As a financial guarantee insurance and investment management services company, our business is materially affected by conditions in global financial markets and has been adversely affected by the deteriorating performance of RMBS and CDOs.
Concerns about monoline insurers and the collapse of certain financial institutions, together with unprecedented levels of volatility and uncertainty in markets around the world, have materially affected our business, with a particular impact from the following events:
The municipal bond market has experienced a significant decline in demand for bond insurance.
Credit deterioration in structured finance exposures led to negative actions by rating agencies for most financial guarantors.
Temporarily suspended the writing of all new structured finance business during a re-assessment of our underwriting origination and monitoring practices.
Elimination of MBIA Inc. dividend provided an additional $174 million of capital flexibility.
For the year ended December 31, 2008, we recorded a net loss of $2.7 billion, or $12.29 per share, compared with a net loss of $1.9 billion, or $15.17 per share, for the year ended December 31, 2007 and net income of $819 million, or $5.99 per share, for the year ended December 31, 2006.
Consolidated revenues in 2008 were a loss of $857 million compared with a loss of $284 million in 2007 and revenues of $2.7 billion in 2006. The increase in our consolidated loss in 2008 compared with 2007 reflects an increase in net realized losses related to sales and impairments of securities and a decrease in net investment income within our investment management services operations, partially offset by a decrease in losses on credit derivatives within our insurance operations and net gains on the repurchase of debt within our investment management services operations. The decrease in consolidated revenues in 2007 compared with 2006 reflects an increase in losses on credit derivatives within our insurance operations, partially offset by an increase in net investment income within our investment management services operations.
Consolidated expenses were $2.9 billion in 2008 compared with $2.8 billion in 2007 and $1.6 billion in 2006. The increase in our consolidated expenses in 2008 compared with 2007 reflects an increase in losses and loss adjustment expenses related to our mortgage exposure and an increase in operating and interest expenses within our insurance operations, partially offset by a decrease in interest expense within our investment management services operations.
MBIA’s insurance operations have been principally conducted through MBIA Insurance Corporation and its subsidiaries (“MBIA Corp.”). MBIA Corp.’s guarantees insure municipal bonds, asset-backed and mortgage-backed securities (“ABS” and “MBS”, respectively), investor-owned utility bonds, bonds backed by publicly or privately funded public-purpose projects, bonds issued by sovereign and sub-sovereign entities, and bonds backed by other revenue sources such as corporate franchise revenues. Insured asset-backed securities include collateral consisting of a variety of consumer loans, corporate loans and bonds, trade and export receivables, aircraft, equipment and real property leases and insured mortgage-backed securities include collateral consisting of residential and commercial mortgages. Additionally, MBIA Corp. has insured credit default swaps (“CDSs”) on structured pools of corporate obligations, residential mortgage-backed securities, and commercial real estate backed securities and loans. The financial guarantees issued by MBIA Corp. provide unconditional and irrevocable guarantees of the payment of the principal of, and interest or other amounts owing on, insured obligations when due. The obligations are generally not subject to acceleration, except that MBIA Corp. may have the right, at its discretion, to accelerate insured obligations upon default or otherwise. Certain investment agreement contracts written by MBIA Inc. and insured by MBIA Corp. are terminable upon ratings downgrades, and if MBIA Inc. were to have insufficient assets to pay the termination payments, MBIA Corp. would make such payments.
On February 18, 2009, the Company announced that it had restructured MBIA Insurance Corporation and established a separate U.S. public finance financial guarantee insurance company using MBIA Illinois, an existing public finance financial guarantee insurance company wholly owned by MBIA Insurance Corporation. As part of
In connection with the reinsurance and assignment agreements, MBIA Insurance Corporation paid to MBIA Illinois approximately $2.9 billion, which is equal to the statutory net unearned premium, net of a ceding commission and loss and loss adjustment expense reserves, as premium to reinsure the policies covered by these agreements. The ceding commission paid to MBIA Insurance Corporation equaled 22% of the net unearned premium reserve ceded.
To provide additional protection to its policyholders, MBIA Illinois has also issued second-to-pay policies for the benefit of the policyholders covered by the above reinsurance and assignment agreements. These second-to-pay policies, which are direct obligations of MBIA Illinois, are held by a trustee and provide that if MBIA Insurance Corporation or FGIC, as applicable, do not pay valid claims of their policyholders, the policyholders will then be able to make claims directly against MBIA Illinois. MBIA Insurance Corporation will retain its structured finance and international insured exposure, as well as its guarantee of investment agreement contracts and medium-term notes (“MTNs”) issued by the Company’s investment management services operations, and plans to resume business in these markets when its credit ratings and market conditions permit.
We believe that the separation of our U.S. public finance business from our structured finance and international businesses is a significant step towards re-entering and competing in these markets while preserving the interests of all policyholders. Refer to “Note 28: Subsequent Events” in the Notes to Consolidated Financial Statements for further information about the reorganization of the Company’s insurance operations.
In December 2006, MBIA completed the sale of Capital Asset Holdings GP, Inc. and certain affiliated entities (“Capital Asset”). The sale of Capital Asset also included three VIEs established in connection with MBIA-insured
The Company prepares its financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”), which requires the use of estimates and assumptions. The following accounting estimates are viewed by management to be critical because they require significant judgment on the part of management. Management has discussed and reviewed the development, selection and disclosure of the critical accounting estimates with the Company’s Audit Committee. Financial results could be materially different if alternate methodologies were used or if management modified its assumptions.
The Company establishes two types of loss and LAE reserves: an unallocated loss reserve and case basis reserves. The unallocated loss reserve is established with respect to the Company’s entire non-derivative insured portfolio. The Company’s unallocated loss reserve represents the Company’s estimate of losses that have occurred or are probable to occur as a result of credit deterioration in the Company’s insured portfolio but which have not yet been specifically identified and applied to specific insured obligations. Case basis reserves represent the Company’s estimate of probable losses on specifically identified credits that have defaulted or are expected to default.
Each quarter we calculate our provision for the unallocated loss reserve as a fixed percent of scheduled net earned premium of the insurance operations. Prior to the first quarter of 2008, scheduled net earned premium of
During the years ended December 31, 2008, 2007 and 2006, the Company’s loss and LAE provision for the unallocated loss reserve based on a loss factor of 14.5%, 12% and 12% was $92 million, $86 million and $81 million, respectively. These amounts are recorded within loss and loss adjustment expenses on the Company’s statements of operations. In 2008 and 2007, the Company recorded $1.2 billion and $814 million, respectively, of additional loss and LAE to increase case loss reserves on its RMBS exposure as a result of stress in the mortgage markets and an increase in defaults on MBS. Therefore, our provision for loss and LAE for the years ended December 31, 2008 and 2007 totaled $1.3 billion and $900 million, respectively. We believe that the current loss factor of 14.5% provides an adequate reserve for probable losses in our non-derivative insured portfolio, excluding the RMBS exposure that we have separately reserved for.
For the year ended December 31, 2006, the Company’s additions to specific case basis reserves were less than the loss and LAE provision calculated from its loss factor. Conversely, additions to specific case basis reserves in the years ended December 31, 2005, 2007 and 2008 exceeded the Company’s loss and LAE provision calculated from its loss factor. However, with the exception of the additional loss and LAE recorded in 2008 and 2007 related to MBIA’s RMBS exposure, the Company has calculated its provision for the unallocated loss reserve at a consistent percentage of scheduled net earned premium of its insurance operations since 2002. Given the increased level of specific case basis losses recorded in the last several years, such as those related to our RMBS exposure, if none of the other variables used in deriving the loss factor had changed, the Company’s cumulative loss factor through December 31, 2008 would approximate 42%, which would have generated loss and LAE of $268 million, $265 million and $261 million for the years ended December 31, 2008, 2007 and 2006, respectively. However, another variable that changed over the last several years and that affects the determination of the loss factor is the mix of business among different sectors. During the last several years, the Company had ceased writing business in certain sectors in which loss experience has been high relative to its total portfolio, such as tax liens, lower rated high yield collateralized bond obligations, manufactured housing and
certain direct corporate obligations, which offset the impact that the higher case basis incurred activity would have on the loss factor. Excluding actual loss experience incurred in the sectors listed above and the reserves established for RMBS exposure in 2008 and 2007 in addition to its loss factor, the Company’s cumulative loss factor through December 31, 2008 would approximate 10%, which would have generated loss and LAE of $61 million, $60 million and $59 million for the years ended December 31, 2008, 2007 and 2006, respectively.
In establishing case basis reserves, we present value estimated loss payments, net of estimated recoveries, using a discount rate equal to the yield-to-maturity of MBIA Insurance Corporation’s fixed-income investment portfolio, excluding investments in money market funds and including intercompany loans under repurchase agreements, as of the current reporting date. The discount rate used to calculate case basis reserves of December 31, 2008 was 5.03%. If the Company were to reference a different discount rate, its case basis reserves may have been higher or lower than those established as of December 31, 2008. For example, a higher discount rate would have decreased the amount of case basis reserves established by the Company and a lower rate would have increased the amount of reserves established by the Company. However, we believe that the discount rate used represents the most appropriate rate of return for present valuing our reserves as it reflects the rate of return on the assets supporting future claim payments by the Company.
We assumed that loans reported as delinquent as of August 31, 2008 would default during the following six months at an assumed default rate based on the number of days that the loan was delinquent at such time (the “Roll Rate Default Methodology”).
For loans that are current (not delinquent), we derived the Roll to Loss rates by multiplying the percentage of loans in the 30-59 bucket and the Roll to Loss rates for the 30-59 delinquency bucket (“Current to Loss”). We applied this percentage each month going forward to the remaining current pool balance to project future losses.
We have run various elevated default period duration scenarios when determining loss reserves. Our expected cases assume that the current elevated loss period will begin to decrease during the first half of 2009. As such, we begin to reduce monthly defaults over a period of six to eight months.
In addition, for transactions secured by HELOCs, the model considered borrower draws and repayment rates. For HELOCs, the current three-month average draw rate was used to project future draws on the line. For HELOCs and transactions secured by fixed rate CES, the three-month average conditional repayment rate (“CRR”) was used to project voluntary principal repayments. Cash flows also assumed a constant basis spread between floating rate assets and floating rate insured debt obligations (the difference between Prime and LIBOR interest rates, minus any applicable fees). For all transactions, cash flows considered allocations and other structural aspects of a transaction, including managed amortization periods, rapid amortization periods and claims against MBIA’s insurance policy consistent with such policy’s terms and conditions.
The assumptions and cash flow structure referenced above resulted in a forecasted cumulative collateral loss that was added to existing actual cumulative collateral losses. The resulting estimated net claims on MBIA’s insurance policies were discounted to a net present value reflecting MBIA’s obligation to pay claims over time and not on an accelerated basis. The above assumptions represent MBIA’s best estimate of how transactions will perform over time.
significantly reduce the impact of current reserves and/or potential increases to reserves in future periods due to elevated peak loss rates.
Fair value is defined as an exit price, which is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at a specified measurement date. The degree of judgment used to determine the fair values of financial instruments generally correlates to the degree of pricing observability. Financial instruments in liquid markets with readily available and actively quoted prices, or with such prices for comparable instruments usually have the most pricing observability. Financial instruments rarely traded or not quoted have less observability and are usually measured by valuation models that require judgment. Pricing observability is affected by type of financial instrument, whether the instrument is well established in the market, by characteristics unique to individual transactions and by overall market conditions, including whether prices are generated as distressed transactions.
We have categorized our financial instruments measured at fair value into the three-level classification of SFAS 157, “Fair Value Measurements,” which considers this issue of pricing observability. 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 conservatively using the lowest level category at which we can generate reliable fair values. The determination of reliability requires management to exercise judgment.
The fair value pricing of assets and liabilities is a function of many components which includes interest rate risk, market risk, liquidity risk and credit risk. For financial instruments that are internally valued by the Company, as well as those for which the Company uses broker quotes or pricing services, credit risk is typically incorporated by using appropriate credit spreads or discount rates as inputs.
Assets with fair value derived from broker quotes or pricing services can be within Level 1, 2 or 3 of the SFAS 157 fair value hierarchy, depending on the observability of inputs. Typically we receive one broker quote or pricing service value for each instrument, which represents a non-binding indication of value. We review the assumptions, inputs and methodologies used by pricing services as a basis for classification within the three levels of the SFAS 157 fair value hierarchy. For example, broker quoted prices are classified as Level 3 if we consider the inputs used are not market-based and observable. Pricing service data is received monthly and on a
quarterly basis, and we use a variety of methods to analyze the reasonableness of these third-party valuations, including comparisons to similar quality and maturity assets, internal modeling of implied credit spreads by sector and quality, comparison to published spread estimates, and assessment relative to comparable dealer offerings or any actual transactions from a recent time period. When we believe a third-party quotation differs significantly from our internal value, whether higher or lower, we review our data or assumptions with the provider. The price provider may subsequently provide an updated price. We do not make any internal adjustments to prices provided by a broker or pricing service.
Financial assets recorded on the Company’s balance sheet at fair value as of December 31, 2008 totaled $18.4 billion, of which $16.3 billion were valued using pricing services or broker quotes. The following table presents the type, amount and fair value hierarchy classification for financial assets for which pricing services or broker quotes were used by the Company in determining fair value as of December 31, 2008:
The Company’s financial instruments categorized as liabilities primarily consist of investment agreements and MTNs issued by the asset/liability products and conduit segments within our investment management services operations, as well as debt issued for general corporate purposes. Such liabilities are typically recorded at face value adjusted for premiums or discounts. The fair values of these financial instruments are generally not reported within the Company’s financial statements but disclosed in the accompanying notes. However, financial liabilities which qualify as part of fair value hedging arrangements under SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended are reported in the Company’s balance sheet at a value that reflects changes in the risks being hedged, which offsets changes in the value of the hedging instrument. MBIA uses cash flow modeling techniques to estimate the value of its liabilities that qualify as hedged obligations under SFAS 133, incorporating current market data. Financial liabilities that the Company has elected to fair value under SFAS 155, “Accounting for Certain Hybrid Financial Instruments” or that require fair value reporting or disclosures within the
The following table presents the type, amount and fair value hierarchy classification for financial liabilities for which pricing services or broker quotes were used by the Company in determining fair value as of December 31, 2008:
MBIA has entered into derivative transactions both within its financial guarantee insurance business and in hedging risks associated with its assets and liabilities. CDS contracts are also used in the investment management services operations to replicate investments in cash assets consistent with the risk tolerance and criteria for this business. We account for derivative transactions in accordance with SFAS 133, which requires that all such transactions be recorded on the Company’s balance sheet at fair value. The fair value of derivative instruments is determined as the amount that would be received to sell the derivative when in an asset position (when the Company would be owed money under the derivative in a termination) or transfer the derivative when in a liability position (when the Company would owe money under the derivative in a termination). Changes in the fair value of derivatives, exclusive of insured derivatives, are recorded each period in current earnings within “Net gains (losses) on financial instruments at fair value and foreign exchange” or in shareholders’ equity within “Accumulated other comprehensive income (loss)” depending on whether the derivative is designated as a hedge, and if so designated, the type of hedge.
The majority of our derivative exposure lies in credit derivative instruments insured by MBIA Corp. Prior to 2008, MBIA Corp. insured CDSs entered into by LaCrosse Financial Products LLC (“LaCrosse”), an entity that is consolidated into MBIA’s GAAP financial statements under the FIN 46(R) criteria. In February 2008, we stopped insuring such derivative instruments except in transactions reducing our existing insured derivative exposure.
The majority of MBIA’s insured credit derivatives referenced structured pools of cash securities and CDSs. We generally insured the most senior liabilities of such transactions, and at transaction closing our exposure generally had more subordination than needed to achieve triple-A ratings from credit rating agencies (referred to as “Super Triple-A” exposure). The collateral backing our insured derivatives was cash securities and CDSs referencing primarily corporate, asset-backed, residential mortgage-backed, commercial mortgage-backed, commercial real estate loans, and CDO securities.
A portion of MBIA’s insured CDS contracts require that MBIA make payments for losses of the principal outstanding under the contracts when losses on the underlying referenced collateral exceed a predetermined
Our payment obligations are structured to prevent large one-time claims upon an event of default of underlying reference obligations and to allow for payments over time (i.e. “pay-as-you-go” basis) or at final maturity. However, the size of payments will ultimately depend on the timing and magnitude of losses. There are three types of payment provisions:
(iii) payments upon settlement of individual referenced collateral losses in excess of policy-specific deductibles and subordination. The deductible or loss threshold is the amount of losses experienced
As a result of these significant differences between market standard CDS contracts and the CDS contracts insured by MBIA, we believe there are no relevant third-party exit value market observations for our insured structured credit derivative contracts, and therefore no principal market as described in SFAS 157. In the absence of a principal market, we value these insured credit derivatives in a hypothetical market where market participants are assumed to be other comparably-rated primary financial guarantors. Since there are no observable transactions in the financial guarantee market that could be used to value our transactions, we generally use internal and third-party models, depending on the type and structure of the contract, to estimate the fair value of our insured derivatives.
credit spreads of the underlying collateral. This is based on actual spreads or spreads on similar collateral with similar ratings, or in some cases is benchmarked,
diversity score of the collateral pool as an indication of correlation of collateral defaults, and
Default probability is determined by three factors: credit spread, recovery rate after default and the time period under risk.
Correlation is modeled using a diversity score, which is calculated based on rules regarding industry or sector concentrations. Recovery rates are based on historical averages and updated based on market evidence.
The Company reviews the model results on a quarterly basis to assess the appropriateness of the assumptions and results in light of current market activity and conditions. This review is performed by internal staff with relevant expertise. If live market spreads are observable for similar transactions, those spreads are an integral part of the analysis. For example, new insured transactions that resemble existing (previously insured) transactions would be considered, as would negotiated settlements of existing transactions. However, this data has been scarce or non-existent in recent periods. As a result, our recent reviews have focused more on internal consistency and relativity, as well as the reasonableness of modeled results given current market conditions.
2) The model is a well-documented, consistent approach to marking positions that minimizes the level of subjectivity. Model structure, inputs and operation are well-documented both by Moody’s and by MBIA’s internal controls, creating a strong controls process in execution of the model. We have also developed a hierarchy for usage of various market-based spread inputs that reduces the level of subjectivity, especially during periods of high illiquidity.
1) There is no longer a market in which to test and verify the fair values generated by our model, and at December 31, 2008, the model inputs were also either unobservable or highly illiquid, adversely impacting their reliability.
3) Results may be affected by averaging of spreads and use of a single diversity factor, rather than using specific spreads for each piece of underlying collateral and collateral-specific correlation assumptions. While more specific data could improve the reliability of the results, it is not currently available and neither is a model that could produce more reliable results in the absence of that data.
The average spread of collateral is a key input as we assume credit spreads reflect the market’s assessment of default probability for each piece of collateral. Spreads are obtained from market data sources published by third parties (e.g. dealer spread tables for assets most closely resembling collateral within our transactions) as well as
collateral-specific spreads on the underlying reference obligations provided by trustees or market sources. Also, when these sources are not available, we benchmark spreads for collateral against market spreads, including in some cases, assumed relationships between the two spreads. This data is reviewed on an ongoing basis for reasonableness and applicability to our derivative portfolio.
We use the spread hierarchy listed below in determining which source of spread information to use, with the rule being to use CDS spreads where available and cash security spreads as the next alternative. Cash spreads reflect trading activity in funded fixed-income instruments while CDS spreads reflect trading levels for non-funded derivative instruments. While both markets are driven partly by an assessment of the credit quality of the referenced security, there are factors which create significant differences: CDS spreads can be driven by speculative activity since the CDS market facilitates both long and short positions without ownership of the underlying security, allowing for significant leverage.
3) Corporate spreads (Bloomberg and Risk Metrics spread tables based on rating).
4) Benchmark from most relevant spread source (for example, if no specific spreads are available and corporate spreads are not directly relevant, an assumed relationship is used between corporate spreads or sector-specific spreads and collateral spreads). Benchmarking can also be based on a combination of market spread data and fundamental credit assumptions.
For example, if current market-based spreads are not available then we apply either sector-specific spreads from spread tables provided by dealers or corporate cash spread tables. The sector-specific spread applied depends on the nature of the underlying collateral. Transactions with corporate collateral use the corporate spread table. Transactions with asset-backed collateral use one or more of the dealer asset-backed tables. If there are no observable market spreads for the specific collateral, and sector-specific and corporate spread tables are not appropriate to estimate the spread for a specific type of collateral, we use the fourth alternative in our hierarchy. An example is tranched corporate collateral, where we apply corporate spreads as an input with an adjustment for our tranched exposure.
In addition, due to financial market uncertainty this past year, transaction volume in CMBS and trading activity in the CMBX were both dramatically lower than in prior periods. We also considered that the implied loss rates within the CMBX index were much higher than that forecast by fundamental researchers and MBIA’s internal analysis. Also, the implied illiquidity premium on the index was very high and the model assumed that all of this would influence monoline pricing. This has not been the case in other periods of market illiquidity (because monoline insurers have “buy and hold” portfolios, spread changes that reflect illiquidity versus changes in perceived credit fundamentals are not typically fully reflected in pricing). As a result of these issues, we concluded that the CMBX indices and the CMBS spread tables were unreliable model inputs for the purpose of estimating fair value in our hypothetical market among monoline insurers.
Over time as market data and research changes we also update our techniques to reflect the change in data and estimates. This was required in 2008 regarding our assumption for average life in the CMBX analog index. Our preferred approach is to use an average life that is known to be consistent with the Cumulative Net Loss assumptions, but published research on loss assumptions does not disclose underlying corresponding average life. Initially we had used tranche duration for average life, also as published by third-party independent market research considering this appropriate as it was produced by research based on a wide variety of market transactions. During the third quarter of 2008 as credit spreads continued to widen to unprecedented levels, it became clear that these tranche duration assumptions were not compatible with the expectations of future losses that most market participants would use. We determined that an internally developed tranche weighted average life based on our own transactions would be more consistent with the characteristics of our portfolio. We believe this change results in a measurement more representative of fair value in the current market.
In compliance with the requirements of SFAS 157, effective January 1, 2008, we updated our valuation methodology for insured credit derivative liabilities to incorporate the Company’s own nonperformance risk and the nonperformance risk of its reinsurers. We calculated this adjustment by discounting the estimated market value loss on insured CDSs at MBIA Corp.’s and the reinsurers’ CDS spreads at December 31, 2008. The calculation resulted in a pre-tax $13.2 billion reduction in the fair value of the derivative liability. Nonperformance risk is a fair value concept and does not contradict the Company’s internal view, based on fundamental credit analysis of our economic condition, that the Company will be able to pay all claims when due.
The Company believes that it is important to consistently apply its valuation techniques. However, we may consider making changes in the valuation technique if the change results in a measurement that is equally or more representative of fair value under current circumstances. Prior to the third quarter of 2008, the difference between the MBIA nonperformance credit adjusted value of certain portions of the derivative liability related to collateral defaults in excess of subordination and the unadjusted value of those same portions of the derivative liability was immaterial relative to the Company’s unrealized gains (losses) on insured derivatives reported on the Company’s statement of operations. As a result, the Company made no nonperformance risk adjustment for this portion of the derivative liability. During the third quarter of 2008, the magnitude of the difference between the MBIA nonperformance credit adjusted value of this portion of the derivative liability and the unadjusted value of the same portion of the derivative liability was material relative to the Company’s unrealized gains (losses) on insured derivatives reported on the Company’s statement of operations. The Company recognized that losses related to collateral defaults that exceeded the attachment point in certain transactions could be paid over time as opposed to immediately at MBIA’s option. Therefore, the Company adjusted its estimate of nonperformance risk to reflect the longer exposure period for this portion of the liability. The formula the Company used was the same as what it uses to adjust other unrealized losses for counterparty risk. It takes into account the upfront and annual cost of buying CDS protection in MBIA’s name in the marketplace as well as the average life of the transactions where the losses occurred.
The majority of pricing for investments is provided by third-party providers who use their own data sources and models to arrive at fair value pricing for each security. Refer to “Financial Assets” above for a discussion on the use of pricing services and brokers, as well as the validation procedures performed.
With respect to insured credit derivatives, we use a fair value validation process. We review the model results on a quarterly basis to assess the appropriateness of the assumptions and results in light of current market activity and conditions. This review is performed by internal staff with relevant expertise. If live market spreads are observable for similar transactions, those spreads are an integral part of the analysis. For example, new insured transactions that resemble existing (previously insured) transactions would be considered, as would negotiated settlements of existing transactions. However, this data has been scarce or non-existent in recent periods. As a result, our recent reviews have focused more on internal consistency and relativity, as well as the reasonableness of modeled results given current market conditions.
The effect of the Company’s upfront premium earnings policy is to recognize greater levels of upfront premiums in the earlier years of each policy insured, thus matching revenue recognition with exposure to the underlying risk. Recognizing premium revenue on a straight-line basis over the life of each policy without allocating premiums to the sinking fund payments would materially affect the Company’s financial results. Premium earnings would be more evenly recorded as revenue throughout the period of risk than under the current method, but the Company does not believe that the straight-line method would appropriately match premiums earned to the Company’s exposure to the underlying risk. Therefore, the Company believes its upfront premium earnings methodology is the most appropriate method to recognize its upfront premiums as revenue. The premium earnings methodology currently used by the Company is similar to that used throughout the financial guarantee industry. Effective January 1, 2009, premium revenue recognition changed as a result of the adoption of SFAS 163. Refer to the “Recent Accounting Pronouncements” section included herein for additional information on the adoption of SFAS 163.
Under SFAS 142, “Goodwill and Other Intangible Assets,” goodwill and intangible assets with indefinite lives are tested for impairment at least annually. This test includes a two-step process aimed at determining the amount, if any, by which the carrying value of a reporting unit exceeds its fair value and should be charged as an expense through net income. As of December 31, 2008, goodwill totaled $77 million and was related to our insurance
operations. In the fourth quarter of 2008, goodwill related to our investment management services operations of $2 million was written off. As of December 31, 2007, goodwill totaled $79 million, of which $77 million was related to our insurance operations and $2 million was related to our investment management services operations.
The Company adopted the provisions of SFAS 157, excluding non-financial assets and liabilities per FSP FAS 157-2, “Effective Date of FASB Statement No. 157,” beginning January 1, 2008. SFAS 157 defines fair value as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. In February 2008, the FASB issued FSP FAS 157-2, which delayed the effective date of SFAS 157 to fiscal years beginning after November 15, 2008, for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). A transition adjustment to opening retained earnings was not required.
In April 2007, the FASB issued FSP FIN 39-1, “Amendment of FASB Interpretation No. 39.” FSP FIN 39-1 permits a reporting entity that is a party to a master netting agreement to offset fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral against fair value amounts recognized for derivative instruments that have been offset under the same master netting agreement. FSP FIN 39-1 is effective for fiscal years beginning after November 15, 2007 and is required to be applied retrospectively for all financial statements presented unless it is impracticable to do so. The Company adopted the provisions of the FSP beginning January 1, 2008 and elected not to offset fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral under a master netting agreement against fair value amounts recognized for derivative instruments that have been offset under the same master netting agreement. The Company may reevaluate in the future its election to not offset the fair value amounts recognized for derivative contracts executed with the same counterparty under a master netting agreement.
In May 2008, the FASB issued SFAS 163 which requires financial guarantee insurance (and reinsurance) contracts issued by reporting entities considered insurance enterprises under SFAS 60, “Accounting and Reporting by Insurance Enterprises” to recognize and measure premium revenue based on the amount of insurance protection provided and the period in which it is provided and to recognize and measure claim liabilities based on the present value of expected net cash outflows to be paid, using a risk-free rate, in excess of the unearned premium revenue. SFAS 163 does not apply to financial guarantee insurance contracts accounted for as derivative instruments within the scope of SFAS 133. SFAS 163 is effective for the Company prospectively as of January 1, 2009, except for the presentation and disclosure requirements related to claim liabilities effective for financial statements prepared on or after September 30, 2008, as presented and disclosed in “Note 12: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements. The cumulative effect of initially applying SFAS 163 will be recognized as an adjustment to the opening balance of retained earnings for the fiscal year beginning January 1, 2009. The Company expects the adoption of SFAS 163 to have a material impact on the Company’s consolidated balance sheets and results of operations. However, the amount is not known or reasonably estimable at this time as the Company is currently evaluating the required changes to its accounting processes and systems, which are significant.
In February 2008, the FASB issued FSP FAS 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions.” FSP FAS 140-3 requires an initial transfer of a financial asset and a repurchase financing that was entered into contemporaneously with or in contemplation of the initial transfer to be evaluated as a linked transaction under SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities” unless certain criteria are met. FSP FAS 140-3 was effective for the Company beginning January 1, 2009, and will be applied to new transactions entered into after the date of adoption. Early adoption is prohibited. The Company does not expect the adoption of FSP FAS 140-3 will have a material impact on the Company’s consolidated balance sheets, results of operations or cash flows.
In December 2007, the FASB issued SFAS 160, “Noncontrolling Interests in Consolidated Financial Statements,” an amendment of Accounting Research Bulletin No. 51. SFAS 160 requires reporting entities to present noncontrolling (minority) interest as equity (as opposed to liability or mezzanine equity) and provides guidance on the accounting for transactions between an entity and noncontrolling interests. The presentation and disclosure requirements are to be applied retrospectively. SFAS 160 is effective January 1, 2009 for the Company and earlier adoption is prohibited. The adoption of SFAS 160 will result in preferred stock issued by a subsidiary to be reclassified from minority interests to a separate component of equity. The Company does not expect the adoption of SFAS 160 will have a material impact on the Company’s consolidated balance sheets, results of operations or cash flows.
The following table presents a summary of our consolidated financial results for 2008, 2007 and 2006. Items listed under “Other per share information (effect on net income (loss))” are items that we commonly identify for the readers of our financial statements because they are a by-product of the Company’s operations or due to general market conditions beyond the control of the Company.
The Company recorded a net loss for 2008 of $2.7 billion compared with a net loss of $1.9 billion for 2007. Net loss per diluted share was $12.29 for 2008 compared with a net loss per diluted share of $15.17 for 2007. The decrease in net loss per diluted share resulted from an increase of approximately 90.9 million weighted average shares outstanding as a result of issuing common stock in the first quarter of 2008. Consolidated revenues from continuing operations decreased to a loss of $857 million in 2008 from a loss of $284 million in 2007. The decrease in insurance losses principally resulted from a $1.4 billion decrease in net losses on insured derivatives, an increase in gains on the Company’s Money Market Committed Preferred Custodial Trust (“CPCT”) securities facility and an increase in premiums earned principally due to greater refunding activity. Refer to the discussion under “Net Change in Fair Value of Insured Credit Derivatives” included herein for the Company’s estimate of credit impairments on insured derivatives. The decrease in investment management services operations’ revenues resulted from realized losses from security sales and other-than-temporary impairments of available-for-sale securities and a decrease in interest income within our asset/liability products segment, partially offset by gains related to debt repurchases. The increase in corporate revenues principally resulted from gains related to debt repurchases and an increase in interest income attributable to an increase in invested assets.
The Company recorded a net loss for 2007 of $1.9 billion compared with net income of $819 million for 2006. Net loss per diluted share was $15.17 for 2007 compared with net income per diluted share of $5.99 for 2006. Consolidated revenues from continuing operations decreased to a loss of $284 million in 2007 compared with income of $2.7 billion in 2006. The decline in insurance revenues resulted from a $3.6 billion loss on insured derivatives, which was primarily the result of adverse changes in the fair value of the Company’s insured credit derivative portfolio and an adjustment to the Company’s carrying value of its investment in Channel Reinsurance Ltd. (“Channel Re”), partially offset by an unrealized gain on the Company’s CPCT facility. The investment management services operations’ revenues increased primarily due to an increase in interest income resulting from growth in the asset/liability products segment, higher fees in the advisory services segment due to growth in assets under management and an increase in gains on financial instruments at fair value and foreign exchange due to gains on total return swaps resulting from declines in underlying bond prices. Consolidated expenses from continuing operations increased 77% to $2.8 billion in 2007 from $1.6 billion in 2006. The increase in consolidated expenses was principally due to an increase in loss and LAE incurred in the insurance operations reflecting $614 million of specific case basis reserves and $200 million of non-specific unallocated reserves related to MBIA’s second-lien RMBS exposure. In addition, investment management services’ interest expense increased due to growth in the asset/liability products segment, commensurate with the increase in interest income.
Our book value (total shareholders’ equity) was $994 million as of December 31, 2008, down from $3.7 billion as of December 31, 2007. The decrease in book value resulted from our 2008 net loss of $2.7 billion and an aggregate $1.3 billion unrealized depreciation in the value of our investment portfolios, partially offset by $1.6 billion of proceeds from the issuance of common stock. Book value per share as of December 31, 2008 was $4.78, down 84% from $29.16 as of December 31, 2007. The decrease in book value per share was due to the decline in book value and an increase in shares outstanding from the issuance of common stock during 2008.
The following table presents the financial results of the insurance operations for 2008, 2007 and 2006. These results include revenues and expenses from transactions with the Company’s investment management services and corporate operations. Effective January 1, 2008, net premiums written no longer include premiums from insured derivatives. Additionally, premiums earned and fees related to insured derivatives are no longer reported within “Premiums earned” and “Fees and reimbursements,” respectively, but are instead reported within “Realized gains (losses) and other settlements on insured derivatives” and changes in the fair values of insured derivatives are no longer reported within “Net gains (losses) on financial instruments at fair value and foreign exchange” but are instead reported within “Unrealized gains (losses) on insured derivatives.” These reclassifications resulted from an industry-wide effort, in consultation with the SEC, to present the results of financial guarantees written in derivative form consistently. Prior periods have been adjusted to conform to the current presentation, which had no effect on total revenues or total expenses.
In 2007, total revenues from the Company’s insurance operations were a loss of $2.1 billion compared with income of $1.5 billion in 2006. The decrease in insurance operations’ revenues in 2007 compared with 2006 resulted from a $3.7 billion unrealized losses on insured derivatives, which was primarily the result of adverse changes in the fair value of our insurance credit derivative portfolio and an $86 million adjustment to the carrying value of our investment in Channel Re. The adjustment to the carrying value of our investment in Channel Re contributed to the loss on the net change in fair value of our insured derivatives as a result of eliminations the Company was required to make under the equity method of accounting. These losses were partially offset by a $110 million unrealized gain on the Company’s CPCT facility. In addition, there was a decline in fees and reimbursements and net investment income in 2007 compared with 2006. Partially offsetting the impact of the decreases in insurance revenues were increases in net realized gains and premiums earned. Total insurance expenses increased 212% to $1.2 billion in 2007 from $380 million in 2006. The increase in insurance expenses was due to the $614 million of case basis reserves and $200 million of non-specific unallocated reserves related to our second-lien RMBS exposure. Partially offsetting the increase in losses and LAE was a decrease in operating expenses due to an increase in costs allocated from the insurance segment to other segments and a decline in loss prevention expenses. Gross operating expenses (expenses before ceding commission income and the deferral or amortization of acquisition costs) decreased 8% in 2007 compared with 2006 as a result of an increase in costs allocated to our investment management services and corporate operations and a decrease in loss prevention costs.
In the third quarter of 2008, we closed a reinsurance transaction between MBIA Corp. and FGIC in which MBIA assumed a significant portion of FGIC’s U.S. public finance insurance portfolio. As of the closing date, the reinsured portfolio consisted exclusively of investment grade credits, primarily in the general obligation, water and sewer, tax-backed and transportation sectors, and did not contain any CDS contracts, below investment grade credits or other credits that were inconsistent with our credit underwriting standards. The reinsurance was provided on a “cut-through” basis, which enables FGIC’s policyholders to receive the benefit of MBIA’s reinsurance by allowing them to present claims directly to MBIA.
Under the FGIC reinsurance transaction, MBIA assumed total par of approximately $181 billion and received upfront unearned premiums, net of a ceding commission paid to FGIC, of approximately $717 million. As required by the New York State Insurance Department (“NYSID”) in connection with its approval of the reinsurance transaction, the funds have been placed in a trust and will be released to MBIA upon the earlier of its removal from ratings review with its then current ratings or nine months from the closing date of the transaction. Additionally, under the terms of the trust, the funds will be released to MBIA as the premiums are earned and can be used to pay claims on policies assumed under the reinsurance agreement.
MBIA evaluates the premium rates it charges for insurance guarantees through the use of internal and external rating agency quantitative models. These quantitative models assess the Company’s premium rates and return on capital results on a risk adjusted basis. In addition, market research data is used to evaluate pricing levels across the financial guarantee industry for comparable risks, as well as pricing for similar risks in the bank loan, bond and CDS markets, when available. Since 2005, domestic municipal spreads contracted to tighter levels through mid-2007. Since mid-2007, credit spreads have reached historically wide levels and bond insurance rates have increased to historically high levels.
CREDIT QUALITY Financial guarantee insurance companies use a variety of approaches to assess the underlying credit risk profile of their insured portfolios. MBIA uses both an internally developed credit rating system as well as third-party rating sources in the analysis of credit quality measures of its insured portfolio. In evaluating credit risk, we obtain, when available, the underlying rating of the insured obligation before the benefit of its insurance policy from nationally recognized rating agencies (Moody’s, S&P and Fitch). All references to insured credit quality distributions contained herein reflect the underlying rating levels from these third-party sources. Other companies within the financial guarantee industry may report credit quality information based upon internal ratings that would not be comparable to our presentation.
During 2008, total net par insured rated A or above, before giving effect to MBIA’s guarantee, was 94% compared with 82% during 2007 and 77% during 2006. These percentages reflect a change in the mix of business written during each year among sectors with varying levels of risk. Additionally, 2008 includes a significant amount of par assumed from FGIC, which comprised high-quality domestic public finance exposure. At December 31, 2008, 84% of the Company’s outstanding net par insured was rated A or above before giving effect to MBIA’s guarantee compared with 83% at December 31, 2007. The following table presents the credit quality distribution of MBIA’s outstanding net par insured as of December 31, 2008 and 2007. All ratings are as of the period presented and represent S&P ratings. If transactions are not rated by S&P, a Moody’s equivalent rating is used. If transactions are not rated by either S&P or Moody’s, an MBIA equivalent rating is used.
GLOBAL PUBLIC FINANCE MARKET MBIA’s premium writings and premium earnings in both the new issue and secondary global public finance markets on non-derivative financial guarantees are presented in the following table:
In 2008, global public finance GPW increased 100% to $1.1 billion from $538 million in 2007. This increase was due to a 161% increase in U.S. business written as a result of the reinsurance transaction with FGIC in which the Company received $916 million of U.S. public finance upfront premiums. GPW related to the FGIC transaction was partially offset by a decrease in direct U.S. and non-U.S. business written during 2008 compared with 2007. In 2008, the number and net par amount of public finance transactions directly insured by MBIA decreased 77% and 94%, respectively, compared with 2007. The decrease in direct business written resulted from a sharp decline in demand for bond insurance within the municipal bond market, particularly from insurance companies that have had their insurance financial strength ratings downgraded, as well as an overall decline in municipal issuances during 2008 related to the disruption in the financial markets. NPW increased 117% in 2008 to $1.1 billion from $504 million in 2007 as a result of the 100% increase in GPW and a decrease in premiums ceded to reinsurers. Excluding the effects of the FGIC transaction, net premiums written during 2008 decreased 65% to $179 million compared with $504 million during 2007. During 2008, the Company commuted reinsured premium of $43 million from several of its reinsurers, which resulted in a negative cession rate, excluding the FGIC portfolio, of 11% compared with a positive cession rate of 6% in 2007. In 2008, global public finance net premiums earned increased 32% to $622 million from $470 million in 2007. The increase in net premiums earned was due to a 125% increase in refunded premiums earned and a 5% increase in scheduled premiums earned. The increase in refunded premiums earned was consistent with an observed overall increase in the refunding of debt obligations by municipal issuers compared with 2007. Excluding premiums earned from policies reinsured from FGIC, premiums earned were $579 million during 2008, a 23% increase from 2007.
In 2007, global public finance GPW increased 5% to $538 million from $512 million in 2006. This increase was due to a 29% increase in U.S. business written primarily in the transportation, higher education and military housing sectors, as well as three credits insured in Puerto Rico. Partially offsetting this increase was a 26% decrease in non-U.S. business written primarily due to the impact of a $55 million non-U.S. public finance upfront policy written in the second quarter of 2006 with no comparatively large upfront policy written in 2007. Non-U.S. business written in the second half of 2007 was adversely affected by growing concerns about the U.S. mortgage and housing markets. NPW increased 5% in 2007 to $504 million from $479 million in 2006 as a result of the increase in GPW. The global public finance cession rate for business written during 2007 and 2006 remained flat at 6%. Global public finance net premiums earned decreased 7% to $470 million in 2007 compared with $503 million in 2006. A 27% decrease in refunded premiums earned was partially offset by a 2% increase in scheduled premiums earned. Refunded premiums declined primarily due to an increase in interest rates on new tax exempt issuances in 2007 as compared to 2006.
In 2008, global structured finance GPW decreased 8% to $293 million from $319 million in 2007. As announced on February 25, 2008, we suspended the writing of all new structured finance business for approximately six months. Given the dislocation in the financial markets, the decline in demand for MBIA-insured obligations, and the lack of structured financing transactions, we did not write any new structured finance business in the remainder of 2008. Therefore, premiums written during 2008 were principally generated from installment-based policies closed in prior periods. NPW in 2008 decreased 8% to $250 million from $272 million in 2007 due to the decrease in GPW. The global structured finance cession rate for business written during 2008 and 2007 remained flat at 15%. Global structured finance net premiums earned in 2008 of $258 million were 4% lower than 2007. The decrease in net premiums earned reflects the maturity and termination of policies in the absence of new business.
In 2007, global structured finance GPW decreased 1% to $319 million from $321 million in 2006. NPW in 2007 increased 3% to $272 million from $263 million in 2006 due to a decline in premiums ceded to reinsurers, which offset the decline in GPW. The global structured finance cession rate for business written during 2007 was 15% compared with 18% for 2006. Global structured finance net premiums earned of $270 million in 2007 were 1% higher than 2006.
Global structured finance net par insured rated A or above, before giving effect to MBIA’s guarantee, was 78% during 2007 and 71% during 2006. There was no comparable percentage for 2008 as a result of MBIA not writing structured finance business. At December 31, 2008, 75% of the outstanding global structured finance net par insured was rated A or above before giving effect to the Company’s guarantee, down from 80% as of December 31, 2007. This decrease is principally a result of ratings downgrades on our mortgage-related exposure.
In 2008, our insurance segment’s pre-tax net investment income, excluding net realized gains and losses, increased 2% to $584 million from $573 million in 2007. The increase in pre-tax net investment income reflects growth in average invested assets from the proceeds of our surplus notes and the Warburg Pincus equity transactions and, to a lesser extent, proceeds from our reinsurance transaction with FGIC. The effect of the increase in average invested assets was partially offset by a decrease in yields on tax-exempt and short-term investments. The decrease in ending assets as of December 31, 2008 compared with December 31, 2007 was the result of liquidating investments into cash for purposes of enhancing short-term liquidity, including providing a $2 billion repurchase agreement to our investment management services operations, and paying claims on insurance policies. After-tax net investment income increased only 1% in 2008 as the proportion of taxable investments increased compared with 2007.
VIE interest income is generated from interest bearing assets held by such entities and supports the payment of interest expense on debt issued by these entities. The decrease in VIE interest income primarily resulted from a decline in floating interest rates on VIE assets. Excluding interest income related to VIEs and interest income related to Northwest Airlines’ enhanced equipment trust certificates (“EETCs”) received as part of a remediation, which the Company sold in June 2007, insurance-related net investment income decreased 4% on a pre-tax basis and 10% on an after-tax basis in 2008 compared with 2007. Ending asset balances at amortized cost, excluding VIE assets, were $8.2 billion and $10.1 billion at December 31, 2008 and 2007, respectively. Tax-exempt investments represented 40% and 58% of ending asset balances, excluding VIE and Northwest Airlines’ EETCs assets, at December 31, 2008 and 2007, respectively.
FEES AND REIMBURSEMENTS In 2008, fees and reimbursements in our insurance operations of $9 million decreased 54% compared with 2007. In 2007, fees and reimbursements of $20 million decreased 38% compared with 2006. Decreases in both years primarily resulted from decreases in expense reimbursements associated with loss prevention efforts. Due to the transaction-specific nature inherent in fees and reimbursements, these revenues can vary significantly from year to year.
On February 25, 2008, the Company announced that it ceased insuring new credit derivative contracts except in transactions related to the reduction of existing derivative exposure. As a result, premiums earned related to insured credit derivatives will decrease over time as exposure to such transactions declines. However, reinsurance commutations that included insured derivatives will increase our net premium and net exposure related to such contracts. The increase in net premiums written and earned in 2008 reflects installment premiums from business written during 2007.
Unrealized losses on insured derivatives in 2008 were $1.8 billion compared with $3.7 billion in 2007. Unrealized losses in 2008 were principally driven by spreads widening and, to a lesser extent, subordination erosion, collateral rating migration and lower recovery rates. The impact of these factors was significantly offset by the effects of MBIA’s nonperformance risk. In 2008, unrealized losses on insured credit derivatives would have been
Costs associated with mitigating credit impairments on insured derivatives are expensed as incurred and included within “Operating expenses” in our consolidated statements of operations. Such costs totaled $6.3 million in 2008. The Company did not incur such costs in 2007 and 2006.
NET REALIZED GAINS AND LOSSES Net realized gains and losses on our insurance operations are largely due to sales of investment securities for purposes of maximizing the total return of our investment portfolio and managing liquidity to meet payment obligations. Net realized losses were $35 million in 2008 compared with net realized gains of $56 million in 2007 and net realized gains of $6 million in 2006. Net realized gains in 2007 included $32 million of gains related to the disposition of Delta and Northwest Airlines’ EETCs the Company received from insurance remediations. Net realized gains in 2006 included an $11 million gain related to the sale of the Company’s investment in RAM Holdings, Inc., the holding company of RAM Reinsurance Company Ltd. and a $25 million impairment loss recorded on a salvage receivable.
Total case basis activity was $1.5 billion in 2008, $678 million in 2007 and $75 million in 2006. During 2008, case basis activity primarily consisted of reserves related to our second-lien RMBS exposure, which was principally established from the additional loss and LAE provisions of $1.2 billion in 2008 and $200 million of the $814 million in 2007. During 2007, case basis activity primarily consisted of reserves related to the Company’s second-lien RMBS exposure, which were established from $614 million of the $814 million additional losses and LAE recorded in 2007, reserves for insured obligations related to the Student Loan Finance Corporation (“SFC”), a multi-sector CDO executed in the cash market, and insured obligations within the home equity loan (pre-2005 vintage) and manufactured housing sectors. Partially offsetting these loss reserves were reversals of previously established case basis reserves within the aircraft EETCs sector. During 2006, case basis activity primarily consisted of insured obligations within the CDO, equipment lease pools and home equity loan sectors, MBIA’s guaranteed tax lien portfolio and insured obligations issued by Allegheny Health, Education and Research Foundation (“AHERF”). Case basis activity related to AHERF was partly the result of a reduction in expected litigation recoveries from the AHERF bankruptcy estate. Partially offsetting this activity were reversals of previously established case basis reserves relating to the aircraft EETCs and manufactured housing sectors.
Following implementation on June 28, 2007, of Eurotunnel’s safeguard plan, MBIA remained exposed to Class G notes issued by Fixed-Link Finance, B.V. (“FLF1”). That exposure was collateralized by cash and short-term investments. On February 2, 2009, FLF1 used the cash received on account of its Eurotunnel Tiers 1, 2 and 3 claims to make scheduled interest payments and all available cash will be used to repay FLF1’s outstanding notes in order of priority. As a result, FLF1’s Class A, B and G notes were repaid in full and MBIA’s exposure to FLF1 declined to $0. Currently, MBIA is cooperating with other parties in interest to unwind FLF1 and pay the proceeds to holders of Class C notes. At December 31, 2008, MBIA’s exposure to FLF1 debt on account of the Class G notes was approximately $688 million in net par outstanding. MBIA paid no claims with respect to its exposure to FLF1.
subprime transactions directly guaranteed by MBIA include collateral consisting of mortgages originated during 2005, 2006 and 2007, given the amount of subordination below MBIA’s insured portion of such transactions available to absorb any losses from collateral defaults, we currently do not expect material ultimate losses on these transactions. As of December 31, 2008, there were no insured direct subprime mortgage transactions with 2005, 2006, or 2007 subprime mortgage collateral appearing on the Company’s Classified List or Caution Lists. However, as of December 31, 2008, we expected losses of $9 million (on a present value basis) on three secondary market multi-sector CDOs with net par outstanding of $85 million that include subprime mortgage exposure and that were reported on our Classified List. Additionally, there were two secondary market multi-sector CDOs with net par outstanding of $23 million that include subprime mortgage exposure and that were reported on our Caution Lists.
In October 2008, MBIA Corp. filed lawsuits against two mortgage loan seller/servicers alleging, among other things, misrepresentations concerning the quality of loans made by these seller/servicers, which were included in a number of MBIA-insured second-lien residential mortgage securitizations. In particular, MBIA believes that a very high proportion of the defaulted loans in these securitizations are in breach of the originators’ representations with respect to such loans and, therefore, should have been excluded from the securitizations. In addition, after extensive review, it is clear to us that these entities have failed to honor their contractual obligations regarding loan repurchases and ongoing servicing practices. The Company has not yet reflected as salvage or subrogation any potential recoveries resulting from the seller/servicers’ obligations to repurchase ineligible loans from these second-lien residential mortgage transactions. We continue to evaluate these and other potential recoveries and intend to pursue them aggressively. Once we have concluded our evaluation, including assessing the amount of potential recoveries, we are likely to establish salvage and subrogation receivables that, depending upon the transaction, fully or partially offset the related case loss reserves. The ineligibility of mortgages in the securitizations and the litigation in general will have no impact on the holders of the insured securities, as MBIA will continue to honor its payment obligations under its insurance policies.
The following table presents the net par outstanding by vintage year of MBIA’s second-lien residential mortgage securitization insured exposure as of December 31, 2008:
The following table provides a listing of second-lien residential mortgage securitization transactions included in MBIA’s insured portfolio that were performing below MBIA’s expectations as of December 31, 2008:
REINSURANCE 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. In 2008, MBIA recaptured business from four reinsurers as a result of their ratings downgrades. Additionally, business from two reinsurers was recaptured during 2008 unrelated to their ratings. MBIA will continue to evaluate its use of reinsurance during 2009, which may result in future portfolio commutations from reinsurers. The Company also maintained other reimbursement agreements with its reinsurers that were not accounted for as reinsurance, which were commuted during 2008.
MBIA will recognize a premium deficiency if the sum of the expected loss and LAE and unamortized policy acquisition costs exceed the related unearned premiums. If MBIA was to have a premium deficiency that is greater than unamortized acquisition costs, the unamortized acquisition costs would be reduced by a charge to expense and a liability would be established for any remaining deficiency. Although GAAP permits the inclusion of anticipated investment income when determining a premium deficiency, MBIA currently does not include this in making its determination. To date, MBIA has not recognized a premium deficiency.
Gross insurance expenses decreased 20% to $198 million in 2008 from $248 million in 2007 as a result of a decrease in compensation costs related to the reversal of prior year bonus and long-term incentive award accruals. In 2007, gross insurance expenses decreased 8% to $248 million from $268 million in 2006 as a result of an increase in costs allocated to our investment management services and corporate operations and a decrease in loss prevention efforts. In 2008, the amortization of deferred acquisition costs increased 12% to $75 million from $67 million in 2007. The increase in the amortization of deferred acquisition costs was the result of an increase in premiums earned during 2008 to which the costs related. In 2007, the amortization of deferred acquisition costs increased 1% to $67 million, consistent with the change in premiums earned.
VARIABLE INTEREST ENTITIES The Company provides credit enhancement services to global finance clients through third-party (issuer-sponsored) special purpose entities (“SPEs”), which are used in a variety of structures guaranteed by MBIA. We have determined that such SPEs fall within the definition of a VIE under FIN 46(R). Under the provisions of FIN 46(R), MBIA must determine whether it has a variable interest in a VIE and if so, whether that variable interest would cause MBIA to be the primary beneficiary. The Company would be required to consolidate VIEs if it was determined to be the primary beneficiary of the VIEs. The primary beneficiary is the entity that will absorb the majority of the expected losses, receive the majority of the expected residual returns, or both, of a VIE. We conduct consolidation analyses under the provisions of FIN 46(R) upon the inception of our guarantees to the third-party VIEs and upon the occurrence of certain reconsideration events.
COLLATERALIZED DEBT OBLIGATIONS AND RELATED INSTRUMENTS As part of its insurance operations, the Company provides guarantees on the senior most tranches of CDO, as well as protection on structured pools of CMBS and corporate securities.
Certain Net Par Exposure increased due to reinsurance commutations in the fourth quarter of 2008.
As of December 31, 2008, the Company estimated $1.2 billion of total credit impairment on eight deals insured during 2006 and 2007, with a total net par of $7.9 billion. Four transactions insured in 2006 (totaling $3.6 billion) have an impairment of $0.4 billion while four transactions insured in 2007 (totaling $4.3 billion), have an impairment of $0.8 billion.
Multi-Sector CDO Portfolio: Vintage and Collateral Ratings of CDOs Containing Non Subprime RMBS
Since mid-2007, the multi-sector CDO portfolio has experienced stress related to the U.S. subprime mortgage crisis. Impairment estimates were increased for the three CDOs for which the Company estimated impairment during the fourth quarter of 2007; in addition, impairments were estimated for an additional six CDOs during the first quarter of 2008 due to the further degradation of underlying RMBS and CDO of ABS collateral. During the second quarter of 2008, impairments were further increased to reflect three months of accretion or in other words, the effects of the shortening of the discount period by three months. During the third quarter of 2008, an impairment on one additional CDO was established. During the fourth quarter of 2008, MBIA increased the impairments further and added four transactions to the list of impaired deals. As of December 31, 2008, MBIA estimated credit impairment in connection with twelve multi-sector CDO transactions aggregating to $1.2 billion for which MBIA expects to incur actual claims in the future. In the event of further deteriorating performance of the
In addition, $14.0 billion net par of MBIA’s insured Investment Grade Corporate CDOs are typically structured to include buckets (30%-35% allocations) of references to specific tranches of other Investment Grade Corporate CDOs (monotranches). In such transactions, MBIA’s insured Investment Grade Corporate CDOs includes, among direct corporate or structured credit reference risks, a monotranche or single layer of credit risk referencing a diverse pool of corporate assets or obligors with a specific attachment and a specific detachment point. The reference monotranches in such CDOs are typically rated double-A and each reference monotranche will typically be sized to approximately 3% of the overall reference risk pool. Deals with buckets for monotranche exposure are managed transactions. The inner referenced monotranches are themselves managed exposures (managed by the same manager as the MBIA-insured investment grade corporate CDO). The inner referenced monotranches are not subject to acceleration and do not give control rights to a senior investor.
Investment Grade Corporate CDO Portfolio: Collateral Composition, Subordination, and Net Derivative Asset/Liability
The CDO collateral composition contains CDOs of ABS, CLOs, and Collateralized Bond Obligations (“CBOs”).
Years contain deals with allowances for synthetic tranches of leveraged investment grade corporate debt. In such transactions, MBIA’s insured Investment Grade Corporate CDOs include, among direct corporate or structured credit reference risks, a monotranche or single layer of credit risk referencing a diverse pool of assets or obligors with a specific attachment and a specific detachment point. The reference monotranches in such CDOs are typically rated double-A and each reference monotranche will typically be sized to approximately 3% of the overall reference risk pool. Deals with buckets for monotranche exposure are managed transactions. The inner referenced monotranches are themselves managed exposures (managed by the same manager as the MBIA-insured Investment Grade Corporate CDO). The inner referenced monotranches are not subject to acceleration and do not give control rights to a senior investor. These transactions also may contain RMBS securities within limits ranging from 0% to 20% with one exception at 33%.
Below IG (Investment Grade) denotes collateral credit ratings of below BBB-.
The years contain deals with allowances for synthetic tranches of leveraged investment grade corporate debt. Collateral contained in referenced Monotranche obligations are classified as Corporate Exposure as they are 100% corporate references.
All figures represent MBIA’s insured net par outstanding as of December 31, 2008. Data was gathered from several third-party sources such as trustee reports, Intex, Bloomberg and rating agency websites; therefore, amounts and distributions may differ depending on data source and interpretation. Collateral ratings are current as of January 8, 2009. The totals may not sum due to rounding.
The High Yield Corporate CDO portfolio totaling $12.9 billion is largely comprised of middle-market/special-opportunity corporate loan transactions, broadly syndicated bank CLOs and older vintage corporate high yield bond CDOs. The CDOs in this category are diversified by both vintage and geography (with European and U.S. collateral). The Company’s net par exposure to High Yield Corporate CDOs represents 10% of the Company’s CDO exposure and approximately 2% of the Company’s total net par insured as of December 31, 2008. The Company did not experience any material credit deterioration to this portfolio during the nine months ended December 31, 2008. The High Yield Corporate CDO portfolio did not contain any Subprime RMBS, Non-subprime RMBS, and CDOs of ABS exposures.
This column represents the net derivative asset / (liability) primarily for CDS deals written in that year. Note that not all insurance contracts are considered derivatives. Please refer to “Note 4: Fair Value of Financial Instruments” and “Note 7: Derivative Instruments” in the Notes to Consolidated Financial Statements for the Company’s accounting treatment of derivatives (including CDS on CDOs).
The Company’s CRE CDO exposure comprised approximately 8% or $9.7 billion of the Company’s CDO exposure and 1% of the Company’s total insured net par as of December 31, 2008. CRE CDOs are managed pools of CMBS, CRE whole loans, B-Notes, mezzanine loans, REIT debt and other securities (including, in some instances, buckets for RMBS and CRE CDOs) that allow for reinvestment during a defined time period. The structures benefit from typical CDO structural protections such as cash diversion triggers, collateral quality tests and manager replacement provisions. MBIA guarantees timely interest and ultimate principal on these CDOs. As with the Company’s other CDOs, these transactions are generally structured with triple-A, or a multiple of triple-A credit support protection below the Company’s guarantee.
The table does not provide collateral level detail on eight Structured CMBS pools totaling $0.3 billion of net par executed in the secondary market. These deals were insured prior to 2005. In addition, all eight deals were rated triple-A at the time MBIA wrote insurance.
CRE CDOs: Vintage and Collateral Ratings of CDOs Containing Non Subprime RMBS
The transactions insured by MBIA are subject to ratings downgrade risk in the event that general economic performance continues to decline. In the event that the portfolio is downgraded, the capital requirements for the portfolio could increase materially and impact the Company’s ratings at that time. In light of the current economic environment, we believe the risk of a severe and prolonged recession has increased. In such an event, the performance of the underlying commercial mortgages in the portfolio may be materially adversely affected. In the event that loan level losses exceed the credit enhancement in our pools, the Company could incur material losses. Based on our analysis of the portfolio’s projected performance in current or stressed environments, we have not recognized any impairments on these transactions.
The Company’s investment management services operations provide an array of products and services to the public, not-for-profit, corporate and financial services sectors. Such products and services are provided primarily by MBIA Inc. and certain of its wholly owned subsidiaries and include cash management, discretionary asset management and structured products and investment agreement, MTN and commercial paper programs related to funding assets for third-party clients and for investment purposes. The investment management services operations consist of three operating segments: asset/liability products, which include investment agreements and MTNs not related to the conduit segment; advisory services, which consist of third-party and related-party fee-based asset management; and conduits.
Beginning with the first quarter of 2008, net interest income and expense and net realized gains and losses related to non-hedging derivative instruments are no longer reported within “Net investment income,” “Interest expense,” and “Net realized gains (losses),” respectively, but are instead reported within “Net gains (losses) on financial instruments at fair value and foreign exchange.” These reclassifications were made in order to report derivative results consistent with presentations commonly used throughout the financial services industry. Prior periods have been adjusted to conform to the current presentation, which had no effect on pre-tax income.
In 2008, asset/liability products reported a pre-tax loss of $1.4 billion compared with pre-tax income of $294 million in 2007. The pre-tax loss in 2008 resulted from $1.7 billion of net realized losses from investment securities sales and impairments, partially offset by $66 million of net gains on financial instruments recorded at fair value and foreign exchange and $341 million of net gains on MTN repurchases and investment agreement terminations. Excluding realized gains and losses from investment securities, net gains and losses on financial instruments at fair value and foreign exchange and net gains from debt repurchases, the segment’s pre-tax loss in
In 2008, advisory services reported pre-tax income of $15 million, down 18% from $18 million in 2007. The decrease in 2008 primarily resulted from $8 million in realized losses generated from a $5 million write-down of a receivable and a $3 million write-down of goodwill. In 2007, advisory services’ pre-tax income was down 18% from 2006 due to a decrease in assets under management during 2007.
Average assets under management during 2008 were $34.6 billion, compared with $37.3 billion during 2007. Third-party ending assets under management were $20.3 billion and $22.1 billion at December 31, 2008 and December 31, 2007, respectively. The market values of assets related to the Company’s insurance and corporate investment portfolios managed by the investment management services operations at December 31, 2008 were $11.6 billion, slightly up from the balance at December 31, 2007 of $10.7 billion.
The Company has issued commitments to three pooled investment programs managed or administered by MBIA-MISC and its subsidiary. These commitments cover losses in such programs should the net asset values per share decline below specified per share values. At December 31, 2008, the maximum amount of future payments that the Company would be required to make under these commitments was $4.5 billion. These commitments will be in effect so long as MBIA-MISC and its subsidiary remain as manager or administrator and each program remains in compliance with its respective investment objectives and policies. Although the pools generally hold high-quality short-term investments, given the current credit and liquidity environment, there is an increased risk that the Company will be required to make payments or incur a loss under these guarantees in the event of material redemptions by shareholders of the pools and the need to liquidate investments held in the pools. These guarantees are accounted for as derivatives, and the net unrealized gains on these derivatives for 2008 and 2007 were $9 thousand and $5 thousand, respectively. The Company has, and may in the future, purchase investments at its discretion from the pooled investment programs it manages, whether or not such programs have been guaranteed by the Company.
Meridian Funding Company, LLC (“Meridian”) is one of two MBIA-owned and administered conduit financing vehicles. During 2008, $883 million of assets owned by Meridian prepaid. Meridian has invested the proceeds of the prepayment in eligible assets, which will provide adequate maturing proceeds to meet Meridian’s obligations as they come due. Certain of the eligible assets were purchased from MBIA Inc.
During 2008, conditions in the asset-backed commercial paper market deteriorated making it increasingly difficult for Triple-A One to issue new commercial paper at commercially acceptable rates to refund maturing obligations. Accordingly, Triple-A One began drawing down on its liquidity facilities to repay maturing commercial paper. By September 2008, these facilities were drawn in full and Triple-A One ceased issuing commercial paper. All commercial paper holders were repaid in full and balances under liquidity facilities will be repaid as the assets purchased by Triple-A One mature.
NON-CONSOLIDATED CONDUITS AND COLLATERALIZED DEBT OBLIGATIONS The Company provides structured funding to global finance clients through the use of certain MBIA-administered, bankruptcy-remote special purpose vehicles (“SPVs”). The Company has determined that such SPVs fall within the definition of a VIE under FIN 46(R).
During 2006, the Company structured a non-consolidated funding conduit, East-Fleet Finance Limited (“East-Fleet”). A subsidiary of MBIA Asset Management provides fee-based asset management and administrative services, acting under approved management agreements and at the direction of an independent board of directors. The obligations issued by East-Fleet are not guaranteed by the Company, and the Company has no liquidity obligations to East-Fleet.
At the inception of East-Fleet’s operations, the Company conducted a consolidation analysis under the provisions of FIN 46(R). The Company has no investment in either the senior or junior notes of East-Fleet. Therefore, the Company’s share of variable interest outcomes was measured solely on the program management fees its asset management subsidiary earns. The Company utilized a stochastic Monte Carlo model to project potential favorable and unfavorable outcomes related to asset credit risk, interest rate risk and expenses. The Company’s share of variability absorbed was measured based on the management fees it would receive under each scenario. Modeled results indicated that the asset manager would not absorb the majority of the variability and, therefore, the Company concluded that while East-Fleet met the definition of a VIE, MBIA was not the primary
Our corporate operations primarily consist of holding company activities. The following table summarizes the consolidated results of our corporate operation over the last three years. These results include revenues and expenses from transactions with the Company’s insurance and investment management services operations.
Net realized gains from investment securities in our corporate operations were $3 million in 2008 compared with net realized losses of $4 million in 2007 and net realized gains of $4 million in 2006. Net realized gains and losses are typically generated from the ongoing management of our investment portfolio. However, the Company realized $10 million of impairment losses on a subprime mortgage-oriented investment in 2007.
In 2007, the corporate operations recorded insurance recoveries of $6.4 million, which represented recoveries received on the Company’s directors’ and officers’ insurance policy. These insurance recoveries reimbursed the Company for a portion of the expenses incurred by the Company in connection with regulatory investigations and related private securities and derivative litigations. No additional recoveries were received in 2008. However, we are pursuing additional recoveries under our directors’ and officers’ insurance policy and have filed a lawsuit against two of our insurance carriers seeking additional recoveries.
The Company is required to establish a valuation allowance against its deferred tax asset when it is more likely than not that all or a portion of the deferred tax asset will not be realized. All evidence, both positive and negative, needs to be identified and considered in making the determination. Future realization of the existing deferred tax asset ultimately depends on the existence of sufficient taxable income of appropriate character (for example, ordinary income versus capital gains) within the carryforward period available under the tax law. As of December 31, 2008, the Company reported a net deferred tax asset of $2.4 billion primarily related to unrealized losses recorded on the Company’s derivative and investment portfolios. Included in the net deferred tax asset of $2.4 billion is the valuation allowance of $351 million. Refer to “Note 14: Income Taxes” in the Notes to Consolidated Financial Statements for a further discussion about our deferred tax asset and valuation allowance.
As of December 31, 2008, the Company has not experienced an ownership change under Section 382. However, had one occurred as of December 31, 2008, the ownership change, in itself, would not have had a material impact on the Company’s financial position or results of operations. The Company has already established a full valuation allowance against its capital loss carryforwards and the Company has the ability and intent to hold securities with a built-in loss as of December 31, 2008 to maturity or until such time as the value recovers as not to trigger a built-in loss. Additionally, the Company expects to have sufficient income to utilize its alternative minimum tax credit, which may be carried forward indefinitely. The Company had no NOL carryforwards as of December 31, 2008.
The Company manages its capital resources to minimize its cost of capital while maintaining appropriate claims-paying resources. Capital resources are defined by the Company as total shareholders’ equity and long-term debt issued for general purposes. As of December 31, 2008, total shareholders’ equity was $994 million and total long-term debt was $2.4 billion. MBIA maintains debt at levels it considers to be prudent based on its cash flow and total capital (shareholders’ equity plus long-term debt). The following table presents the Company’s long-term debt and the ratio used to measure it:
Long-term debt includes debt issued by MBIA Inc. for general corporate purposes, surplus notes issued by MBIA Corp. and bank loans under liquidity facilities. The increase in the long-term debt to capital ratio reflects the issuance of surplus notes, net of repurchases, and liquidity facility draw downs in 2008, as well as a substantial reduction in our total shareholders’ equity. Significant losses recorded in our investment portfolios and insurance exposure have offset growth in shareholders’ equity from the issuance of common stock during 2008.
Market deterioration in the RMBS and CDO sectors resulted in the major rating agencies reassessing the capital adequacy ratios of financial guarantors to reflect deterioration in the expected performance of transactions within the financial guarantors’ insured portfolios. During 2008, MBIA Corp.’s financial strength ratings were downgraded by the major credit rating agencies. The rating agencies attributed their downgrades to factors that included a diminished outlook for new business generation, reduced financial flexibility, vulnerability to further stress in the residential mortgage sector, and declines in share price and CDS spreads. Also during 2008, we continued a comprehensive capital strengthening plan with near-term objectives that included deleveraging our balance sheet and maximizing our liquidity position to maintain appropriate claims-paying resources. Each of the components of our capital strengthening are discussed below.
On December 10, 2007, the Company announced that it had entered into an agreement, subsequently amended on February 6, 2008, with Warburg Pincus (the “Warburg Pincus Agreement”), a private equity firm, which committed to invest up to $1.25 billion in the Company through a direct purchase of MBIA Inc. common stock and a backstop for a common stock offering.
connection with its initial investment, Warburg Pincus received warrants to purchase 8.7 million shares of MBIA Inc. common stock at a price of $40 per share and “B” warrants, which, upon obtaining certain approvals, became exercisable to purchase 7.4 million shares of MBIA Inc. common stock at a price of $40 per share. The term of the warrants is seven years. In addition, the securities purchased by Warburg Pincus are subject to significant transfer restrictions for a minimum of one year and up to three years. The Company’s senior management team originally committed to invest a total of $2 million in MBIA Inc.’s common stock at the same price as Warburg Pincus, which commitment was later adjusted downward. Since that time, the current senior management team has satisfied their purchase commitment. The majority of the net proceeds received from Warburg Pincus’ initial investment were contributed to the surplus of MBIA Corp. to support its business plan.
On February 6, 2008, the Company and Warburg Pincus amended the Warburg Pincus Agreement to provide that Warburg Pincus would backstop a MBIA Inc. common stock offering by agreeing to purchase up to $750 million of convertible participating preferred stock. Warburg Pincus was also granted the option to purchase up to $300 million of preferred stock prior to the closing of a common stock offering or February 15, 2008. Finally, Warburg Pincus was granted “B2” warrants which, upon obtaining certain approvals, became exercisable to purchase between 4 million and 8 million shares of MBIA Inc. common stock, whether or not the common stock offering was completed.
On January 16, 2008, MBIA Corp. issued surplus notes due January 15, 2033. The surplus notes have an initial interest rate of 14% until January 15, 2013 and thereafter at an interest rate of three-month LIBOR plus 11.26%. The surplus notes are callable at par at MBIA Corp.’s option on the fifth anniversary of the date of issuance and every fifth anniversary thereafter, subject to prior approval by the Superintendent of the NYSID and other restrictions. The cash received from the surplus notes will be used for general purposes.
Our capital position has been enhanced as a result of the amortization, maturation, refunding, and negotiated terminations of existing contracts within our insurance and asset/liability products segments during 2008. However, our capital position improvement was partially offset by increased capital requirements for downgraded credits and downgraded reinsurers.
In August 2008, our Board of Directors approved the resumption of our share repurchase program. Repurchases of 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 believe that share repurchases can be an appropriate deployment of capital in excess of amounts needed to maintain the claims-paying ratings of MBIA Corp. and support MBIA’s businesses.
As of December 31, 2008, MBIA Corp. maintained a $450 million limited recourse standby line of credit facility with a group of major banks to provide funds for the payment of claims in excess of the greater of $500 million of cumulative claims, net of recoveries, or 5% of average annual debt service with respect to U.S. public finance transactions. The agreement is for a ten-year term, which expires in March 2015. In connection with the Company’s restructuring of MBIA Insurance Corporation, it intends to negotiate with the providers of this facility a transfer of the facility from MBIA Insurance Corporation to MBIA Illinois.
hold them until the next auction in which sufficient bids were received. The maximum prescribed rate was 30-day LIBOR plus 150 basis points if MBIA Corp. maintained a financial strength rating from S&P and Moody’s at or above AA- and Aa3, respectively, or 30-day LIBOR plus 200 basis points if MBIA Corp.’s financial strength rating fell below either AA- or Aa3. Due to the decline in the demand for short-term structured securities during 2007, all CPCT securities were unable to be remarketed at their last remarketing date, resulting in the investors of the CPCT securities receiving the maximum prescribed interest rate from August 2007 through November 2008. As of December 31, 2007, the Trusts were rated AA and Aa2 by S&P and Moody’s, respectively. However, in January 2008 and again in June 2008 the Trusts were downgraded by both S&P and Moody’s to A- and Baa2, respectively.
MBIA’s financial guarantee insurance business model is built upon the premise of “pay-as-you-go” cash flows. Its financial guarantee contracts and CDS contracts cannot be accelerated (absent an insolvency or payment default of MBIA Corp.), thereby mitigating liquidity risk. However, when a default or impairment of an insured obligation occurs, MBIA encounters liquidity risk resulting from its irrevocable pledge to pay principal and interest, or other amounts owing on insured obligations, when due. Additionally, MBIA’s insurance operations require cash for the payment of operating expenses, as well as principal and interest related to its surplus notes and preferred stock issuance. Finally, MBIA Corp. also provides secured lending to our asset/liability products segment to support its business operations and liquidity position, as described below. These lending arrangements reduce the liquidity position of MBIA Corp.
Beginning in the fourth quarter of 2007 and throughout 2008, MBIA made a significant amount of payments associated with insured second-lien RMBS securitizations, as well as settlement payments relating to CDS contracts referencing ABS CDOs. Among MBIA’s outstanding insured portfolio, these types of payments exhibit the highest degree of volatility and, therefore, pose material liquidity risk. The level of future loss payments on second-lien RMBS, CDO-squared, and ABS CDO transactions is dependent upon the performance trends of the underlying collateral supporting these insured transactions.
In order to monitor liquidity risk and maintain appropriate liquidity resources for payments associated with our residential mortgage related exposures, MBIA employs a stress scenario-based liquidity model using the same “Roll Rate Default Methodology” as described under the “Loss and Loss Adjustment Expense” heading within the “Critical Accounting Estimates” section included herein. Using this methodology, the Company estimates the level of payments that would be required to be made under low probability stress-level default assumptions of the underlying collateral taking into account MBIA’s obligation to cover such defaults under our insurance policies. These estimated payments, together with all other significant operating, financing and investing cash flows are forecasted over the next 24-month period on a monthly basis and then annually thereafter to the final maturity of the longest dated outstanding insured obligation. The stress-loss scenarios and cash flow forecasts are frequently updated to account for changes in risk factors and to reconcile differences between forecasted and actual payments.
In addition to our residential mortgage stress scenario, we also monitor liquidity risk using a Monte Carlo estimation of potential stress-level claims for all insured principal and interest payments due in the next 12-month period at a 99.99% confidence interval. These probabilistically determined payments are then compared to the Company’s invested assets to ensure adequate coverage of worst-case loss scenario measurements. This theoretic liquidity model supplements the scenario-based liquidity model described above providing the Company with a robust set of liquidity metrics with which to monitor its risk position.
The Company manages the investment portfolio of its insurance operations in a conservative manner to maintain cash and liquid securities in an amount in excess of all stress scenario payment requirements. To the extent our liquidity resources fall short of our target liquidity cushion under the stress-loss scenario testing, the Company will seek to increase its cash holdings position, primarily through the sale of high-quality bonds held in its investment portfolio. As of December 31, 2008, MBIA Corp. had unencumbered cash and available-for-sale investments of $7.4 billion, of which $2.4 billion comprised cash and short-term investments.
As of December 31, 2008, the Company has determined that the liquidity position of its insurance operations was sufficient to meet cash requirements under both its stress scenario and probabilistic measurements.
Within the investment management services operations, the asset/liability products segment had material liquidity needs during 2008. In addition to the payment of operating expenses, cash needs in the asset/liability products segment are primarily for the payment of principal and interest on investment agreements and MTNs, and for posting collateral under repurchase agreements, derivatives and investment agreements. During 2008, liquidity needs increased significantly due to the requirement to post additional high-grade eligible collateral and to fund terminations of certain investment agreements resulting from the downgrades of MBIA Corp. by the credit rating agencies. The sources of cash within the asset/liability products segment used to meet its liquidity needs include scheduled maturities of high-quality assets, net investment income and dedicated capital held within the
investment management services operations. If needed, assets held within the segment can be sold or used in secured repurchase agreement borrowings to raise cash. However, our ability to sell assets or borrow against non-U.S. government securities in the fixed-income markets decreased dramatically and the cost of such transactions increased dramatically in 2008 due to the impact of the credit crisis on the willingness of investors to purchase or lend against even very high-quality assets. In addition, negative net interest spread between asset and liability positions resulted from the need to hold cash as collateral against terminable investment agreement contracts and reduced the cash flow historically provided by net investment income.
In order to monitor liquidity risk and maintain appropriate liquidity resources for near-term cash and collateral requirements within our asset/liability products segment, the Company calculates monthly forecasts of asset and liability maturities, as well as collateral posting requirements. Cash availability at the low point of our 12-month forecasted cash flows is measured against one-week and one-year liquidity needs using stress-scenario testing of each of the potential liquidity needs described above. To the extent there is a shortfall in our liquidity coverage, the Company proactively manages its cash position and liquidity resources to maintain an adequate cushion to the stress scenario. These resources include the sale of unpledged assets, the use of free cash at the holding company, and potentially increased borrowings from MBIA Insurance Corporation.
The asset/liability products segment, through MBIA Inc., has maintained simultaneous repurchase and reverse repurchase agreements with MBIA Insurance Corporation under which MBIA Inc. borrowed government securities in exchange for lending other high-quality fixed-income securities to MBIA Insurance Corporation. The government securities borrowed by the asset/liability products segment are pledged to counterparties under collateralized investment agreements and repurchase agreements. Security borrowings under these agreements totaled $1.3 billion as of December 31, 2008. In connection with the Company’s restructuring of MBIA Insurance Corporation in February 2009, the assets borrowed by MBIA Inc. were transferred from MBIA Insurance Corporation to MBIA Illinois. As a result, the Company terminated the repurchase and reverse repurchase agreements between MBIA Inc. and MBIA Insurance Corporation and established new agreements between MBIA Inc. and MBIA Illinois for up to $2 billion under substantially the same terms.
During 2008, our corporate segment liquidity was also under stress. While we maintained a substantial cash cushion through the third quarter of 2008, $600 million was transferred to our asset/liability management segment to support that segment’s liquidity needs, as described above, and the holding company has not received dividends from any of its subsidiaries since April 2007. As of December 31, 2008, the corporate segment had $452 million of cash and investments available for general corporate liquidity purposes, of which $416 million comprised cash and short-term investments, enough to meet its corporate debt service for nearly five years or its corporate debt service and estimated operating expense payments for three years.
For the year ended December 31, 2008, net cash used by operating activities totaled $156 million compared with net cash provided by operating activities of $1.0 billion for the year ended December 31, 2007. The Company’s net use of cash for the year ended December 31, 2008 resulted from a substantial increase in loss payments related to financial guarantee policies and insured CDSs, as well as a decrease in net investment income, which more than offset an increase in premium collections. For the year ended December 31, 2007, the majority of net cash provided by operating activities was generated from premium writings and net investment income in the Company’s insurance operations.
For the year ended December 31, 2008, net cash provided by investing activities was $18.1 billion compared with net cash used by investing activities of $6.3 billion for the year ended December 31, 2007. Net cash provided by investing activities for the year ended December 31, 2008 resulted from sales of securities for purposes of funding investment agreement withdrawals and terminations, MTN maturities repurchases, insurance-related loss payments, and improving liquidity in our business segments. For the year ended December 31, 2007, net cash used by investing activities primarily related to the purchase of fixed-maturity investments resulting from growth in our asset/liability products program.
On February 17, 2009, MBIA Corp. declared and paid a dividend of $1.1 billion to MBIA Inc., related to the restructuring of MBIA Insurance Corporation, after receiving prior approval from the Superintendent of the NYSID. As a result, MBIA Corp. will not be able to pay dividends without prior approval from the Superintendent of the NYSID until February 10, 2010. The $1.1 billion dividend, together with a $938 million return of capital, was used to further capitalize MBIA Illinois.
Investments for which the Company has recorded unrealized losses are tested quarterly for other-than-temporary impairment. For each security that meets the threshold of either 20% impaired at the time of review or 5% impaired at the time of review with a fair value below amortized cost for a consecutive 12-month period, a further analysis of the security is performed to assess if the impairment is other than temporary. As of December 31, 2008, the Company had a pre-tax unrealized net loss of $2.3 billion related to its investment management services operations’ available-for-sale investment portfolio, which primarily resulted from changes in the market value of ABS investments due to a significant widening of market credit spreads. Included in the investment management services operations’ pre-tax unrealized net loss of $2.3 billion were unrealized gross losses totaling $1.1 billion within the asset-backed sector, primarily consisting of CDO, RMBS, auto loan and credit card investments. Refer to “Note 5: Investments” and “Note 6: Investment Income and Gains and Losses” in the Notes to Consolidated Financial Statements for further information on the Company’s investment portfolios and related gains and losses. The Company’s investment management services operations has entered into total return swaps that economically hedge changes in the value of certain asset-backed investments. For 2008, MBIA recorded $41.7 million in pre-tax gains on these total return swaps within “Net gains (losses) on financial instruments at fair value and foreign exchange” in the Company’s consolidated statement of operations.
We have reviewed the above securities as part of our assessment of other-than-temporary impairments of our entire investment portfolio. During our review, we assessed (i) the magnitude and duration of declines in fair value and (ii) the reasons for the declines, such as general credit spread movements in each asset-backed sector, transaction-specific changes in credit spreads, credit rating downgrades, and modeled defaults and principal and interest payment priorities within each investment structure. Ninety-two percent of our investments in ABS included in the preceding table were rated investment grade with 37% rated Aaa. Of the $1.6 billion of ABS investments reported in the preceding table, $630 million include the benefit of guarantees provided by third-party financial guarantors and $385 million include the benefit of guarantees provided by MBIA Corp. The average credit rating of all guaranteed ABS investments, using the higher of the guarantors’ ratings or the underlying bond
Based on our assessment of other-than-temporary impairments within our investment portfolios, we concluded that 21 ABS investments included in the preceding table were other-than-temporarily impaired and we recorded realized losses of $279 million on these securities through current earnings. During 2008, we recorded total realized losses of $574 million on 38 other-than-temporarily impaired ABS investments. Impairments of ABS investments resulted from our reassessment of the likelihood we will receive an amount equal to our carrying value over the remaining maturities of the securities or from our determination that we no longer intend to hold securities to a recovery of amortized cost due to actual or expected securities sales executed in connection with rebalancing our asset/liabilities products asset portfolio in 2008. We believe that, over time, the remainder of our ABS investments will recover to fair values at least equal to their amortized costs through improvements in market conditions and the repayment of principal. As we have the ability and intent to hold these securities until such a recovery in value, we have not realized losses on the remainder of our ABS investment portfolio through current earnings. However, if the creditworthiness of these investments or our intent to hold were to change, we may take additional impairments on these securities in the future.
The weighted average credit quality of the Company’s fixed-income portfolios has been maintained at double-A since its inception. The quality distribution of the Company’s fixed-income investment portfolios, excluding short-term investments, based on ratings from Moody’s as of December 31, 2008 is presented in the following table. Alternate ratings sources, such as S&P, have been used for a small percentage of securities that are not rated by Moody’s.
The distribution of the Company’s Insured Investments by financial guarantee insurer as of December 31, 2008 is presented in the following table.
In purchasing Insured Investments, the Company independently assesses the underlying credit quality, structure and liquidity of each investment, in addition to the creditworthiness of the insurer. Insured Investments are diverse by sector, issuer and size of holding. The Company assigns underlying ratings to its Insured Investments without giving effect to financial guarantees based on the lower of underlying ratings assigned by S&P or Moody’s when an underlying rating is published by either rating agency, or when an external underlying rating is not available, the underlying rating is based on the Company’s best estimate of the rating of such investment. A downgrade of a financial guarantee insurer will likely have an adverse affect on the fair value of investments insured by the downgraded financial guarantee insurer. If MBIA determines that declines in the fair values of Insured Investments are other than temporary, the Company will record a realized loss through earnings.
Without giving effect to the MBIA guarantee of MBIA Insured Investments in the consolidated investment portfolio, at December 31, 2008, based on the actual or estimated underlying ratings, the weighted average rating of the consolidated investment portfolio would be in the Aa range, the weighted average rating of only the MBIA Insured Investments in the consolidated investment portfolio would be in the A range, and 4.6% of the consolidated investment portfolio would be rated below investment grade.
The following table summarizes the Company’s future estimated cash payments relating to contractual obligations as of December 31, 2008. Estimating these payments requires management to make estimates and assumptions regarding these obligations. The estimates and assumptions used by management are described below. Since these estimates and assumptions are subjective, actual payments in future periods may vary from those reported in the following table. Refer to “Note 17: Net Insurance In Force” in the Notes to Consolidated Financial Statements for information about the Company’s exposure under insurance contracts.
In general, MBIA’s market risk relates to changes in the value of financial instruments that arise from adverse movements in factors such as interest rates, credit spreads and foreign exchange rates. MBIA is exposed to changes in interest rates and credit spreads that affect the fair value of its financial instruments, namely investment securities, investment agreement liabilities, MTNs, debentures and certain derivative transactions. The Company’s investment portfolio holdings are primarily U.S. dollar-denominated fixed-income securities including municipal bonds, U.S. Government bonds, mortgage-backed securities, collateralized mortgage obligations, corporate bonds and asset-backed securities. In periods of rising and/or volatile interest rates and credit spreads, profitability could be adversely affected should the Company have to liquidate these securities.
MBIA minimizes its exposure to interest rate risk and credit spread movement through active portfolio management to ensure a proper mix of the types of securities held and to stagger the maturities of its fixed-income securities. In addition, the Company enters into various swap agreements that hedge the risk of loss due to interest rate and foreign currency volatility.
Interest rate sensitivity can be estimated by projecting a hypothetical instantaneous increase or decrease in interest rates. The following table presents the estimated pre-tax change in fair value of the Company’s financial instruments as of December 31, 2008 from instantaneous shifts in interest rates.
Since December 31, 2006, the Company’s portfolio of insured structured CDSs has become increasingly concentrated in transactions where the underlying reference obligations comprise CMBS and asset-backed collateral including RMBS, in addition to corporate securities. As a result, the portfolio is more sensitive to changes in credit spreads in those sectors. Beginning in the second half of 2007, credit spreads in those sectors increased significantly, resulting in a substantial decrease in the fair value of the Company’s portfolio of structured CDSs. Refer to the discussion of the attribution of the 2008 unrealized loss included in the “Results of Operations” section.
Sensitivity to changes in credit spreads can be estimated by projecting a hypothetical instantaneous shift in credit spread curves. The following table presents the estimated pre-tax change in fair value and the cumulative estimated net fair value of the Company’s credit derivatives portfolio of instantaneous shifts in credit spreads as of December 31, 2008. Estimated changes in fair value are calculated using the valuation methods described in the “Critical Accounting Estimates” section included herein. In scenarios where credit spreads decreased, a floor of zero was used.
Actual shifts in credit spread curves will vary based on the credit quality of the underling reference obligations. In general, within any asset class, higher credit rated reference obligations will exhibit less credit spread movement than lower credit rated reference obligations. Additionally, the degree of credit spread movement can vary significantly for different asset classes. The basis point change presented in the preceding table, however, represents a fixed basis point change in reference obligation credit spreads across all credit quality rating categories and asset classes and, therefore, the actual impact of spread changes would vary from this presentation depending on the credit rating and distribution across asset classes, both of which will adjust over time depending on new business written and runoff of the existing portfolio.
Sensitivity to changes in the collateral portfolio credit quality can be estimated by projecting a hypothetical change in rating migrations. The following table presents the estimated pre-tax change in fair value and the cumulative estimated net fair value of the Company’s insurance credit derivatives portfolio of a one and three notch rating change in the credit quality as of December 31, 2008. A notch represents a one step movement up or down in the credit rating. Estimated changes in fair value are calculated using the valuation methods described in the “Critical Accounting Estimates” section included herein.
Recovery rates on defaulted collateral are an input into the Company’s valuation model. Sensitivity to changes in the recovery rate assumptions used by the Company can be estimated by projecting a hypothetical change in these assumptions. The following table presents the estimated pre-tax change in fair value and the cumulative estimated net fair value of the Company’s insurance credit derivatives portfolio of a 10% and 20% change in the recovery rate assumptions as of December 31, 2008. Estimated changes in fair value are calculated using the valuation methods described in the “Critical Accounting Estimates” section included herein.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
SFAS 157 requires the Company to incorporate its own nonperformance risk in its valuation methodology. Sensitivity to changes in the Company’s credit spreads can be estimated by projecting a hypothetical change in this assumption. The following table presents the estimated pre-tax change in fair value and the cumulative estimated net fair value of the Company’s insurance credit derivative portfolio using upfront credit spreads of 65% and 0%. The actual upfront spread used in the valuation at December 31, 2008 was 46.50%. The below amounts include an additional annual running credit spread of 5%.
MBIA Inc., together with its consolidated subsidiaries, (collectively, “MBIA” or the “Company”) operates the largest financial guarantee insurance business in the industry and a substantial asset/liability management program. MBIA also provides asset management and other specialized financial services. These activities are managed through two principal business operations: insurance and investment management services. Corporate operations include revenues and expenses that arise from general corporate activities. MBIA’s insurance and certain investment management services programs have historically relied upon triple-A credit ratings. The loss of those ratings in the second quarter of 2008 resulted in a dramatic reduction in the Company’s business activities. As of December 31, 2008, MBIA Insurance Corporation was rated AA with a negative outlook by Standard & Poor’s Corporation (“S&P”) and Baa1 with a developing outlook by Moody’s Investors Service, Inc. (“Moody’s”).
MBIA’s insurance operations have been principally conducted through MBIA Insurance Corporation and its subsidiaries (“MBIA Corp.”). MBIA Corp.’s guarantees insure municipal bonds, asset-backed and mortgage-backed securities (“ABS” and “MBS”, respectively), investor-owned utility bonds, bonds backed by publicly or privately funded public-purpose projects, bonds issued by sovereign and sub-sovereign entities, and bonds backed by other revenue sources such as corporate franchise revenues. Insured ABSs include collateral consisting of a variety of consumer loans, corporate loans and bonds, trade and export receivables, aircraft, equipment and real property leases and insured MBSs include collateral consisting of residential and commercial mortgages. Additionally, MBIA Corp. has insured credit default swaps (“CDSs”) on structured pools of corporate obligations, residential mortgage-backed securities (“RMBS”), and commercial real estate backed securities and loans. The financial guarantees issued by MBIA Corp. provide unconditional and irrevocable guarantees of the payment of the principal of, and interest or other amounts owing on, insured obligations when due. The obligations are generally not subject to acceleration, except that MBIA Corp. may have the right, at its discretion, to accelerate insured obligations upon default or otherwise. Certain investment agreement contracts written by MBIA Inc. and insured by MBIA Corp. are terminable upon ratings downgrades, and if MBIA Inc. were to have insufficient assets to pay the termination payments, MBIA Corp. would make such payments.
In February 2008, the Company announced its intention to reorganize its insurance operations in a manner that would provide public finance and structured finance insurance from separate operating entities. In February 2009, after receiving the required regulatory approvals, the Company restructured its principal insurance subsidiary, MBIA Insurance Corporation, and established a separate U.S. public finance financial guarantee insurance company using MBIA Insurance Corp. of Illinois (“MBIA Illinois”), an existing public finance financial guarantee insurance company wholly owned by MBIA. Refer to “Note 28: Subsequent Events” for information about this reorganization.
In December 2006, MBIA completed the sale of Capital Asset Holdings GP, Inc. and certain affiliated entities (“Capital Asset”). The sale of Capital Asset also included three variable interest entities (“VIEs”) established in connection with MBIA-insured securitizations of Capital Asset tax liens, which were consolidated within the Company’s insurance operations in accordance with Financial Accounting Standards Board (“FASB”) Interpretation No. (“FIN”) 46(R), “Consolidation of Variable Interest Entities - an interpretation of ARB No. 51.” In December 2006, MBIA completed the sale of MBIA MuniServices Company and certain of its wholly owned subsidiaries (“MuniServices”) to an investor group led by the management of MuniServices. MBIA’s municipal services operations consisted of the activities of MuniServices and Capital Asset. As a result of the sale of MuniServices and Capital Asset, the Company no longer reports municipal services operations and the assets, liabilities, revenues and expenses of these entities have been reported within discontinued operations for 2006 in accordance with Statement of Financial Accounting Standards No. (“SFAS”) 144, “Accounting for the Impairment or Disposal of Long-lived Assets.” Refer to “Note 16: Discontinued Operations” for information relating to the Company’s discontinued operations.
The Company has instituted a liquidity risk management framework to evaluate its enterprise-wide liquidity position. The primary objective of this risk management system is to monitor potential liquidity constraints and guide the proactive management of liquidity resources to ensure adequate protection against liquidity risk. MBIA’s liquidity risk management framework monitors the Company’s cash and liquid asset resources using stress-scenario testing. Members of MBIA’s senior management meet frequently to review liquidity metrics, discuss contingency plans and establish target liquidity cushions on an enterprise-wide basis.
MBIA’s financial guarantee insurance business model is built upon the premise of “pay-as-you-go” cash flows. Its financial guarantee contracts and CDS contracts cannot be accelerated (absent an insolvency or payment default
In order to monitor liquidity risk and maintain appropriate liquidity resources for payments associated with MBIA’s residential mortgage related exposures, the Company employs a stress scenario-based liquidity model using the same “Roll Rate Default Methodology” as it uses in its loss reserving. Using this methodology, the Company estimates the level of payments that would be required to be made under low probability stress-level default assumptions of the underlying collateral taking into account MBIA’s obligation to cover such defaults under its insurance policies. These estimated payments, together with all other significant operating, financing and investing cash flows are forecasted over the next 24-month period on a monthly basis and then annually thereafter to the final maturity of the longest dated outstanding insured obligation. The stress-loss scenarios and cash flow forecasts are frequently updated to account for changes in risk factors and to reconcile differences between forecasted and actual payments.
In addition to MBIA’s residential mortgage stress scenario, the Company also monitors liquidity risk using a Monte Carlo estimation of potential stress-level claims for all insured principal and interest payments due in the next 12-month period at a 99.99% confidence interval. These probabilistically determined payments are then compared to the Company’s invested assets to ensure adequate coverage of worst-case loss scenario measurements. This theoretic liquidity model supplements the scenario-based liquidity model described above providing the Company with a robust set of liquidity metrics with which to monitor its risk position.
The Company manages the investment portfolio of its insurance operations in a conservative manner to maintain cash and liquid securities in an amount in excess of all stress scenario payment requirements. To the extent the Company’s liquidity resources fall short of its target liquidity cushion under the stress-loss scenario testing, the Company will seek to increase its cash holdings position, primarily through the sale of high-quality bonds held in its investment portfolio.
Within MBIA’s investment management services operations, the asset/liability products segment had material liquidity needs during 2008. In addition to the payment of operating expenses, cash needs in the asset/liability products segment are primarily for the payment of principal and interest on investment agreements and medium-term notes, and for posting collateral under repurchase agreements, derivatives and investment agreements. During 2008, liquidity needs increased significantly due to the requirement to post additional high-grade eligible collateral and to fund terminations of certain investment agreements resulting from the downgrades of MBIA Corp. by the credit rating agencies. The sources of cash within the asset/liability products segment used to meet its liquidity needs include scheduled maturities of high-quality assets, net investment income and dedicated capital held within the investment management services operations. If needed, assets held within the segment can be sold or used in secured repurchase agreement borrowings to raise cash. However, the Company’s ability to sell assets or borrow against non-U.S. government securities in the fixed-income markets decreased dramatically and the cost of such transactions increased dramatically in 2008 due to the impact of the credit crisis on the
At each balance sheet date, MBIA evaluates its investments for which fair value is less than amortized cost to determine whether the decline in value is other than temporary. An investment is considered for a potential other-than-temporary impairment if it meets any of the following criteria:
The security’s current fair value is less than current book value by a magnitude of 5% or greater, and the fair value has been less than book value by at least 5% for a period of greater than twelve months; or
Policy acquisition costs include those expenses that relate primarily to, and vary with, the acquisition of new insurance business. The Company periodically conducts a study to determine which operating costs have been incurred to acquire new insurance business and qualify for deferral. For business produced directly by MBIA Corp., such costs include compensation of employees involved in underwriting and policy issuance functions, certain rating agency fees, state premium taxes and certain other underwriting expenses, reduced by ceding commission income on premiums ceded to reinsurers. Policy acquisition costs also include ceding commissions paid by the Company in connection with assuming business from other financial guarantors. Policy acquisition costs, net of ceding commissions received, related to non-derivative insured financial guarantee transactions are deferred and amortized over the period in which the related premiums are earned. Policy acquisition costs related to insured derivative transactions are expensed as incurred.
MBIA will recognize a premium deficiency if the sum of expected loss and loss adjustment expenses (“LAE”) and unamortized policy acquisition costs exceed the related unearned premiums. If MBIA were to have a premium deficiency that is greater than unamortized acquisition costs, the unamortized acquisition costs would be reduced by a charge to expense, and a liability (if necessary) would be established for any remaining deficiency. As of December 31, 2008, there have been no premium deficiencies. Although GAAP permits the inclusion of anticipated investment income when determining a premium deficiency, it is currently not being included in the Company’s evaluation.
Property, leasehold improvements and equipment are tested for potential impairment whenever events or changes in circumstances suggest that an asset’s or asset group’s carrying value may not be fully recoverable in accordance with SFAS 144. An impairment loss, calculated as the difference between the estimated fair value and the carrying value of an asset or asset group, is recognized if the sum of the expected undiscounted cash flows relating to the asset or group of assets is less than the corresponding carrying value.
A fair value hedge represents the hedging of an exposure to changes in the fair value of an asset, liability, or unrecognized firm commitment that is attributable to a particular risk. A cash flow hedge represents the hedging of an exposure to the variability in expected future cash flows that is attributable to a particular risk. A derivative instrument or a non-derivative financial instrument that results in a foreign currency transaction gain or loss arising under SFAS 52, “Foreign Currency Translation,” can be designated as hedging changes in the fair value of an unrecognized firm commitment, or a specific portion, attributable to foreign currency exchange rates.
For a qualifying fair value hedge, gains and losses on the hedging instrument are recognized in income, and gains and losses (change in fair value) on the hedged item attributable to the hedged risk are recorded as an adjustment to the carrying amount of the hedged item and recognized in income. For a qualifying cash flow hedge, the effective portion of the gain or loss on a derivative designated as a cash flow hedge is reported in other comprehensive income (loss), net of tax, and the ineffective portion is reported in income. The effective portions of the gain or loss of the derivative deferred in accumulated other comprehensive income (loss), net of tax, is then reclassified into income in the same period or periods during which the hedged forecasted transaction affects income.
If circumstances or events arise that require the termination and settlement of a derivative contract prior to maturity, any resulting gain or loss will be recognized immediately in earnings. For qualifying fair value hedges, if the hedge relationship is terminated, the derivative fair value adjustment is reported as part of the basis of the hedged item and is amortized to earnings as a yield adjustment. For qualifying cash flow hedges, if the hedge relationship is terminated, the derivative fair value adjustment recorded in other comprehensive income (loss) is recognized in earnings at the time the hedged cash flows are recognized, consistent with the original hedge strategy. If the underlying hedged item of a hedge relationship ceases to exist, all changes in the fair value of the derivative are recognized in earnings each period until the derivative matures or terminates.
They provide for payments to be made solely to reimburse the guaranteed party for failure of the debtor to satisfy its required payment obligations under a non-derivative contract, either at pre-specified
payment dates or accelerated payment dates, as a result of the occurrence of an event of default (as defined in the financial obligation covered by the guarantee contract) or notice of acceleration being made to the debtor by the creditor;
Approximately 82% of the Company’s financial guarantee contracts qualify for the scope exception defined above and, therefore, are accounted for in accordance with SFAS 60, “Accounting and Reporting by Insurance Enterprises.” The remaining contracts do not meet the scope exception, primarily because the guaranteed party is not exposed to the risk of nonpayment both at inception of the financial guarantee contract and throughout its term. These contracts are accounted for as derivatives and reported on the Company’s balance sheet as either assets or liabilities, depending on the rights or obligations under the contract, at fair value. The Company refers to these contracts as insured CDS contracts.
Refer to “Note 7: Derivative Instruments” for a further discussion of the Company’s use of derivatives and their impact on the Company’s financial statements and “Note 4: Fair Value of Financial Instruments” for derivative valuation techniques and fair value disclosures.
MBIA adopted the provisions of SFAS 157, “Fair Value Measurements” excluding non-financial assets and liabilities per FASB Staff Position No. (“FSP”) FAS 157-2, “Effective Date of FASB Statement No. 157,” beginning January 1, 2008. Under this standard, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date.
In determining fair value, the Company uses various valuation approaches, including both market and income approaches. SFAS 157 establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be
used when available and reliable. Observable inputs are those the Company believes that market participants would use in pricing the asset or liability developed based on market data. Unobservable inputs are those that reflect the Company’s beliefs about the assumptions market participants would use in pricing the asset or liability developed based on the best information available. The hierarchy is broken down into three levels based on the observability and reliability of inputs as follows:
The Company previously elected to record at fair value under SFAS 155, “Accounting for Certain Hybrid Financial Instruments” certain financial instruments that contained an embedded derivative requiring bifurcation under SFAS 133. These instruments included certain medium-term notes and certain available-for-sale securities. Management elected to fair value hybrid instruments in those instances where the host contract and the embedded derivative were not separately subject to a hedging relationship.
Refer to “Note 4: Fair Value of Financial Instruments” for additional fair value disclosures.
Loss and LAE reserves are established by the Company’s Loss Reserve Committee, which consists of members of senior management. This estimate requires the use of judgment and estimates with respect to the occurrence, timing and amount of a loss on an insured obligation. Loss and LAE reserves relate only to MBIA’s non-derivative financial guarantees.
The unallocated loss reserve is increased on a quarterly basis using a formula that applies a “loss factor” to the Company’s scheduled net earned premium for the respective quarter, both of which are defined and set forth below. This increase in the unallocated reserve is included in the Company’s provision for loss and loss adjustment expenses as reported on the Company’s consolidated statements of operations. Scheduled net earned premium represents total quarterly premium earnings, net of reinsurance, from all policies in force less the portion of quarterly premium earnings that have been accelerated as a result of the refunding or defeasance of insured obligations. Total earned premium as reported on the Company’s consolidated statements of operations includes both scheduled net earned premium and premium earnings that have been accelerated, net of reinsurance. Once a policy is originated, the amount of scheduled net earned premium recorded in earnings will be included in the Company’s calculation of its unallocated loss reserve. When an insured obligation is refunded, defeased or matures, the Company does not reverse the unallocated loss reserve previously generated from the scheduled net earned premium on such obligation as the Company’s unallocated loss reserve is not specific to any individual obligation.
Each quarter the Company calculates its provision for the unallocated loss reserve as a fixed percent of scheduled net earned premium of the insurance operations. Prior to the first quarter of 2008, scheduled net earned premium of the insurance operations included premiums from both its non-derivative insured portfolio and its insured derivative portfolio. Effective January 1, 2008, premiums from insured derivative contracts are no longer included as part of scheduled net earned premium but are rather reported as part of “Realized gains (losses) and other settlements on insured derivatives.” As a result, the Company increased its loss factor to 14.5% from 12% in order to maintain a loss and LAE provision consistent with that calculated using historical scheduled net earned premium.
When a case basis reserve is established, MBIA reclassifies the estimated amount from its unallocated loss reserve in an amount equal to the specific case basis loss reserve. Therefore, the amount of available unallocated loss reserve at the end of each period is reduced by the actual case basis reserves established in the same period. Such reclassification has no effect on the Company’s statement of operations as the unallocated loss reserve and specific case basis reserves, gross of recoveries from reinsurers, are reported as liabilities within “Loss and loss adjustment expense reserves” on the Company’s balance sheet. In the event that case basis reserves develop at a significantly faster or slower rate than anticipated by applying the loss factor to net scheduled earned premium, the Company will perform a qualitative evaluation with respect to the adequacy of the remaining unallocated loss reserve. In performing this evaluation, the Company considers the anticipated amounts of future transfers to existing case basis reserves, as well as the likeliness those policies for which case basis reserves have not been established will require case basis reserves at a faster or slower rate than initially expected.
MBIA establishes new case basis reserves with respect to a specific insurance policy when the Loss Reserve Committee determines that (i) a claim has been made or is probable in the future with respect to such policy based on specific credit events that have occurred and (ii) the amount of the ultimate loss that MBIA will incur under such policy can be reasonably estimated. The amount of the case basis reserve with respect to any policy
A number of variables are taken into account in establishing specific case basis reserves for individual policies that depend primarily on the nature of the underlying insured obligation. These variables include the nature and creditworthiness of the underlying issuer of the insured obligation, whether the obligation is secured or unsecured and the expected recovery rates on the insured obligation, the projected cash flow or market value of any assets that support the insured obligation and the historical and projected loss rates on such assets. Factors that may affect the actual ultimate realized losses for any policy include economic conditions and trends, changes in interest rates, rates of inflation, changes in borrower behavior, and the default rate and salvage values of specific collateral.
contracts are reported for regulatory purposes as property and casualty insurance, normally considered short-duration, but have elements of long-duration contracts in that they are irrevocable and extend over a period that may be in excess of 30 years.
Upfront premiums are earned in proportion to the expiration of the related principal balance of an insured obligation. Therefore, for transactions in which the premium is received upfront, premium earnings are greater in the earlier periods when there is a higher amount of principal outstanding. The upfront premiums are apportioned to individual sinking fund payments of a bond issue according to an amortization schedule. After the premiums are allocated to each scheduled sinking fund payment, they are earned on a straight-line basis over the period of that sinking fund payment. Accordingly, deferred premium revenue represents the portion of premiums written that is applicable to the unexpired risk of insured bonds and notes. When an MBIA-insured obligation is retired early, is called by the issuer, or is in substance paid in advance through a refunding accomplished by placing U.S. Government securities in escrow, the remaining deferred premium revenue is earned at that time since there is no longer risk to the Company. Installment premiums are earned on a straight-line basis over each installment period, generally one year or less. As the outstanding principal of an installment-based policy is paid down by the issuer of an MBIA-insured obligation, less premium is collected and recognized by MBIA. The Company may receive premiums upon the early termination of installment-based policies, which are earned when received. Both upfront and installment premium recognition methods recognize premiums over the term of an insurance policy in proportion to the remaining outstanding principal balance of the insured obligation. Premium revenue recognition is changing as a result of the adoption of SFAS 163. Refer to “Note 3: Recent Accounting Pronouncements” for additional information on the adoption of SFAS 163.
The Company collects insurance related fees for services performed in connection with certain transactions. In addition, the Company may be entitled to reimbursement of third-party insurance expenses that it incurs in connection with certain transactions. Depending upon the type of fee received and whether it is related to an insurance policy, the fee is either earned when it is received or deferred and earned over the life of the related transaction. Work, waiver and consent, termination, administrative and management fees are earned when the related services are completed and the fee is received. Structuring and commitment fees are earned on a straight-line basis over the life of the related insurance policy. Expense reimbursements are recognized when received.
Financial statement accounts expressed in foreign currencies are translated into U.S. dollars in accordance with SFAS 52. Under SFAS 52, functional currency assets and liabilities denominated in foreign currencies are translated into U.S. dollars generally using rates of exchange prevailing at the balance sheet date. Operating results are translated at average rates of exchange prevailing during the year. Unrealized gains or losses, net of deferred taxes, resulting from translation of the financial statements of a non-U.S. operation, when the functional currency is other than U.S. dollars, are included in accumulated other comprehensive income (loss) in shareholders’ equity. Foreign currency remeasurement gains and losses resulting from transactions in non-functional currencies are recorded in current earnings. Exchange gains and losses resulting from foreign currency transactions are recorded in current earnings.
The Internal Revenue Code permits companies writing financial guarantee insurance to deduct from taxable income amounts added to the statutory contingency reserve, subject to certain limitations. The tax benefits
In January 2009, the FASB issued FSP EITF 99-20-1 “Amendments to the Impairment Guidance of EITF Issue No. 99-20” which amends the impairment guidance in EITF Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets,” to achieve more consistent determination of whether an other-than-temporary impairment has occurred with that of SFAS 115. The adoption of FSP EITF 99-20-1 did not have a material effect on the Company’s consolidated balance sheets, results of operations or cash flows.
The Company adopted the provisions of SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” effective January 1, 2008. SFAS 159 provides entities the option to measure certain financial assets and financial liabilities at fair value with changes in fair value recognized in earnings each period. SFAS 159 permits the fair value option election on an instrument-by-instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument. The Company applies the disclosure requirements of SFAS 159 for certain eligible instruments which it previously elected to fair value under SFAS 155. These instruments included certain medium-term notes and certain available-for-sale securities which contained embedded derivatives requiring bifurcation. The Company did not elect the fair value option under SFAS 159 for any eligible financial instruments.
The Company adopted the provisions of SFAS 157, excluding non-financial assets and liabilities per FSP FAS 157-2 beginning January 1, 2008. SFAS 157 defines fair value as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. In February 2008, the FASB issued FSP FAS 157-2, which delayed the effective date of SFAS 157 to fiscal years beginning after November 15, 2008, for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). A transition adjustment to opening retained earnings was not required. Refer to “Note 4: Fair Value of Financial Instruments” for the Company’s disclosures relating to fair value, including the impact of incorporating MBIA’s nonperformance risk, as required by SFAS 157, in its valuation of insured credit derivatives.
The following table presents the carrying value and fair value of financial instruments reported on the Company’s consolidated balance sheets as of December 31, 2008 and December 31, 2007.
The valuation techniques for fair valuing financial instruments included in the preceding table are described below. The Company’s assets and liabilities recorded at fair value have been categorized according to the fair value hierarchy prescribed by SFAS 157 within the following “Fair Value Measurements” section. Refer to “Note 2: Significant Accounting Policies” for a description of the fair value hierarchy.
The Company records under the fair value provisions of SFAS 155 certain structured investments, which are included in available-for-sale securities. Fair value is derived using quoted market prices or cash flow models. As these securities are not actively traded, certain significant inputs are unobservable. These investments are categorized as Level 3 of the fair value hierarchy.
The fair values of investment agreements are estimated using discounted cash flow calculations based upon interest rates currently being offered for similar agreements with maturities consistent with those remaining for the investment agreements being valued. These agreements contain collateralization and termination agreements that sufficiently mitigate the nonperformance risk of the Company.
Long-term debt consists of long-term notes, debentures, surplus notes and floating rate liquidity loans. The fair value of long-term notes, debentures and surplus notes are estimated based on quoted market prices for the same or similar securities. For floating rate liquidity loans in Triple-A One Funding Corporation (“Triple-A One”), the carrying value approximates fair value and the nonperformance risk of MBIA is not applicable since there are asset cash flows that support the payments of the liabilities.
The investment management services operations have entered into derivative transactions primarily consisting of interest rate, cross currency, credit default and total return swaps and principal protection guarantees. These OTC derivatives are valued using industry standard models developed by vendors. Observable and market-based inputs include interest rate yields, credit spreads and volatilities. These derivatives are categorized as Level 2 within the fair value hierarchy except with respect to certain complex derivatives where observable pricing inputs were not able to be obtained, which have been categorized as Level 3.
In compliance with requirements of SFAS 157, the Company considers its own credit risk and that of counterparties when valuing derivative assets and liabilities. The Company has policies and procedures in place regarding counterparties, including review and approval of the counterparty and the Company’s exposure limit, collateral posting requirements, collateral monitoring and margin calls on collateral. The Company manages counterparty credit risk on an individual counterparty basis through master netting arrangements covering derivative transactions in the Investment Management Services and Corporate operations. These agreements allow the Company to contractually net amounts due from a counterparty with those amounts due to such counterparty when certain triggering events occur. The Company only executes swaps under master netting agreements, which typically contain mutual credit downgrade provisions that generally provide the ability to require assignment or termination in the event either the Company or the counterparty is downgraded below a specified credit rating. The netting agreements minimize the potential for losses related to credit exposure and thus serve to mitigate the Company’s nonperformance risk under these derivatives.
The majority of the Company’s derivative exposure lies in credit derivative instruments insured by MBIA Corp. Prior to 2008, MBIA Corp. insured CDSs entered into by LaCrosse Financial Products LLC (“LaCrosse”), an entity that is consolidated into MBIA’s GAAP financial statements under the FIN 46(R) criteria. In February 2008, the Company stopped insuring such derivative instruments except in transactions reducing its existing insured derivative exposure.
Approximately 99.6% of the balance sheet fair value of insurance derivatives as of December 31, 2008 is valued using BET, which is a probabilistic approach to calculate expected loss on the Company’s exposure based on market variables for underlying referenced collateral. The BET was originally developed by Moody’s to estimate a probability distribution of losses on a diverse pool of assets. The Company has made modifications to this technique in an effort to incorporate more market information and provide more flexibility in handling pools of dissimilar assets: a) the Company uses market credit spreads to determine default probability instead of using historical loss experience, and b) for collateral pools where the spread distribution is characterized by extremes, the Company models each segment of the pool individually instead of using an overall pool average.
The pool loss estimation is calculated by reference to the following (described in further detail under “Model Inputs” below):
Credit spreads of the underlying collateral. These are based on actual spreads or spreads on similar collateral with similar ratings, or in some cases are benchmarked;
Additional structural assumptions of the model worth noting are listed below:
Default probability is determined by three factors: credit spread, recovery rate after default and the time period under risk;
correlation is modeled using a diversity score, which is calculated based on rules regarding industry or sector concentrations. Recovery rates are based on historical averages and updated based on market evidence.
2) There are diverse approaches to estimating fair value of such transactions among other financial guarantee insurance companies.
The Company uses the spread hierarchy listed below in determining which source of spread information to use, with the rule being to use CDS spreads where available and cash security spreads as the next alternative. Cash spreads reflect trading activity in funded fixed-income instruments while CDS spreads reflect trading levels for non-funded derivative instruments. While both markets are driven partly by an assessment of the credit quality of the referenced security, there are factors which create significant differences: CDS spreads can be driven by speculative activity since the CDS market facilitates both long and short positions without ownership of the underlying security, allowing for significant leverage.
The recovery rate represents the percentage of par expected to be recovered after an asset defaults, indicating the severity of a potential loss. MBIA generally uses rating agency recovery assumptions which may be adjusted to account for differences between the characteristics and performance of the collateral used by the rating agencies and the actual collateral in MBIA-insured transactions. The Company may also adjust rating agency assumptions based on the performance of the collateral manager and on empirical market data. For example, in the first quarter of 2008, new S&P research used a lower recovery rate for securities backed by Alternative A-paper and subprime real estate collateral and in the same period trading spreads widened materially for these assets, so the Company adjusted the recovery rates in its mortgage-backed collateral by approximately 10 percentage points. The Company did this even though the collateral backing its transactions is on average a better credit quality than the assets used in S&P’s research. Also in the fourth quarter of 2008 MBIA began using a distribution of potential recovery rates instead of a single point estimate.
Approximately $47 billion gross par of MBIA’s insured derivative transactions include substantial amounts of CMBS and commercial mortgage collateral. In prior years, the Company had used spreads drawn from CMBX indices and CMBS spread tables as pricing input on the underlying referenced collateral in these transactions. In 2008 as the financial markets became illiquid, the Company saw a significant disconnect between cumulative loss expectations of market analysts on underlying commercial mortgages, which were based on the continuation of low default and loss rates, and loss expectations implied by the CMBX indices and CMBS spread tables. CMBS collateral in MBIA’s insured credit derivatives has performed in line with the market analysts’ assessments and continue to be rated triple-A by Moody’s or S&P.
Over time, as market data and research changes, the Company also updates its techniques to reflect the change in data and estimates. This was required in 2008 regarding the Company’s assumption for average life in the CMBX analog index. The Company’s preferred approach is to use an average life that is known to be consistent with the Cumulative Net Loss assumptions, but published research on loss assumptions does not disclose underlying corresponding average life. Initially the Company had used tranche duration for average life, also as published by third-party independent market research considering this appropriate as it was produced by research based on a wide variety of market transactions. During the third quarter of 2008 as credit spreads continued to widen to unprecedented levels, it became clear that these tranche duration assumptions were not compatible with the expectations of future losses that most market participants would use. The Company determined that an internally developed tranche weighted average life based on its own transactions would be more consistent with the characteristics of its portfolio. The Company believes this change results in a measurement more representative of fair value in the current market.
Ceded Financial Guarantees-The Company estimates the fair value of its ceded financial guarantee liability by calculating the portion of the gross financial guarantee liability that has been ceded to reinsurers. The carrying value of ceded financial guarantee liability consists of prepaid reinsurance premiums and reinsurance recoverable on unpaid losses as reported on the Company’s consolidated balance sheets.
Transfers into and out of Level 3 were $1.2 billion and $959 million for the year ended December 31, 2008, respectively. These transfers were principally for available-for-sale securities where inputs, which are significant to their valuation, became unobservable or observable during the year. Foreign governments, corporate obligations, MBS and ABS constituted the majority of the affected instruments. The net unrealized loss related to the transfers into and out of Level 3 as of December 31, 2008 were $25 million and $82 million, respectively.
For the year ended December 31, 2008, the fair value of hybrid financial assets decreased $4 million on a pre-tax basis and $3 million on an after-tax basis and the fair value of hybrid financial liabilities, which related to four medium-term notes, decreased $149 million on a pre-tax basis and $97 million on an after-tax basis. Contractual interest coupon payments related to these medium-term notes are recorded within “Interest expense” on the Company’s consolidated statements of operations.
A portion of the obligations under investment agreements require the Company to pledge securities as collateral. As of December 31, 2008 and 2007, the fair value of securities pledged as collateral with respect to these obligations approximated $2.7 billion and $8.0 billion, respectively. Additionally, the Company has pledged cash in the amount of $2.2 billion.
It is MBIA’s policy to obtain an underlying rating from both Moody’s and S&P for each new transaction funded through the Company’s conduit segment prior to the execution of such transactions. All transactions currently funded in the conduit segment had an underlying rating of investment grade by Moody’s and S&P prior to funding. The weighted average underlying rating for transactions currently funded in the Company’s conduits was A- by S&P and A2 by Moody’s at the time such transactions were funded. MBIA estimates that the weighted average underlying rating of all outstanding conduit segment transactions was A- by S&P and A3 by Moody’s as of December 31, 2008.
The following tables present the gross unrealized losses included in accumulated other comprehensive income (loss) as of December 31, 2008 and 2007 related to available-for-sale fixed-maturity and other investments. The tables segregate investments that have been in a continuous unrealized loss position for less than twelve months from those that have been in a continuous unrealized loss position for twelve months or longer.
As of December 31, 2007, there were 507 securities that were in an unrealized loss position for a continuous twelve-month period or longer with aggregate unrealized losses of $233 million. Within the 507 securities, the book value of 123 securities exceeded market value by more than 5%.
MBIA has evaluated whether the unrealized losses in its investment portfolios were other than temporary considering the circumstances that gave rise to the unrealized losses, along with MBIA’s ability and intent to hold these securities to maturity or until such time as to recover an amount equal to their amortized cost. Based on its evaluation, the Company realized other-than-temporary impairments of $954 million related to taxable fixed-maturity assets. MBIA determined that the unrealized losses on the remaining securities were temporary in nature because its impairment analysis, including projected future cash flows, indicated that the Company would be able to recover the amortized cost of impaired assets. The Company also concluded that it has both the ability and intent to hold these securities until their fair values recover to an amount at least equal to amortized cost or to maturity. In making this conclusion, the Company examined the cash flow projections for its investment portfolios, the potential sources and uses of cash in its businesses, and the cash resources availability to its business other than sales of securities. It also considered the existence of any risk management or other plans as of December 31, 2008 that would require the sale of impaired securities. On a quarterly basis, MBIA will reevaluate the unrealized losses in its investment portfolios and determine whether an impairment loss should be realized in current earnings. Refer to “Note 6: Investment Income and Gains and Losses” for information on realized losses due to other-than-temporary impairments. Additionally, refer to “Note 2: Significant Accounting Policies” for a description of the process used by the Company to determine other-than-temporary impairments.
For 2008, net realized losses from fixed-maturity investments of $1.6 billion included other-than-temporary impairments of $954 million primarily related to ABS and corporate securities and realized losses on security sales. For 2007, the net realized gain of $53 million included a realized gain of $36 million in connection with the disposition of the Delta and Northwest Airlines Enhanced Equipment Trust Certificates (“EETCs”) that were obtained in remediation. In addition, in 2007 the Company recognized realized losses of $20 million due to other-than-temporary impairments of taxable fixed-maturity investments.
For 2008, other net realized losses of $94 million resulted from interest rate swap terminations in a loss position. In 2006, other net realized losses of $21 million include $25 million of impairment losses on receivables the Company recorded through salvage and subrogation rights it obtained as a result of claim payments it previously made on insured credits.
Changes in the fair value of derivatives, excluding insured derivatives, are recorded each period in current earnings within “Net gains (losses) on financial instruments at fair value and foreign exchange” or in shareholders’ equity within “Accumulated other comprehensive income (loss),” depending on whether the derivative is designated as a hedge, and if so designated, the type of hedge. The total changes in fair value of the insured derivatives are recorded in “Net change in fair value of insured derivatives.” “Realized gains (losses) and other settlements on insured derivatives” include (i) net premiums received and receivable on written CDS contracts, (ii) net premiums paid and payable to reinsurers in respect of CDS contracts, (iii) net amounts received or paid on reinsurance commutations, (iv) losses paid and payable to CDS contract counterparties due to the occurrence of
Cash flow hedges related to the investment management services operations resulted in an aggregate net unrealized loss of $4 million (net of tax) in accumulated other comprehensive income (loss) at December 31, 2008. The aggregate net unrealized loss is composed of both positive and negative future cash flows. The
Company expects that approximately $0.3 million of unrealized gains (including foreign exchange and net of tax) will migrate from accumulated other comprehensive income (loss) into earnings during 2009 and the remaining amount over the term of the contracts.
The cross currency swap resulted in an aggregate unrealized gain of $0.2 million (net of tax) remaining in accumulated other comprehensive income (loss) at December 31, 2008. The Company expects that approximately $0.4 million of unrealized losses (including foreign exchange and net of tax) will migrate from accumulated other comprehensive income (loss) into earnings during 2009 and the remaining balance over the term of the contract.
The notional values of all derivative instruments by business operations as of December 31, 2008 are as follows:
credit rating. If the Company were to settle all transactions covered under netting agreements as of December 31, 2008, the amount required to be paid to counterparties would have been reduced by $509 million as a result of its contractual right to offset amounts due from such counterparties. The Company has chosen not to net receivables due from counterparties with payables due to counterparties in its balance sheet, but instead to report these amounts on a gross basis as assets and liabilities.
In certain non-insurance derivative contracts, the Company also manages credit risk through collateral agreements that give the Company the right to hold or the obligation to provide collateral when the current market value of certain derivative contracts exceeds an exposure threshold. Under these arrangements, the Company may receive or provide U.S. Treasury and other highly rated securities or cash to secure counterparties’ exposure to the Company or its exposure to counterparties, respectively. Such collateral is available to the holder to pay for replacing the counterparty in the event that the counterparty defaults. As of December 31, 2008, the Company did not hold cash collateral from derivative counterparties but posted cash collateral to derivative counterparties of $92 million. As of December 31, 2008, the Company had securities with a fair value of $284 million posted to derivative counterparties.
As of December 31, 2008, the fair value was positive on four different Credit Support Annexes (“CSAs”) which govern collateral posting requirements between MBIA and its derivative counterparties. The aggregate positive fair value for these four CSAs was $128 million for which the Company did not receive collateral because the Company’s credit rating was below the CSA minimum credit ratings level for holding counterparty collateral. The lowest rated of the four counterparties was rated A+ by S&P and Aa3 by Moody’s.
Includes interest income and expense for derivatives in a hedge relationship in the investment management services and corporate operations.
As of December 31, 2008, the Company reported an accumulated unrealized loss of $4 million (net of tax) in other comprehensive income (loss) related to the fair value of the cash flow hedges compared with a $13 million accumulated unrealized loss (net of tax) as of December 31, 2007. The change resulted from a $7 million unrealized loss (net of tax) in the fair value of the cash flow hedges and the transfer of $3 million loss (including foreign exchange and net of tax) to earnings as a result of scheduled interest payments and receipts on the cash flow hedges. As of December 31, 2008, the maximum term of derivative instruments related to cash flow hedges was approximately 10 years.
As of December 31, 2008, consolidated VIE assets and liabilities were $2.3 billion and $1.8 billion, respectively, including the VIEs consolidated in the fourth quarter of 2008 and other VIEs with outstanding obligations insured by MBIA that hold residential mortgages or securities as collateral. These VIEs were also consolidated as of December 31, 2007, with assets and liabilities each totaling $1.4 billion. Creditors of issuer-sponsored VIEs do not have recourse to the general assets of MBIA. In the event of nonpayment of an insured obligation issued by a consolidated VIE, the Company is obligated to pay principal and interest, when due, on the respective insured obligation only. The Company’s exposure to consolidated VIEs is limited to the credit protection provided on insured obligations and the additional variable interests acquired.
In its investment management services operations, the Company invests in obligations issued by issuer-sponsored SPEs which are included in fixed-maturity securities held as available-for-sale and investments held-to-maturity. The Company evaluates issuer-sponsored SPEs to determine if the entity is a VIE. For all entities determined to be VIEs, the Company evaluates whether its investment will absorb the majority of the expected losses of the VIE, receive the majority of the expected returns of the VIE, or both, as of the date of initial purchase and as of any subsequent date of additional acquisitions of interests in the VIE. The investment policies of the Company limit the amount of credit exposure to any one issuer and seek to invest in high-quality investments (average rating double-A or above). MBIA is not the primary beneficiary of any VIEs and does not hold any significant variable interests in issuers considered VIEs based on its assessment of the investment portfolio.
The following table presents the carrying amounts and classification of assets and liabilities of consolidated VIEs as of December 31, 2008 and 2007:
The Company’s long-term debt presented in the preceding table is subject to certain restrictive covenants, none of which significantly restrict the Company’s operating activities or dividend-paying ability. At December 31, 2008 and December 31, 2007, the Company was in compliance with all debt covenants as there was no occurrence of any event of default with respect to the above securities. Key events of default include (i) default in the payment of any interest or principal when it becomes due and payable, (ii) default in the performance, or breach, of any covenant or warranty of MBIA, (iii) events of default with respect to the Company’s indebtedness, other than its debt securities or non-recourse obligations, in an aggregate principal amount in excess of $10 million which consist of the failure to make any payment at maturity or result in the acceleration of the maturity of the Company’s indebtedness, (iv) entry by a court having jurisdiction in the premises of a decree or order for relief in respect of MBIA in an involuntary case or proceeding under any applicable federal or state bankruptcy, insolvency, reorganization or other similar law, and (v) commencement by MBIA of a voluntary case or proceeding under any applicable federal or state bankruptcy, insolvency, reorganization or other similar law.
In December 2000, MBIA issued Swiss franc notes due June 2010 bearing interest at 4.5%. During the second half of 2008, MBIA repurchased $79 million par value outstanding of its Swiss franc notes at an average price of 75.00. Also, in connection with these notes, MBIA entered into a swap transaction that met the criteria for cash flow hedge accounting. The swap transaction converts the interest rate from a fixed Swiss franc debt rate of 4.5% to a fixed U.S. dollar rate of 7.56% and converts the Swiss franc principal amount due at maturity to a fixed U.S. dollar amount of approximately $80 million.
The Company has available various facilities, such as lines of credit and equity-based facilities, which further support its liquidity and claims-paying resources. As of December 31, 2008, MBIA Corp. maintained a $450 million limited recourse standby line of credit facility with a group of major banks to provide funds for the payment of claims on U.S. public finance transactions in excess of the greater of $500 million of cumulative claims, net of recoveries, or 5% of average annual debt service of the covered transactions. The agreement expires in March 2015. The remaining term is approximately six years. During 2008, there were no balances outstanding under the facility. Cumulative covered losses incurred to date under the facility are $17 million. In connection with the Company’s restructuring of MBIA Insurance Corporation, it intends to negotiate with the providers of this facility a transfer of the facility from MBIA Insurance Corporation to MBIA Illinois.
MBIA maintained a revolving credit facility totaling $500 million with a group of highly rated global banks, which expires in May 2011. The facility contains certain covenants including, among others, that the consolidated net worth of MBIA Inc. and MBIA Corp. will not fall below $2.8 billion and that the ratio of consolidated debt to equity for MBIA Inc. and MBIA Corp. will not exceed 30%, at any time. In January 2008, the Company amended the credit facility to treat the surplus notes as equity in the net worth and leverage calculations. This facility does not include any material credit rating triggers or any provisions that could require the posting of collateral. During 2008, there were no draws upon this facility nor were there any balances outstanding under the facility. The Company has been negotiating an amendment to the terms of the facility to exclude unrealized gains and losses on insured credit derivatives from the calculation of net worth. After consideration of the terms and conditions required to obtain an amendment, MBIA elected to terminate the facility effective February 27, 2009 in accordance with its rights under the credit facility. As of the termination date, neither MBIA Inc. nor MBIA Corp. had outstanding borrowings under the facility, and there were no early termination fees or premiums paid as a result of terminating the facility.
The Company has $20 million of outstanding letters of credit for MBIA-MISC that are intended to support the net asset value of certain investment pools managed by MBIA-MISC. These letters of credit can be drawn upon in the
event that the liquidation of such assets is required and the proceeds are less than the cost. In addition, the Company has issued commitments to three pooled investment programs managed or administered by MBIA-MISC and its subsidiary. These commitments cover losses in such programs should the net asset values per share decline below specified per share values. At December 31, 2008, the maximum amount of future payments that the Company would be required to make under these commitments was $4.5 billion. These commitments shall be in effect so long as MBIA-MISC and its subsidiary remain as manager or administrator and each program remains in compliance with its respective investment objectives and policies.
Foreign currency denominated investment agreements are presented in U.S. dollars. Amounts reflect principal due at maturity for investment agreements issued at a discount.
Under private placement offerings, Triple-A One issued commercial paper to fund the purchase of assets from structured finance clients with maturities of up to 270 days. Assets purchased by Triple-A One are insured by MBIA Corp. Historically, Triple-A One has maintained backstop liquidity facilities for each transaction, covering 100% of the face amount of commercial paper outstanding. These liquidity facilities were designed to allow Triple-A One to repay investors in the event of a market disruption in which Triple-A One would be unable to issue new commercial paper to replace maturing commercial paper. The financial guarantee policies issued by MBIA to insure the assets of Triple-A One cannot be accelerated to repay maturing commercial paper or borrowings under liquidity facilities and only guarantee ultimate payments over time relating to the assets.
Note 11: Investment Agreement, Commercial Paper and Medium-Term Note Obligations (continued)
Medium-term note obligations are recorded as liabilities on the Company’s balance sheet based upon proceeds received, net of unamortized discounts and premiums, plus unpaid accrued interest at the balance sheet date. MBIA adopted the provisions of SFAS 155 on January 1, 2007 and applied SFAS 155 fair value measurement to medium-term note liabilities. Medium-term notes are issued by MBIA Global Funding, LLC (“GFL”) as part of MBIA’s asset/liability products segment and by Meridian as part of MBIA’s conduit segment. Medium-term notes have been issued with either fixed or floating interest rates and GFL has issued medium-term notes in U.S. dollars and foreign currencies. As of December 31, 2008, the interest rates of the medium-term notes ranged from 0.00% to 7.08 % and the weighted average interest rate was 1.64%. As of December 31, 2007, the interest rates of the medium-term notes ranged from 3.59% to 6.40% and the weighted average interest rate was 5.15%. Principal payments due under medium-term note obligations based on their contractual maturity dates are as follows:
Foreign currency denominated medium-term notes are presented in U.S. dollars. Amounts reflect the principal due at maturity for notes issued at a discount or premium.
MBIA establishes two types of loss and LAE reserves for non-derivative financial guarantees: case basis reserves and an unallocated loss reserve. Refer to “Note 2: Significant Accounting Policies” for information regarding the Company’s loss reserving policy. A summary of the case basis and unallocated activity and the components of the liability for loss and LAE reserves are presented in the following table:
Represents the amount of losses and LAE incurred that have been eliminated in proportion to MBIA’s ownership interest in Channel Reinsurance Ltd. (“Channel Re”), which is carried on an equity method accounting basis.
The unallocated loss reserve approximated $232 million at December 31, 2008, which represents the Company’s estimate of losses, associated with credit deterioration, that have occurred in the Company’s insured portfolio but have not been specifically identified and is available for future case-specific activity. During 2008, additions to case basis reserves related to MBIA’s insured exposure to second-lien RMBS transactions consisting of home equity lines of credit (“HELOC”) and closed-end second-lien mortgages totaled $1.8 billion. The Company incurred $1.3 billion of loss and loss adjustment expenses during 2008. Of the $1.3 billion, $92 million was based on the Company’s loss factor of 14.5% of the insurance segment’s scheduled net earned premium and $1.2 billion represented additional loss and loss adjustment expenses related to insured RMBS exposure.
Total net paid activity for 2008 of $1.1 billion primarily related to insured obligations within MBIA’s RMBS sector and Allegheny Health, Education and Research Foundation (“AHERF”). The Company had salvage and subrogation receivables of $459 million at December 31, 2008 and $108 million at December 31, 2007, included in “Other assets.” Amounts due to reinsurers related to salvage and subrogation totaled $13 million at December 31, 2008 and $4 million at December 31, 2007, and are included in “Other liabilities.”
Once an obligation is insured, MBIA typically requires the issuer, servicer (if applicable) and the trustee to furnish periodic financial and asset related information, including audited financial statements, to IPM for review. IPM also monitors publicly available information related to insured obligations. Potential problems uncovered through this review, such as poor financial results, low fund balances, covenant or trigger violations and trustee or servicer problems or other events that could have an adverse impact on the insured obligation, could result in an immediate surveillance review and an evaluation of possible remedial actions. IPM also monitors and evaluates the impact on issuers of general economic conditions, current and proposed legislation and regulations, as well as state and municipal finances and budget developments.
“Caution List - High”-Includes issuers where more proactive remedial action is needed but where no defaults on debt service payments are expected. Issuers in this category exhibit more significant weaknesses, such as low debt service coverage, reduced or insufficient collateral protection or inadequate liquidity, which could lead to debt service defaults in the future. Issuers in this category have breached one or more covenants or triggers, have not taken conclusive remedial action, and IPM adopts a remediation plan and takes more proactive remedial actions.
“Classified List”-Includes all insured obligations where MBIA has paid a claim and where a claim payment is probable and estimable. Generally, IPM is actively remediating these credits where possible, including restructurings through legal proceedings, usually with the assistance of specialist counsel and advisors.
The following table provides information about the financial guarantees and related loss reserves (“claim liability”) included in each of MBIA’s surveillance categories as of December 31, 2008:
An “issue” represents the aggregate of financial guarantee policies that share the same revenue source for purposes of making debt service payments.
Reported within “Reinsurance recoverable on paid and unpaid losses” on MBIA Inc.’s consolidated balance sheets.
Remediation actions may involve, among other things, waivers or renegotiations of financial covenants or triggers, waivers of contractual provisions, the granting of consents, transfer of servicing, consideration of restructuring plans, acceleration, security or collateral enforcement, actions in bankruptcy or receivership, litigation and similar actions. The types of remedial actions pursued are based on the insured obligation’s risk type and the nature and scope of the event giving rise to the remediation. As part of any such remedial actions, MBIA seeks to improve its security position and to obtain concessions from the issuer of the insured obligation. From time to time, the issuer of an MBIA-insured obligation may, with the consent of MBIA, restructure the insured obligation by extending the term, increasing or decreasing the par amount or decreasing the related interest rate, with MBIA insuring the restructured obligation. If, as the result of such a restructuring, MBIA estimates that it will suffer an ultimate loss on the restructured obligation, MBIA will record a case basis reserve for the restructured obligation or, if it has already recorded a case basis reserve, it will re-evaluate the impact of the restructuring on the recorded reserve and adjust the amount of the reserve accordingly.
Under SFAS 142, goodwill and intangible assets with indefinite lives are tested for impairment at least annually. As of December 31, 2008, goodwill totaled $77 million and was related to the Company’s insurance operations. In the fourth quarter of 2008, goodwill related to the Company’s investment management services operations of $2 million was written off. As of December 31, 2007, goodwill totaled $79 million, of which $77 million was related to the Company’s insurance operations and $2 million was related to the Company’s investment management services operations.
MBIA’s insurance operations are principally conducted through MBIA Corp. The Company defines its insurance operations as both a reporting unit and an operating segment. The fair value of the Company’s insurance operating segment is estimated by increasing book value calculated under GAAP (shareholders’ equity) for the after-tax effects of net deferred premium revenue and the present value of future installment premiums less the after-tax effects of deferred acquisition costs and a provision for losses, and by excluding the after-tax effects of cumulative unrealized net gains or losses, net of credit impairments, to arrive at adjusted book value. In the third quarter of 2008, the Company refined its calculation of adjusted book value to exclude the after-tax effects of all cumulative unrealized gains or losses, net of credit impairments, instead of only excluding those related to insured derivatives. The below estimated fair value of the Company’s insurance operations as of December 31, 2007 has been adjusted to reflect this refinement.
Income (loss) from operations before provision for income tax consisted of:
The tax effects of temporary differences that give rise to deferred tax assets and liabilities at December 31, 2008 and 2007 are presented in the following table:
asset ultimately depends on the existence of sufficient taxable income of appropriate character (for example, ordinary income versus capital gains) within the carryforward period available under the tax law. As of December 31, 2008, the Company reported a net deferred tax asset of $2.4 billion primarily related to unrealized losses recorded on the Company’s derivative and investment portfolios. Included in the net deferred tax asset of $2.4 billion is a valuation allowance of $351 million.
Due to the long-tail nature of the financial guarantee business, it is important to note that MBIA Corp., even without regard to any new business, will have a steady stream of scheduled premium earnings with respect to the existing insured portfolio. MBIA Corp.’s announcement in February 2008 of a temporary suspension in writing new structured finance transactions and in insuring new CDS contracts, except in transactions related to the reduction of existing derivative exposure, would not have an impact on the expected earnings related to the existing insured portfolio. Although MBIA Corp. expects the majority of the unrealized losses to reverse at maturity, MBIA Corp. performed a taxable income projection over a 15-year period to determine whether it will have sufficient income to offset its deferred tax assets that will generate future ordinary deductions. In this analysis, MBIA Corp. concluded that premium earnings, even without regard to any new business, combined with investment income, less deductible expenses, will be sufficient to recover the net deferred tax asset of $2.4 billion, which includes the $1.7 billion related primarily to CDS contracts. Furthermore, MBIA Corp.’s existing earnings have been further increased by the FGIC reinsurance transaction, which closed on September 30, 2008.
The Company’s decision to eliminate the current dividend on its common stock and raise $2.6 billion in additional capital in January and February of 2008 was for the purpose of meeting the ratings agencies’ additional capital requirement in order to preserve the Company’s triple-A rating. While the Company was not able to retain its triple-A rating, the downgrade did not have a material impact to its earnings on the existing insured portfolio which the Company believes will be sufficient to absorb losses in the event that the cumulative unrealized losses become fully impaired.
The Company believes that the ratings downgrade by S&P and Moody’s in 2008 will not have a material impact to the Company’s earnings on its existing insured portfolio. With respect to installment policies, the Company generally does not have an automatic cancellation provision solely in connection with ratings downgrades. For purposes of projecting future taxable income, the Company has applied a haircut to account for the cancellation of future installment premiums based on recent data. With regard to upfront policies, to the extent that the issuer chooses to terminate a policy, any unearned premium reserve with respect to that particular policy will be accelerated and earned (i.e. refundings).
The Company treats the CDS contracts as insurance contracts for U.S. tax purposes. The Company provides an insurance policy guaranteeing CDS contracts written by LaCrosse. While LaCrosse’s financial information is consolidated into MBIA’s GAAP financial statements based on the FIN 46(R) criteria, MBIA does not hold any equity interest with respect to LaCrosse. MBIA’s income derived from CDS contracts is treated as premium income for statutory income purposes. In the event that there is a default in which MBIA is required to pay claims on such CDS contracts, the Company believes that the losses should be characterized as an ordinary loss for tax purposes and, as such, the event or impairment will be recorded as case reserves for statutory accounting purposes in recognition of the potential claim payment. For tax purposes, MBIA follows the statutory accounting principle as the basis for computing its taxable income. Because the federal income tax treatment of CDS contracts is an unsettled area of tax law, in the event that the Internal Revenue Service (“IRS”) has a different view in
which the losses are considered capital losses, the Company would be required to establish a valuation allowance against substantially all of the deferred tax asset related to these losses. The establishment of this valuation allowance would have a material adverse effect on MBIA’s financial condition.
Section 382 of the Internal Revenue Code of 1986, as amended, imposes annual limitations on the utilization of net operating loss (“NOL”) carryforwards, other tax carryforwards, and certain built-in losses, as defined under that Section, upon an ownership change. In general terms, an ownership change may result from transactions that increase the aggregate ownership of certain stockholders in the Company’s stock by more than 50 percentage points over a testing period (generally three years).
The Company adopted the provisions of FIN 48 on January 1, 2007. The adoption of FIN 48 did not have a material impact on the Company’s financial statements. Prior to the adoption of FIN 48, the Company classified interest and/or penalties related to income taxes as a component of income from continuing operations. In
The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was approximately $8 million as of December 31, 2008.
MBIA manages its activities primarily through two principal business operations: insurance and investment management services. The Company’s reportable segments within its business operations are determined based on the way management assesses the performance and resource requirements of such operations.
SEC-registered investment advisor and Financial Industry Regulatory Authority member firm. AM-UK provides fee-based asset management services to the Company’s foreign insurance affiliates and EAAL, and to third-party institutional clients and investment structures. AM-UK is registered with the Financial Services Authority in the U.K.
The following table summarizes the Company’s operations for the years ended December 31, 2008, 2007 and 2006:
In December 2006, MBIA completed the sale of Capital Asset, a servicer of delinquent tax liens, to a third-party company that is engaged in tax lien servicing and collection and that had been overseeing the servicing operations of Capital Asset since July 2006. The sale of Capital Asset also included three VIEs established in connection with the securitization of Capital Asset tax liens, which were consolidated within the Company’s insurance operations in accordance with FIN 46(R). The sale of Capital Asset and the related VIEs resulted in an after-tax loss of $0.6 million.
The plan to exit the businesses described above resulted from the Company’s decision that such activities no longer fit within the Company’s overall business objectives.
The creditworthiness of each insured obligation is evaluated prior to the issuance of insurance, and each insured obligation must comply with MBIA Corp.’s underwriting guidelines. Further, the payments to be made by the issuer on the bonds or notes may be backed by a pledge of revenues, reserve funds, letters of credit, investment contracts or collateral in the form of mortgages or other assets. The right to such funds or collateral would typically become MBIA Corp.’s upon the payment of a claim by MBIA Corp.
As of December 31, 2008, insurance in force, which represents principal and interest or other amounts owing on insured obligations, net of cessions to reinsurers and other reimbursement agreements, had an expected maturity range of 1-49 years. Another reimbursement agreement that had been netted from the Company’s insurance in force as reported below related to a contract under which the Company was entitled to reimbursement of losses on its insured portfolio but which did not qualify as reinsurance under GAAP. This reimbursement agreement, covering $3.5 billion of insured par, was reassumed in 2008. The reimbursement agreement resulted in a deduction of $7.0 billion for 2007. The distribution of net insurance in force by geographic location, excluding $8.5 billion and $25.7 billion relating to transactions guaranteed by MBIA Corp. on behalf of various investment management services affiliated companies in 2008 and 2007, respectively, is presented in the following table:
Includes Investor owned utilities, industrial development and pollution control revenue bonds.
The insurance operations have entered into certain guarantees of derivative contracts, included in the preceding tables, which do not qualify for the financial guarantee scope exception under SFAS 133. MBIA Corp. generally guarantees the timely payment of principal and interest related to these derivatives upon the occurrence of a credit event with respect to a referenced obligation. The maximum amount of future payments that MBIA Corp. may be required to make under these guarantees is $122.9 billion. This amount is net of $22.7 billion of insured derivatives ceded under reinsurance agreements and capital market transactions in which MBIA Corp. economically hedges a portion of the credit and market risk associated with its insured derivatives. MBIA Corp.’s guarantees of derivative contracts have a legal maximum maturity range of 1-87 years. A small number of guaranteed credit derivative contracts have long maturities to satisfy regulatory requirements imposed on MBIA’s counterparties. However, the expected maturities of such contracts are much shorter due to amortizations and prepayments in the underlying collateral pools. In accordance with SFAS 133, the fair values of these guarantees at December 31, 2008 are recorded on the balance sheet as assets and liabilities, representing gross gains and losses, of $747 million and $6.2 billion, respectively. These derivative contracts are discussed further in “Note 7: Derivative Instruments.”
Includes investor owned utilities, industrial development and pollution control revenue bonds.
The following table presents the credit ratings and ratings status, percentage of outstanding par ceded, the reinsurance recoverable, derivative asset, and estimated credit impairments by reinsurer as of December 31, 2008. Estimated credit impairments represent the reinsurers’ portion of amounts the Company expects to pay on insured derivative contracts.
The components of financial guarantee net premiums written and earned, including premiums assumed from and ceded to other companies, are presented in the following table:
MBIA Corp. is subject to insurance regulations and supervision of the State of New York (its state of incorporation) and all U.S. and non-U.S. jurisdictions in which it is licensed to conduct insurance business. The
extent of insurance regulation and supervision varies by jurisdiction, but New York and most other jurisdictions have laws and regulations prescribing minimum standards of solvency and business conduct, which must be maintained by insurance companies. Among other things, these laws prescribe permitted classes and concentrations of investments and limit both the aggregate and individual securities risks that MBIA Corp. may insure on a net basis based on the type of obligations insured. In addition, some insurance laws and regulations require the approval or filing of policy forms and rates. MBIA Corp. is required to file detailed annual financial statements with the NYSID and similar supervisory agencies in other jurisdictions in which it is licensed. The operations and accounts of MBIA Corp. are subject to examination by regulatory agencies at regular intervals.
Refer to “Note 28: Subsequent Events” for additional information about the dividend capacity of MBIA Insurance Corporation and MBIA Illinois.
reserves for losses and LAE are established at present value for specific insured issues that are identified as currently or likely to be in default. Under GAAP, reserves are established based on the Company’s reasonable estimate of the identified and unallocated losses and LAE on the insured obligations it has written. Additionally, under GAAP, estimates for credit impairment on its insured credit derivatives portfolio are recorded as a derivative liability;
guarantees of derivatives are not recorded at fair value, while under GAAP, guarantees that do not qualify for the financial guarantee scope exception under SFAS 133 are recorded at fair value;
certain assets designated as “non-admitted assets” are charged directly against surplus but are reflected as assets under GAAP;
VIE’s are not consolidated by the primary beneficiary under statutory requirements.
Consolidated net income/(loss) of MBIA Corp. determined in accordance with statutory accounting practices for the years ended December 31, 2008, 2007 and 2006 was $(1.4) billion, $171 million and $669 million, respectively. Consolidated statutory surplus of MBIA Corp. determined in accordance with statutory accounting practices for the years ended December 31, 2008 and December 31, 2007 was $3.5 billion and $3.7 billion, respectively.