeitures, was $15 million as of December 31, 2013, which is expected to be recognized as expense over a weighted average period of 2.15 years. Unearned compensation is amortized to expense over the appropriate three- to five-year vesting period (except for a minor portion granted to members of the MBIA Inc. Board of Directors which is amortized over a ten-year period).
Compensation expense related to the restricted shares, net of estimated forfeitures, was $11 million, $11 million and $9 million for the years ended December 31, 2013, 2012 and 2011, respectively. The tax benefit related to the restricted share awards during 2013, 2012 and 2011 was $1 million, $1 million and $2 million, respectively. In addition, during 2011 there was a tax charge of $1 million in paid-in capital related to the restricted shares that vested at a lower market value in comparison to the market value on the date of grant.
A summary of the Company’s restricted shares outstanding as of December 31, 2013, 2012 and 2011, and changes during the years ended on those dates, is presented in the following table:
During 2010, the Board of Managers of Cutwater established the Cutwater Asset Management Equity Participation Plan (“the Plan”). The purpose of the Plan is to promote the interests of Cutwater and its equity security holders and is designed to provide compensation tied to the value of Cutwater by the grant of equity participation units. Each unit represents the contractual right to receive cash payments based on the value of Cutwater. These grants have a restriction period lasting five years, after which time the awards fully vest providing the participant is continuously employed by Cutwater or one of its affiliates during that period. The maximum number of units available for grant under the Plan is 350,000. During 2013, no new units were granted and 8,334 units were canceled. As of December 31, 2013, 223,312 units were outstanding and 126,688 units were available for future grants under the Plan. In accordance with the accounting guidance for awards that include a cash-based settlement feature, the Plan is classified as a liability award. The original value of the award was determined on the date of grant and remeasured at each balance sheet date. A liability is accrued over the vesting period of the Plan and reflects the present value of the award as of each balance sheet date. Any change is reflected in earnings. For the year ended December 31, 2013, no compensation cost related to the Plan was recorded. Compensation cost related to the Plan for the years ended December 31, 2012 and 2011 was a benefit of $3 million and $2 million, respectively. The benefits were due to declines in the present value of the award.
Basic earnings per share excludes dilution and is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects the dilutive effect of all stock options, warrants and unvested restricted stock outstanding during the period that could potentially result in the issuance of common stock. The dilution from stock options, warrants and unvested restricted stock are calculated by applying the two-class method and using the treasury stock method. The treasury stock method assumes the proceeds from the exercise of stock options and warrants or the unrecognized compensation expense from unvested restricted stock will be used to purchase shares of the Company’s common stock at the average market price during the period. For the years ended December 31, 2013, 2012 and 2011, there were 32,206,222, 31,927,315 and 32,628,037, respectively, of stock options, warrants and unvested restricted stock outstanding that were not included in the diluted earnings per share calculation because they were antidilutive.
During 2008, the Company granted Warburg Pincus warrants to purchase 11.5 million shares of MBIA common stock at an exercise price of $30.25 per share, “B” warrant, which, upon obtaining certain approvals, will become exercisable to purchase 9.8 million shares at a price of $30.25 per share, and “B2” warrant to purchase 4 million shares at a price of $16.20 per share.
In connection with the BofA Settlement Agreement described in “Note 1: Business Developments and Risks and Uncertainties” in the Notes to Consolidated Financial Statements, on May 6, 2013, MBIA Inc. issued Blue Ridge a five-year warrant to purchase 9.94 million shares of MBIA Inc. common stock at an exercise price of $9.59 per share.
In accordance with MBIA’s fixed-rate election, the dividend rate on the preferred stock was determined using a fixed-rate equivalent of LIBOR plus 200 basis points. Each share of preferred stock has a par value of $1,000 with a liquidation preference of $100,000. The holders of the preferred stock are generally not entitled to any voting rights. Subject to certain requirements, the preferred stock may be redeemed, in whole or in part, at the option of MBIA Corp. at any time or from time to time for cash at a redemption price equal to the liquidation preference per share plus any accrued and unpaid dividends thereon at the date of redemption for the then current dividend period and any previously accumulated dividends payable without interest on such unpaid dividends. As of December 31, 2013 and 2012, there were no dividends declared on the preferred stock. Payment of dividends on MBIA Corp.’s preferred stock is subject to the same restrictions that apply to dividends on common stock under NYIL. The terms of the preferred stock provide that if MBIA Corp. fails to pay dividends in full on the preferred stock for 18 consecutive months, the authorized number of members of the MBIA Corp. Board of Directors will automatically be increased by two and the holders of the preferred stock will be entitled to fill the vacancies so created at a special meeting of the preferred shareholders of MBIA Corp. Due to its nonpayment of dividends on the preferred stock for 18 consecutive months, MBIA Corp. held a meeting of preferred stockholders on August 12, 2011 to elect the two new directors. The meeting was adjourned because a quorum was not present.
Other parties that can significantly influence the management or policies of the transacting parties or that have an ownership interest in one of the transacting parties and can significantly influence the other to the extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests.
On December 14, 2009, MBIA Corp. commenced an action in New York State Supreme Court, New York County, against Credit Suisse. The complaint seeks damages for fraud and breach of contractual obligations in connection with the procurement of financial guarantee insurance on the HEMT securitization. On January 30, 2013, MBIA Corp. filed an amended complaint. The amended complaint alleges, among other claims, that Credit Suisse falsely represented: (i) the attributes of the securitized loans; (ii) that the loans complied with the governing underwriting guidelines; and (iii) that Credit Suisse had conducted extensive due diligence on and quality control reviews of the securitized loans to ensure compliance with the underwriting guidelines. The complaint further alleges that the defendants breached their contractual obligations to cure or repurchase loans found to be in breach of the representations and warranties applicable thereto and denied MBIA the requisite access to all records and documents regarding the securitized loans. On March 8, 2013, the defendants filed their answer to the amended complaint. On April 19, 2013, the court issued an order scheduling fact discovery to close by June 30, 2014.
On September 14, 2012, MBIA Insurance Corp. filed a complaint alleging fraud against J.P. Morgan Securities LLC (f/k/a Bear, Stearns & Co. Inc.) relating to Bear, Stearns & Co. Inc.’s role as lead securities underwriter on the GMAC Mortgage Corporation Home Equity Loan Trust 2006-HE4. Oral argument on J.P. Morgan Securities LLC’s motion for summary judgment was held on November 22, 2013. A decision is pending.
On July 18, 2013, the City of Detroit, Michigan filed a voluntary petition under Chapter 9 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Eastern District of Michigan; Case No. 13-53846-swr. On December 5, 2013, Judge Steven W. Rhodes entered an order finding the City of Detroit eligible to be a debtor under Chapter 9. On November 8, 2013, National, together with Assured Guaranty Municipal Corp. (“Assured”), commenced an adversary proceeding, captioned National Public Finance Guarantee Corp. et al. v City of Detroit, Michigan et al.; Adv. Pro. No 13-05309, against the City of Detroit and certain individuals. On December 23, 2013, National and Assured filed an amended complaint seeking, among other things, a declaratory judgment that the City of Detroit and its employees/managers must comply with Michigan state law in the collection, segregation and use of restricted ad valorem tax proceeds levied and pledged to repay the principal and interest on several series of Detroit’s unlimited tax general obligation bonds, as well as declaratory relief with respect to National’s and Assured’s rights and interests in the ad valorem tax proceeds. On January 17, 2014, the defendants filed a motion to dismiss the amended complaint. Oral argument on the motion was heard on February 19, 2014, and a decision is pending.
On July 23, 2008, the City of Los Angeles filed a complaint in the Superior Court of the State of California, County of Los Angeles, against a number of financial guarantee insurers, including MBIA. At the same time and subsequently, additional complaints against MBIA and nearly all of the same co-defendants were filed by various municipal entities and quasi-municipal entities, mostly in California. These cases are part of a coordination proceeding in Superior Court, San Francisco County, before Judge Richard A. Kramer, referred to as the Ambac Bond Insurance Cases. In August 2011, the plaintiffs filed amended versions of their respective complaints. The claims allege participation by all the defendants in a conspiracy in violation of California’s antitrust laws to maintain a dual credit rating scale that misstated the credit default risk of municipal bond issuers and not-for-profit issuers and thus created market demand for bond insurance. The plaintiffs also allege that the individual bond insurers participated in risky financial transactions in other lines of business that damaged each bond insurer’s financial condition (thereby undermining the value of each of their guaranties), and each failed to adequately disclose the impact of those transactions on their financial condition. In addition to the statutory antitrust claim, the plaintiffs assert common law claims of breach of contract and fraud against MBIA and the other monoline defendants. The non-municipal plaintiffs also allege a California unfair competition cause of action. The plaintiffs filed a notice of appeal of the March 22, 2013 decision that granted the Bond Insurer defendants’ motion to strike pursuant to California’s Anti-SLAPP statute dismissing the plaintiffs’ claims under California’s Cartwright Act. On October 1, 2013, the Bond Insurer defendants’ filed a notice of cross-appeal.