The Company maintains office space located in Purchase, New York, in which the Company, National, MBIA Corp., and MBIA Services Corporation have their headquarters. The Company also leases office space in New York, New York; San Francisco, California; Mexico City, Mexico; and London, England. The Company generally believes that these facilities are adequate and suitable for its current needs.
MBIA Inc., together with its consolidated subsidiaries, (collectively, “MBIA”, the “Company”, “we”, “us”, or “our”) operates one of the largest financial guarantee insurance businesses in the industry. MBIA manages its business within three operating segments: 1) United States (“U.S.”) public finance insurance; 2) corporate; and 3) international and structured finance insurance. Our U.S. public finance insurance business is primarily operated through National Public Finance Guarantee Corporation (“National”), our corporate segment is operated through MBIA Inc. and several of its subsidiaries, including our service company, MBIA Services Corporation (“MBIA Services”) and our international and structured finance insurance business is primarily operated through MBIA Insurance Corporation and its subsidiaries (“MBIA Corp.”). References to MBIA Inc. generally refer to activities within our corporate segment and, unless otherwise indicated or the context otherwise requires, references to “MBIA Corp.” are (i) for any references relating to the period ended January 10, 2017, to MBIA Insurance Corporation, together with its subsidiaries, MBIA UK Insurance Limited (“MBIA UK”), and MBIA Mexico S.A. de C.V. (“MBIA Mexico”) and (ii) for any references relating to the period after January 10, 2017, to MBIA Insurance Corporation together with MBIA Mexico.
National pursues opportunities for new business in most municipal sectors. Based on our underwriting and pricing criteria, the majority of our new business is in the general obligation, tax-backed and revenue bond sectors. In addition to the new issue market, we are pursuing opportunities in the secondary market with respect to bonds issued previously that were not insured and that meet our underwriting criteria.
As of December 31, 2016, National had $3.6 billion of gross insured par outstanding ($4.1 billion of gross insured par outstanding when including accreted interest on insured capital appreciation bonds (“CABs”)) related to the Commonwealth of Puerto Rico and certain of its instrumentalities (“Puerto Rico”). Puerto Rico continues to experience significant fiscal stress and constrained liquidity. As of December 31, 2016, National owned, in aggregate, $144 million of bonds issued by the Puerto Rico Electric Power Authority (“PREPA”) in connection with the Restructuring Support Agreement (“RSA”) entered into on December 23, 2015. On July 1, 2016 Puerto Rico defaulted on scheduled debt service for certain National insured bonds and National paid gross claims in the aggregate of $173 million as a result. Subsequent to December 31, 2016, National paid additional gross claims in the aggregate of $24 million. Refer to the “U.S. Public Finance Insurance Puerto Rico Exposures” section for additional information on our Puerto Rico exposures.
Our near-term strategy at the holding company is to reduce our leverage to a level consistent with a mid-investment grade capital structure. In addition to scheduled debt maturities, from time to time, we reduce unsecured debt through calls or repurchases. We may also repurchase outstanding MBIA Inc. common shares when we deem it beneficial to our shareholders. The following table presents our activity relating to the repurchase of MBIA Inc. common shares and reductions of medium-term notes (“MTNs”) and MBIA Inc. Senior Notes for the years ended December 31, 2016, 2015 and 2014:
In addition to the unsecured debt referenced in the preceding table, MBIA Inc. and MBIA Investment Management Corp. (“IMC”) issued investment agreements to which we have pledged high-quality securities as collateral. All of our MTNs, MBIA Inc. Senior Notes and investment agreements are collectively managed and serviced by available liquidity. Based on MBIA Inc.’s debt service requirements and expected operating expenses, we expect that MBIA Inc. will have sufficient cash to satisfy its debt obligations and its general corporate needs over time from expected subsidiary dividends, additional anticipated releases under our tax sharing agreement (the “Tax Sharing Agreement”) and related tax escrow account (“Tax Escrow Account”), investment income and potential securities issuance; however, there can be no assurance that such sources will be adequate or that we will have access to the capital markets when needed. Refer to the “Liquidity - MBIA Inc. Liquidity” section for information on MBIA Inc.’s liquidity and refer to the “Capital Resources” section for further information on our share and debt repurchases.
MBIA Insurance Corporation has significant negative statutory earned surplus and therefore no current capacity to pay dividends. In addition, since July 15, 2012, the New York State Department of Financial Services (“NYSDFS”) has not approved any payments on MBIA Insurance Corporation’s outstanding surplus notes. MBIA Corp. has contributed to the Company’s net operating loss carryforward (“NOL”), which is used in the calculation of our consolidated income taxes. If MBIA Corp. becomes profitable, it is not expected to make any tax payments under our Tax Sharing Agreement. Based on MBIA Corp.’s current projected earnings and our expectation that it will not write new business, we believe it is unlikely that MBIA Corp. will generate significant income in the near future. As a result, we believe MBIA Corp. does not provide significant economic or shareholder value to MBIA Inc. Refer to the “Capital Resources - MBIA Insurance Corporation” section for additional information on MBIA Insurance Corporation’s surplus notes and statutory capital.
Payment of the Zohar I Claim and the Zohar II Claim entitles MBIA Corp. to reimbursement of such payments plus interest and expenses and/or to exercise certain rights and remedies to seek recovery of such payments. In connection with the exercise of its rights and remedies, MBIA Corp. directed the trustee for Zohar I to commence an auction (the “Auction”) of all of the assets of Zohar I, which occurred on December 21, 2016. MBIA Corp. was the winning bidder in the Auction, and in connection therewith, acquired the beneficial ownership of the Zohar I assets, which include loans made to, and equity interests in, companies purportedly controlled by sponsor and former collateral manager of Zohar I and Zohar II. Refer to “Note 1: Business Developments and Risks and Uncertainties” in the Notes to Consolidated Financial Statements for a further discussion on the Zohar I and Zohar II recoveries.
The U.S. economy ended 2016 with solid momentum from strong consumer spending, rising housing prices and increased business investment. In addition, job growth remained strong and the unemployment rate held steady throughout 2016. As a result of these positive signs, the Federal Open Market Committee (“FOMC”) raised the federal funds rate in December of 2016. The FOMC has announced that they expect multiple rate hikes in 2017. Also, for 2017, we expect Congress to focus on tax reform, a reduction in regulation and an increase in infrastructure spending.
During 2016, the U.K. held a referendum in which it voted to leave the European Union, referred to as “Brexit”. This decision caused financial markets volatility and concerns over a potential recession in the U.K. and the rest of Europe with an unusually high level of uncertainty that could undermine European confidence and growth. In January of 2017, we sold our operating subsidiary, MBIA UK.
Instruments that trade infrequently and, therefore, have little or no price transparency are classified within Level 3 of the fair value hierarchy. Also included in Level 3 are financial instruments that have significant unobservable inputs deemed significant to the instrument’s overall fair value. Level 3 assets represented approximately 21% and 19% of total assets measured at fair value on a recurring basis as of December 31, 2016 and 2015, respectively. Level 3 liabilities represented approximately 37% and 52% of total liabilities measured at fair value on a recurring basis as of December 31, 2016 and 2015, respectively.
Deferred income taxes are recorded with respect to the temporary differences between the tax bases of assets and liabilities and the reported amounts in our consolidated financial statements that will result in deductible or taxable amounts in future years when the reported amounts of assets and liabilities are recovered or settled. Our temporary differences relate principally to net operating losses, premium revenue recognition, accrued interest on outstanding surplus notes, insured loss reserves, unrealized gains or losses on investments and insured derivatives and deferred acquisition costs.
In evaluating our ability to recover our net deferred tax asset, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, and results of recent operations. In projecting future taxable income, we begin with historical results and incorporate assumptions about the amount of future federal pre-tax income. The assumptions about future taxable income require significant judgment and are consistent with the plans and estimates we are using to manage our underlying businesses. Actual future taxable income or loss could be significantly different from our projections. In evaluating the objective evidence that recent results provide, we consider three years of cumulative pre-tax comprehensive income (loss). We consider a trend of comprehensive income to be positive evidence of our ability to recover our net deferred tax asset and a trend of comprehensive losses to be negative evidence.
We believe that it is more likely than not that the Company’s net deferred tax asset will be realized due to the reliance on the Company’s future projections of income and evidence of a three-year cumulative comprehensive gain as of December 31, 2016. If our assumptions and projections change and/or additional significant evidence becomes available in the future, we may determine we will not be able to realize all of our deferred tax asset. If such determination is made in the future, the tax charge relating to the establishment of a valuation allowance reserve against our net deferred tax asset could be in the full amount of our net deferred tax asset at such time and materially impact our earnings.
The following table presents a summary of our consolidated financial results for the years ended December 31, 2016, 2015 and 2014:
Consolidated total expenses for the years ended December 31, 2015 and 2014 included $123 million and $133 million, respectively, of net insurance loss and LAE. This decrease was principally due to decreases in certain first-lien RMBS exposures, partially offset by an increase in losses on certain U.S. public finance exposures.
Operating income (loss) and operating income (loss) per diluted common share include the combined after-tax results of our U.S. public finance insurance and corporate segments and remove the after-tax results of activities that are not part of our ongoing business strategy. This includes the activities of our international and structured finance insurance segment, advisory services and conduit segments (collectively, “Non-Core Segments”). We do not expect to write new business in our international and structured finance insurance segment. We exited our advisory services segment through the sale of Cutwater effective January 1, 2015 and in the second quarter of 2014, we liquidated our conduit segment.
Elimination of gains (losses) on the sale of investments, net investment losses related to other-than-temporary impairments (“OTTI”) and net gains (losses) on extinguishment of debt since the timing of these transactions are subject to management’s assessment of market opportunities and capital liquidity positions.
(5)-Operating income (loss) per diluted common share is calculated by taking operating income (loss) divided by GAAP weighted average number of diluted common shares outstanding.
As of December 31, 2016, ABV per share was $31.88, an increase from $28.98 as of December 31, 2015, and an increase from $24.21 as of December 31, 2014. The increases in ABV per share were primarily driven by decreases in common shares outstanding from the share repurchases made by the Company during the years ended December 31, 2016 and 2015. The following table provides a reconciliation of consolidated book value per share to consolidated ABV per share:
(1)-The book value of the MBIA Corp. legal entity does not provide significant economic or shareholder value to MBIA Inc. The amount being reversed excludes deferred taxes available to MBIA Inc. As of December 31, 2014, this amount also includes the reversal of the book value of Cutwater which was sold effective January 1, 2015.
(2)-Consists of financial guarantee premiums, net of deferred acquisition costs. The discount rate on financial guarantee installment premiums was the risk-free rate as defined by the accounting principles for financial guarantee insurance contracts.
The following table presents our U.S. public finance insurance segment results for the years ended December 31, 2016, 2015 and 2014:
National supports the credit enhancement needs of municipal debt issuers across the U.S. National maintains underwriting criteria for most municipal risk types and pursues opportunities for new business across the spectrum of municipal sectors. During the year ended December 31, 2016, National insured $1.6 billion of gross par exposure in the primary and secondary markets. The majority of its new business is in the general obligation, tax-backed and revenue bond sectors. Low interest rates and competitive pricing levels continue to limit new business opportunities.
NET INVESTMENT LOSSES RELATED TO OTHER-THAN-TEMPORARY IMPAIRMENTS Net investment losses related to OTTI for 2016, 2015 and 2014 were primarily related to one impaired security for which a loss was recognized as the difference between its amortized cost and the net present value of its projected cash flows. This OTTI resulted from liquidity concerns and other adverse financial conditions of the issuer. Refer to the “Liquidity” section included herein for additional information about impaired investments.
OTHER NET REALIZED GAINS (LOSSES) Other net realized losses for 2015 related to an impairment charge on our Armonk, New York facility to adjust the carrying amount to its sales price less costs to sell. Other net realized losses for 2014 related to an insurance recovery on an errors and omissions liability policy of $18 million, partially offset by an additional impairment charge on our Armonk, New York facility of $3 million.
The following table presents information about our U.S. public finance insurance loss and LAE expenses for the years ended December 31, 2016, 2015 and 2014:
(1)-Loss and LAE with respect to Puerto Rico exposures reflect the expected loss and LAE payments net of expected recoveries on such payments.
For the year ended December 31, 2016, losses and LAE primarily related to increases in actual and expected payments on certain Puerto Rico exposures, partially offset by increases in recoveries of actual and expected payments on certain Puerto Rico exposures. For the year ended December 31, 2015, losses and LAE primarily related to increases in reserves for certain Puerto Rico exposures, partially offset by decreases in reserves for certain municipal utilities. The benefit in losses and LAE for the year ended December 31, 2014 primarily related to decreases in reserves for certain general obligation bonds, partially offset by increases in reserves for certain Puerto Rico exposures.
The following table presents information about our U.S. public finance insurance loss and LAE reserves and recoverables as of December 31, 2016 and 2015:
(2)-Reported within “Provision (benefit) for income taxes” on the Company’s consolidated statements of operations.
INSURED PORTFOLIO EXPOSURE Financial guarantee insurance companies use a variety of approaches to assess the underlying credit risk profile of their insured portfolios. National uses both an internally developed credit rating system as well as third-party rating sources in the analysis of credit quality measures of its insured portfolio. In evaluating credit risk, we obtain, when available, the underlying rating of the insured obligation before the benefit of its insurance policy from nationally recognized rating agencies, Moody’s and S&P. Other companies within the financial guarantee industry may report credit quality information based upon internal ratings that would not be comparable to our presentation. We maintain internal ratings on our entire portfolio, and our ratings may be higher or lower than the ratings assigned by Moody’s or S&P.
The following is a summary of exposures within the insured portfolio of our U.S. public finance insurance segment related to Puerto Rico as of December 31, 2016.
(2)-Additionally secured by the guarantee of the Commonwealth of Puerto Rico.
Developments concerning Puerto Rico’s fiscal condition have occurred, and are occurring, with more frequency. Set forth below are the developments that are significant to National and its exposures to Puerto Rico.
On June 30, 2016, the Puerto Rico Oversight, Management and Economic Stability Act (“PROMESA”), was signed into law by the President of the United States. PROMESA provides both for the creation of an independent oversight board with powers relating to the development and implementation of a fiscal plan for Puerto Rico as well as a court-supervised process (independent of the Bankruptcy Code) that allows Puerto Rico to restructure its debt if voluntary agreement cannot be reached with creditors through a collective action process.
In October of 2016, a group of GO bondholders, which had previously initiated litigation against Puerto Rico in July of 2016, moved to amend its complaint to add a challenge to Puerto Rico’s purported diversion of funds to the Puerto Rico Sales Tax Financing Corporation (“COFINA”). The plaintiff group contends that the funds being used to pay bonds issued by COFINA constitute “available resources” within the meaning of article VI, section 8 of the Puerto Rico Constitution, and therefore must be devoted to payment of principal and interest on Puerto Rico’s public debt before they may be used for other purposes. By failing to redirect such funds to pay GO bondholders, the plaintiff group claims that Puerto Rico is improperly diverting funds to COFINA bondholders. After being granted leave to amend, the plaintiffs filed their Second Amended Complaint in November of 2016. In February of 2017, the Court held that the COFINA-related claims were not stayed under PROMESA, and further allowed the Oversight Board and several COFINA creditors to intervene in the litigation. Currently, National has exposure to COFINA debt of over $1.0 billion, including CAB accreted interest. As legal opinions from Puerto Rico justice secretaries and bond counsel have confirmed, National believes that the legal structure of COFINA is sound and that it maintains a valid statutory lien on the sales tax revenue stream backing the bonds. Although the Court previously ruled that the automatic stay provision of PROMESA did not apply to some of the plaintiffs’ claims in the original complaint, some claims in the second amended complaint, including the COFINA-related claims, may be subject to the litigation stay. Notwithstanding the foregoing, until all legal challenges are resolved, there can be no assurance that the COFINA structure will be upheld and the sales tax revenue lien will be recognized.
National’s largest exposure to Puerto Rico, by gross par outstanding, is to PREPA. On December 23, 2015, National, Assured Guaranty, and the ad hoc group of bondholders (representing approximately $3.0 billion, or 37.0% of the power revenue bonds, (collectively the “Supporting Creditors”)) entered into an RSA with the support of approximately 65% of $8.1 billion of outstanding PREPA bonds, including approximately $1.4 billion of PREPA bonds insured by National. The RSA calls for a newly formed bankruptcy remote special purpose entity (“SPE”) to issue securitized bonds including bonds that are equal in principal amount to the outstanding principal of the PREPA bonds insured by National and by other monoline insurers (“Mirror Bonds”). The Mirror Bonds will bear interest at the same rate and will amortize at the same schedule as the existing insured legacy bonds which they back. The payments on the Mirror Bonds will be used to make payment on the insured legacy bonds.
Finally, as a condition to the RSA, the Supporting Creditors agreed to purchase certain bonds of PREPA in the aggregate amount of $111 million (the “2016A and 2016B bonds”) of which National’s portion is approximately $35 million. The Supporting Creditors closed on the 2016A and 2016B bonds in May and June of 2016, respectively. The bonds will earn 10% interest, will mature on July 1, 2019 and will be supported by Mirror Bonds when the SPE issues its securitization bonds. In February of 2016, the PREPA Revitalization Act (the “Revitalization Act”) was approved by Puerto Rico’s House of Representatives and Senate and signed into law by the then Governor of Puerto Rico. Enactment of the Revitalization Act was required by the RSA and is an integral component of the PREPA restructuring. Validation of the Revitalization Act is required by the RSA and certain lawsuits have been filed challenging it. There is no concrete timetable for resolution of these lawsuits. PREPA made its July 1, 2016 debt service payment of approximately $417 million. In order to provide liquidity to PREPA, the Supporting Creditors purchased approximately $264 million of bonds (Series 2016C, 2016D and 2016E) and National purchased $105 million of 2016C bonds. The 2016C bonds will earn 5.4% interest, will amortize over the next four years, and will be supported by Mirror Bonds when the SPE issues its securitization bonds.
The following tables presents our scheduled gross debt service due on our Puerto Rico insured exposures as of December 31, 2016, for each of the subsequent five years ending December 31 and thereafter:
Our corporate segment consists of general corporate activities, including providing general support services to MBIA Inc.’s subsidiaries and asset and capital management. General support services are provided by our service company, MBIA Services, including, among others, management, legal, accounting, treasury, information technology, and insurance portfolio surveillance, on a fee-for-service basis. Capital management includes activities related to servicing obligations issued by MBIA Inc. and its subsidiaries, MBIA Global Funding, LLC (“GFL”) and IMC. MBIA Inc. issued debt to finance the operations of the MBIA group. GFL raised funds through the issuance of MTNs with varying maturities, which were in turn guaranteed by MBIA Corp. GFL lent the proceeds of these MTN issuances to MBIA Inc. IMC, along with MBIA Inc., provided customized investment agreements, guaranteed by MBIA Corp., for bond proceeds and other public funds for such purposes as construction, loan origination, escrow and debt service or other reserve fund requirements. The Company has ceased issuing these MTNs and investment agreements and the outstanding liability balances and corresponding asset balances have declined over time as liabilities mature, terminate or are called or repurchased. All of the debt within the corporate segment is managed collectively and is serviced by available liquidity.
NET INVESTMENT INCOME The decrease in net investment income for 2016 compared with 2015 was primarily due to lower average asset balances.
INTEREST EXPENSE Interest expense decreased for 2016 compared with 2015 and 2014 primarily due to the continued maturities and repurchases of debt obligations issued by the Company.
The following table presents a reconciliation of GAAP net income (loss) to operating income (loss) for the years ended December 31, 2016, 2015 and 2014:
MBIA Corp. insures non-U.S. public finance and global structured finance, including asset-backed obligations. MBIA Corp. has insured sovereign-related and sub-sovereign bonds, privately issued bonds used for the financing of utilities, toll roads, bridges, airports, public transportation facilities, and other types of infrastructure projects serving a substantial public purpose. Global structured finance and asset-backed obligations typically are securities repayable from cash flows generated by a specified pool of assets, such as residential and commercial mortgages, insurance policies, consumer loans, corporate loans and bonds, trade and export receivables, and leases for equipment, aircraft and real estate property. We no longer insure new credit derivative contracts except for transactions related to the restructuring or reduction of existing derivative exposure.
The following table presents our international and structured finance insurance segment results for the years ended December 31, 2016, 2015 and 2014:
As of December 31, 2016, MBIA Corp. had $588 million of gross par outstanding on insured credit derivatives compared with $3.2 billion as of December 31, 2015. During the year ended December 31, 2016, $1.8 billion of gross par outstanding on insured credit derivatives were terminated or matured. As of December 31, 2016, four insured credit derivatives remained outstanding.
NET GAINS (LOSSES) ON FINANCIAL INSTRUMENTS AT FAIR VALUE AND FOREIGN EXCHANGE The net gains on financial instruments and foreign exchange for 2016 were primarily related to gains from foreign currency revaluation of Chilean Unidad de Fomento and Euro denominated premium receivables and realized foreign exchange gains from the liquidation of an investment portfolio in the U.K. The net losses on financial instruments at fair value and foreign exchange for 2015 were primarily due to losses from foreign currency revaluation of Chilean Unidad de Fomento denominated premium receivables and foreign exchange currency losses on the sale of Euro denominated investments.
OTHER NET REALIZED GAINS (LOSSES) Other net realized gains (losses) for 2016 related to the loss recorded to adjust the carrying value of MBIA UK to its fair value less costs to sell. On January 10, 2017, MBIA UK was sold to Assured. The other net realized gains (losses) for 2014 was primarily related to an insurance recovery received on an errors and omissions liability policy. Refer to the previous “Results of Operations - Summary of Consolidated Results” section for additional information about the loss recorded to adjust the carrying value of MBIA UK to its fair value less costs to sell.
(3)-Gross loss and LAE reserves with respect to Zohar II exposure reflect the expected loss and LAE payments net of expected recoveries on such reserves.
The decrease in the amortization of deferred acquisition costs for 2016 compared with 2015 was due to higher refunding activity in 2015. We did not defer a material amount of policy acquisition costs during 2016, 2015 or 2014. Policy acquisition costs in these periods were primarily related to commissions and premium taxes on installment policies written in prior periods.
Outside the U.S., financial guarantee insurance has been used on structured finance securities and by issuers of sovereign-related and sub-sovereign bonds, utilities and providers of public purpose projects, among others. MBIA does not insure any direct European sovereign debt. However, we do insure both structured finance and public finance obligations in select international markets. MBIA’s indirect European sovereign insured debt exposure totaled $5.2 billion as of December 31, 2016 and included obligations of sovereign-related and sub-sovereign issuers, such as regions, departments, and sovereign-owned and private entities that are supported by a sovereign state, region or department. Sovereign-related includes Private Finance Initiative transactions that involve private entities that receive contractual payments for providing services to public sector entities. Of the $5.2 billion of insured gross par outstanding, $432 million and $185 million were related to Spain and Ireland, respectively. The remaining $4.6 billion was related to the U.K. We do not insure any sovereign or sub-sovereign debt from Greece. Effective January 10, 2017, MBIA UK was sold with the related sovereign debt exposure. The Company has an immaterial amount of European sovereign debt holdings.
Reinsurance enables the Company to cede exposure for purposes of syndicating risk. 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. Currently, we do not intend to use reinsurance on new policies to decrease our insured exposure. Refer to “Note 13: Insurance in Force” in the Notes to Consolidated Financial Statements for a further discussion about our reinsurance agreements.
The following table summarizes the results and assets under management of our advisory services segment for the year ended December 31, 2014. These results include revenues and expenses from transactions with the Company’s insurance, corporate, and conduit segments.
In 2014, the Company’s conduit segment was operated through Meridian and administered through MBIA Asset Finance, LLC. Assets held by Meridian were funded by MTNs. In the second quarter of 2014, we retired the remaining $129 million of outstanding MTNs issued by Meridian and dissolved the conduit segment. Certain of MBIA’s consolidated subsidiaries had received fees for services provided to Meridian. The following table presents the results of our conduit segment for the year ended December 31, 2014. These results include revenues and expenses from transactions with the Company’s other segments.
The Company’s income taxes and the related effective tax rates for the years ended December 31, 2016, 2015 and 2014 are presented in the following table:
For 2015, our effective tax rate applied to our income before income taxes was higher than the U.S. statutory rate of 35% primarily due to nondeductible equity-based compensation expense.
The Company is a party to the Tax Sharing Agreement which has been in effect since January 1, 1987 and subsequently amended and restated effective September 8, 2011.
In addition, MBIA Inc. also supports the MTN and investment agreement obligations issued by the Company. We seek to maintain sufficient liquidity and capital resources to meet the Company’s general corporate needs and debt service. Based on MBIA Inc.’s debt service requirements and expected operating expenses, we expect that MBIA Inc. will have sufficient cash to satisfy its debt obligations and its general corporate needs over time from distributions from its operating subsidiaries; however, there can be no assurance that MBIA Inc. will have sufficient cash in the event of unanticipated payments. In addition, the Company may also consider raising third-party capital. For further information, refer to “Strategic Plan Related and Other Risk Factors” in Part I, Item 1A of this Form 10-K and “Liquidity-MBIA Inc. Liquidity” section for additional information about MBIA Inc.’s liquidity.
During 2016, we exhausted the capacity remaining under the October 28, 2015 repurchase program of $94 million by repurchasing 14.9 million common shares of MBIA Inc. at an average share price of $6.30.
National and MBIA Insurance Corporation are incorporated and licensed in, and are subject to primary insurance regulation and supervision by the State of New York. MBIA UK is authorized by the Prudential Regulation Authority (“PRA”) and regulated by the Financial Conduct Authority (“FCA”) and the PRA in the U.K. MBIA Mexico is regulated by the Comisión Nacional de Seguros y Fianzas in Mexico. National and MBIA Insurance Corporation each are required to file detailed annual financial statements, as well as interim financial statements, with the NYSDFS and similar supervisory agencies in each of the other jurisdictions in which it is licensed. These financial statements are prepared in accordance with New York State and the National Association of Insurance Commissioners’ statements of U.S. STAT and assist our regulators in evaluating minimum standards of solvency, including minimum capital requirements, and business conduct. MBIA UK is required to file quarterly and annual regulatory returns with the PRA and the FCA.
National reported total statutory capital of $3.5 billion as of December 31, 2016, compared with $3.4 billion as of December 31, 2015. As of December 31, 2016, statutory capital comprised $2.7 billion of policyholders’ surplus and $745 million of contingency reserves. National had statutory net income of $192 million for the year ended December 31, 2016. As of December 31, 2016, National’s unassigned surplus was $2.1 billion.
National had positive earned surplus as of December 31, 2016, which provides National with dividend capacity. During 2016, National declared and paid a dividend of $118 million to its ultimate parent, MBIA Inc. For the foreseeable future, we expect the as-of-right declared and paid dividend amounts from National to be limited to prior year net investment income and similar in amount to the 2016 dividend payment.
National’s CPR and components thereto, as of December 31, 2016 and 2015 are presented in the following table:
In order to maintain its New York State financial guarantee insurance license, MBIA Insurance Corporation is required to maintain a minimum of $65 million of policyholders’ surplus. Under NYIL, MBIA Insurance Corporation is required to invest its minimum surplus and contingency reserves and 50% of its loss reserves and unearned premium reserves in certain qualifying assets. As of December 31, 2016, MBIA Insurance Corporation maintained its minimum requirement of policyholders’ surplus but did not have enough qualifying assets to support its contingency reserves and 50% of its loss reserves and unearned premium reserves. As of December 31, 2016 and 2015, MBIA Insurance Corporation was in compliance with its aggregate risk limits under the NYIL, but was not in compliance with certain of its single risk limits. If new overages occur with respect to its single risk limits, MBIA Insurance Corporation will report them to the NYSDFS. If MBIA Insurance Corporation is not in compliance with its aggregate risk and its single risk limits, the NYSDFS may prevent MBIA Insurance Corporation from transacting any new financial guarantee insurance business until it no longer exceeds the limitations.
The NYSDFS has not approved MBIA Insurance Corporation’s requests to make interest payments on the Surplus Notes since, and including, the January 15, 2013 interest payment. The NYSDFS has cited both MBIA Insurance Corporation’s liquidity and financial condition as well as the availability of “free and divisible surplus” as the basis for such non-approvals. As of January 15, 2017, the most recent scheduled interest payment date, there was $510 million of unpaid interest on the par amount outstanding of $953 million of the Surplus Notes. The unpaid interest on the Surplus Notes will become due on the first business day on or after which MBIA Insurance Corporation obtains approval to pay some or all of such unpaid interest. No interest has been accrued or will accrue on the deferred interest.
MBIA Corp.’s CPR and components thereto, as of December 31, 2016 and 2015 are presented in the following table:
National maintains a simultaneous repurchase and reverse repurchase facility (“Asset Swap”) with MBIA Inc. which provides MBIA Inc. with eligible assets to pledge under investment agreements and derivative contracts. As of December 31, 2016, the notional amount used under each of these agreements was $129 million and the fair value of collateral pledged by National and MBIA Inc. under these agreements was $131 million and $137 million, respectively. The net average interest rate on these transactions was 0.41%, 0.26% and 0.23% for the years ended December 31, 2016, 2015 and 2014 respectively.
releases from the tax sharing agreement, which are primarily funded by subsidiaries;
Based on our projections of National’s and MBIA Corp.’s future earnings and losses, we expect that for the foreseeable future National will be the primary source of dividends and tax sharing agreement payments to MBIA Inc. During 2016, National declared and paid a dividend of $118 million to its ultimate parent, MBIA Inc. There can be no assurance as to the amount and timing of any such future dividends. Also, for the foreseeable future, absent a special dividend subject to the approval of the NYSDFS, we expect the declared and paid dividend amounts from National to be limited to prior year net investment income and similar in amount to the 2016 dividend payment. Refer to the “Capital Resources - Insurance Statutory Capital” section for additional information on payments of dividends. We do not expect MBIA Inc. to receive distributions from MBIA Corp. During the year ended December 31, 2016, $105 million was released to MBIA Inc. under the MBIA group tax sharing agreement and related escrow agreement. This amount represented National’s liability under the tax sharing agreement for the 2013 tax year, which was released from escrow pursuant to the terms under the tax sharing agreement following the expiration of National’s two-year net operating loss carry-back period under U.S. tax rules. During 2016, National paid to the Tax Escrow Account estimated 2016 taxes of $103 million. As of December 31, 2016, $329 million was held in escrow for the 2014 through 2016 tax years. In the first quarter of 2017, $94 million was released to MBIA Inc. from the Tax Escrow Account related to the 2014 year. We expect to release up to $130 million from the Tax Escrow Account related to the 2015 tax year in January of 2018, subject to the terms and provisions of the Company’s tax sharing agreement. There can be no assurance that payments under the Tax Escrow Account from subsidiaries will be released to MBIA Inc. due to deductible or creditable tax attributes of National and/or the market value performance of the assets supporting the Tax Escrow Account.
MBIA Corp. has recorded expected excess spread recoveries of $439 million as of December 31, 2016 associated with insured RMBS issues, including recoveries related to consolidated VIEs. MBIA Corp. has also recorded expected recoveries related to its claims against Credit Suisse for ineligible mortgage loans included in an MBIA Corp. insured RMBS transaction. There can be no assurance that it will be successful or not be delayed in realizing these recoveries. During the year ended December 31, 2016, MBIA Corp. collected $92 million of excess spread recoveries related to insured RMBS issues.
In January of 2017, MBIA Corp. entered into a Facility, with the Senior Lenders, and with MBIA Inc., pursuant to which the Senior Lenders provided $325 million of senior financing and MBIA Inc. provided $38 million of subordinated financing to MZ Funding, which in turn lent the proceeds of such financing to MBIA Corp. MBIA Inc. also committed to provide an additional $50 million subordinated financing to MZ Funding, which MZ Funding would then lend to MBIA Corp. if needed by MBIA Insurance Corporation for liquidity purposes.
The Insured Senior Notes are secured by a first lien on the Collateral, and the Insured Subordinated Notes are secured by a second lien on the Collateral. The Company, MZ Funding and the trustees under the Senior Note Indenture and the Subordinated Note Indenture have entered into an Intercreditor Agreement (the “Intercreditor Agreement”), pursuant to which any amounts due the Company in respect of the Insured Subordinated Notes or from the MBIA Corp. policies insuring the Insured Subordinated Notes are subordinated to payment in full of the Insured Senior Notes until the amounts owed to the Senior Lenders in respect of the Insured Senior Notes have been paid in full. Therefore, at any time that the MBIA Loans are repaid, MZ Funding is required to apply the repayment first to the payment of interest and principal on the Insured Senior Notes and, after the Insured Senior Notes are paid in full, to the payment of the Insured Subordinated Notes, subject to certain reimbursements payable to MBIA Corp. The Company’s ability to collect the principal and interest on the Insured Subordinated Notes will be based primarily on the amount recovered by MBIA Corp. with respect to the Collateral, after payment in full of the Insured Senior Notes and other related payment obligations that are senior to the Insured Subordinated Notes pursuant to the Intercreditor Agreement.
Based on the estimated value of the Collateral in relation to the amount of the Senior Insured Notes and the Subordinated Insured Notes, the Company expects that the recoveries from the Collateral will be sufficient to enable the payment in full of the Senior Insured Notes and the Subordinated Insured Notes. There is uncertainty, however, with respect to the realizable value of the Collateral and there can be no assurance that recoveries on the Collateral will be sufficient to pay the Senior Insured Notes and the Subordinated Insured Notes in full or that, in the event that recoveries on the Collateral are not sufficient to pay the Senior Insured Notes and the Subordinated Insured Notes in full, that MBIA Corp. will be able to pay any shortfall necessary to pay the Senior Insured Notes and the Subordinated Insured Notes in full under the policy insuring the Subordinated Insured Notes.
MBIA Inc., National, MBIA Insurance Corporation and certain other affiliates are party to an intercompany advances agreement (the “MBIA Advances Agreement”). The MBIA Advances Agreement permits National to make advances to MBIA Inc. and other MBIA group companies that are party to the agreement at a rate per annum equal to LIBOR plus 0.25%. The agreement also permits other affiliates to make advances to National or MBIA Insurance Corporation at a rate per annum equal to LIBOR minus 0.10%. Advances by National cannot exceed 3% of its admitted assets as of the last quarter end. As of December 31, 2016 and 2015, there were no amounts drawn under the agreement.
Information about our consolidated cash flows by category is presented on our consolidated statements of cash flows. The following table summarizes our consolidated cash flows for the years ended December 31, 2016, 2015 and 2014:
Net cash used by financing activities increased for the year ended December 31, 2016 compared with 2015 primarily due to an increase in the principal paydowns of consolidated VIE notes of $1.7 billion related to the deconsolidation of VIEs in 2016, partially offset by a decrease in the purchases of treasury stock of $195 million. Net cash used by financing activities increased for the year ended December 31, 2015 compared with 2014 primarily due to an increase in the purchases of treasury stock of $271 million, partially offset by decreases in the principal paydowns of VIE notes and investment agreements of $195 million.
The following discussion of investments, including references to consolidated investments, excludes investments reported under “Assets of consolidated variable interest entities” on our consolidated balance sheets. Investments of VIEs support the repayment of VIE obligations and are not available to settle obligations of MBIA. Our available-for-sale (“AFS”) investments comprise high-quality fixed-income securities and short-term investments. The following table presents our investment portfolio as of December 31, 2016 and 2015. As of December 31, 2016, AFS with a fair value of $466 million reported under “Assets held for sale” within our international and structured finance segment are excluded due to the sale of MBIA UK in January of 2017.
As of December 31, 2016, the weighted average credit quality of the Company’s AFS investment portfolios, excluding short-term and other investments, as presented in the preceding table are as follows:
The following table summarizes the Company’s future estimated cash payments relating to contractual obligations as of December 31, 2016. 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 13: Insurance in Force” in the Notes to Consolidated Financial Statements for information about the Company’s exposure under insurance contracts.
(1)-Amounts on certain policies are presented net of expected recoveries. Excludes intercompany reinsurance arrangements.
Gross insurance claim obligations represent the future value of probability-weighted payments MBIA expects to make (before reinsurance and the consolidation of VIEs) under insurance policies for which the Company has recorded loss reserves (financial guarantees) or has estimated credit impairments (insured derivatives). Certain policies included in gross insurance claim obligations are presented net of expected recoveries. The discounted value of estimated payments included in the table, along with probability-weighted estimated recoveries and estimated negotiated early settlements, on policies accounted for as financial guarantee insurance contracts is reported as case basis reserves within “Loss and loss adjustment expense reserves” on the Company’s consolidated balance sheets. Insured derivatives are recorded at fair value and reported within “Derivative liabilities” on the Company’s consolidated balance sheets. Estimated potential claim payments on obligations issued by VIEs consolidated in our international and structured finance insurance segment are included within “Gross insurance claim obligations” in the preceding table. Obligations of these VIEs are collateralized by assets held by the VIEs, and investors in such obligations do not have recourse to the general credit of MBIA. As of December 31, 2016, VIE notes issued by issuer-sponsored consolidated VIEs totaled $2.2 billion, including $1.4 billion recorded at fair value, and are not considered contractual obligations of MBIA beyond MBIA’s insurance claim obligation. The Company’s involvement with VIEs is continually reassessed as required by consolidation guidance, and may result in consolidation or deconsolidation of VIEs in future periods. As the Company consolidates and deconsolidates VIEs, the amount of VIE debt obligations recorded on its balance sheet may change significantly.
Included in international and structured finance insurance segment’s surplus notes for 2017 is $499 million of unpaid interest related to the 2013 through 2016 interest payments in which MBIA Insurance Corporation’s requests for approval to pay was denied by the NYSDFS. This deferred interest payment will be due on the first business day on or after which MBIA Insurance Corporation obtains approval to make such payment. No interest will accrue on the deferred interest. There can be no assurance that the NYSDFS will approve any subsequent payments, or that it will approve any payment by the scheduled interest payment date.
The repayment of principal on our surplus notes is reflected in 2018, which is the next call date. Refer to “Capital Resources - MBIA Insurance Corporation” section for additional information on MBIA Insurance Corporation’s surplus notes and statutory capital. Principal payments under investment agreements are based on expected withdrawal dates. All other principal payments are based on contractual maturity dates.
In January of 2017, MBIA Corp. consummated the Facility with the Senior Lenders and with MBIA Inc., pursuant to which the Senior Lenders have provided $325 million of senior financing and MBIA Inc. has provided $38 million of subordinated financing to MZ Funding, which in turn lent the proceeds of such financing to MBIA Corp. The loans to MBIA Corp. under the Facility mature on January 20, 2020 and bear interest at 14% per annum. Refer to the previous “Executive Overview” section for additional information about the Facility.
Consolidated Statements of Operations for the years ended December 31, 2016, 2015 and 2014
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of comprehensive income (loss), of changes in shareholders’ equity and of cash flows present fairly, in all material respects, the financial position of MBIA Inc. and its subsidiaries at December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 15(a)(2), present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Effective on January 10, 2017, MBIA Corp.’s wholly-owned subsidiary, MBIA UK (Holdings) Limited (“MBIA UK Holdings”), sold its operating subsidiary, MBIA UK, to Assured Guaranty Corp. (“Assured”), a subsidiary of Assured Guaranty Ltd. Refer below for a further discussion of the sale of MBIA UK.
Prior to 2015, MBIA managed two other operating segments, advisory services and conduit. The advisory services segment was primarily operated through Cutwater Holdings, LLC and its subsidiaries (“Cutwater”). Effective on January 1, 2015, the Company exited its advisory business through the sale of Cutwater to a subsidiary of The Bank of New York Mellon Corporation. During the second quarter of 2014, the Company dissolved its conduit segment through liquidation of Meridian Funding Company, LLC (“Meridian”). Refer to “Note 12: Business Segments” for further information about the Company’s operating segments.
On January 10, 2017, MBIA UK Holdings sold its operating subsidiary, MBIA UK, and made a cash payment of $23 million, to Assured in exchange for the receipt by MBIA UK Holdings of certain notes (“Zohar II Notes”) owned by Assured that were issued by Zohar II 2005-1, Limited (“Zohar II”) with an aggregate outstanding principal amount of $347 million as of December 31, 2016 (the “Sale Transaction”). In connection with the sale, the Company adjusted the carrying value of MBIA UK to its fair value less costs to sell and recorded a loss in 2016 that was recorded in the results of the Company’s international and structured finance insurance segment and included in “Other net realized gains (losses)” on the Company’s consolidated statement of operations. Included in the loss calculation were items recorded in “Accumulated other comprehensive income (loss)” related to MBIA UK. The following table summarizes the Sale Transaction:
National’s insured portfolio continued to perform satisfactorily against a backdrop of strengthening domestic economic activity. While a stable or growing economy will generally benefit tax revenues and fees charged for essential municipal services which secure National’s insured bond portfolio, some state and local governments and territory obligors National insures remain under financial and budgetary stress. This could lead to an increase in defaults by such entities on the payment of their obligations and losses or impairments on a greater number of the Company’s insured transactions. The Company monitors and analyzes these situations and other stressed credits closely, and the overall extent and duration of this stress is uncertain.
In particular, the Commonwealth of Puerto Rico and certain of its instrumentalities (“Puerto Rico”) is experiencing significant fiscal stress and constrained liquidity due to, among other things, Puerto Rico’s structural budget imbalance, limited access to the capital markets, a stagnating local economy, net migration of people out of Puerto Rico and a high debt burden. Although Puerto Rico has tried to address its challenges through various fiscal policies, it continues to experience significant fiscal stress. On July 1, 2016, Puerto Rico defaulted on scheduled debt service for certain National insured bonds and National paid gross claims in the aggregate of $173 million as a result. On January 1, 2017, Puerto Rico also defaulted on a scheduled debt service for National insured bonds and National paid gross claims in the aggregate of $24 million as a result. The Company continues to believe, based on its analysis of Puerto Rico’s fiscal and structural circumstances, the details of its insured exposures, and its legal and contractual rights, that all of National’s insured Puerto Rico related debt, and any claims National has made thereon, will ultimately be substantially repaid.
MBIA Corp.’s insured portfolio could deteriorate and result in additional significant loss reserves and claim payments. MBIA Corp.’s ability to meet its obligations is limited by available liquidity and its ability to secure additional liquidity through financing and other transactions. There can be no assurance that MBIA Corp. will be successful in generating sufficient cash to meet its obligations. During 2016, MBIA Corp. was particularly focused on ensuring its ability to cover any payment that might come due on the insurance policy it had written insuring certain notes issued by Zohar II which matured on January 20, 2017 (the “Zohar II Maturity Date”), and on exercising its rights and remedies to seek reimbursement of the $149 million claim (the “Zohar I Claim”) it paid in November of 2015 on its policy insuring the class A-1 and A-2 notes (the “Zohar I Insured Notes”) issued by Zohar collateralized debt obligation (“CDO”) 2003-1, Limited (“Zohar I”).
In addition, MBIA Corp. insured the Zohar I Insured Notes, which matured on November 20, 2015. After Zohar I failed to pay the amounts due, MBIA Corp. paid the Zohar I Claim. As a result, MBIA Corp. was entitled to seek reimbursement of such payment plus interest and expenses from Zohar I and/or to exercise certain rights and remedies to seek recovery of such payment. In connection with the exercise of its rights and remedies, MBIA Corp. directed the trustee for Zohar I to commence an auction (the “Auction”) of all of the assets of Zohar I, which occurred on December 21, 2016. MBIA Corp. was the winning bidder in the Auction, and in connection therewith, acquired the beneficial ownership of the Zohar I assets, which include loans made to, and equity interests in, companies purportedly controlled by the Zohar Sponsor (all the assets of Zohar I, the “Zohar I Assets”). Over time, MBIA Corp. expects to acquire the legal ownership of the Zohar I Assets and recover all or substantially all of the payment it made (plus interest and expenses) with regards to the Zohar I Claim. The primary source of recovery will come from monetization of the Zohar I Assets, however there can be no assurance that the value of the Zohar I Assets will be sufficient to permit MBIA Corp. to recover all or substantially all of the payment it made on the Zohar I Claim.
Given the separation of MBIA Inc. and MBIA Corp. as distinct legal entities, the absence of any cross defaults between the entities and the lack of reliance by MBIA Inc. on MBIA Corp. for the receipt of dividends, the Company does not believe that a rehabilitation or liquidation proceeding with respect to MBIA Insurance Corporation would have any significant liquidity impact on MBIA Inc. or result in a liquidation or similar proceeding of MBIA Mexico. Such a proceeding could have material adverse consequences for MBIA Corp., including the termination of insured credit default swaps (“CDS”) and other derivative contracts for which counterparties may assert market-based claims, the acceleration of debt obligations issued by affiliates and insured by MBIA Corp., the loss of control of MBIA Insurance Corporation to a rehabilitator or liquidator, and unplanned costs.
Based on the Company’s projections of National’s dividends, additional anticipated releases under its tax sharing agreement and related tax escrow account (“Tax Escrow Account”), and other cash inflows, the Company expects that MBIA Inc. will have sufficient cash to satisfy its debt service and general corporate needs. However, MBIA Inc. continues to have liquidity risk which could be triggered by deterioration in the performance of invested assets, interruption of or reduction in dividends or tax payments received from operating subsidiaries, impaired access to the capital markets, as well as other factors which cannot be anticipated at this time. Furthermore, failure by MBIA Inc. to settle liabilities that are also insured by MBIA Corp. could result in claims on MBIA Corp.
The consolidated financial statements include the accounts of MBIA Inc., its wholly-owned subsidiaries and all other entities in which the Company has a controlling financial interest. All intercompany balances and transactions have been eliminated. The Company determines whether it has a controlling financial interest in an entity by first evaluating whether an entity is a voting interest entity or a variable interest entity (“VIE”).
The Company classifies its investments as AFS, held-to-maturity (“HTM”), or trading. AFS investments are reported in the consolidated balance sheets at fair value with unrealized gains and losses, net of applicable deferred income taxes, reflected in accumulated other comprehensive income (loss) (“AOCI”) in shareholders’ equity. Investments carried at fair value are reported in the consolidated balance sheets at fair value and changes in fair value and realized gains and losses from the sale of these securities are reflected in earnings as part of “Net gains (losses) on financial instruments at fair value and foreign exchange.” Investments carried at fair value consist of certain investments elected under the fair value option and investments classified as trading. Short-term investments held as AFS include all fixed-maturity securities with a remaining maturity of less than one year at the date of purchase, commercial paper and money market securities. HTM investments are reported in the consolidated balance sheets at amortized cost. Debt securities are classified as HTM investments when the Company has the ability and intent to hold such investments to maturity. Investment income is recorded as earned. Bond discounts and premiums are amortized using the effective yield method over the remaining term of the securities and reported in “Net investment income.” For mortgage-backed securities (“MBS”) and asset-backed securities (“ABS”), discounts and premiums are amortized using the retrospective method. Realized gains and losses represent the difference between the amortized cost value and the sale proceeds.
Property and equipment consists of leasehold improvements, furniture and fixtures and equipment and software owned by the Company. All property and equipment held for use is recorded at cost and depreciated over the appropriate useful life of the asset using the straight-line method. Leasehold improvements are amortized over the useful life of the improvement or the remaining term of the lease, whichever is shorter. The cost and related accumulated depreciation applicable to assets sold or retired are removed from the Company’s balance sheet and any gain or loss on disposition is recognized in earnings as a component of “Other net realized gains (losses).” Maintenance and repairs are charged to current earnings as incurred.
The Company’s estimated remaining weighted average useful lives of each class of assets held for use as of December 31, 2016 are as follows:
The Company recognizes potential recoveries on paid claims based on probability-weighted net cash inflows present valued at applicable risk-free rates as of the measurement date. Such amounts are reported within “Insurance loss recoverable” on the Company’s consolidated balance sheets. To the extent the Company had recorded potential recoveries in its loss reserves previous to a claim payment, such recoveries are reclassified to “Insurance loss recoverable” upon payment of the related claim and remeasured each reporting period.
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, and termination fees are earned when the related services are completed and the fee is received.
MBIA Inc. and its eligible U.S. subsidiaries file a consolidated federal income tax return. The U.S. income taxes are allocated based on the provisions of the Company’s tax sharing agreement which governs the intercompany settlement of tax obligations and benefits. The method of allocation between the members is generally based upon separate-company calculations as if each member filed a separate tax return on its own. As of December 31, 2016, any member with a net operating loss (“NOL”) has not received any payment with respect to stand-alone tax losses contributed to the consolidated group. Each member with an NOL will receive benefits of its tax losses and credits as it is able to earn them out in the future. However, based on current facts and circumstances, MBIA Inc. has advised its subsidiaries that, its intention is not to allow any member’s NOL, capital loss or tax credit carryforward generated by any subsidiary to expire without compensation, to the extent such carryforward is used in consolidation. Such intention is independent of the tax sharing agreement which does not require any such compensation.
Compensation-Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (A Consensus of the FASB Emerging Issues Task Force) (ASU 2014-12)
In May of 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606).” ASU 2014-09 amends the accounting guidance for recognizing revenue for the transfer of goods or services from contracts with customers unless those contracts are within the scope of other accounting standards. ASU 2014-09 does not apply to financial guarantee insurance contracts within the scope of Topic 944, “Financial Services-Insurance.” In August of 2015, the FASB issued ASU 2015-14, “Revenue from Contracts with Customers (Topic 606) - Deferral of the Effective Date.” ASU 2015-14 defers the effective date of ASU 2014-09 to interim and annual periods beginning January 1, 2018, and is applied on a retrospective or modified retrospective basis. The adoption of ASU 2014-09 is not expected to materially impact the Company’s consolidated financial statements.
In June of 2016, the FASB issued ASU 2016-13, “Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 requires financing receivables and other financial assets measured at amortized cost basis to be presented at the net amount expected to be collected by recording an allowance for credit losses with changes in the allowance recorded as credit loss expense or reversal of credit loss expense based on management’s current estimate of expected credit losses each period. ASU 2016-13 does not apply to credit losses on financial guarantee insurance contracts within the scope of Topic 944, “Financial Services-Insurance.” ASU 2016-13 also requires impairment relating to credit losses on AFS debt securities to be presented through an allowance for credit losses with changes in the allowance recorded in the period of the change as credit loss expense or reversal of credit loss expense. Any impairment amount not recorded through an allowance for credit losses on AFS debt securities is recorded through other comprehensive income. ASU 2016-13 is effective for interim and annual periods beginning January 1, 2020 with early adoption permitted beginning January 1, 2019. ASU 2016-13 is applied on a modified retrospective basis except that prospective application is applied to AFS debt securities with other-than-temporary impairments (“OTTI”) recognized before the date of adoption. The Company is evaluating the impact of adopting ASU 2016-13.
The following tables present the total assets of nonconsolidated VIEs in which the Company holds a variable interest as of December 31, 2016 and 2015, through its insurance operations. The following tables also present the Company’s maximum exposure to loss for nonconsolidated VIEs and carrying values of the assets and liabilities for its interests in these VIEs as of December 31, 2016 and 2015. The Company has aggregated nonconsolidated VIEs based on the underlying credit exposure of the insured obligation. The nature of the Company’s variable interests in nonconsolidated VIEs is related to financial guarantees, insured CDS contracts and any investments in obligations issued by nonconsolidated VIEs.
(2)-Reported within “Premiums receivable” on MBIA’s consolidated balance sheets. Excludes $125 million that is included within “Assets held for sale” on the Company’s consolidated balance sheet.
The carrying amounts of assets and liabilities of consolidated VIEs were $2.7 billion and $2.2 billion, respectively, as of December 31, 2016, and $5.4 billion and $5.1 billion, respectively, as of December 31, 2015. The carrying amounts of assets and liabilities are presented separately in “Assets of consolidated variable interest entities” and “Liabilities of consolidated variable interest entities” on the Company’s consolidated balance sheets. VIEs are consolidated or deconsolidated based on an ongoing reassessment of controlling financial interest, when events occur or circumstances arise, and whether the ability to exercise rights that constitute power to direct activities of any VIEs are present according to the design and characteristics of these entities. One additional VIE was consolidated during the year ended December 31, 2016 and one additional VIE was consolidated during the year ended December 31, 2015.
As of December 31, 2016 and 2015, premiums receivable was $409 million and $792 million, respectively, primarily related to installment policies for which premiums will be collected over the estimated term of the contracts. Premiums receivable for an installment policy is initially measured at the present value of premiums expected to be collected over the expected period or contract period of the policy using a risk-free discount rate. Premiums receivable for policies that use the expected period of risk due to expected prepayments are adjusted in subsequent measurement periods when prepayment assumptions change using the risk-free discount rate as of the remeasurement date. Premiums receivable also includes the current amount of premiums due from installment policies insuring consolidated VIEs when the premiums are payable by third-parties on behalf of the consolidated VIEs.
As of December 31, 2016 and 2015, the risk-free rate used to discount future installment premiums was 2.8% and 2.7%, respectively, and the weighted average expected collection term of the premiums receivable was 10.07 years and 9.08 years, respectively. As of December 31, 2016 and 2015, reinsurance premiums payable was $26 million and $38 million, respectively, and is included in “Other liabilities” in the Company’s consolidated balance sheets. In addition, as of December 31, 2016, $6 million was included in “Liabilities held for sale” in the Company’s consolidated balance sheet. The reinsurance premiums payable is accreted and paid to reinsurers as premiums due to MBIA are accreted and collected.
The following table presents the unearned premium revenue balance and future expected premium earnings as of and for the periods presented. As of December 31, 2016, there was $304 million of unearned premium revenue that was included in “Liabilities held for sale” in the Company’s consolidated balance sheet and excluded in the following table.
“Caution List-Low” -Includes issuers where debt service protection is adequate under current and anticipated circumstances. However, debt service protection and other measures of credit support and stability may have declined since the transaction was underwritten and the issuer is less able to withstand further adverse events. Transactions in this category generally require more frequent monitoring than transactions that do not appear within a surveillance category. IPM subjects issuers in this category to heightened scrutiny.
“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 may have breached one or more covenants or triggers and have not taken conclusive remedial action. Therefore, IPM adopts a remediation plan and takes more proactive remedial actions.
In addition, for second-lien RMBS backed by closed-end second mortgages, the Company considers pool mortgage insurance and for second-lien RMBS backed by home equity lines of credit, the Company assumes a constant basis spread between Prime and LIBOR interest rates.
The Company continues to consider all relevant facts and circumstances in developing its assumptions on expected cash inflows, probability of potential recoveries (including the outcome of litigation) and recovery period. The estimated amount and likelihood of potential recoveries are expected to be revised and supplemented to the extent there are developments in the pending litigation and/or changes to the financial condition of Credit Suisse. While the Company believes it will be successful in realizing its recoveries from its contract claims against Credit Suisse, the ultimate amount recovered may be materially different from that recorded by the Company given the inherent uncertainty of the manner of resolving the claims (i.e., litigation and/or negotiated out-of-court settlement) and the assumptions used in the required estimation process for accounting purposes which are based, in part, on judgments and other information that are not easily corroborated by historical data or other relevant benchmarks.
The following discussion provides information about the Company’s process for estimating reserves and credit impairments on these policies, determined as the present value of the probability-weighted potential future losses, net of estimated recoveries, across multiple scenarios.
The Company’s loss and LAE reserves and recoveries after VIE eliminations included in the Company’s consolidated balance sheets, along with amounts that were eliminated as a result of consolidating VIEs, as of December 31, 2016 and 2015 are presented in the following table:
(1)-As of December 31, 2016 and 2015, $280 million and $382 million were included in “Insurance loss recoverable” and $14 million and $24 million were included in “Loss and loss adjustment expense reserves” on the Company’s consolidated balance sheets, respectively.
(5) -As of December 31, 2016 and 2015, $14 million and $8 million were eliminated from “Insurance loss recoverable.” As of December 31, 2016, $4 million was eliminated from “Loss and loss adjustment expense reserves” on the Company’s consolidated balance sheets.
The following tables present changes in the Company’s loss and LAE reserves for the years ended December 31, 2016 and 2015. Changes in loss reserves attributable to the accretion of the claim liability discount, changes in discount rates, changes in amount and timing of estimated claim payments and recoveries, changes in assumptions and changes in LAE reserves are recorded in “Losses and loss adjustment” expenses in the Company’s consolidated statements of operations. As of December 31, 2016 and 2015, the weighted average risk-free rate used to discount the Company’s loss reserves (claim liability) was 2.07% and 1.82%, respectively. LAE reserves are generally expected to be settled within a one-year period and are not discounted. As of December 31, 2016 and 2015, the Company’s gross loss and LAE reserves included $60 million and $46 million, respectively, related to LAE.
The Company’s financial guarantee insurance losses and LAE (excluding insured credit derivative and consolidated VIEs), net of reinsurance for the years ended December 31, 2016, 2015 and 2014 are presented in the following table:
Costs associated with remediating insured obligations assigned to the Company’s surveillance categories are recorded as LAE and included in “Losses and loss adjustment” expenses on the Company’s consolidated statements of operations. For 2016, 2015 and 2014, gross LAE related to remediating insured obligations were $48 million, $26 million and $36 million, respectively.
The following table provides information about the financial guarantees and related claim liability included in each of MBIA’s surveillance categories as of December 31, 2016:
(3)-The gross claim liability with respect to Puerto Rico and Zohar II exposures are net of expected recoveries.
Financial liabilities, excluding derivative liabilities, issued by the Company primarily consist of debt issued for general corporate purposes within its corporate segment, MTNs, investment agreements, debt issued by consolidated VIEs and warrants. The majority of the financial liabilities that the Company has elected to fair value or that require fair value reporting or disclosures are valued based on the estimated value of the underlying collateral, the Company’s or a third-party’s estimate of discounted cash flow model estimates, or quoted market values for similar products. These valuations include adjustments for expected nonperformance risk of the Company.
The Company’s derivative liabilities are primarily interest rate swaps and insured credit derivatives. The Company’s insured credit derivative contracts are non-traded structured credit derivative transactions. Since insured derivatives are highly customized and there is generally no observable market for these derivatives, the Company estimates their fair values in a hypothetical market based on internal and third-party models simulating what a similar company would charge to assume the Company’s position in the transaction at the measurement date. This pricing would be based on the expected loss of the exposure. The Company reviews its valuation model results on a quarterly basis to assess the appropriateness of the assumptions and results in light of current market activity and conditions. This review is performed by internal staff with relevant expertise. When market spreads or securities prices are observable for similar transactions, those spreads are an integral part of the analysis.
Loan repurchase commitments are obligations owed by the sellers/servicers of mortgage loans to MBIA as reimbursement of paid claims. Loan repurchase commitments are assets of the consolidated VIEs. This asset represents the rights of MBIA against the sellers/servicers for breaches of representations and warranties that the securitized residential mortgage loans sold to the trust to comply with stated underwriting guidelines and for the sellers/servicers to cure, replace, or repurchase mortgage loans. Fair value measurements of loan repurchase commitments represent the amounts owed by the sellers/servicers to MBIA as reimbursement of paid claims. Loan repurchase commitments are not securities and no quoted prices or comparable market transaction information are observable or available. Fair values of loan repurchase commitments are determined using discounted cash flow techniques and are categorized in Level 3 of the fair value hierarchy.
The fair value of long-term notes, debentures and surplus notes are estimated based on quoted prices for these or similar securities. The fair value of the accrued interest expense on the surplus notes due in 2033 is determined based on the scheduled interest payments discounted by the market’s perception of the credit risk related to the repayment of the surplus notes. The credit risk related to the repayment of the surplus notes is based on recent trades of the surplus notes.
The derivative contracts insured by the Company cannot be legally traded and generally do not have observable market prices. The Company determines the fair values of insured credit derivatives using valuation models based on observable inputs and considering nonperformance risk of the Company. The valuation models are applied consistently from period to period, with refinements to the valuation technique being applied as and when the information becomes available. Negotiated settlements are also considered to validate the valuation models and to reflect assumptions the Company believes market participants would use.
The following tables provide quantitative information regarding the significant unobservable inputs used by the Company for assets and liabilities measured at fair value on a recurring basis as of December 31, 2016 and 2015. These tables exclude inputs used to measure fair value that are not developed by the Company, such as broker prices and other third-party pricing service valuations.
The significant unobservable inputs used in the fair value measurement of the Company’s loans receivable at fair value of consolidated VIEs are the impact of the financial guarantee and multiples. The fair value of loans receivable are calculated by subtracting the value of the financial guarantee from the market value of VIE liabilities and by discounted cash flow methodologies. The value of a financial guarantee is estimated by the Company as the present value of expected cash payments under the policy. As expected cash payments provided by the Company under the insurance policy increase, there is a lower expected cash flow on the underlying loans receivable of the VIE. This results in a lower fair value of the loans receivable in relation to the obligations of the VIE.
The significant unobservable inputs used in the fair value measurement of MBIA Corp.’s commercial mortgage-backed securities (“CMBS”) credit derivatives, which are valued using the BET Model, are CMBS spreads, recovery rates, nonperformance risk and weighted average life. The CMBS spread is an indicator of credit risk of the collateral securities. The recovery rate represents the percentage of notional expected to be recovered after an asset defaults, indicating the severity of a potential loss. The nonperformance risk is an assumption of MBIA Corp.’s own ability to pay and whether MBIA Corp. will have the necessary resources to pay the obligations as they come due. Weighted average life is based on the Company’s estimate of when the principal of the underlying collateral of the CMBS structure will be repaid. A significant increase or decrease in CMBS spreads would result in an increase or decrease in the fair value of the derivative liability, respectively. A significant increase in weighted average life can result in an increase or decrease in the fair value of the derivative liability, depending on the discount rate and the timing of significant losses. Any significant increase or decrease in recovery rates, or MBIA Corp.’s nonperformance risk would result in a decrease or increase in the fair value of the derivative liabilities, respectively. CMBS spreads, recovery rates, nonperformance risk and weighted average lives are determined independently. Changes in one input will not necessarily have any impact on the other inputs.
(2)-Represents an investment that was measured at fair value by applying the net asset value per share practical expedient, and was not required to be classified in the fair value hierarchy.
(2)-Represents investments that were measured at fair value by applying the net asset value per share practical expedient, and were not required to be classified in the fair value hierarchy.
Gains and losses (realized and unrealized) included in earnings relating to Level 3 assets and liabilities for the years ended December 31, 2016, 2015 and 2014 are reported on the Company’s consolidated statements of operations as follows:
Investment agreement obligations require the Company to pledge securities as collateral. Securities pledged in connection with investment agreements may not be repledged by the investment agreement counterparty. As of December 31, 2016 and 2015, the fair value of securities pledged as collateral for these investment agreements approximated $416 million and $457 million, respectively. The Company’s collateral as of December 31, 2016 consisted principally of U.S. Treasury and government agency and state and municipal bonds, and was primarily held with major U.S. banks. Additionally, the Company pledged cash and money market securities as collateral under investment agreements in the amount of $6 million and $12 million as of December 31, 2016 and 2015, respectively.
Gross unrealized losses on HTM investments decreased as of December 31, 2016 compared with December 31, 2015 principally due to an increase in forecasted cash flows used in the Company’s fair value modeling. The increase in forecasted cash flows was primarily due to new and positive market information indicating a higher probability that cash flows will be adequate to repay principal and interest owing on the securities.
With the weighting applied on the fair value of each security relative to the total fair value, the weighted average contractual maturity of securities in an unrealized loss position as of December 31, 2016 and 2015 was 22 and 17 years, respectively. As of December 31, 2016 and 2015, there were 46 and 65 securities, respectively, that were in an unrealized loss position for a continuous twelve-month period or longer, of which, fair values of 12 and 22 securities, respectively, were below book value by more than 5%.
The following table presents the distribution of securities in an unrealized loss position for a continuous twelve-month period or longer where fair value was below book value by more than 5% as of December 31, 2016:
The Company concluded that it does not have the intent to sell securities in an unrealized loss position and it is more likely than not, that it would not have to sell these securities before recovery of their cost basis. In making this conclusion, the Company examined the cash flow projections for its investment portfolios, the potential sources and uses of cash in its businesses, and the cash resources available to its business other than sales of securities. It also considered the existence of any risk management or other plans as of December 31, 2016 that would require the sale of impaired securities. Impaired securities that the Company intends to sell before the expected recovery of such securities’ fair values have been written down to fair value.
ABS investments are evaluated for OTTI using historical collateral performance, deal waterfall and structural protections, credit ratings, and forward looking projections of collateral performance based on business and economic conditions specific to each collateral type and risk. The underlying collateral is evaluated to identify any specific performance concerns, and stress scenarios are considered in forecasting ultimate returns of principal. Based on this evaluation, if a principal default is projected for a security, estimated future cash flows are discounted at the security’s interest rate used to recognize interest income on the security. For CDO investments, the Company uses the same tools as its RMBS investments discussed below, aggregating the bond level cash flows to the CDO investment level. If the present value of cash flows is less than the Company’s amortized cost for the security, the difference is recorded as an OTTI loss.
Corporate obligation investments are evaluated for OTTI using credit analysis techniques. The Company’s analysis includes a detailed review of a number of quantitative and qualitative factors impacting the value of an individual security. These factors include the interest rate of the security (fixed or floating), the security’s current market spread, any collateral supporting the security, the security’s position in the issuer’s capital structure, and credit rating upgrades or downgrades. Additionally, these factors include an assessment of various issuer-related credit metrics including market capitalization, earnings, cash flow, capitalization, interest coverage, leverage, liquidity, management and a third-party quantitative default probability model. The Company’s analysis is augmented by comparing market prices for similar securities of other issuers in the same sector, as well as any recent corporate or government actions that may impact the ultimate return of principal. If the Company determines that a principal default is projected, a recovery analysis is performed using the above data. If the Company’s estimated recovery value for the security is less than its amortized cost, the difference is recorded as an OTTI loss.
Gross realized gains and losses are recorded within “Net gains (losses) on financial instruments at fair value and foreign exchange” on the Company’s consolidated statements of operations. The increase in proceeds and net gains on the sales of investments for the year ended December 31, 2016 compared with 2015 and 2014 was primarily due to sales as a result of favorable market conditions and to generate liquidity for payments on certain Puerto Rico exposures. The proceeds and the gross realized gains and losses from sales of fixed-maturity securities held as AFS for the years ended December 31, 2016, 2015 and 2014 are as follows:
The Company has entered into derivative instruments primarily consisting of interest rate swaps to manage the risks associated with fluctuations in interest rates of certain contracts.
MBIA may hold recourse provisions with third parties in derivative instruments through both reinsurance and subrogation rights. MBIA’s reinsurance arrangements provide that in the event MBIA pays a claim under a guarantee of a derivative contract, MBIA has the right to collect amounts from any reinsurers that have reinsured the guarantee on either a proportional or non-proportional basis, depending upon the underlying reinsurance agreement. MBIA may also have recourse through subrogation rights whereby if MBIA makes a claim payment, it may be entitled to any rights of the insured counterparty, including the right to any assets held as collateral.
Under these agreements, the Company may receive or provide cash, U.S. Treasury or other highly rated securities 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, 2016, the Company did not hold cash collateral to derivative counterparties but posted cash collateral to derivative counterparties of $1 million. All of the $1 million is included within “Other liabilities” as cash collateral netted against accrued interest on derivative liabilities. As of December 31, 2015, the Company did not hold cash collateral to derivative counterparties but posted cash collateral to derivative counterparties of $50 million. Of this amount, $31 million is netted within “Derivative liabilities” and $19 million is included within “Other liabilities” as cash collateral netted against accrued interest on derivative liabilities. As of December 31, 2016 and 2015, the Company had securities with a fair value of $276 million and $259 million, respectively, posted to derivative counterparties and these amounts are included within “Fixed-maturity securities held as available-for-sale, at fair value” on the Company’s consolidated balance sheets.
The fair value of amounts recognized for eligible derivative contracts executed with the same counterparty under a master netting agreement, including any cash collateral that may have been received or posted by the Company, is presented on a net basis in accordance with accounting guidance for the offsetting of fair value amounts related to derivative instruments. Insured CDS and insured swaps are not subject to master netting agreements. VIE derivative assets and liabilities are not presented net of any master netting agreements. Counterparty netting of derivative assets and liabilities offsets balances in “Interest rate swaps” as of December 31, 2016 and 2015.
The following table presents the total fair value of the Company’s derivative assets and liabilities by instrument and balance sheet location, before counterparty netting and posting of cash collateral, as of December 31, 2016:
As of December 31, 2015, the total fair value of the Company’s derivative assets, after counterparty netting of $1 million, was $19 million, of which $14 million was reported within “Other assets” and “Other Assets” presented under “Assets of consolidated variable interest entities” on the Company’s consolidated balance sheets. Embedded derivatives of $5 million were reported within “Medium-term notes” on the Company’s consolidated balance sheets.
The following table presents the effect of derivative instruments on the consolidated statements of operations for the years ended December 31, 2016, 2015 and 2014:
(3)-Contractual interest rate is based on three month LIBOR plus 11.26%.
Interest and principal payments on the surplus notes are subject to prior approval by the NYSDFS. From the January 15, 2013 interest payment to the present, MBIA Corp.’s requests for approval of the note interest payments have been denied by the NYSDFS. MBIA Corp. provides notice to the Fiscal Agent when it does not make a scheduled interest payment. The deferred interest payment will become due on the first business day on or after which MBIA Corp. obtains approval to make such payment. No interest will accrue on the deferred interest. The surplus notes were callable at par at the option of MBIA Corp. on the fifth anniversary of the date of issuance, and are callable at par on January 15, 2018 and every fifth anniversary thereafter and are callable on any other date at par plus a make-whole amount, subject to prior approval by the Superintendent and other restrictions. The cash received from the issuance of surplus notes was used for general business purposes and the deferred debt issuance costs are being amortized over the term of the surplus notes.
MTNs are denominated in U.S. dollars or foreign currencies and accrue interest based on fixed or floating interest rates. Certain MTNs are measured at fair value in accordance with the accounting guidance for hybrid financial instruments. As of December 31, 2016, the interest rates of the MTNs ranged from 0% to 6.00% and the weighted average interest rate was 2.43%. As of December 31, 2015, the interest rates of the MTNs ranged from 0% to 6.40% and the weighted average interest rate was 2.42%. During 2016, the Company repurchased $6 million par value outstanding at a cost of approximately 97% of par value and redeemed $4 million at par value of MTNs issued by the Company’s corporate segment. Expected principal payments due under MTN obligations based on their contractual maturity dates are as follows:
The maturity of the Company’s international and structured finance insurance segment’s VIE notes, as of December 31, 2016 is presented in the following table:
(1)-Includes $1.4 billion of VIE notes accounted for at fair value as of December 31, 2016.
The Company files a consolidated tax return that includes all of its U.S. subsidiaries and foreign branches. The Company also files tax returns in the United Kingdom, Spain, and various state and local jurisdictions. Income tax expense (benefit) on income (loss) and shareholders’ equity consisted of:
A reconciliation of the U.S. federal statutory tax rate of 35% to the Company’s effective income tax rate for the years ended December 31, 2016, 2015 and 2014 is presented in the following table:
The Company has come to the conclusion that it is more likely than not that its net deferred tax asset, other than that portion of the asset related to foreign tax credits which have been claimed on its prior years’ tax returns and are being carried forward, will be fully realized after weighing all positive and negative evidence available as required under GAAP. The positive evidence that was considered included the cumulative operating income the Company has earned over the last three years, and the significant unearned premium income to be included in taxable income. The positive evidence outweighs any negative evidence that exists. As such, the Company believes that no valuation allowance is necessary in connection with this deferred tax asset. The Company will continue to analyze the need for a valuation allowance on a quarterly basis.
Due to held for sale accounting of MBIA UK as of December 31, 2016, $36 million of deferred tax liabilities has been reported within “Liabilities held for sale” on MBIA’s consolidated balance sheet.
Federal income tax returns through 2011 have been examined or surveyed.
As of December 31, 2016, the Company’s net operating loss (“NOL”) is approximately $2.7 billion. The NOL will expire between tax years 2029 through 2034. As of December 31, 2016, the Company has a foreign tax credit carryforward of $7 million, which will expire between tax years 2019 through 2026. As of December 31, 2016, the Company has an alternative minimum tax credit carryforward of $26 million, which does not expire.
The Company’s U.S. public finance insurance segment is principally conducted through National. The financial guarantees issued by National provide unconditional and irrevocable guarantees of the payment of the principal of, and interest or other amounts owing on, U.S. public finance insured obligations when due. The obligations are not subject to acceleration, except that National may have the right, at its discretion, to accelerate insured obligations upon default or otherwise. National issues financial guarantees for municipal bonds, including tax-exempt and taxable indebtedness of U.S. political subdivisions, as well as utilities, airports, health care institutions, higher educational facilities, student loan issuers, housing authorities and other similar agencies and obligations issued by private entities that finance projects that serve a substantial public purpose. Municipal bonds and privately issued bonds used for the financing of public purpose projects are generally supported by taxes, assessments, fees or tariffs related to the use of these projects, lease payments or other similar types of revenue streams.
The Company’s corporate segment consists of general corporate activities, including providing general support services to MBIA’s other operating businesses and asset and capital management. General support services are provided by the Company’s service company, MBIA Services Corporation (“MBIA Services”). MBIA Services provides various support services including, among others, management, legal, accounting, treasury, information technology, and insurance portfolio surveillance, on a fee-for-service basis. Capital management includes activities related to servicing obligations issued by MBIA Inc. and its subsidiaries, MBIA Global Funding, LLC (“GFL”) and MBIA Investment Management Corp. (“IMC”). MBIA Inc. issued debt to finance the operations of the MBIA group. GFL raised funds through the issuance of MTNs with varying maturities, which were in turn guaranteed by MBIA Corp. GFL lent the proceeds of these MTN issuances to MBIA Inc. IMC, along with MBIA Inc., provided customized investment agreements, guaranteed by MBIA Corp., for bond proceeds and other public funds for such purposes as construction, loan origination, escrow and debt service or other reserve fund requirements. The Company has ceased issuing these MTNs and investment agreements and the outstanding liability balances and corresponding asset balances have declined over time as liabilities mature, terminate or are retired. All of the debt within the corporate segment is managed collectively and is serviced by available liquidity.
The Company’s international and structured finance insurance segment is principally conducted through MBIA Corp. The financial guarantees issued by MBIA Corp. generally provide unconditional and irrevocable guarantees of the payment of principal of, and interest or other amounts owing on, non-U.S. public finance and global structured finance insured obligations when due, or in the event MBIA Corp. has the right, at its discretion, to accelerate insured obligations upon default or otherwise. MBIA Corp. insures the investment contracts written by MBIA Inc., and if MBIA Inc. were to have insufficient assets to pay amounts due upon maturity or termination, MBIA Corp. would make such payments. MBIA Corp. insures debt obligations of the following affiliates:
MBIA Corp. insures non-U.S. public finance and global structured finance insured obligations, including asset-backed obligations. MBIA Corp. has insured sovereign-related and sub-sovereign bonds, utilities, privately issued bonds used for the financing of projects that include toll roads, bridges, airports, public transportation facilities, and other types of infrastructure projects serving a substantial public purpose. Global structured finance and asset-backed obligations typically are securities repayable from expected cash flows generated by a specified pool of assets, such as residential and commercial mortgages, insurance policies, consumer loans, corporate loans and bonds, trade and export receivables, and leases for equipment, aircraft and real estate property. MBIA Corp. has also written policies guaranteeing obligations under certain other derivative contracts, including termination payments that may become due upon certain insolvency or payment defaults of the financial guarantor or the issuer. The Company is no longer insuring new credit derivative contracts except for transactions related to the restructuring or reduction of existing derivative exposure. MBIA Corp. has not written any meaningful amount of business since 2008.
(2)-Represents intercompany premium income and expense, intercompany asset management fees and expenses, intercompany interest income and expenses pertaining to intercompany receivables and payables and intercompany loans.
Premiums on financial guarantees and insured derivatives reported within the Company’s insurance segments are generated within and outside the U.S. The following table summarizes premiums earned on financial guarantees and insured derivatives by geographic location of risk for the years ended December 31, 2016, 2015 and 2014:
(4)-Includes regions, departments or their equivalent in each jurisdiction as well as sovereign owned entities that are supported by a sovereign state, region or department.
(5)-Includes $2.6 billion and $5.1 billion of structured insurance securitizations as of December 31, 2016 and 2015, respectively.
(1)-Includes $170 million in ceded par outstanding related to MBIA UK.
(2)-Total reinsurance recoverable is primarily related to recoverables on unpaid losses.
For the year ended December 31, 2016, payments received for claims related to financial guarantee policies under reinsurance contracts totaled $12 million. For the year ended December 31, 2014, total salvage paid for financial guarantee policies under reinsurance contracts was $5 million. Ceding commissions from reinsurance, before deferrals and net of returned ceding commissions, were $1 million, $1 million and $2 million for the years ended December 31, 2016, 2015, and 2014, respectively.
For the years ended December 31, 2016 and 2015, National had statutory net income of $192 million and $284 million, respectively. As of December 31, 2016, National’s statutory capital was $3.5 billion, consisting of policyholders’ surplus of $2.7 billion and contingency reserves of $745 million. As of December 31, 2015, National had statutory capital of $3.4 billion.
In 2016 and 2015, National declared and paid dividends of $118 million and $114 million, respectively, to its ultimate parent, MBIA Inc.
Results of operations for MBIA Insurance Corporation determined in accordance with statutory accounting practices for the years ended December 31, 2016 and 2015 were a net operating loss of $323 million and net income of $25 million, respectively. For the year ended December 31, 2016, MBIA Insurance Corporation recorded a loss of $114 million to adjust the carrying value of MBIA UK to its estimated fair value less costs to sell. In addition, MBIA Insurance Corporation’s policyholders’ surplus was negatively impacted as of December 31, 2016 and 2015 by $112 million and $75 million, respectively, as it was not permitted to treat the portion of its investment in subsidiaries in excess of 60% of net admitted assets less the par value of common and preferred stock and liabilities as an admitted asset, as required under NYIL. MBIA Insurance Corporation’s policyholders’ surplus as of December 31, 2016 and 2015 included negative unassigned surplus of $1.8 billion and $1.4 billion, respectively. MBIA Insurance Corporation’s policyholders’ surplus may be further negatively impacted if future additional insured losses are incurred and the percentage of its assets invested in subsidiaries continues to increase.
As of December 31, 2016, MBIA Insurance Corporation’s statutory capital was $492 million, consisting of policyholders’ surplus of $238 million and contingency reserve of $254 million. As of December 31, 2015, MBIA Insurance Corporation had statutory capital of $885 million.
The Company also maintains a qualified profit sharing/401(k) plan. The plan is a voluntary contributory plan that allows eligible employees to defer compensation for federal income tax purposes under Section 401(k) of the Internal Revenue Code of 1986, as amended. Employees may contribute, through payroll deductions, up to 25% of eligible compensation. The Company matches employee contributions up to the first 5% of such compensation. The 401(k) matching contributions are made in the form of cash, whereby participants may direct the Company match to an investment of their choice. The 401(k) matching benefits vest over a five-year period with 20% vested after two years, 60% vested after three years, 80% vested after four years and 100% vested after five years. Generally, a participating employee is entitled to distributions from the plans upon termination of employment, retirement, death or disability. Participants who qualify for distribution may receive a single lump sum, transfer the assets to another qualified plan or individual retirement account, or receive a series of specified installment payments. Profit sharing/401(k) expense related to the Company’s qualified plan for the years ended December 31, 2016, 2015 and 2014 was $1 million, $2 million, and $2 million, respectively.
There were 5,565,306 shares available for future grants under the Omnibus Plan as of December 31, 2016.
During 2016, 2015 and 2014, there were no stock option awards granted. During 2016 and 2015, the Company expensed deferred tax assets of $1 million and $2 million, respectively, related to the stock option awards as a charge through the statements of operations. During 2014, the Company expensed a deferred tax asset of $4 million, related to the stock option awards as a charge to paid-in capital. As of December 31, 2016, there was no remaining unrecognized compensation cost and all stock options had vested.
A summary of the Company’s stock options outstanding as of December 31, 2016, 2015 and 2014, and changes during the years ended on those dates, is presented in the following tables:
The following table summarizes information about outstanding stock options as of December 31, 2016:
(1) Includes 930,406, 617,909 and 412,769 of participating securities that met the service condition and were eligible to receive nonforfeitable dividends or dividend equivalents for the years ended December 31, 2016, 2015 and 2014, respectively.
During 2008, the Company granted Warburg warrants to purchase 11.5 million shares of MBIA common stock at an exercise price of $30.25 per share, “B” warrant, which, upon obtaining certain approvals, would become exercisable to purchase 9.8 million shares at a price of $30.25 per share, and “B2” warrant to purchase 4 million shares at a price of $16.20 per share.
In August of 2013, pursuant to the anti-dilution provisions of warrants issued by MBIA to Warburg, the terms of the warrants issued to Warburg in 2008 were amended, which resulted in (a) Warburg’s warrant to purchase 11.5 million shares exercisable at $30.25 per share was revised to 11.8 million shares at $29.44 per share (“Warburg Warrant”); (b) Warburg’s B warrant to purchase 9.8 million shares exercisable at $30.25 per share was revised to 10.1 million shares at $29.44 per share (“Warburg B Warrant”); and (c) Warburg’s B2 warrant to purchase 4 million shares exercisable at $16.20 per share was revised to 4,004,945 shares at $16.18 per share (“Warburg B2 Warrant”). In addition, under the agreement, Warburg had certain gross-up rights that are triggered in connection with the offering by the Company of any equity securities. As such, MBIA issued Warburg a five-year warrant to purchase 1.91 million shares of MBIA common stock at an exercise price of $9.59 per share (“Gross-Up Warrant”).
Stock warrants are recorded as liabilities and reported within “Other liabilities” on the consolidated balance sheets due to terms and conditions in the agreements that could require net cash settlement. As of December 31, 2016 and 2015, the fair value of the warrants was $33 million and $18 million, respectively.
On February 1, 2007, the Company’s Board of Directors authorized the repurchase of common stock up to $1 billion under a share repurchase program. During 2014, the Company exhausted any remaining capacity under this share repurchase program.
The following table provides information about the Company’s share repurchases for the years ended December 31, 2016, 2015 and 2014:
During 2016 and 2015, 419,806 and 580,692 shares, respectively, were purchased by the Company for settling awards under the Company’s long-term incentive plans.
In accordance with MBIA’s fixed-rate election, the dividend rate on the preferred stock was determined using a fixed-rate equivalent of LIBOR plus 200 basis points. Each share of preferred stock has a par value of $1,000 with a liquidation preference of $100,000. The holders of the preferred stock are generally not entitled to any voting rights. Subject to certain requirements, the preferred stock may be redeemed, in whole or in part, at the option of MBIA Corp. at any time or from time to time for cash at a redemption price equal to the liquidation preference per share plus any accrued and unpaid dividends thereon at the date of redemption for the then current dividend period and any previously accumulated dividends payable without interest on such unpaid dividends. As of December 31, 2016 and 2015, there were no dividends declared on the preferred stock. Payment of dividends on MBIA Corp.’s preferred stock is subject to the same restrictions that apply to dividends on common stock under NYIL.
On September 14, 2012, MBIA Corp. filed a complaint alleging fraud against J.P. Morgan Securities LLC (f/k/a Bear, Stearns & Co. Inc.) relating to Bear, Stearns & Co. Inc.’s role as lead securities underwriter on the GMAC Mortgage Corporation Home Equity Loan Trust 2006-HE4. On September 18, 2014, the court granted in part MBIA Corp.’s motion to file an amended complaint. MBIA filed its amended complaint on September 29, 2014. J.P. Morgan filed its answer to the amended complaint on October 10, 2014. The parties each cross-appealed the September 18, 2014 decision and those appeals were fully submitted as of June 8, 2015. J.P. Morgan’s motion for summary judgment was argued in December of 2015. On June 6, 2016, the court denied J.P. Morgan’s motion for summary judgment. J.P. Morgan filed a notice of appeal of that ruling on July 6, 2016. On November 2, 2016, the Second Department of the Appellate Division of the New York State Supreme Court (the “Second Department”) issued a decision on J.P. Morgan’s separate appeal, and MBIA Corp.’s cross appeal, from the trial court’s Order of September 18, 2014, which had granted MBIA’s motion for leave to amend its complaint to assert a cause of action for fraudulent concealment, and denied its motion to amend its complaint to assert cause of action alleging material misrepresentation in the procurement of an insurance contract brought under common law as informed by NYIL Section 3105. The Second Department decision affirmed the Order as it pertained to allowing the assertion of the fraudulent concealment claim, and reversed it as to the denial of the motion to add the claim of material misrepresentation in the procurement of an insurance contract. Consistent with the Second Department decision, on February 24, 2017, MBIA Corp. filed a Second Amended Complaint adding a claim for material misrepresentation in the procurement of an insurance contract as informed by NYIL Section 3105.
The Company is defending against the aforementioned actions in which it is a defendant and expects ultimately to prevail on the merits. There is no assurance, however, that the Company will prevail in these actions. Adverse rulings in these actions could have a material adverse effect on the Company’s ability to implement its strategy on its business, results of operations, cash flows and financial condition. At this stage of the litigation, there has not been a determination as to the amount, if any, of damages. Accordingly, the Company is not able to estimate any amount of loss or range of loss.
The Company leases its headquarters in Purchase, New York. The initial lease term expires in 2030 with the option to terminate the lease in 2025 upon the payment of a termination amount. At the end of the initial lease term, the Company has the option to extend the term of the lease for two additional terms of five years at a fixed annual rent based on the fair market rent at the time of any extension. As of December 31, 2016, total future minimum lease payments remaining was $39 million. The total future minimum lease payments include annual rent escalation amounts. The lease agreement has been classified as an operating lease, and operating rent expense is recognized on a straight-line basis.