A wholly-owned subsidiary of National owns the 280,729 square foot office building on approximately 38 acres of property in Armonk, New York, in which the Company, National, MBIA Corp., Cutwater, Optinuity and LatAm have their headquarters. The Company also has offices with approximately 22,776 square feet of rental space in New York, New York; San Francisco, California; Paris, France; Madrid, Spain; London, England; and Mexico City, Mexico. Cutwater Asset Management has 7,607 square feet of office space in Denver, Colorado, 3,100 square feet in Orlando, Florida and 2,640 square feet in London, England. The Company generally believes that these facilities are adequate and suitable for its current needs.
This annual report of MBIA Inc. (“MBIA”, the “Company”, “we”, “us” or “our”) includes statements that are not historical or current facts and are “forward-looking statements” made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The words “believe,” “anticipate,” “project,” “plan,” “expect,” “estimate,” “intend,” “will likely result,” “looking forward” or “will continue,” and similar expressions identify forward-looking statements. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. MBIA cautions readers not to place undue reliance on any such forward-looking statements, which speak only to their respective dates. We undertake no obligation to publicly correct or update any forward-looking statement if the Company later becomes aware that such result is not likely to be achieved.
the possibility that unprecedented budget shortfalls will result in credit losses or impairments on obligations of state and local governments that we insure;
our ability to access capital and our exposure to significant fluctuations in liquidity and asset values within the global credit markets;
The above factors provide a summary of and are qualified in their entirety by the risk factors discussed under “Risk Factors” in Part I, Item 1A of this annual report on Form 10-K. In addition, refer to “Note 1: Businesses, Developments, Risks and Uncertainties” in the Notes to Consolidated Financial Statements for a discussion of certain risks and uncertainties related to our financial statements.
MBIA operates the largest financial guarantee insurance business in the industry and is a provider of asset management advisory services. These activities are managed through three business segments: U.S. public finance insurance, structured finance and international insurance, and advisory services. Our U.S. public finance insurance business is operated through National, our structured finance and international insurance business is primarily operated through MBIA Insurance Corporation and its subsidiaries (“MBIA Corp.”), and our advisory services business is primarily operated through Cutwater Holdings, LLC and its subsidiaries (“Cutwater”). We also manage certain business activities through our corporate, asset/liability products, and conduit segments. Our corporate segment includes revenues and expenses that arise from general corporate activities. Funding programs managed through our asset/liability products and conduit segments are in wind-down.
During the third quarter of 2010, MBIA Insurance Corporation and MBIA UK Insurance Limited (“MBIA UK”) commuted all of their reinsurance with Channel Reinsurance Ltd. (“Channel Re”) and MBIA Insurance Corporation liquidated Channel Re and its parent company, ChannelRe Holdings Ltd., which MBIA Insurance Corporation acquired on July 19, 2010. In connection with the commutation, MBIA Insurance Corporation, National and MBIA UK reassumed insured exposure of $21.6 billion, $7.8 billion and $2.1 billion, respectively. The transaction, including the commutation and liquidation, resulted in an increase in MBIA Corp.’s statutory capital of $132 million and an increase in its liquidity position of $595 million.
During the fourth quarter of 2010, MBIA Corp. reached agreements with five counterparties for commutations of transactions including multi-sector CDOs, CDO-squared transactions, structured CMBS pools, CRE CDOs and high-yield corporate CDOs. The agreements eliminated $15.7 billion in gross insured exposure. In the first quarter of 2011, MBIA Corp. reached an agreement for the commutation of $3.3 billion of additional gross insured exposure, comprising structured CMBS pools and an investment grade corporate CDO. The total amount the Company paid to commute the transactions in the fourth quarter of 2010 and the first quarter of 2011 was within its aggregate statutory loss reserve for those transactions. Since the fourth quarter of 2008, the Company has commuted $28.0 billion of its multi-sector CDO, multi-sector CDO-squared, CRE CDO, CMBS pool and corporate CDO gross insured exposure for payments that were within its aggregate statutory loss reserves for those transactions. In consideration for the commutation of insured transactions, including the transactions described above, the Company has made and may in the future make payments to the counterparties the amounts of which, if any, may be less than or greater than any statutory loss reserves established for the respective transactions.
Our financial results have been extremely volatile since the fourth quarter of 2007 as a result of unrealized gains and losses on our insured credit derivatives, which we do not believe reflect the underlying economics of our business. We fully expect that both economic performance and reported financial results may remain volatile and uncertain during 2011 as a result of actual and perceived future performance of our insured credit derivatives.
In January 2011, S&P proposed, and requested comment on, changes to its rating methodology for financial guarantee insurers. If implemented in their current form, the proposed changes would substantially increase the amount of capital required to achieve S&P’s highest ratings and would incorporate additional qualitative considerations into the ratings process. As a result, our insurance subsidiaries could be downgraded in the near term, could be unable to achieve S&P’s highest ratings in the future, could choose not to take the steps necessary to obtain the highest S&P ratings, or could choose to stop carrying the S&P ratings. The absence of S&P’s highest ratings could adversely impact our ability to write new insurance business and the premiums we can charge, and could diminish the acceptance of our financial guarantee insurance products. We have joined other market participants in providing comments to S&P stating our concerns with their revisions.
Refer to “Note 24: Commitments and Contingencies” in the Notes to Consolidated Financial Statements for a detailed discussion on the lawsuits filed against the Company.
For the year ended December 31, 2010, we recorded consolidated net income of $53 million or $0.26 per share compared with consolidated net income of $623 million or $2.99 per share for the year ended December 31, 2009, after adjusting for preferred stock dividends of MBIA Insurance Corporation, and a consolidated net loss of $2.7 billion or $12.11 per share for the year ended December 31, 2008.
We also use adjusted pre-tax income, a non-GAAP measure, to supplement our analysis of pre-tax income. We consider adjusted pre-tax income a measure of fundamental periodic financial performance, which we believe is useful for an understanding of our results. Adjusted pre-tax income adjusts GAAP pre-tax income to remove the effects of consolidating insured variable interest entities (“VIEs”) and gains and losses related to fair valuing insured credit derivatives, which we believe will reverse over time, as well as to add in changes in the present value of insurance claims we expect to pay on insured credit derivatives based on our ongoing insurance loss monitoring. Adjusted pre-tax income is not a substitute for and should not be viewed in isolation from GAAP pre-tax income, and our definition of adjusted pre-tax income may differ from that used by other companies. Refer to the following “Results of Operations” section for a reconciliation of adjusted pre-tax income to GAAP pre-tax income.
Our consolidated book value (total shareholders’ equity) was $2.8 billion as of December 31, 2010, increasing from $2.6 billion as of December 31, 2009. Our consolidated book value per share as of December 31, 2010 was $14.18, increasing from $12.66 as of December 31, 2009.
In addition to book value per share, we also analyze adjusted book value (“ABV”) per share, a non-GAAP measure. We consider ABV a measure of fundamental value of the Company and the change in ABV an important measure of financial performance. ABV adjusts GAAP book value to remove the impact of certain items which the Company believes will reverse over time, as well as to add in the impact of certain items which the Company believes will be realized in GAAP book value in future periods. The Company has limited such adjustments to those items that it deems to be important to fundamental value and performance and which the likelihood and amount can be reasonably estimated. ABV assumes no new business activity. We have presented ABV to allow investors and analysts to evaluate the Company using the same measure that MBIA’s management regularly uses to measure financial performance and value. ABV is not a substitute for and should not be viewed in isolation from GAAP book value, and our definition of ABV may differ from that used by other companies. Refer to the following “Results of Operations” section for a further discussion of ABV, including the change we made to this measure in the fourth quarter of 2010, and a reconciliation of consolidated book value per share to ABV per share.
As of December 31, 2010, ABV per share was $36.81, down 5% from $38.94 as of December 31, 2009. The decrease in ABV per share was primarily driven by an increase in impairments on insured credit derivatives.
A detailed discussion of our financial results is presented within the “Results of Operations” section included herein. Refer to the “Capital Resources-Insurance Statutory Capital” section included herein for a discussion of National’s and MBIA Corp.’s capital position under statutory accounting principles.
Loss and loss adjustment expense (“LAE”) reserves are established by loss reserve committees in each of our operating insurance companies (National, MBIA Insurance Corporation and MBIA UK) and reviewed by our executive Loss Reserve Committee, which consists of members of senior management. Loss and LAE reserves include case basis reserves and accruals for LAE incurred with respect to non-derivative financial guarantees. Case basis reserves represent our estimate of expected losses to be paid under insurance contracts, net of potential recoveries, on insured obligations that have defaulted or are expected to default. These reserves require the use of judgment and estimates with respect to the occurrence, timing and amount of paid losses and recoveries on insured obligations. Given that the reserves are based on such estimates and assumptions, there can be no assurance that the actual ultimate losses will not exceed such estimates resulting in the Company recognizing additional loss and LAE in earnings.
We take into account a number of variables in establishing specific case basis reserves for individual policies that depend primarily on the nature of the underlying insured obligation. These variables include the nature and creditworthiness of the issuers of the insured obligations, expected recovery rates on unsecured obligations, the projected cash flow or market value of any assets pledged as collateral on secured obligations, and the expected rates of recovery, cash flow or market values on such obligations or assets. Factors that may affect the actual ultimate realized losses for any policy include economic conditions and trends, levels of interest rates, rates of inflation, borrower behavior, the default rate and salvage values of specific collateral, and our ability to enforce contractual rights through litigation and otherwise. Our remediation strategy for an insured obligation that has defaulted or is expected to default may also have an impact on our loss reserves.
As of December 31, 2010 and over the last several years, the majority of our case basis reserves and insurance loss recoveries were related to insured RMBS transactions. Refer to “Note 6: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements for a comprehensive discussion of our RMBS loss reserves and recoveries, including critical accounting estimates used in the determination of these amounts.
We have categorized our financial instruments measured at fair value into the three-level hierarchy according to accounting guidance for fair value measurements and disclosures based on the significance of pricing inputs to the measurement in its entirety. Fair value measurements of financial instruments that use quoted prices in active markets for identical assets or liabilities are generally categorized as Level 1, and fair value measurements of financial instruments where significant inputs are not observable are generally categorized as Level 3. We categorize our financial instruments conservatively using the lowest level category at which we can generate reliable fair values. The determination of reliability requires management to exercise judgment. The degree of judgment used to determine the fair values of financial instruments generally correlates to the degree to which pricing is not observable.
The fair market values of financial instruments held or issued by the Company are determined through the use of observable market data when available. Market data is obtained from a variety of third-party sources, including dealer quotes. If dealer quotes are not available for an instrument that is infrequently traded, we use alternate
MBIA has entered into derivative transactions both within its financial guarantee insurance business and in hedging risks associated with its assets and liabilities. Credit default swap (“CDS”) contracts are also used in our wind-down operations to replicate investments in cash assets consistent with the risk tolerance and criteria for this business. We account for derivative transactions in accordance with the accounting principles for derivatives and hedging activities, which require that all such transactions be recorded on the Company’s consolidated balance sheet at fair value. The fair value of derivative instruments is determined as the amount that would be received to sell the derivative when in an asset position (when the Company would be owed money under the derivative in a termination) or transfer the derivative when in a liability position (when the Company would owe money under the derivative in a termination). Changes in the fair value of derivatives, exclusive of insured derivatives, are recorded each period in current earnings within “Net gains (losses) on financial instruments at fair value and foreign exchange” or in shareholders’ equity within “Accumulated other comprehensive income (loss)” depending on whether the derivative is designated as a hedge, and if so designated, the type of hedge.
Refer to “Note 7: Fair Value of Financial Instruments” in the Notes to Consolidated Financial Statements for a comprehensive discussion of our valuation process for insured derivatives, including critical accounting estimates.
(2) Valued using quoted prices for which the inputs are unobservable or valuation models with significant unobservable inputs.
Level 3 assets represented approximately 24% and 17% of total assets measured at fair value on a recurring basis as of December 31, 2010 and 2009, respectively. Level 3 liabilities represented approximately 78% and 99% of total liabilities measured at fair value on a recurring basis as of December 31, 2010 and 2009, respectively. Refer to “Note 7: Fair Value of Financial Instruments” in the Notes to Consolidated Financial Statements for additional information about assets and liabilities classified as Level 3.
Deferred income taxes are recorded with respect to the temporary differences between the tax bases of assets and liabilities and the reported amounts in the Company’s financial statements that will result in deductible or taxable amounts in future years when the reported amounts of assets and liabilities are recovered or settled. Our temporary differences relate principally to unrealized appreciation or depreciation of investments and derivatives, invested asset impairments, premium revenue recognition, deferred acquisition costs, and deferred compensation.
Valuation allowances are established to reduce deferred tax assets to an amount that more likely than not will be realized. Changes in the amount of a valuation allowance are reflected within our provision for income taxes in our statement of operations. Determining whether to establish a valuation allowance and, if so, the amount of the valuation allowance requires management to exercise judgment and make assumptions regarding whether such tax benefits will be realized in future periods. All evidence, both positive and negative, needs to be identified and considered in making this determination. Future realization of the existing deferred tax asset ultimately depends on management’s estimate of the future profitability and existence of sufficient taxable income of appropriate character (for example, ordinary income versus capital gains) within the carry-forward period available under the tax law. In the event that the Company’s estimate of taxable income is less than that required to utilize the full amount of any deferred tax asset, a valuation allowance is established. As of December 31, 2010 and 2009, the Company’s valuation allowance included in its deferred tax asset was $376 million and $490 million, respectively, and primarily related to realized losses on sales of investments being carried forward as capital losses and impairments of certain assets characterized as capital losses.
revenues was principally due to a $769 million net loss on insured derivatives in 2010 compared with a $1.5 billion net gain in 2009. The net loss and net gain in 2010 and 2009, respectively, principally resulted from changes in the market perception of MBIA Corp.’s credit risk. The net loss in 2010 principally reflected a tightening of the Company’s credit spreads and an improvement in the Company’s recovery rate while the net gain in 2009 principally reflected a widening of the Company’s credit spreads and a reduction in the Company’s recovery rate. Consolidated expenses for the year ended December 31, 2010 were $989 million compared with $1.7 billion for the same period of 2009. The decrease in our consolidated expenses principally reflects a reduction in loss and LAE incurred on our financial guarantee RMBS exposure, a decrease in interest expense resulting from a reduction in outstanding debt within our asset/liability products program, and overall lower operating and policy acquisition expenses.
For the year ended December 31, 2009, our consolidated net income of $623 million or $2.99 per share, after adjusting for preferred stock dividends of MBIA Insurance Corporation, increased compared with a net loss of $2.7 billion or $12.11 per share for 2008. Weighted average shares outstanding totaled 208 million for the year ended December 31, 2009, down 6% from 2008 as a result of repurchases of common stock by the Company. Consolidated revenues for the year ended December 31, 2009 were $3.0 billion compared with a loss of $856 million for 2008. The increase in our consolidated revenues principally reflects net gains on insured derivatives, an increase in insurance fees, and lower realized losses from the sale of securities and other-than-temporary impairments, partially offset by a reduction in net investment income. Consolidated expenses for the year ended December 31, 2009 were $1.7 billion compared with $2.9 billion for 2008. The decrease in our consolidated expenses was primarily due to a decline in interest expense as a result of a reduction in outstanding debt within our wind-down operations and a reduction in losses and LAE incurred on our RMBS exposure.
The following table presents our consolidated adjusted pre-tax income (a non-GAAP measure) and provides a reconciliation of adjusted pre-tax income to GAAP pre-tax income for the years ended December 31, 2010, 2009 and 2008:
For the year ended December 31, 2009 consolidated adjusted pre-tax income was a loss of $877 million compared with a loss of $2.9 billion for the same period of 2008. Total revenues for the year ended December 31, 2009 were $1.6 billion compared with $1.4 billion for the same period of 2008. The increase in total revenues was principally due to gains on financial instruments at fair value and foreign exchange and lower realized losses on other-than-temporary impairments, partially offset by reductions in net investment income and gains on extinguishment of debt. Total expenses for the year ended December 31, 2009 were $2.4 billion compared with $4.4 billion for 2008. The decrease in total expenses is principally due to lower insurance losses and a decline in interest expense as a result of a reduction in outstanding debt within our wind-down operations.
As of December 31, 2010, ABV per share (a non-GAAP measure) was $36.81, down 5% from $38.94 as of December 31, 2009. The decrease in ABV per share was primarily driven by an increase in impairments on insured credit derivatives. The following table provides a reconciliation of consolidated book value per share to consolidated ABV per share:
Our U.S. public finance insurance business is 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, insured obligations when due or, in the event National has the right at its discretion to accelerate insured obligations upon default or otherwise, upon National’s acceleration. National’s guarantees insure municipal bonds, including tax-exempt and taxable indebtedness of U.S. political subdivisions, as well as utility districts, airports, health care institutions, higher educational facilities, student loan issuers, housing authorities and other similar agencies and obligations issued by private entities that finance projects that serve a substantial public purpose. Municipal bonds and privately issued bonds used for the financing of public purpose projects are generally supported by taxes, assessments, fees or tariffs related to the use of these projects, lease payments or other similar types of revenue streams.
For the years ended December 31, 2010 and 2009, we did not write a meaningful amount of U.S. public finance insurance. The lack of insurance writings in the U.S. public finance segment reflects the insurance financial strength credit ratings assigned to National, and the impact of litigation over the formation of National in 2009. We do not expect to write a material amount of new business prior to an upgrade of our insurance financial strength ratings and market acceptance that such ratings will be stable in the future. The timing of any such upgrade is uncertain and will depend on a variety of quantitative and qualitative factors used by the rating agencies in their evaluation, including the resolution of pending litigation. We believe that we will resume writing business in the U.S. public finance market before actively re-engaging in the structured finance and international markets.
Total U.S. public finance gross par outstanding rated A or above, before giving effect to MBIA’s guarantee, was 90% as of December 31, 2010 and 2009. As of December 31, 2010 and 2009, gross par outstanding rated below investment grade was less than 1%.
FEES AND REIMBURSEMENTS For the year ended December 31, 2010, fees and reimbursements increased to $22 million from $15 million for the same period of 2009. The increase was primarily due to rental income earned from our affiliates related to their occupancy of the Armonk facility and an increase in waiver and consent fees related to the ongoing maintenance of our insured portfolio. Due to the transaction-specific nature inherent in fees and reimbursements, these revenues can vary significantly period to period.
The following tables present information about our U.S. public finance insurance reserves and recoverables as of December 31, 2010 and 2009, as well as our related loss and LAE provision for the years ended December 31, 2010 and 2009:
For the year ended December 31, 2010, losses and LAE incurred of $73 million primarily related to three housing transactions, two student loan transactions, a not-for-profit transaction and a health care transaction. For the year ended December 31, 2009, losses and LAE incurred of $94 million primarily related to a housing transaction and a student loan transaction.
POLICY ACQUISITION COSTS AND OPERATING EXPENSES U.S. public finance insurance segment expenses for the years ended December 31, 2010 and 2009 are presented in the following table:
The following table presents the adjusted pre-tax income of our U.S. public finance insurance segment, and a reconciliation of adjusted pre-tax income to GAAP pre-tax income for the years ended December 31, 2010 and 2009:
Structured Finance and International Insurance (Comparison of Years Ended December 31, 2010 and 2009)
MBIA Corp.’s guarantees insure structured finance and asset-backed obligations, privately issued bonds used for the financing of public purpose projects, which are primarily located outside of the U.S. and that include toll roads, bridges, airports, public transportation facilities, utilities and other types of infrastructure projects serving a substantial public purpose, and obligations of sovereign and sub-sovereign issuers. Structured finance and asset-backed securities (“ABS”) typically are securities repayable from expected cash flows generated by a specified pool of assets, such as residential and commercial mortgages, insurance policies, consumer loans, corporate loans and bonds, trade and export receivables, leases for equipment, aircraft and real property.
In certain cases, we may be required to consolidate entities established as part of securitizations when we insure the assets or liabilities of those entities and in connection with remediations or renegotiations of insurance policies. These entities typically meet the definition of a VIE under accounting principles for the consolidation of VIEs. We do not believe there is any difference in the risks and profitability of financial guarantees provided to VIEs compared with other financial guarantees written by us. Refer to “Note 3: Recent Accounting Pronouncements” in the Notes to Consolidated Financial Statements for information on accounting guidance that affected the consolidation of VIEs.
For the years ended December 31, 2010 and, 2009, we did not write a meaningful amount of structured finance and international insurance. Activity was largely limited to our structuring and reinsurance of a financing transaction for the State of Mexico, which closed in the third quarter of 2010. The lack of insurance writings in our structured finance and international insurance segment reflects the impact of the downgrades of MBIA Corp.’s insurance financial strength ratings by the major rating agencies, which occurred in 2008 and 2009. The Company does not expect to write a material amount of new business prior to an upgrade of the insurance financial strength ratings of MBIA Corp. and market acceptance that such ratings will be stable in the future. The timing of any such upgrade is uncertain and will depend on a variety of quantitative and qualitative factors used by the rating agencies in their evaluation, including the resolution of pending litigation.
(1)-Includes gross par outstanding of $18.1 billion and $1.7 billion related to our consolidated VIEs as of December 31, 2010 and 2009, respectively.
As of December 31, 2010, total structured finance and international gross par outstanding rated A or above, before giving effect to MBIA’s guarantee, was 60% compared with 70% as of December 31, 2009. Additionally, as of December 31, 2010 and 2009, 18% and 15%, respectively, of gross par outstanding was rated below investment grade. Adverse changes in the ratings of our structured finance and international insured gross par outstanding were principally a result of ratings downgrades on CDO and commercial mortgage securitizations.
NET PREMIUMS EARNED Net premiums earned on non-derivative financial guarantees for the years ended December 31, 2010 and 2009 are presented in the following table. Net premiums earned represent gross premiums earned net of premiums ceded to reinsurers, and include scheduled premium earnings and premium earnings from refunded issues.
For the year ended December 31, 2010 structured finance and international net premiums earned were $251 million compared with $333 million for the same period in 2009. The decrease was due to the maturity and termination of insured transactions with no new material insurance writings. Additionally, 2009 benefited from $45 million of premiums earned related to the termination of MBIA’s remaining Eurotunnel exposure.
Investment asset balances at amortized cost as of December 31, 2010 and 2009 are presented in the following table:
FEES AND REIMBURSEMENTS For the year ended December 31, 2010, fees and reimbursements were $204 million compared with $234 million for the same period of 2009. The decrease was primarily due to a reduction in ceding commission revenue associated with the cession of public finance policies to National. Due to the transaction-specific nature inherent in fees and reimbursements, these revenues can vary significantly period to period.
The Company no longer insures new credit derivative contracts except in transactions related to the restructuring or reduction of existing derivative exposure. As a result, premiums earned related to insured credit derivatives will decrease over time as exposure to such transactions declines. Realized losses on insured derivatives for the year ended December 31, 2010 primarily resulted from $890 million of settlement and claim payments made on multi-sector CDO and CMBS transactions, partially offset by $607 million of payments received from Channel Re in connection with the commutation of ceded derivative exposure. Realized losses on insured derivatives for the year ended December 31, 2009 resulted from the settlement of three CDO transactions and claim payments related to a multi-sector CDO transaction.
For the year ended December 31, 2010, unrealized losses on insured derivatives were principally the result of the effects of MBIA’s nonperformance risk on its derivative liability, which resulted from a tightening of its own credit
As of December 31, 2010, we had $99.5 billion of gross par outstanding on insured credit derivatives compared with $126.7 billion as of December 31, 2009. The decrease in gross par outstanding was primarily due to contractual terminations and maturities. During the year ended December 31, 2010, 46 insured credit derivative transactions, representing $21.2 billion in gross par outstanding, have either matured or were contractually settled prior to maturity.
Since our insured credit derivatives have similar terms, conditions, risks, and economic profiles to our financial guarantee insurance policies, we evaluate them for impairment periodically in the same way that we estimate loss and LAE for our financial guarantee policies. Credit impairments on insured derivatives represent the present values of our estimates of expected future claim payments for such transactions using a discount rate of 5.93%, the same rate used to calculate our statutory loss reserves as of December 31, 2010. We estimate that additional credit impairments on insured derivatives for the year ended December 31, 2010 were $1.2 billion across 35 CDO insured issues. Beginning with the fourth quarter of 2007 through December 31, 2010, total credit impairments on insured derivatives were estimated at $3.7 billion across 38 CDO insured issues, inclusive of 33 CDO insured issues for which we made settlement and claim payments of $1.3 billion, net of reinsurance and collections. Accordingly, we expect to realize additional net losses of $2.4 billion.
Our estimate of credit impairments, a non-GAAP measure, may differ from the fair values recorded in our financial statements. Although the Company’s income statement includes the fair values, the Company regards the changes in credit impairment estimates as critical information for investors since the credit impairment estimates reflect the present values of amounts it expects to pay in claims net of recoveries with respect to insured credit derivatives. The fair value of an insured derivative contract will be influenced by a variety of market and transaction-specific factors that may be unrelated to potential future claim payments. In the absence of credit impairments or the termination of derivatives at losses, the cumulative unrealized losses recorded from fair valuing insured derivatives should reverse before or at the maturity of the contracts. Contracts also may be settled prior to maturity at amounts that may be more or less than their recorded fair values. Those settlements can result in realized gains or losses, and will result in the reversal of unrealized gains or losses. The Company is not required to post collateral to counterparties of these contracts.
REVENUES OF CONSOLIDATED VIEs For the year ended December 31, 2010, total revenues of consolidated VIEs were $247 million compared with a loss of $58 million for the same period of 2009. Fluctuations in revenues of consolidated VIEs were principally driven by gains and losses on financial instruments recorded at fair value and foreign exchange, as well as other-than-temporary impairments of VIE assets. For the year ended December 31, 2010, net gains on financial instruments at fair value and foreign exchange were $270 million compared with $10 million for the same period of 2009. The net gains in 2010 resulted from the extrapolation of RMBS put-back recoveries within our consolidated VIEs, most of which were consolidated in the first quarter of 2010. Losses related to other-than-temporary impairments were $93 million in 2009 with no comparable impairments in the same period of 2010.
LOSSES AND LOSS ADJUSTMENT EXPENSES MBIA’s insured portfolio management group within its structured finance and international insurance business is responsible for monitoring structured finance and international insured issues. The level and frequency of monitoring of any insured issue depends on the type, size, rating and performance of the insured issue. If we identify concerns with respect to the performance of an insured issue we may designate such insured issue as “Caution List-Low,” “Caution List-Medium,” “Caution List-High,” or “Classified” depending on the likelihood of a loss.
The following amounts included within this “Losses and Loss Adjustment Expenses” section exclude realized and unrealized gains and losses and estimated credit impairments on insured credit derivatives. Refer to the “Net Change in Fair Value of Insured Derivatives” section included herein for additional information about payments we have made or expect to make under insured credit derivative transactions.
The following tables present information about our insurance reserves and recoverables as of December 31, 2010 and 2009, as well as our loss and LAE provision for the years ended December 31, 2010 and 2009:
Losses and LAE incurred in our structured finance and international insurance segment totaled $159 million in 2010. Included in the $159 million was $883 million of gross losses related to actual and expected future payments, of which $659 million related to insured RMBS transactions. Offsetting these losses were increases in recoveries of actual and expected payments of $712 million, of which $656 million related to insured RMBS transactions, and reinsurance of $12 million. The $656 million of RMBS recoveries of actual and expected payments consisted of $609 million in actual and expected recoveries resulting from ineligible mortgage loans included in insured second-lien residential mortgage and alternative A-paper (“Alt-A”) securitization exposures that are subject to contractual obligations by sellers/servicers to repurchase or replace such mortgage loans and $47 million related to excess interest cash flows within the securitizations.
Losses and LAE incurred in our structured finance and international insurance segment totaled $770 million in 2009. Included in the $770 million were gross losses related to actual and expected future payments of $3.1 billion, of which $2.9 billion related to insured RMBS transactions. Offsetting these losses were recoveries of actual and expected payments of $2.3 billion, primarily related to our RMBS transactions, and reinsurance of $46 million. The $2.3 billion of RMBS recoveries of actual and expected payments was comprised of $1.6 billion related to estimates of potential recoveries resulting from ineligible mortgage loans included in insured second-lien residential mortgage and Alt-A securitization exposures that are subject to contractual obligations by sellers/servicers to repurchase or replace such mortgage loans and $684 million related to excess interest cash flows within the securitizations.
For the year ended December 31, 2010, losses and LAE incurred included the elimination of $79 million of losses as a result of consolidating VIEs. The $79 million elimination included gross losses related to actual and expected future payments of $1.1 billion, offset by recoveries of actual and expected payments of $1.0 billion.
Included in the Company’s case basis reserves are both loss reserves for insured obligations for which a payment default has occurred and MBIA Corp. has already paid a claim and also for which a payment default has not yet occurred but a claim is expected in the future. As of December 31, 2010, case basis reserves consisted of the following:
MBIA reports expected potential recoveries of paid claims within “Insurance loss recoverable” and the corresponding estimated recovery amounts due to reinsurers within “Other liabilities” in the Company’s consolidated balance sheets. As of December 31, 2010 and 2009, our insurance loss recoverables were $2.5 billion and $2.4 billion, respectively. The increase in our insurance loss recoverable principally resulted from an increase in expected potential recoveries resulting from the aforementioned obligations of the sellers/servicers of RMBS transactions to repurchase ineligible loans, partially offset by a reclassification of $356 million in recoveries from “Insurance loss recoverable” to “Loan repurchase commitments” and the elimination of excess spread of $238 million, both resulting from the adoption of the amended accounting guidance for the consolidation of VIEs. As of December 31, 2010 and 2009, our insurance loss recoverable also included recoveries of approximately $674 million and $906 million, respectively, from expected excess interest in RMBS securitizations. Insurance loss recoverables due to reinsurers totaled $1 million and $45 million as of December 31, 2010 and 2009, respectively. Insurance loss recoverables are only paid to reinsurers upon receipt of such amounts by MBIA.
MBIA Corp. also insures MBS backed by subprime mortgage loans directly through RMBS securitizations. MBIA Corp. also has indirect exposure to subprime mortgages that are included in CDOs in which MBIA Corp. guaranteed the senior most tranche of such transactions. There has been considerable stress and continued deterioration in the subprime mortgage market since 2008 reflected by increased delinquencies and losses, particularly related to subprime mortgage loans originated during 2005, 2006 and 2007. As of December 31, 2010, the Company had $3.0 billion of net par outstanding from direct exposure to subprime mortgages and $1.6 billion of indirect exposure to subprime mortgages in the form of collateral within CDOs compared with $3.7 billion and $4.9 billion, respectively, as of December 31, 2009. As of December 31, 2010, $1.4 billion of the $1.6 of indirect exposure was related to CDOs executed in derivative form. As of December 31, 2009, $4.4 billion of the $4.9 billion of indirect exposure was related to CDOs executed in derivative form. While subprime transactions directly guaranteed by MBIA Corp. include collateral consisting of mortgages originated during 2005, 2006, and 2007, given the amount of subordination below MBIA Corp.’s insured portion of such transactions available to
absorb any losses from collateral defaults, we currently do not expect material ultimate losses on these transactions. As of December 31, 2010, the Company had $309 million of net par outstanding in four insured direct subprime mortgage transactions with 2005, 2006, or 2007 subprime mortgage collateral appearing on the Company’s Classified List or Caution Lists. As of December 31, 2010, we expect losses of $94 million (on a present value basis) on fourteen secondary market multi-sector CDOs with net par outstanding of $440 million that include subprime mortgage exposure and that were reported on our Classified List. Additionally, there were ten secondary market multi-sector CDOs with net par outstanding of $216 million that included subprime mortgage exposure and that were reported on our Caution Lists.
The following table presents the net par outstanding of MBIA Corp.’s total direct RMBS insured exposure, including those issues that have been placed in a surveillance category, as of December 31, 2010 by S&P credit rating category. Amounts include the net par outstanding related to transactions that the Company consolidates under accounting guidance for VIEs.
As of December 31, 2010, the net par outstanding on insured RMBS transactions included in the preceding table was $6.7 billion compared with $12.0 billion as of December 31, 2009. As of December 31, 2010 we expect to pay an additional $1.2 billion (on a present value basis) on these transactions. We expect to receive a total of $1.1 billion (on a present value basis) in reimbursement of past and future expected claims through excess spread in these transactions. Of this amount, $674 million is included in “Insurance loss recoverable” and $438 million is included in “Loss and loss adjustment expense reserves.” In addition, we expect to receive $1.7 billion (on a present value basis) in respect of the sellers’/servicers’ obligation to repurchase ineligible loans and that amount is included in “Insurance loss recoverable”.
As of December 31, 2010, the net par outstanding on the insured RMBS transactions included in the preceding table was $3.1 billion. As of December 31, 2010 we expect to pay an additional $238 million (on a present value basis) on these transactions. We expect to receive a total of $292 million (on a present value basis) in reimbursement of past and future expected claims through excess spread in these transactions. In addition, we expect to receive $835 million (on a present value basis) in respect to the sellers’/servicers’ obligation to repurchase ineligible loans and that amount is included in “Loan repurchase commitments”.
Since the second half of 2007, we have observed an increase in delinquencies in our insured RMBS transactions, which peaked in January 2009, and a greater than expected level of losses being realized. The largest single contributor to our losses appears to be the failure of most of the individual mortgage loans in many of our insured transactions to comply with the underwriting guidelines represented to us at origination. These breaches, combined with inadequate servicer performance and relatively few successful loan modifications, led to loss and LAE expense related to our residential mortgage exposures. The majority of expected recoveries from RMBS transactions recorded since 2009 arose from a forensic review of defaulted mortgage loans in 32 insured issues containing first and second-lien mortgage loan securitizations. The representations and warranties in each insured RMBS securitization contractually obligate the seller to cure the contractual breach, replace the loans or repurchase the ineligible loans at a price equal to their outstanding principal balance plus accrued interest or to replace them with eligible mortgage loans. While the Company believes that these mortgage loans are subject to repurchase or replacement obligations by the sellers/servicers, successful challenges of such determinations by the sellers/servicers could result in the Company recovering less than the amount of its estimated recoveries. We continued to review mortgage loans in our insured transactions during 2010 to identify ineligible loans which the
Since September 2008, MBIA Corp. initiated litigation against multiple mortgage loan sellers/servicers alleging, among other things, that such sellers/servicers made material misrepresentations concerning the quality of loans made by these sellers/servicers, which were included in a number of MBIA Corp.-insured second-lien residential mortgage securitizations. In particular, complaints in these actions allege that a very high proportion of the defaulted loans in these securitizations were ineligible for inclusion and thus reflect breaches of the originators’ representations with respect to such loans. In addition, the complaints allege that the sellers/servicers have failed to honor their contractual obligations regarding loan repurchases and ongoing servicing practices. For more information on these and other lawsuits commenced by MBIA Corp., refer to “Note 24: Commitments and Contingencies” in the Notes to Consolidated Financial Statements.
We have recorded put-back recoveries for amounts paid on all RMBS transactions included in the above table with the exception of two issues with original par insured of $695 million, net par outstanding of $146 million, and net claims paid since inception of $405 million. There is one issue excluded from the above table for which a forensic review has been performed, but the issue has not been placed on our “Classified List” and we have not made a claim payment.
We may seek to purchase, from time to time, directly or indirectly, obligations guaranteed by MBIA or seek to commute policies where such actions are intended to reduce future expected economic losses. The amount of insurance exposure reduced, if any, and the nature of any such actions will depend on market conditions, pricing levels from time to time, and other considerations. In some cases, these activities may result in a reduction of expected loss reserves, but in all cases they are intended to limit our ultimate losses and reduce the future volatility in loss development on the related policies.
Gross expenses represent total insurance expenses before the deferral of any policy acquisition costs. Gross expenses decreased for the year ended December 31, 2010 compared with the same period of 2009 due to reductions in compensation and other administrative expenses resulting from the transfer of employees to Optinuity Alliance Resources Corp. (“Optinuity”), the service company that we established in the first quarter of 2010.
The decrease in the amortization of deferred acquisition costs for the year ended December 31, 2010 compared with the same period of 2009 was consistent with the decrease in the amortization of the related unearned premium revenue. Operating expenses decreased for the year ended December 31, 2010 compared with the same period of 2009 as a result of the decrease in gross expenses. We did not defer a material amount of policy acquisition costs during 2010 or 2009. Policy acquisition costs in these periods were related to premium taxes and assessments on installment policies written in prior periods.
INTEREST EXPENSE Interest expense incurred by our structured finance and international insurance segment primarily consists of interest related to MBIA Corp.’s surplus notes. For the years ended December 31, 2010 and 2009, interest expense related to MBIA Corp.’s surplus notes was $134 million.
structured finance and international insurance segment. Adjusted pre-tax income is not a substitute for pre-tax income determined in accordance with U.S. GAAP, and our definition of adjusted pre-tax income may differ from that used by other companies.
The following table presents the adjusted pre-tax income of our structured finance and international insurance segment, and a reconciliation of adjusted pre-tax income to GAAP pre-tax income for the years ended December 31, 2010 and 2009:
In the first quarter of 2009 we separated our insurance operations into two segments: U.S. public finance insurance and structured finance and international insurance. However, in order to provide a basis of comparison for the years ended December 31, 2009 and 2008, we have combined the results of our U.S. public finance insurance and structured finance and international insurance segments in the discussions that follow. Where practical, we have provided information about the year ended December 31, 2008 separately for our U.S. public finance insurance segment and our structured finance and international insurance segment. Additionally, the results presented in this section include revenues and expenses from transactions with our advisory services, corporate operations and wind-down operations.
In 2009, U.S. public finance net premiums earned of $563 million increased $57 million or 11% compared with 2008. The increase was attributable to an increase in scheduled premiums earned of $137 million related to premium earnings on policies assumed from Financial Guaranty Insurance Company (“FGIC”) in 2008. This increase was partially offset by a decrease in refunding activity of $80 million compared with 2008. The decrease is consistent with the overall decline in refundings experienced in the municipal market during 2009.
INVESTMENT INCOME In 2009, our combined insurance pre-tax net investment income decreased 17% to $438 million from $528 million in 2008. The decrease in pre-tax net investment income reflects a decline in average invested assets as a result of loss payments made in 2009.
For the year ended December 31, 2009, our U.S. public finance insurance investment portfolio generated $217 million of pre-tax net investment income, excluding net realized gains and losses. Invested assets in this segment were principally funded by capital contributions to National and the assumption of U.S. public finance premiums from MBIA Corp., including those premiums assigned under the reinsurance agreement with FGIC on February 17, 2009. Additionally, National entered into simultaneous repurchase and reverse repurchase agreements with our asset/liability products segment, which provides yield enhancement to our U.S. public finance insurance investment portfolio as a result of increased net interest earnings from these collective agreements. As of December 31, 2009, the notional amount utilized under these agreements was $1.7 billion.
FEES AND REIMBURSEMENTS For the year ended December 31, 2009, combined insurance fees and reimbursements were $113 million compared with $9 million for the same period of 2008. The increase in fees and reimbursements was primarily due to the receipt of amounts in excess of those which were contractually due to MBIA upon the termination of certain reinsurance agreements, totaling $85 million, advisory fees of $7 million on a Latin American infrastructure transaction, and an increase in waiver and consent fees related to the ongoing management of our structured finance and international insurance business.
NET CHANGE IN FAIR VALUE OF INSURED DERIVATIVES As of December 31, 2009, we had $119.2 billion of net par outstanding on insured derivatives compared with $140.3 billion as of December 31, 2008. During the year ended December 31, 2009, 23 insured credit derivative transactions, representing $15.2 billion in net par outstanding, either matured or were contractually terminated prior to maturity. The following table presents the net premiums earned related to insured derivatives and the components of the net change in fair value of insured derivatives for the years ended December 31, 2009 and 2008:
Realized losses on insured derivatives for the year ended December 31, 2009 resulted from the settlement of three CDO transactions and loss payments related to a multi-sector CDO transactions. Realized losses on insured derivatives for the year ended December 31, 2008 resulted from the settlement of all or a portion of four multi-sector CDO transactions. Settlements in 2009 were $159 million for $1.3 billion of par outstanding compared with settlements in 2008 of $558 million for $2.7 billion of par outstanding.
Unrealized gains on insured derivatives for the year ended December 31, 2009 were $1.7 billion compared with unrealized losses in 2008 of $1.8 billion. Unrealized gains in 2009 were primarily related to changes in MBIA’s CDS and recovery swaps pricing, narrower collateral spreads, and transaction terminations, partially offset by losses resulting from enhancements to our valuation models and inputs, subordination erosion, lower estimated
recovery rates on collateral and collateral rating migration. The main enhancements to our valuation models and inputs were the development of a direct pricing model for multi-sector CDOs, assumptions about ABS collateral defaults, the calculation of nonperformance risk for CDOs, and the refinement of a spread model for CMBS transactions. Enhancements to our valuation models and inputs are discussed further in the “Critical Accounting Estimates” section included herein. Unrealized losses for the year ended December 31, 2008 were primarily due to spread widening, and to a lesser extent, subordination erosion, collateral rating migration and lower recovery rates. This was significantly offset by the deterioration in MBIA’s CDS spreads. For example, MBIA’s five year CDS spread as of December 31, 2007 was 3.41% per annum. As of December 31, 2008, the cost of the CDS was 46.5% upfront plus 5% per annum; and as of December 31, 2009, MBIA Corp.’s five year CDS cost was 64.25% upfront plus 5% per annum. Our mark-to-market on insured credit derivatives as of year end 2009 uses the most appropriate of the one to ten year CDS for each transaction, and those costs ranged from 17.5% upfront plus 5% per annum to 64.25% upfront plus 5% per annum.
Credit impairments on insured derivatives, a non-GAAP measure, represent the present values of our estimates of expected future claim payments for such transactions using a discount rate of 6.51%. We estimated that additional credit impairments on insured derivatives for the year ended December 31, 2009 were $777 million across 13 CDO transactions. Beginning with the fourth quarter of 2007 through December 31, 2009, total credit impairments on insured derivatives were estimated at $2.5 billion across 16 CDO transactions, inclusive of eight CDO transactions for which we made settlement and claim payments of $838 million, net of reinsurance and collections.
NET GAINS AND LOSSES ON FINANCIAL INSTRUMENTS AT FAIR VALUE AND FOREIGN EXCHANGE Combined insurance net gains and losses on financial instruments at fair value and foreign exchange represent net gains and losses from the sale of investments, including foreign exchange gains and losses, the translation of non-functional currency balances into U.S. dollars, and the fair valuing of financial instruments. For the year ended December 31, 2009, net gains on financial instruments at fair value and foreign exchange were $83 million compared with $185 million in 2008. Net gains for the year ended December 31, 2009 were primarily generated from sales of investment securities within both of our insurance segments’ portfolios, as well as net foreign exchange gains generated by our structured finance and international insurance segment. Net gains for the year ended December 31, 2008 were largely due to gains resulting from the change in value of a credit facility of $250 million, which was terminated in the fourth quarter of 2008. Gains on this facility were due to an increase in the differential between the Company’s CDS spreads and the yield applicable to the facility.
REVENUES OF CONSOLIDATED VIEs For the year ended December 31, 2009, total revenues of consolidated VIEs were a loss of $58 million compared with income of $56 million for the same period of 2008. The decrease in revenues of consolidated VIEs was principally driven by other-than-temporary impairments of VIE assets, as well as other net realized losses, partially offset by net investment income. For the year ended December 31, 2009, losses related to other-than-temporary impairments were $93 million with no comparable impairments in the same period of 2008. Other net realized losses were $41 million for the year ended December 31, 2009 and related to impairment charges on an international infrastructure transaction with no comparable losses in the same period of 2008. Net investment income for the year ended December 31, 2009 was $66 million compared with $56 million for the same period of 2008. The increase in net investment income resulted from consolidating additional VIEs in 2009.
LOSSES AND LOSS ADJUSTMENT EXPENSES The following table presents information about our loss and LAE provision for the years ended December 31, 2009 and 2008:
As of December 31, 2009 and 2008, our loss and LAE reserves totaled $1.6 billion and our insurance loss recoverables totaled $2.4 billion and $459 million, respectively. The increase in our insurance loss recoverable principally resulted from $1.4 billion in expected potential recoveries resulting from the aforementioned obligations of the sellers/servicers of RMBS transactions to repurchase ineligible loans. As of December 31, 2009 and 2008, our insurance loss recoverable also included recoveries of approximately $906 million and $331 million, respectively, based on expected excess interest in RMBS securitizations. As of December 31, 2009 and 2008, insurance loss recoverables due to reinsurers totaled $46 million and $13 million, respectively.
As of December 31, 2009, we had paid a cumulative total of $3.8 billion, net of reinsurance and collections, on RMBS transactions and have case basis reserves of $1.2 billion. The case basis reserves represent the present value of the difference between cash payments we expected to make on the insured transactions and the cash receipts we expected from the performing mortgages in the securitizations, reduced by potential recoveries from sellers/servicers.
EXPENSE OF CONSOLIDATED VIEs For the year ended December 31, 2009, total expenses of consolidated VIEs were $87 million compared with $56 million for the same period of 2008. The increase in expenses was primarily due to interest expense associated with additional VIEs consolidated in 2009.
As part of our structured finance and international insurance activities, MBIA Corp. typically provided guarantees on senior and mezzanine tranches of CDOs, as well as protection on structured pools of CMBS and corporate securities, and CDS referencing such securities. The following discussion, including reported amounts and percentages, includes insured CDO transactions consolidated by the Company as VIEs.
(1)-Includes one multi-sector CDO-Squared transaction with gross par of $0.2 billion as of December 31, 2010.
Our multi-sector CDOs, as well as certain other insured CDO transactions, benefit from two sources of credit enhancement in that we are subject to a claim to the extent (i) the subordination in the underlying securities collateralizing MBIA Corp.’s insured tranche (“Underlying Collateral Subordination”) is fully eroded and (ii) the subordination below MBIA Corp.’s insured tranche in the CDO transaction (“Insured Tranche Subordination”) is fully eroded. MBIA Corp.’s payment obligations after a default vary by deal and by insurance type. There are currently two policy payment types: (i) where MBIA Corp. insures current interest and ultimate principal; and (ii) where MBIA Corp. insures payments upon settlement of individual collateral losses as they occur after the complete erosion of deal deductibles (referred to as “Asset Coverage with a Deductible”).
Our gross par of insured investment grade corporate CDOs includes $16.5 billion that was typically structured to include buckets (typically 30%-35% of the overall CDO) of references to specific tranches of other investment grade corporate CDOs (monotranches). In such transactions, MBIA Corp.’s insured investment grade corporate CDOs include, among direct corporate or structured credit reference risks, a monotranche or single layer of credit risk referencing a diverse pool of corporate assets or obligors with a specific attachment and a specific detachment point. The referenced monotranches in such CDOs are typically rated double-A and each referenced monotranche was typically sized to approximately 3% of the overall reference risk pool. The inner referenced monotranches are not typically subject to acceleration and do not give control rights to a senior investor. The inner referenced monotranches have experienced Insured Tranche Subordination erosion due to the default of their referenced corporate assets.
Corp.’s obligation attached at a minimum of a triple-A level. The deductible sizing was a function of the underlying collateral ratings and certain structural attributes. MBIA Corp.’s guarantee for most structured CMBS pool transactions covers losses on collateral assets once the deductible has been eroded. These deductibles provide credit enhancement and subordination to MBIA’s insured position.
The collateral in the pools are generally CMBS bonds or CDSs referencing CMBS bonds (collectively, “CMBS bonds”). MBIA Corp.’s guarantee generally is in the form of a CDS referencing the static pooled transactions. MBIA Corp. would have a payment obligation if the volume of CMBS bond defaults exceeds the deductible level in the transaction. Each pool comprising CMBS bonds is backed by commercial mortgage loans. The same CMBS bonds may be referenced in multiple pools. The Company’s structured CMBS pools are static, meaning that the collateral pool of securitizations cannot be and has not been changed since the origination of the policy. Most transactions comprise similarly rated underlying tranches. The deductible for each transaction varies according to the ratings of the underlying collateral. For example, a transaction comprising originally BBB rated underlying CMBS bonds would typically include a 30-35% deductible to MBIA Corp.’s position whereas a transaction comprising all originally AAA rated underlying CMBS bonds would typically require a 5-10% deductible.
The following table presents the collateral as a percentage of the pool balances, as well as the current deductible, as of December 31, 2010 for all MBIA Corp.-insured structured CMBS pool transactions:
par outstanding of $35.9 billion as of December 31, 2010, 50.7% of the underlying CMBS bonds referenced were issued in 2006 and 20.4% were issued in 2007. Of these 2007 vintage CMBS bonds, over 50% were rated AAA at the time they were issued.
The following table presents the vintage and original rating composition of the CMBS collateral in our static CMBS pools.
Our structured CMBS pool portfolio comprises approximately 55,000 loans. The current weighted average debt service coverage ratio (“DSCR”) of underlying mortgages in the CMBS pools is 1.69 based on net operating income derived from the most recent property level financial statements (based on 84% of the properties having provided financial statements from 2009 or a more recent time period) compared to an average DSCR of 1.56 as of December 2009. Although the average DSCR increased, many properties experienced declining financial performance over the past year resulting in the percentage of properties with a DSCR less than 1.0 increasing from under 11% as of December 31, 2009 to nearly 15% as of December 31, 2010. The weighted average loan-to-value ratio was 76% as of December 31, 2010 compared to 71% as of December 31, 2009. The majority of the loans are long-term and fixed-rate in nature. Approximately 17% of the loans will mature within the next three years; however, the weighted average DSCR of these loans is significantly higher at 2.23 based on the latest available financial statements. Eight percent of the loans mature in the next 12 months and these loans have a weighted average DSCR of 2.96. Deal attachment points range from 5% to 86% and underlying bond collateral loss coverage generally ranges from 0% to 30% or higher, both of which are structural factors that were intended to minimize potential losses.
As of December 31, 2010, our gross par exposure to CRE CDOs totaled $7.4 billion and represented approximately 4% of MBIA Corp.’s total gross par insured. CRE CDOs are managed pools of CMBS, CRE whole loans, B-Notes, mezzanine loans, REIT debt, and other securities (including, in some instances, buckets for RMBS and CRE CDOs) that allow for reinvestment during a defined time period. Most of these transactions benefit from typical CDO structural features such as cash diversion triggers, collateral quality tests, and manager replacement provisions. Typically, MBIA Corp. guarantees timely interest and ultimate principal of these CDOs. As with our other insured CDOs, these transactions were generally structured with credit protection originally rated triple-A, or a multiple of triple-A, below our guarantee. As of December 31, 2010, our CRE CDO insured portfolio did not contain any CDOs of ABS exposures. Several of the CRE CDO transactions do contain some RMBS collateral, but overall this comprises less than 5% of the CRE CDO portfolio.
Within our CRE CDO portfolio, we had five transactions with 2006 or 2007 vintages totaling $2.4 billion of gross par outstanding as of December 31, 2010 in which substantially all of the collateral originally comprised BBB or BBB- rated tranches of CMBS. While these transactions were designed to include managed portfolios, trading has been minimal since inception. We have recorded impairments on of $35 million on three CRE CDO transactions.
Reinsurance enables the Company to cede exposure for purposes of syndicating risk and increasing its capacity to write new business while complying with its single risk and credit guidelines. When a reinsurer is downgraded by one or more of the rating agencies, less capital credit is given to MBIA under rating agency models and the overall value of the reinsurance to MBIA is reduced. The Company generally retains the right to reassume the business ceded to reinsurers under certain circumstances, including a reinsurer’s rating downgrade below specified thresholds. In 2010, MBIA reassumed par outstanding of $35.0 billion from two reinsurers, Channel Re and Mitsui Sumitomo Insurance Company, Ltd. As of December 31, 2010, our use of reinsurance was immaterial to our insurance operations and we expect that it will continue to be immaterial in the future.
The following table presents information about our reinsurance agreements as of December 31, 2010 for our U.S. public finance and structured finance and international insurance operations. Estimated credit impairments represent the reinsurers’ portion of amounts we expect to pay on insured derivative contracts.
The following table summarizes the results and assets under management of our advisory services segment for the years ended December 31, 2010, 2009 and 2008. These results include revenues and expenses from transactions with the Company’s insurance, corporate, and wind-down operations.
For the year ended December 31, 2010, the increase in fee revenue compared to the same period of 2009 primarily relates to a change in the fee structure for managing the assets of MBIA. Operating expenses for the year ended December 31, 2010 increased due to expenses associated with Cutwater’s re-branding and reorganization, transfers of employees, and higher allocated expenses from other MBIA units. For the year ended December 31, 2009, the decrease in fee revenue primarily relates to a decrease in asset management fees earned on assets managed for our other segments (principally for our asset/liability products segment), which declined substantially.
Average third-party assets under management for the years ended December 31, 2010, 2009 and 2008 were $26.0 billion, $23.7 billion and $21.9 billion, respectively. The increase in 2009 primarily resulted from increases in municipal pool balances and new separate account and CDO management assignments. As of December 31, 2010, third-party ending assets under management were $25.3 billion, a decrease of $0.1 billion from December 31, 2009 and an increase of $5.0 billion from December 31, 2008. As of December 31, 2010, ending assets under management related to the Company’s other segments were $15.4 billion, decreasing from $16.7 billion as of December 31, 2009 and $23.3 billion as of December 31, 2008 primarily due to declines in assets of our asset/liability products segment.
The Company has issued commitments to three pooled investment programs managed or administered by Cutwater Investor Services Corp. (“Cutwater-ISC”), formerly known as MBIA Municipal Investor Service Corporation, and its subsidiary. These commitments, which are accounted for as derivatives and recorded on the Company’s balance sheet at fair value, cover losses in such programs should the net asset values per share decline below specified per share values. As of December 31, 2010, the maximum amount of payments that the Company would be required to make under these commitments was $4.2 billion. These commitments would be terminated if Cutwater-ISC or its subsidiary was no longer manager or administrator or a program was no longer in compliance with its respective investment objectives and policies. Although the pools hold high-quality short-term investments, there is risk that the Company will be required to make payments or incur a loss under these guarantees in the event of material redemptions by shareholders of the pools and the need to liquidate investments held in the pools. The net unrealized losses on these derivatives were $1 thousand for the year ended December 31, 2010. The Company has purchased, and may in the future purchase, investments at its discretion from the pooled investment programs it manages, whether or not such programs have been guaranteed by the Company.
During the fourth quarter of 2010, the corporate segment made a capital contribution to the asset/liability products segment in the amount of $600 million in settlement of the full outstanding principal balance of the advance made to the asset/liability products segment during the fourth quarter of 2008. As a result, the asset/liability products segment will not make any future payments of principal or interest to the corporate segment under the loan. Interest income on the loan, included in net investment income, approximated $14 million for the year ended December 31, 2010.
Net losses on financial instruments at fair value and foreign exchange for all periods presented are primarily related to changes in the fair value of outstanding warrants issued on MBIA Inc. common stock. These changes were attributable to fluctuations in MBIA Inc.’s stock price and volatility, which are used in the valuation of the warrants.
During 2009 and 2008, we repurchased $47 million and $127 million, respectively, of par value outstanding of corporate debt at a discount to carrying value and recognized net gains of $4 million and $30 million, respectively.
The following tables present the results of our asset/liability products segment for years ended December 31, 2010, 2009 and 2008. These results include revenues and expenses from transactions with the Company’s insurance and corporate operations.
As of December 31, 2010, principal and accrued interest outstanding on investment agreement and MTN obligations and securities sold under agreements to repurchase totaled $4.2 billion compared with $5.5 billion as of December 31, 2009. The decrease in these liabilities resulted from scheduled amortizations and repurchases of MTNs. In addition to investment agreements, MTNs and third-party repurchase agreements, as of December 31, 2010, the segment had a secured loan payable outstanding to MBIA Corp. of $975 million.
Cash and investments supporting the segment’s liabilities, including intercompany liabilities, had market values plus accrued interest of $4.2 billion and $5.3 billion as of December 31, 2010 and December 31, 2009, respectively. These assets comprised securities with an average credit quality rating of A1. Additionally, receivables for securities sold net of payables for securities purchased were $8 million and $37 million as of December 31, 2010 and December 31, 2009, respectively. Refer to the “Liquidity” section included herein for a discussion about the liquidity position of the asset/liability products program.
The following table presents the results of our conduit segment for the years ended December 31, 2010, 2009 and 2008. These results include revenues and expenses from transactions with the Company’s insurance and corporate operations.
For the year ended December 31, 2009, the Company’s effective tax rate applied to our pre-tax income was higher than the statutory tax rate of 35% primarily due to an increase in our valuation allowance.
Refer to “Note 14: Income Taxes” in the Notes to Consolidated Financial Statements for a further discussion of income taxes, including the Company’s Section 382 position, the valuation allowance against deferred tax assets and its accounting for tax uncertainties.
The Company manages its capital resources to minimize its cost of capital while maintaining appropriate claims-paying resources for National and MBIA Corp. The Company’s capital resources consist of total shareholders’ equity, total debt issued by MBIA Inc. for general corporate purposes, and surplus notes issued by MBIA Insurance Corporation. Total capital resources were $4.7 billion and $4.6 billion as of December 31, 2010 and 2009, respectively. MBIA Inc. utilizes its capital resources to support the business activities of its subsidiaries. As of December 31, 2010, MBIA Inc.’s investments in subsidiaries totaled $4.5 billion, and its asset/liability management business had negative shareholder’s equity of $743 million.
Repurchases of debt and/or common stock may be made from time to time in the open market or in private transactions as permitted by securities laws and other legal requirements. We believe that debt and/or share repurchases can be an appropriate deployment of capital in excess of amounts needed to support our liquidity while maintaining the claims-paying resources of MBIA Corp. and National as well as other business needs.
During 2010, MBIA Inc. repurchased 251 shares of the outstanding preferred stock of MBIA Insurance Corporation at a weighted average purchase price of approximately $10,400 per share or 10.4% of the face value. As of December 31, 2010, on a consolidated basis, 1,426 shares of preferred stock of MBIA Insurance Corporation remained outstanding to unaffiliated investors with a carrying value of $14 million.
National reported total statutory capital of $2.4 billion as of December 31, 2010 compared with $2.0 billion as of December 31, 2009. As of December 31, 2010, statutory capital comprised $1.5 billion of contingency reserves and $0.9 billion of policyholders’ surplus. The increase in National’s statutory capital is primarily due to statutory net income of $409 million in 2010. Consistent with our plan to transform our insurance business, the Company received approval from the NYSID to reset National’s unassigned surplus to zero, which was effective January 1, 2010. As of December 31, 2010, National’s unassigned surplus was $318 million. In October 2010, the plaintiffs in the litigation challenging the establishment of National initiated a court proceeding challenging the approval of the surplus reset. Refer to “Legal Proceedings - Transformation Litigation” in Part I, Item 3 of this Form 10-K for a discussion of this action.
National’s statutory policyholders’ surplus was lower than its GAAP shareholder’s equity by $2.2 billion as of December 31, 2010. Statutory accounting principles differ from GAAP in certain respects. For National, the significant differences include the following: contingency reserves are recorded on a statutory basis and not on a GAAP basis; upfront and installment premium revenue are earned under different schedules between U.S. STAT and GAAP; acquisition costs are charged as incurred under U.S. STAT rather than deferred and amortized under GAAP; changes in deferred income tax balances are recognized in surplus under U.S. STAT rather than recognized either in net income or other comprehensive income under GAAP; and “non-admitted assets” are charged directly against surplus under U.S. STAT but are reflected as assets under GAAP.
Claims-paying resources (“CPR”) is a key measure of the resources available to National to pay claims under its insurance policies. CPR consists of total financial resources and reserves calculated on a statutory basis. CPR has been a common measure used by financial guarantee insurance companies to report and compare resources, and continues to be used by MBIA’s management to evaluate changes in such resources. We have provided CPR to allow investors and analysts to evaluate National using the same measure that MBIA’s management uses to evaluate National’s resources to pay claims under its insurance policies. There is no directly comparable GAAP measure.
National’s total CPR as of December 31, 2010 was $5.6 billion compared with $5.5 billion as of December 31, 2009. The increase in CPR is primarily due to an increase in total earned and unearned premiums from the commutation of reinsurance with Channel Re and the impact of net investment income, partially offset by paid losses.
In order to maintain its New York State financial guarantee insurance license, MBIA Corp. is required to maintain a minimum of $65 million of policyholders’ surplus. MBIA Corp.’s policyholders’ surplus was $1.0 billion as of December 31, 2010. MBIA Corp.’s policyholders’ surplus will grow over time from the recognition of unearned premiums and investment income and the expected release of the contingency reserves. In addition, MBIA Corp.’s policyholders’ surplus position could be enhanced by the settlement, commutation or repurchase of insured transactions at prices less than statutory loss reserves. Conversely, incurred losses or an inability to collect on our ineligible loan put-back claims would reduce policyholders’ surplus.
MBIA Corp.’s CPR, and components thereto, as of December 31, 2010 and 2009 are presented in the following table:
MBIA Corp.’s total CPR as of December 31, 2010 was $5.2 billion compared with $6.4 billion as of December 31, 2009. The decrease in CPR is primarily due to loss payments associated with our RMBS securities, commutation payments, and a reduction in expected future premium collections. As of December 31, 2010, loss and LAE reserves are in a receivable position as expected recoveries on our insured RMBS transactions more than offset case basis reserves on the remainder of MBIA Corp.’s insured portfolio.
As part of our liquidity risk management framework, we also seek to evaluate and manage liquidity on both a legal entity basis and a segment basis. Legal entity liquidity is an important consideration as there are legal, regulatory and other limitations on our ability to utilize the liquidity resources within the overall enterprise. We also seek to manage segment liquidity, particularly between our corporate and asset/liability products segments as they relate to MBIA. Unexpected loss payments arising from ineligible mortgage loans in securitizations that we have insured, dislocation in the global financial markets, the overall economic downturn in the U.S., and the loss of our triple-A insurance financial strength ratings in 2008 significantly increased the liquidity needs and decreased the financial flexibility in our segments and legal entities. We continued to satisfy all of our payment obligations and we believe that we have adequate resources to meet our ongoing liquidity needs in both the short-term and the long-term. However, the Company could face additional liquidity pressure in all of its operations and businesses through increased liquidity demands or a decrease in its liquidity supply if (i) loss payments on the Company’s insured transactions were to rise significantly, including due to ineligible mortgage loans in securitizations that we have
Liquidity risk arises in our U.S. public finance insurance segment when claims on insured exposures result in payment obligations, when operating cash inflows fall due to depressed new business writings, lower investment income, or unanticipated expenses, or when invested assets experience credit defaults or significant declines in fair value.
In the event of a default in payment of principal, interest or other insured amounts by an issuer, however, National generally promises to make funds available in the insured amount generally on the next business day following notification. National provides for this payment, in some cases through a third-party bank, upon receipt of proof of ownership of the obligations due, as well as upon receipt of instruments appointing the insurer as agent for the holders and evidencing the assignment of the rights of the holders with respect to the payments made by the insurer.
Defaults, credit impairments and adverse capital market conditions such as we are currently experiencing, can create payment requirements as a result of our irrevocable pledges to pay principal and interest, or other amounts owing on insured obligations, when due. Additionally, our U.S. public finance insurance segment requires cash for the payment of operating expenses. Finally, National also provides liquid assets to our asset/liability products segment through matched repurchase and reverse repurchase agreements to support its business operations and liquidity position, as described below.
Since the fourth quarter of 2007 through December 31, 2010, MBIA Corp. has made $7.6 billion of cash payments, before reinsurance and collections and including payments made to debt holders of consolidated VIEs, associated with RMBS securitizations and commutations and claim payments relating to CDS contracts referencing CDO-squared, multi-sector CDOs, CMBS pools and CRE CDOs. These cash payments include loss payments of $461 million made in 2010 on behalf of MBIA Corp.’s consolidated VIEs. The total gross insured exposure associated with the commuted insured obligations was $24.7 billion and related to ABS CDOs, CRE CDOs, CMBS pools and high yield corporate CDOs. In MBIA Corp.’s outstanding insured portfolio, these types of insured exposures have exhibited the highest degree of payment volatility and continue to pose material liquidity risk to MBIA Corp. As a result of the placement of ineligible loans in RMBS securitizations and current economic stress, MBIA Corp. could incur additional payment obligations beyond these mortgage-related exposures, which may be substantial, increasing the stress on its liquidity position.
Of the $7.6 billion, MBIA Corp. has paid $5.5 billion of claims on policies insuring second-lien RMBS securitizations. We believe these payments were driven primarily by an overwhelming number of ineligible mortgage loans being placed in the securitizations in breach of the representations and warranties of the sellers/servicers. As a result, payments have been far in excess of the level that might be expected in an economic downturn. As a result of the unprecedented and unexpected mortgage loan defaults driven by placement of ineligible loans in RMBS securitizations, MBIA could incur payment obligations beyond its current estimate. MBIA is seeking to enforce its rights to have mortgage sellers/servicers cure, replace or repurchase ineligible loans from securitizations and has recorded a total of $2.5 billion of related recoveries on its statutory balance sheet. These recoveries are being pursued through litigation discussed more fully in “Note 24: Commitments and Contingencies” in the Notes to Consolidated Financial Statements.
The Company believes the current liquidity position of MBIA Corp. is adequate to make expected future payments on its RMBS exposures, but the degree of loss within these transactions has been unprecedented, and continued elevated levels of payments would cause additional stress on MBIA’s liquidity position.
In order to monitor liquidity risk and maintain appropriate liquidity resources for payments associated with our residential mortgage-related exposures, MBIA employs a stress scenario-based liquidity model using the same “Roll Rate Methodology” as described in “Note 6: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements. Using this methodology, the Company estimates the level of payments that would be required to be made under stress-level default assumptions of the underlying collateral taking into account MBIA’s obligation to cover such defaults under our insurance policies. These estimated payments, together with all other significant operating, financing and investing cash flows are forecasted on a monthly basis for a period covering (i) the next 24-months and (ii) then annually thereafter to the final maturity of the longest dated outstanding insured obligation. The stress-loss scenarios and cash flow forecasts are periodically updated to account for changes in risk factors and to reconcile differences between forecasted and actual payments.
The Company manages the liquidity of its structured finance and international insurance segment with the goal of maintaining cash and liquid securities in an amount in excess of all projected stress scenario payment requirements. To the extent our projected liquidity resources fall short of our target liquidity cushions under the stress-loss scenario testing in the future, the Company will seek to increase its cash holdings position by selling or financing assets in its investment portfolio or drawing upon one or more of its contingent sources of liquidity. The Company’s contingent liquidity sources may include cash, investments, other assets owned by its various regulated and unregulated subsidiaries, and capital markets access. Access to this contingent liquidity by a particular legal entity generally involves the transfer and/or sale of such assets and the need for regulatory or third party approvals prior to their transfer and/or sale and are, therefore, contingent on the receipt of such approvals, among other things. There can be no assurance that such approvals will be received.
As of December 31, 2010, MBIA Corp. had unencumbered cash and available-for-sale investments of $2.4 billion, of which $1.2 billion comprised cash and highly liquid assets of MBIA Insurance Corporation (without regard to its investments in its subsidiaries). The $1.2 billion of cash and highly liquid assets include the benefit of cash and highly liquid assets received from the acquisition of Channel Re in the third quarter of 2010. Additionally, in aggregate, we believe the Company’s remaining contingent sources of liquidity accessible within one to three months totaled approximately $228 million as of December 31, 2010. We believe that MBIA Corp.’s liquidity resources will adequately provide for anticipated cash outflows.
Liquidity needs in our corporate segment are generally predictable and primarily relate to certain activities of MBIA Inc., such as principal and interest payments on corporate debt and operating expenses. In addition to MBIA Inc.’s corporate liquidity needs, it issued investment agreements and MTNs reported within the Company’s asset/liability products segment, all of which are currently collateralized by high-quality liquid investments. Refer to the “Asset/Liability Products Liquidity” section below for a detailed discussion of the liquidity risks associated with that business.
As of December 31, 2010, the corporate activities of MBIA Inc. had $335 million of cash and highly liquid assets available for general corporate liquidity purposes. Existing cash and expected cash flows to the corporate segment are anticipated to be sufficient to cover cash needs through 2014 even if no further dividends are received from insurance, asset management or advisory subsidiaries. In December 2010, MBIA Inc. submitted a refund claim for $41 million related to the carry back of its additional 2009 NOL. The refund was received in January 2011. In addition, the Company expects a $4.5 million refund from the State of New York as a result of filing its 2009 New York State franchise tax return. As of December 31, 2010, corporate debt of MBIA Inc. totaled $971 million, which primarily matures in 2022 through 2034, and the annual interest payments associated with this debt prior to 2022 are approximately $55 million.
The Company’s corporate debt, investment agreements, MTNs, and derivatives may be accelerated by the holders of such instruments upon the occurrence of certain events, such as a breach of covenant or representation, a bankruptcy of MBIA Inc. or the filing of an insolvency proceeding in respect to MBIA Corp. MBIA Inc.’s obligations under its loans from GFL may only be accelerated upon the occurrence of a bankruptcy or liquidation of MBIA Inc. Refer to “Note 15: Business Segments” in the Notes to Consolidated Financial Statements for a description of the GFL loans. In the event of any acceleration of the Company’s obligations, including under its corporate debt, investment agreements, MTNs, or derivatives, the Company likely would not have sufficient liquid resources to pay amounts due with respect to its corporate debt and other obligations.
The Company has also issued commitments to three pooled investment programs managed or administered by Cutwater-ISC and its subsidiary. As of December 31, 2010, these commitments had a notional amount of $4.2 billion. Although the pooled investment programs hold high-quality short-term investments, there is risk that the Company will be required to make payments or incur a loss under these guarantees in the event of material redemptions by shareholders of the pools and the need to liquidate investments held in the pools. Refer to the “Results of Operations-Advisory Services” section included herein for a description of the pooled investment programs.
Under New York State insurance law, without prior approval of the Superintendent of the NYSID, financial guarantee insurance companies can pay dividends from earned surplus subject to retaining a minimum capital requirement. The payment of regular dividends in any 12-month period is limited to the lesser of (i) 10% of policyholders’ surplus as reported in the latest filed statutory financial statements and (ii) 100% of adjusted net investment income. MBIA Corp. is currently unable to pay dividends, including dividends on its preferred stock, due to earned surplus deficits per its statutory financial statement filing as of December 31, 2010.
During 2010, as a result of a review of its ongoing capitalization needs, Cutwater declared and paid cash dividends of $19 million to MBIA Inc. In the future, we expect that Cutwater will be able to pay dividends to the holding company out of its retained earnings, although there can be no assurance that it will have adequate profitability or that dividends will be paid.
Our asset/liability products segment is subject to material liquidity risk. Cash needs in the asset/liability products segment are primarily for the payment of principal and interest on investment agreements and MTNs, and for posting collateral under repurchase agreements, derivatives and investment agreements, as well as for the payment of operating expenses. The primary sources of cash within the asset/liability products segment used to meet its liquidity needs include scheduled principal and interest on assets held in the segment’s investment portfolio and unencumbered assets, including cash held within the wind-down operations that is not required for posting against any of its liabilities. If needed, assets held within the segment can be sold or used in secured repurchase agreement borrowings to raise cash. However, our ability to sell assets or borrow against non-U.S. government securities in the fixed-income markets decreased dramatically and the cost of such transactions increased dramatically over the last two years due to the impact of the credit crisis on the willingness of investors to purchase or lend against even very high-quality assets. In addition, negative net interest spread between asset and liability positions resulted from the need to hold cash as collateral against terminable investment agreement contracts and reduced the cash flow historically provided by net investment income.
During the fourth quarter of 2010, the corporate segment made a capital contribution to the asset/liability products segment in the amount of $600 million in settlement of the full outstanding principal balance of the advance made to the segment during the fourth quarter of 2008. Between the fourth quarter of 2008 and the fourth quarter of 2010, we believed that debt repurchases by the asset/liability products segment would enable the segment to eliminate its book value equity deficit and generate excess net assets to repay the $600 million loan. As of December 31, 2010, we do not expect sufficient gains from debt repurchases to repay the loan. As a result, the asset/liability products segment will not make any future payments of principal or interest to the corporate segment under the loan. Other liquidity support outstanding as of December 31, 2010 included a secured loan between MBIA Inc. and MBIA Corp. for up to $2.0 billion, under which $975 million was outstanding as of December 31, 2010 and a repurchase agreement between the asset/liability products segment (through MBIA Inc.) and the conduit segment (through Meridian) for up to $1 billion, under which $50 million was
As of December 31, 2010, the asset/liability products segment held $781 million in cash and short-term investments of which $239 million was free cash not pledged as collateral against its liabilities.
well as cash recognized in the consolidation of VIEs. In 2009, net cash provided by investing activities resulted from sales of securities for purposes of funding investment agreement withdrawals and terminations, MTN maturities and repurchases, and improving liquidity in our business segments.
Triple-A One, an MBIA-administered multi-seller conduit consolidated in the Company’s conduit segment, historically issued commercial paper to fund assets, which were insured by MBIA Corp. Triple-A One also maintained backstop liquidity facilities covering 100% of the face amount of commercial paper outstanding. During 2008, conditions in the asset-backed commercial paper market deteriorated making it increasingly difficult for Triple-A One to issue new commercial paper at commercially acceptable rates to repay maturing obligations. Accordingly, Triple-A One borrowed under its liquidity facilities to repay maturing commercial paper. MBIA Corp.’s obligations under the financial guarantee policies issued by MBIA Corp. to insure the assets of Triple-A One cannot be accelerated to repay borrowings under the liquidity facilities and these policies only guarantee ultimate payments over time relating to the assets. By September 2008, these facilities were drawn in full and Triple-A One ceased issuing commercial paper. As of December 31, 2010, borrowings under liquidity facilities totaled $360 million and will be repaid as the assets purchased by Triple-A One mature.
Our available-for-sale investments comprise high-quality fixed-income securities and short-term investments. As of December 31, 2010 and 2009 the fair value of our consolidated available-for-sale investments was $11.9 billion and $12.8 billion, respectively, as presented in the following table. Additionally, consolidated cash and cash equivalents as of December 31, 2010 and 2009 were $366 million and $803 million, respectively.
The carrying value of our consolidated investment portfolio was $11.9 billion and $12.8 billion as of December 31, 2010 and 2009, respectively.
As of December 31, 2010, the weighted average credit quality of the Company’s available-for-sale investment portfolios, excluding short-term and other investments, as presented in the preceding table are as follows:
As of December 31, 2010, based on the actual or estimated underlying ratings of our consolidated investment portfolio, without giving effect to financial guarantees, the weighted average rating of the consolidated investment portfolio would be in the Aa range, the weighted average rating of only the Insured Investments in the investment portfolio would be in the Baa range, and 6% of the total investment portfolio would be rated below investment grade.
In purchasing Insured Investments, the Company independently assesses the underlying credit quality, structure and liquidity of each investment, in addition to the creditworthiness of the insurer. Insured Investments are diverse by sector, issuer and size of holding. The Company assigns underlying ratings to its Insured Investments without giving effect to financial guarantees based on underlying ratings assigned by Moody’s, or another external agency, when a rating is not published by Moody’s. When an external underlying rating is not available, the underlying rating is based on the Company’s best estimate of the rating of such investment. A downgrade of a financial guarantee insurer will likely have an adverse affect on the fair value of investments insured by the downgraded financial guarantee insurer. If MBIA determines that declines in the fair values of Insured Investments are other-than-temporary, the Company will record a realized loss through earnings.
Without giving effect to the MBIA guarantee of the Company-Insured Investments in the consolidated investment portfolio, as of December 31, 2010, based on actual or estimated underlying ratings, the weighted average rating of the consolidated investment portfolio was in the Aa range, the weighted average rating of only the Company-Insured Investments was in the Baa range, and 4% of the Company-Insured Investment portfolio was rated below investment grade.
As part of our assessment of other-than-temporary impairments of investments, we consider (i) the magnitude and duration of decline in fair value, (ii) the reason for the decline in fair value, and (iii) whether we have the intent to sell the securities or more likely than not will be required to sell the securities before their anticipated recovery. In calculating credit-related losses, we utilize cash flow modeling based on the type of security. Our cash flow analysis considers all sources of cash, including credit enhancement, that support the payment of amounts owed by an issuer of a security. This includes the consideration of cash expected to be provided by financial guarantors, including MBIA Corp., resulting from an actual or potential insurance policy claim.
The following table summarizes the Company’s future estimated cash payments relating to contractual obligations as of December 31, 2010. Estimating these payments requires management to make estimates and assumptions regarding these obligations. The estimates and assumptions used by management are described below. Since these estimates and assumptions are subjective, actual payments in future periods may vary from those reported in the following table. Refer to “Note 16: Insurance In Force” in the Notes to Consolidated Financial Statements for information about the Company’s exposure under insurance contracts.
Gross insurance claim obligations represent the future value of probability-weighted payments MBIA expects to make (before estimated recoveries, 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). 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 sheet. Insured derivatives are recorded at fair value and reported within “Derivative liabilities” on the Company’s consolidated balance sheet. Estimated potential claim payments on obligations issued by VIEs consolidated in our structured finance and international 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, 2010, VIE notes issued by issuer-sponsored consolidated VIEs totaled $9.5 billion, including $6.7 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.
Interest rate sensitivity can be estimated by projecting a hypothetical instantaneous increase or decrease in interest rates. The following table presents the estimated pre-tax change in fair value of the Company’s financial instruments as of December 31, 2010 from instantaneous shifts in interest rates.
MBIA issued insurance policies insuring payments due on structured credit derivative contracts and directly entered into credit derivative contracts, which are marked-to-market through earnings under the accounting principles for derivatives and hedging activities. All these transactions were insured by the Company’s structured finance and international insurance operations. The majority of these structured CDSs related to structured finance transactions with underlying reference obligations of cash securities and CDSs referencing liabilities of corporations or of other structured finance securitizations. The asset classes of the underlying reference obligations included corporate, asset-backed, residential mortgage-backed and commercial mortgage-backed securities. These transactions were usually underwritten at or above a triple-A credit rating level. As of December 31, 2010, approximately 21% of the tranches insured by the Company were rated triple-A. Additionally, MBIA’s wind-down operations enter into single-name CDSs as part of its asset management activities. In 2010,
the value of the Company’s credit derivative contracts was affected predominantly by the effect of the Company’s own credit risk on the portfolio. As risk factors change, the values of credit derivative contracts will change and the resulting gains or losses will be recorded within net income.
In 2010, the Company has observed a tightening of its own credit spreads. As changes in fair value can be caused by factors unrelated to the performance of MBIA’s business and credit portfolio, including general market conditions and perceptions of credit risk, as well as market use of credit derivatives for hedging purposes unrelated to the specific referenced credits in addition to events that affect particular credit derivative exposures, the application of fair value accounting will cause the Company’s earnings to be more volatile than would be suggested by the underlying performance of MBIA’s business operations and credit portfolio.
Sensitivity to changes in credit spreads can be estimated by projecting a hypothetical instantaneous shift in credit spread curves. The following table presents the estimated pre-tax change in fair value and the cumulative estimated net fair value of the Company’s credit derivatives portfolio of instantaneous shifts in credit spreads as of December 31, 2010. In scenarios where credit spreads decreased, a floor of zero was used. Refer to “Note 7: Fair Value of Financial Instruments” in the Notes to Consolidated Financial Statements for further information about the Company’s financial assets and liabilities that are accounted for at fair value, including valuation techniques and disclosures required by GAAP.
Actual shifts in credit spread curves will vary based on the credit quality of the underlying reference obligations. In general, within any asset class, higher credit rated reference obligations will exhibit less credit spread movement than lower credit rated reference obligations. Additionally, the degree of credit spread movement can vary significantly for different asset classes. The basis point change presented in the preceding table, however, represents a fixed basis point change in referenced obligation credit spreads across all credit quality rating categories and asset classes and, therefore, the actual impact of spread changes would vary from this presentation depending on the credit rating and distribution across asset classes, both of which will adjust over time depending on new business written and runoff of the existing portfolio.
Since the Company is now using collateral prices as an input into the new Direct Price Model for certain multi-sector insured CDOs, a sensitivity analysis below shows the estimated pre-tax change in fair value and the cumulative estimated net fair value of the Company’s insurance credit derivatives portfolio of a 10% and 20% change in collateral prices as of December 31, 2010.
Recovery rates on defaulted collateral are an input into the Company’s valuation model. Sensitivity to changes in the recovery rate assumptions used by the Company can be estimated by projecting a hypothetical change in these assumptions. The following table presents the estimated pre-tax change in fair value and the cumulative estimated net fair value of the Company’s insurance credit derivatives portfolio of a 10% and 20% change in the recovery rate assumptions as of December 31, 2010. Refer to “Note 7: Fair Value of Financial Instruments” in the Notes to Consolidated Financial Statements for further information about the Company’s financial assets and liabilities that are accounted for at fair value, including valuation techniques and disclosures required by GAAP.
With the inclusion of the MBIA recovery rate in the calculation of nonperformance risk for insured CDS liabilities, the following sensitivity analysis shows the change in fair value of insured CDS liabilities due to changes in that recovery rate. The values we are showing below reflect the approximate trading range of the MBIA recovery rate in the last few months.
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of changes in shareholders’ equity and of cash flows present fairly, in all material respects, the financial position of MBIA Inc. and its subsidiaries (the “Company”) as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010 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, 2010, based on criteria established in Internal Control-Integrated Framework 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.
The Company has been unable to write meaningful amounts of new insurance business since 2008 and does not expect to write significant new business prior to an upgrade of its credit ratings. As of December 31, 2010, National was rated BBB with a developing outlook by Standard & Poor’s Financial Services LLC (“S&P”) and Baa1 with a developing outlook by Moody’s Investors Service, Inc. (“Moody’s”). As of December 31, 2010, MBIA Insurance Corporation was rated B with a negative outlook by S&P and B3 with a negative outlook by Moody’s.
The Company has been actively responding to these developments. In 2007 and 2008, it raised $3.0 billion in debt and equity capital to support MBIA Corp. and the asset/liability products segment. In 2008, MBIA was one of the first market participants to recognize the inappropriate underwriting and breaches of representations and warranties in the second-lien mortgage origination and securitization sector and commenced enforcement actions against sellers/servicers who did not honor their contractual obligations to repurchase or replace ineligible loans. As of December 31, 2010, the Company had recorded loan put-back recovery assets of $2.5 billion. The Company also focused on its asset management business and grew third-party assets under management in its fee-for-service asset management advisory business. Additionally, in 2008 and 2009, the Company pursued and received approval from the New York State Insurance Department (“NYSID”) to separate MBIA Corp. into two insurance companies, MBIA Corp. and National, to meet the market’s demand for municipal bond insurance from municipal-only companies. The NYSID and the Company are both vigorously defending litigation seeking to challenge the NYSID’s decision.
Since 2008, the Company has sought to reduce both the absolute amount and the volatility of its liabilities and contingent liabilities through repurchases of securities and commutations of insurance policies. In the period 2008 through 2010, the Company undertook actions to mitigate the declines in the liquidity of MBIA Corp. and the asset/liability products segment through reinsurance commutations, inter-company lending arrangements and the monetization of illiquid assets. The impact of these actions has been to mitigate statutory capital erosion and
preserve liquidity in those two businesses, and to reduce volatility. MBIA Corp. ended 2010 with $1.2 billion in liquid assets after claim payments and commutations of insured derivatives, versus $1.1 billion at year-end 2009. The Company also reduced its use of reinsurance during this period. At the same time, the U.S. economy has grown for the past six quarters, the pace of increase in delinquencies in troubled real estate sectors has declined, and asset values have begun to improve.
The Company’s financial statements include estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses. The outcome of certain significant risks and uncertainties could cause the Company to revise its estimates and assumptions or could cause actual results to differ from the Company’s estimates. Significant risks and uncertainties that could affect amounts reported in the Company’s financial statements in future periods include, but are not limited to, the following:
If the economy weakens, commercial real estate values decline and commercial real estate servicer behavior does not continue to mitigate potential or actual credit losses in line with current trends, MBIA could incur substantial additional losses in that sector. As of December 31, 2010, MBIA Corp. had CMBS pool and commercial real estate (“CRE”) collateralized debt obligation (“CDO”) insured par exposure of approximately $35.9 billion and $7.4 billion, respectively, and during 2010, MBIA Corp. increased its statutory loss reserves related to those exposures by $1.1 billion and $35 million, respectively. Refer to “Note 6: Loss and Loss Adjustment Expense Reserves” for information about the Company’s estimate of CMBS credit impairments.
While incurred losses from insured residential mortgage-backed securities (“RMBS”) have declined from their peaks, they could ultimately be in excess of the Company’s current estimated loss reserves. Refer to “Note 6: Loss and Loss Adjustment Expense Reserves” for information about the Company’s RMBS loss reserves.
While the Company has settled a substantial part of its insured ABS CDO exposure at levels within MBIA Corp.’s statutory loss reserves related to those exposures, further economic stress might cause increases in the Company’s loss estimates.
MBIA Corp.’s efforts to recover losses from the second-lien securitization originators could be delayed, settled at amounts below its contractual claims (approximately $4.4 billion as of December 31, 2010), or potentially settled at amounts below those recorded on its balance sheets (approximately $2.5 billion as of December 31, 2010) prepared under statutory accounting principles and accounting principles generally accepted in the United States of America (“GAAP”). Refer to “Note 6: Loss and Loss Adjustment Expense Reserves” for information about the Company’s RMBS loss recoveries.
Currently, the Company’s asset/liability products segment has a deficit of cash, investments and other liquid assets at amortized cost to debt issued to third-parties and affiliates at amortized cost of approximately $330 million, but is expected to have positive cash flows through 2012. The Company expects to actively manage this business to reduce that deficit.
The Company’s recent financial results have been volatile, which has impacted management’s ability to accurately project future taxable income. Insurance losses incurred beyond those currently projected may cause the Company to record allowances against some or all of its deferred tax assets, which totaled $908 million as of December 31, 2010. Refer to “Note 14: Income Taxes” for information about the Company’s deferred tax assets.
Litigation over the NYSID’s approval of National’s creation or additional hurdles to achieving high stable ratings may impede National’s ability to resume writing municipal bond insurance for some time, reducing its long-term ability to generate capital and cash from operations. Also, municipal and state fiscal distress could adversely affect the Company’s operations if they result in larger than expected incurred insurance losses.
In the event the economy and the markets to which MBIA is exposed do not improve, or decline, the unrealized losses on insured credit derivatives could increase, causing additional stress in the
Company’s reported financial results. In addition, volatility in the relationship between MBIA’s credit spreads and those on underlying collateral assets of insured credit derivatives can create significant unrealized gains and losses in the Company’s reported results of operations. Refer to “Note 7: Fair Value of Financial Instruments” for information about the Company’s valuation of insured credit derivatives.
While the Company believes it continues to have sufficient capital and liquidity to meet all of its obligations for the foreseeable future, if one or more possible adverse outcomes were to be realized, its statutory capital, financial position, results of operations and cash flows could be materially and adversely affected. Statutory capital, defined under statutory accounting principles as policyholders’ surplus and contingency reserves, is a key measure of an insurance company’s financial condition under insurance laws and regulations. Failure to maintain adequate levels of statutory surplus and total statutory capital could lead to intervention by the Company’s insurance regulators in its operations and constitute an event of default under certain of the Company’s contracts, thereby materially and adversely affecting the Company’s financial condition and results of operations.
MBIA’s U.S. public finance insurance business is conducted through National. National has not written any meaningful amount of business since its formation in 2009, and as of December 31, 2010 had insured gross par outstanding of $482.7 billion and statutory capital of $2.4 billion. 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, insured obligations when due or, in the event National has the right at its discretion to accelerate insured obligations upon default or otherwise, upon National’s acceleration. National’s guarantees insure municipal bonds, including tax-exempt and taxable indebtedness of U.S. political subdivisions, as well as utility districts, airports, health care institutions, higher educational facilities, student loan issuers, housing authorities and other similar agencies and obligations issued by private entities that finance projects that serve a substantial public purpose. Municipal bonds and privately issued bonds used for the financing of public purpose projects are generally supported by taxes, assessments, fees or tariffs related to the use of these projects, lease payments or other similar types of revenue streams.
securities (“ABS”) typically are securities repayable from expected cash flows generated by a specified pool of assets, such as residential and commercial mortgages, insurance policies, consumer loans, corporate loans and bonds, trade and export receivables, leases for equipment, aircraft and real property. Since the beginning of the economic downturn in 2008, the collateral underlying many of MBIA Corp.’s insured structured finance transactions has experienced diminished value and financial stress. Although the Company’s current reserves represent its best estimate of losses that it incurred to date, there is a possibility such losses could increase significantly. A material increase in losses in the Company’s structured finance insured portfolio could have a material adverse effect on MBIA Corp.’s statutory capital, financial condition, cash flows, and results of operations.
In 2010, the accounting guidance for the consolidation of variable interest entities (“VIEs”) was amended and the Company was required to consolidate certain entities that are designed as VIEs where MBIA has contractual rights under insurance policies to direct the activities of the VIE when performance and other triggers were breached. The Company does not believe there is any difference in the risks and profitability of financial guarantees provided to VIEs compared with other financial guarantees written by MBIA. Refer to “Note 3: Recent Accounting Pronouncements” for information on accounting guidance that affected the consolidation of VIEs.
The Company has instituted a liquidity risk management framework, the primary objective of which is to monitor potential liquidity constraints in its asset and liability portfolios and guide the proactive matching of liquidity resources to needs. The Company’s liquidity risk management framework seeks to monitor the Company’s cash and liquid asset resources using stress-scenario testing. Members of MBIA’s senior management meet regularly to review liquidity metrics, discuss contingency plans and establish target liquidity cushions on an enterprise-wide basis.
Liquidity risk arises in the Company’s structured finance and international insurance segment when claims on insured exposures result in payment obligations, when operating cash inflows fall due to depressed new business writings, when investment income decreases, when unanticipated expenses arise, or when invested assets experience credit defaults or significant declines in fair value.
The reference herein to “ineligible” mortgage loans refers to those mortgages that the Company believes failed to comply with the representations and warranties made by the sellers/servicers of the securitizations to which those mortgages were sold with respect to such mortgages, including failure to comply with the related underwriting criteria, based on the Company’s assessment, which included information provided by third-party review firms, of such mortgages’ compliance with such representations and warranties. The Company’s assessment of the ineligibility of individual mortgages could be challenged/disputed by the sellers/servicers of the securitizations in litigation and there is no assurance that the Company’s determinations will prevail.
As in the U.S. public finance business, the structured finance and international insurance segment’s financial guarantee contracts and CDS contracts generally cannot be accelerated, thereby mitigating liquidity risk. However, with respect to the insurance of CDS contracts, in certain events, including the insolvency or payment default of the insurer or the issuer of the CDS, the CDS contract may be subject to termination by the counterparty, triggering a claim for the fair value of the contract. Further, in the event of a default in payment of principal, interest or other insured amounts by an insured issuer, MBIA’s structured finance and international insurance companies generally promise to make funds available in the insured amount generally on the next business day following notification for U.S. transactions and within longer timeframes for international transactions, depending on the terms of the insurance policy. MBIA’s structured finance and international insurance companies provide for this payment, in some cases through a third-party bank, upon receipt of proof of ownership of the obligations due, as well as upon receipt of instruments appointing the insurer as agent for the holders and evidencing the assignment of the rights of the holders with respect to the payments made by the insurer or other appropriate documentation.
Additionally, the Company’s structured finance and international insurance segment requires cash for the payment of operating expenses, as well as principal and interest related to its surplus notes. MBIA Corp. also provides guarantees to the holders of the Company’s asset/liability products debt obligations. If the Company’s asset/liability products segment or MBIA Inc. were unable to service the principal and interest payments on its debt and investment agreements, the holders of the insured liabilities would make a claim under the MBIA Corp. insurance policies. Finally, in 2008, MBIA Corp. lent $2.0 billion to the asset/liability products segment on a secured basis for the purpose of minimizing the risk that such a claim would be made. The loan matures in the fourth quarter of 2011. During 2010, a total of $625 million was repaid and the amount outstanding was $975 million as of December 31, 2010.
The Company manages the liquidity of its structured finance and international insurance segment with the goal of maintaining cash and liquid securities in an amount in excess of all projected stress scenario payment requirements. To the extent the Company’s projected liquidity resources fall short of its target liquidity cushions under the stress-loss scenario testing in the future, the Company will seek to increase its cash holdings position by selling or financing assets in its investment portfolio or drawing upon one or more of its contingent sources of liquidity. The Company’s contingent liquidity sources may include cash, investments, other assets owned by its various regulated and unregulated subsidiaries, and capital markets access. Access to this contingent liquidity by a particular legal entity generally involves the transfer and/or sale of such assets and the need for regulatory or third-party approvals prior to their transfer and/or sale and are, therefore, contingent on the receipt of such approvals, among other things. There can be no assurance that such approvals will be received.
Certain amounts have been reclassified in prior years’ financial statements to conform to the current presentation. This includes the reclassification of gains and losses from sales of investment securities to “Net gains (losses) on financial instruments at fair value and foreign exchange” from the previously reported line “Net realized gains (losses)” on the Company’s consolidated statements of operations. Such reclassification of gains and losses from sales of investment securities had no impact on total revenues, expenses, assets, liabilities, or stockholders’ equity for all periods presented.
VIEs are entities that lack one or more of the characteristics of a voting interest entity. The consolidation of a VIE is required if an entity has a variable interest (such as an equity or debt investment, a beneficial interest, a guarantee, a written put option or a similar obligation) and that variable interest or interests give it a controlling financial interest in the VIE. A controlling financial interest is present when an enterprise has both (a) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance, and (b) the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. The enterprise with the controlling financial interest, known as the primary beneficiary, is required to consolidate the VIE. The Company consolidates all VIEs in which it is the primary beneficiary. Refer to “Note 4: Variable Interest Entities” for additional information.
Fixed-maturity securities at fair value include all fixed-maturity securities held by the Company for which changes in fair values are reflected in earnings. These include securities designated as trading securities, as well as those fixed maturity securities for which the Company has elected to record at fair value. 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”. Any interest income and amortization of premiums or accretion of discounts are reflected in earnings as part of net investment income. Refer to “Note 7: Fair Value of Financial Instruments” for additional disclosures related to securities for which the Company has elected the fair value option.
The Company’s investment portfolios are reviewed no less than quarterly in order to determine whether a credit loss exists. The majority of the Company’s investments are available-for-sale securities for which an impairment evaluation is subject to, but not limited by, the following criteria:
1) The security’s current fair value is less than current amortized cost by a magnitude of 5% or greater, and the fair value has been less than amortized cost for a period of greater than twelve months; or
If either of the above criteria are met, further analysis is performed to determine whether a credit loss exists. In assessing whether a decline in value is related to a credit loss, the Company considers several factors, including but not limited to (a) the magnitude and duration of the decline, (b) credit indicators and the reasons for the decline, such as general interest rate or credit spread movements, credit rating downgrades, issuer-specific changes in credit spreads, and the financial condition of the issuer, and (c) any guarantees associated with a security such as those provided by financial guarantee insurance companies. Credit loss expectations for ABS and CDOs are assessed using discounted cash flow modeling, and the recoverability of amortized cost for corporate obligations is generally assessed using issuer-specific credit analyses.
Under certain non-insurance derivative contracts entered into by the Company, collateral postings are required by either MBIA or the counterparty. The Company reports cash received or posted in its consolidated statements of cash flows as either operating, investing or financing consistent with the classification of the asset or liability that created the posting requirement.
Goodwill represents the excess of the cost of acquiring a business enterprise over the fair value of the net assets acquired. Goodwill is tested for impairment at least annually. An impairment loss is triggered if the estimated fair value of a reporting unit is less than its carrying value. Any loss is calculated as the difference between the implied fair value and carrying value of goodwill. Refer to “Note 13: Goodwill” for an explanation of the Company’s annual impairment test.
Property and equipment consists of land, buildings, leasehold improvements, furniture, fixtures and computer equipment and software. All property and equipment is recorded at cost and, except for land, is depreciated over the appropriate useful life of the asset using the straight-line method. Leasehold improvements are amortized
over the useful life of the improvement or the remaining term of the lease, whichever is shorter. The cost and related accumulated depreciation applicable to assets sold or retired are removed from the accounts and any gain or loss on disposition is recognized as a component of “Other net realized gains (losses).” Maintenance and repairs are charged to current earnings as incurred.
MBIA has entered into derivative transactions as an additional form of financial guarantee and for purposes of hedging risks associated with existing assets and liabilities. All derivative instruments are recognized at fair value on the balance sheet as either assets or liabilities depending on the rights or obligations under the contract. The recognition of changes in the fair value of a derivative within the statement of operations will depend on the intended use of the derivative. If the derivative does not qualify as part of a hedging relationship or is not designated as such, the gain or loss on the derivative is recognized in the statement of operations as net gains (losses) on financial instruments at fair value and foreign exchange or change in fair value of insured derivatives, depending on the nature of the derivative.
The nature of the Company’s business activities requires the management of various financial and market risks, including those related to changes in interest rates and foreign currency exchange rates. The Company uses derivative instruments to mitigate or eliminate certain of those risks. The Company has designated derivatives as fair value hedges.
A fair value hedge represents the hedging of an exposure to changes in the fair value of an asset or a liability. For a derivative to be accounted for as a fair value hedge, it must be highly effective in achieving offsetting changes in fair value attributable to the hedged risk during the period that the hedge is designated. The Company tests all fair value hedges at least quarterly to ensure that they are highly effective. The Company considers a hedge to be highly effective if the changes in the fair value of the derivative provide offset of at least 80% and not more than 125% of the changes in fair value of the hedged item. For derivatives that qualify as fair value hedges, the gain or loss on the hedging instrument is recognized in earnings and the gain or loss on the hedged item attributable to the hedged risk shall adjust the carrying amount of the hedged item and be recognized currently in earnings. Any portion of the total change in fair value of the hedging instrument that is ineffective in offsetting designated changes in the fair value of the hedged item are recognized in earnings as net gains (losses) on financial instruments at fair value and foreign exchange. The Company does not have a material amount of derivatives classified as cash flow hedges.
Certain of the Company’s financial guarantees that meet the definition of a derivative are subject to a financial guarantee scope exception, as defined by the accounting guidance for derivative instruments and hedging activities. This scope exception provides that these financial guarantee contracts are not subject to accounting guidance for derivative instruments and should be accounted for as financial guarantee contracts only if:
Refer to “Note 10: Derivative Instruments” for a further discussion of the Company’s use of derivatives and their impact on the Company’s financial statements and “Note 7: Fair Value of Financial Instruments” for derivative valuation techniques and fair value disclosures.
Level 3-Valuations based on inputs that are unobservable and supported by little or no market activity and that are significant to the overall fair value measurement. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. Assets and liabilities utilizing Level 3 inputs include certain MBS, ABS and CDO securities where observable pricing information was not able to be obtained for a significant portion of the underlying assets; complex OTC derivatives (including certain foreign currency options, long-dated options and swaps, and certain credit derivatives); and insured derivatives that require significant management judgment and estimation in the valuation.
The availability of observable inputs can vary from product to product and period to period and is affected by a wide variety of factors, including, for example, the type of product, whether the product is new and not yet established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation
The Company previously elected to record at fair value certain financial instruments that contained an embedded derivative requiring bifurcation in accordance with the accounting guidance for hybrid financial instruments. These instruments included certain MTNs and certain available-for-sale securities. Management elected to fair value hybrid instruments in those instances where the host contract and the embedded derivative were not separately subject to a hedging relationship.
The Company recognizes claim liabilities (loss reserves) on a contract-by-contract basis when the present value of expected net cash outflows to be paid under the contract discounted using a risk-free rate as of the measurement date exceeds the unearned premium revenue. A claim liability is subsequently remeasured each reporting period for expected increases or decreases due to changes in the likelihood of default and potential recoveries. Subsequent changes to the measurement of the claim liability are recognized as claim expense in the period of change. Measurement and recognition of claim liability is reported gross of any reinsurance. The Company estimates the likelihood of possible claims payments and possible recoveries using probability-weighted expected cash flows based on information available as of the measurement date, including market information. Accretion of the discount on a claim liability is included in claim expense.
The Company’s claim liability, insurance loss recoverable, and accruals for loss adjustment expenses (“LAE”) incurred are disclosed in “Note 6: Loss and Loss Adjustment Expense Reserves.”
The Company recognizes a liability for unearned premium revenue at the inception of financial guarantee insurance and reinsurance contracts on a contract-by-contract basis. Unearned premium revenue recognized at inception of a contract is measured at the present value of the premium due. For most financial guarantee insurance contracts, the Company receives the entire premium due at the inception of the contract, and recognizes unearned premium revenue liability at that time. For certain other financial guarantee contracts, the Company receives premiums in installments over the term of the contract. Unearned premium revenue and a receivable for future premiums is recognized at the inception of an installment contract, and measured at the present value of premiums expected to be collected over the contract period or expected period using a risk-free discount rate. The expected period is used in the present value determination of unearned premium revenue and receivable for future premiums for contracts where (a) the insured obligation is contractually prepayable, (b) prepayments are probable, (c) the amount and timing of prepayments are reasonably estimable, and (d) a homogenous pool of assets is the underlying collateral for the insured obligation. The Company has determined that substantially all of its installment contracts meet the conditions required to be treated as expected period contracts. The receivable for future premiums is reduced as installment premiums are collected. The Company reports the accretion of the discount on installment premiums receivable as premium revenue and discloses the amount recognized in “Note 5: Insurance Premiums.” The Company assesses the receivable for future premiums for collectability each reporting period, adjusts the receivable for uncollectible amounts and recognizes any write-off as operating expense, and discloses the amount recognized in “Note 5: Insurance Premiums.” As premium revenue is recognized, the unearned premium revenue liability is reduced.
In July 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-20, “Receivables (Topic 310)-Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” ASU 2010-20 provides amended disclosure requirements related to certain financing receivables and related allowance for credit losses. The disclosure provisions are effective for the Company for the year ended December 31, 2010. These amended requirements are related only to disclosures, and do not affect the Company’s consolidated balance sheets, results of operations or cash flows. The Company accounts for its insurance premiums receivable in accordance with Accounting Standards Codification (“ASC”) 944, “Financial Guarantee Insurance Contracts.” Refer to “Note 5: Insurance Premiums” for disclosures related to the Company’s receivable for insurance premiums.
Upon the adoption of the accounting guidance, the Company recognized a cumulative transition adjustment of $319 million, net of tax, as a decrease to its beginning retained earnings balance as of January 1, 2010 as a result of consolidated VIEs. The cumulative transition adjustment represents the recognized changes in assets and liabilities resulting from the adoption, including the impact of the fair value option election for certain of the financial assets and liabilities, offset in part by the elimination of intercompany balances with the consolidated VIEs. The Company also recognized a cumulative transition adjustment of $3 million, net of tax, as a decrease to its beginning retained earnings balance as of January 1, 2010, related to the deconsolidation of VIEs as a result of the implementation of this accounting guidance. This adjustment was the result of the deconsolidation of the assets and liabilities of previously consolidated VIEs, offset in part by the recognition of financial interests in these deconsolidated VIEs which were previously eliminated in consolidation.
In December 2009, the FASB issued ASU 2009-16, “Transfers and Servicing (Topic 860)-Accounting for Transfers of Financial Assets,” to eliminate the concept of a qualified special purpose entity. The accounting guidance also clarifies whether a transferor has surrendered control over transferred financial assets and meets the conditions to derecognize transferred financial assets or a portion of an entire financial asset that meets the definition of a participating interest. The accounting guidance requires enhanced disclosures about transfers of financial assets and a transferor’s continuing involvement with transferred financial assets. The Company adopted this standard in the first quarter of 2010. The effects of adoption of this standard are included in the transition adjustment for the adoption of ASU 2009-17.
In May 2008, the FASB issued accounting guidance for financial guarantee insurance and reinsurance contracts effective prospectively as of January 1, 2009. This accounting guidance amends accounting and reporting by insurance enterprises to clarify how existing guidance applies to financial guarantee insurance and reinsurance contracts. The accounting guidance amends the recognition and measurement of premium revenue and claim liabilities, and expands disclosure requirements. Recognition and measurement of unearned premium revenue and receivable for future premiums are also amended. The accounting guidance does not apply to financial guarantee insurance contracts that are derivative instruments included within the scope of derivatives and hedging (ASC 815-15). Refer to “Note 5: Insurance Premiums” for disclosures related to premiums and “Note 6: Loss and Loss Adjustment Expense Reserves” for disclosures related to loss reserves.
In October 2010, the FASB issued ASU 2010-26, “Financial Services - Insurance (Topic 944)-Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts.” This amendment specifies which costs incurred in the acquisition of new and renewal insurance contracts should be capitalized. The new guidance is effective for the Company beginning January 1, 2012 with early adoption as of January 1, 2011 permitted. The Company did not early adopt the guidance as of January 1, 2011. The Company is currently evaluating the potential impact of adopting this guidance as of January 1, 2012.
Through MBIA’s structured finance and international insurance segment, the Company provides credit enhancement services to issuers of obligations that may involve issuer-sponsored special purpose entities (“SPEs”). An SPE may be considered a VIE to the extent the SPE’s total equity at risk is not sufficient to permit the SPE to finance its activities without additional subordinated financial support or its equity investors lack any one of the following characteristics (i) the power to direct the activities of the SPE that most significantly impact the entity’s economic performance, or (ii) the obligation to absorb the expected losses of the entity or the right to receive the expected residual returns of the entity. A holder of a variable interest or interests in a VIE is required to assess whether it has a controlling financial interest, and thus is required to consolidate the entity as primary beneficiary. An assessment of a controlling financial interest identifies the primary beneficiary as the variable interest holder that has both of the following characteristics (i) the power to direct the activities of the VIE that most significantly impact the entity’s economic performance, and (ii) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. The primary beneficiary is required to consolidate the VIE. An ongoing reassessment of controlling financial interest is required to be performed based on any substantive changes in facts and circumstances involving the VIE and its variable interests.
The Company makes its determination for consolidation based on a qualitative assessment of the purpose and design of a VIE, the terms and characteristics of variable interests of an entity, and the risks a VIE is designed to create and pass through to holders of variable interests. The Company generally provides credit protection on obligations issued by VIEs, and holds certain contractual rights according to the purpose and design of a VIE. The Company may have the ability to direct certain activities of a VIE depending on facts and circumstances, including the occurrence of certain contingent events, and these activities may be considered the activities of a VIE that most significantly impact the entity’s economic performance. The Company generally considers its guarantee of principal and interest payments of insured obligations, given nonperformance by a VIE, to be an obligation to absorb losses of the entity that could potentially be significant to the VIE. At the time the Company determines it has the ability to direct the activities of a VIE that most significantly impact the economic performance of the entity based on facts and circumstances, MBIA is deemed to have a controlling financial interest in the VIE and is required to consolidate the entity as primary beneficiary. The Company performs an ongoing reassessment of controlling financial interest that may result in consolidation or deconsolidation of any VIE. Refer to “Note 3: Recent Accounting Pronouncements” for information on the FASB amendment to consolidation of VIEs.
In the conduit segment, the Company manages and administers two multi-seller conduit SPEs (“Conduits”). The Conduits invest primarily in debt securities and fund the investments through the issuance of VIE notes and long-term debt. The liabilities and certain of the assets of the Conduits are supported by credit enhancement provided through MBIA Corp. The Conduits were designed to provide issuers an efficient source of funding for issued obligations, and to provide an opportunity for MBIA Corp. to issue financial guarantee insurance policies. The Conduits are VIEs and are consolidated by the Company as primary beneficiary.
The following tables present the total assets of nonconsolidated VIEs in which the Company holds a variable interest as of December 31, 2010 and 2009. The following tables present the Company’s maximum exposure to loss for nonconsolidated VIEs as well as the value of the assets and liabilities the Company has recorded for its interest in these VIEs as of December 31, 2010 and 2009. 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 and insured CDSs, and any investments in obligations issued by nonconsolidated VIEs.
Holders of insured obligations of issuer-sponsored VIEs related to the Company’s structured finance and international insurance segment do not have recourse to the general assets of MBIA. In the event of nonpayment of an insured obligation issued by a consolidated VIE, the Company is obligated to pay principal and interest, when due, on the respective insured obligation only. The Company’s exposure to consolidated VIEs is limited to the credit protection provided on insured obligations and any additional variable interests held by MBIA. Creditors of the Conduits do not have recourse to the general assets of MBIA apart from the financial guarantee insurance policies provided by MBIA on insured obligations issued by the Conduits.
The Company recognizes and measures premiums related to financial guarantee (non-derivative) insurance and reinsurance contracts in accordance with the accounting principles for financial guarantee insurance contracts.
As of December 31, 2010 and 2009, the Company reported premiums receivable of $1.6 billion and $2.0 billion, respectively, primarily related to installment policies for which premiums will be collected over the estimated term of the contracts. Premiums receivable for an installment policy is initially measured at the present value of premiums expected to be collected over the expected period or contract period of the policy using a risk-free discount rate. Premiums receivable for policies that use the expected period of risk due to expected prepayments are adjusted in subsequent measurement periods when prepayment assumptions change using the risk-free discount rate as of the remeasurement date. As of December 31, 2010 and 2009, the weighted average risk-free rate used to discount future installment premiums was 3.1% and 3.0%, respectively, and the weighted average expected collection term of the premiums receivable was 9.16 years and 9.13 years, respectively. For the years ended December 31, 2010 and 2009, the accretion of the premiums receivable was $48 million and $56 million, respectively, and is reported in “Scheduled premiums earned” on the Company’s consolidated statements of operations.
The Company evaluates whether any premiums receivable are uncollectible at each balance sheet date. If the Company determines that premiums are uncollectible, it records a write-off of such amounts in current earnings. The majority of the Company’s premiums receivable consists of the present values of future installment premiums that are not yet billed or due primarily from structured finance transactions. Given that premiums due to MBIA typically have priority over most other payment obligations of structured finance transactions, the Company determined that the amount of uncollectible premiums as of December 31, 2010 was insignificant.
The following tables present a roll forward of the Company’s premiums receivable for the years ended December 31, 2010 and 2009:
The Company does not establish any case basis reserves for insured obligations that are assigned to “Caution List-Low,” “Caution List-Medium,” or “Caution List-High.” In the event MBIA expects to pay a claim with respect to an insured transaction, it places the insured transaction on its “Classified List” and establishes a case basis reserve. The following provides a description of each surveillance category:
“Classified List”-Includes all insured obligations where MBIA has paid a claim or where a claim payment is expected. It also includes insured obligations where a significant LAE payment has been made, or is expected to be made, to mitigate a claim payment. This may include property improvements, bond purchases and commutation payments. Generally, IPM is actively remediating these credits where possible, including restructurings through legal proceedings, usually with the assistance of specialist counsel and advisors.
As of December 31, 2010, the majority of the Company’s case basis reserves and insurance loss recoveries were related to insured RMBS transactions, which are discussed below. The Company’s case basis reserves do not include estimated losses on policies insuring credit derivatives. Policies insuring credit derivative contracts are accounted for as derivatives and carried at fair value. Fair value is calculated using a price that would be paid to transfer the contract in an orderly transaction between market participants at the measurement date. As such, the fair value of the Company’s insured credit derivatives considers the price a hypothetical third-party market participant would require to assume the contract and, in general, not the price at which MBIA may settle the contract, either through litigation or other negotiations with counterparties of its contracts.
“Roll Rate” is defined as the probability that current loans become delinquent and that loans in the delinquent pipeline are charged-off. Generally, Roll Rates are calculated for the previous three months and averaged. The Company assumes that the Roll Rate for 90+ days delinquent loans is 100% except for loans within the additional stress case scenario, where the Company assumes a Roll Rate that is calculated using the actual observed average Roll Rate for 90+ day delinquent loans during the past twelve months. As of December 31, 2010, that Roll Rate used in the Company’s additional stress case scenario was 97%. Roll Rates for 30-59 days delinquent loans and 60-89 days delinquent loans are calculated on a transaction specific basis. The Roll Rates are applied to the amounts in the respective delinquency buckets based upon delinquencies as of November 30, 2010 to estimate future losses from loans that are delinquent as of the current reporting period.
Roll Rates for loans that are current as of November 30, 2010 (“Current Roll to Loss”) are calculated on a transaction-specific basis. A proportion of loans reported current as of November 30, 2010 is assumed to become delinquent every month, at a Current Roll to Loss rate that persists at a high level for a time and subsequently starts to decline. A key assumption in the model is the period of time in which the Company projects high levels of Current Roll to Loss to persist. In the Company’s base case, the Company assumes that the Current Roll to Loss begins to decline immediately and continues to decline over the next six months to 25% of their levels as of November 2010. In the stress case, the period of elevated delinquency and loss is extended by six months. In the additional stress case, the Company assumes that the current trends in delinquencies will remain through
mid-2012, after which time they will revert to the base case. For example, as of November 30, 2010, if 10% of the loans are in the 30-59 day delinquent bucket, and recent performance suggests that 30% of those loans will be charged-off, the Current Roll to Loss for the transaction is 3%. In the base case, it is then assumed that the Current Roll to Loss will reduce linearly to 25% of its original value over the next six months (i.e., 3% will linearly reduce to 0.75% over the six months from December 2010 to June 2011). After that six-month period, the Company further reduces the Current Roll to Loss to 0% by early 2014 with the expectation that the performing seasoned loans and an economic recovery will eventually result in loan performance reverting to historically low levels of default. In the model, the Company assumes that all current loans that become delinquent are “charged-off” after six months of delinquency.
In addition, in the Company’s loss reserve models for transactions secured by HELOCs, the Company considered borrower draw and repayment rates. For HELOCs, the current three-month average draw rate was used to project future draws on the line. For HELOCs and transactions secured by fixed-rate CES, the three-month average conditional repayment rate was used to project voluntary principal repayments. The current loans generate excess spread which offsets the losses and reduces the payments. Cash flows also assumed a constant basis spread between floating rate assets and floating rate insured debt obligations (the difference between Prime and LIBOR interest rates, minus any applicable fees). For all transactions, cash flow models considered allocations and other structural aspects of the transactions, including managed amortization periods, rapid amortization periods and claims against MBIA Corp.’s insurance policy consistent with such policy’s terms and conditions. For loans that remain current (not delinquent) throughout the projection period, the Company assumes that voluntary prepayments occur at the average rate experienced in the most recent three-month period. In developing multiple loss scenarios, stress is applied by elongating the Current Roll to Loss rate for various periods, simulating a slower improvement in the transaction performance. The estimated net claims from the procedure above were discounted using a risk-free rate to a net present value reflecting MBIA’s general obligation to pay claims over time and not on an accelerated basis. The above assumptions represent MBIA’s best estimates of how transactions will perform over time.
The Company monitors portfolio performance on a monthly basis against projected performance, reviewing delinquencies, Roll Rates, and prepayment rates (including voluntary and involuntary). In the event of a material deviation in actual performance from projected performance, the Company would increase or decrease the case basis reserves accordingly. If actual performance were to remain at the peak levels the Company is modeling for six months longer than in the probability-weighted outcome, the addition to the case basis reserves before considering potential recoveries would be approximately $275 million.
Since the third quarter of 2009, paid claims in each month have been somewhat below that projected in the Company’s model. The Company has not modified its expectations to reflect this lower paid claims rate. The difference between actual and projected paid claims has not been significant.
As of December 31, 2010, the Company recorded estimated recoveries of $2.5 billion, gross of income taxes, related to RMBS transactions. Of the total $2.5 billion in recoveries, $1.7 billion is recorded as “Insurance loss recoverable” and $835 million is recorded as “Loan repurchase commitments” within consolidated VIEs on the Company’s consolidated balance sheet. As of December 31, 2010, the Company’s estimated recoveries, net of reinsurance and income taxes, were $1.6 billion, which was 58% of the consolidated total shareholders’ equity of MBIA, excluding preferred stock of subsidiaries, and the related statutory measure was 59% of the statutory
Beginning in 2008, the Company engaged loan level forensic review consultants to re-underwrite/review a sample of the mortgage loan files underlying RMBS transactions insured by MBIA. The securitizations on which the Company has recorded losses contain well over 500,000 individual mortgages, of which over 48,000 mortgage loans were reviewed within 32 insured issues containing first and second-lien mortgage loan securitizations. The Company recorded recoveries related to 27 of these 32 issues. It is possible that the Company will review loan files within additional insured issues in the future if factors indicate that material recovery rights exist. During their review, the consultants utilized the same underwriting guidelines that the originators were to have used to qualify borrowers when originally underwriting the loans and determined that there were high proportions of ineligible mortgages within the sample. The forensic review consultants graded the individual mortgages that were sampled into an industry standard three level grading scale, defined as (i) Level 1-loans complied with specific underwriting guidelines, (ii) Level 2-loans contained some deviation from underwriting guidelines but also contained sufficient compensating factors, and (iii) Level 3-loans contained material deviation from the underwriting guidelines without any compensating factors.
As a result of the above developments, the Company revised its put-back recovery scenarios in the fourth quarter of 2010. The Company replaced prior scenarios that were primarily based on loan file reviews with probability-based scenarios primarily based on the percentage of incurred losses the Company expects to collect. The Company’s recovery estimates are based on five scenarios that include full recovery of its incurred losses and limited/reduced recoveries due to litigation delays and risks and/or potential financial distress of the sellers/servicers. Probabilities are assigned across these scenarios, with most of the probability weight on partial recovery scenarios. However, based on the Company’s assessment of the strength of its contract claims, the Company believes it is entitled to collect the full amount of its incurred losses, which totaled $4.4 billion as of December 31, 2010.
The Company’s potential recoveries are typically based on either salvage rights, the rights conferred to MBIA through the transactional documents (inclusive of the insurance agreement), or subrogation rights embedded within financial guarantee insurance policies. The RMBS transactions with respect to which MBIA has estimated put-back recoveries provide the Company with such rights. Expected salvage and subrogation recoveries, as well as recoveries from other remediation efforts, reduce the Company’s claim liability. Once a claim payment has been made, the claim liability has been satisfied and MBIA’s right to recovery is no longer considered an offset to future expected claim payments, but is recorded as a salvage asset. The amount of recoveries recorded by the Company is limited to paid claims plus the present value of projected future claim payments. As claim payments are made, the recorded amount of potential recoveries may exceed the remaining amount of claim liability for a given policy. As of December 31, 2010, the expected value of recoveries related to RMBS paid claims reported in “Insurance loss recoverable” was $1.7 billion. Additionally, $835 million was recorded as “Loan repurchase commitments” within consolidated VIEs.
The Company’s assessment of the recovery outlook for insured RMBS issues is principally based on the following factors:
1. the strength of the Company’s existing contract claims related to ineligible loan substitution/repurchase obligations;
4. the favorable outcome for MBIA on defendants’ motions to dismiss in the actions captioned MBIA Insurance Corp. v. Countrywide Home Loans, Inc., et al, Index No. 08-602825 (N.Y. Sup. Ct.) and MBIA Insurance Corp. v. Residential Funding Co., LLC, Index No. 603552/08 (N.Y. Sup. Ct.), MBIA v GMAC and MBIA Insurance Corp. v. Credit Suisse Securities where the respective courts each allowed MBIA’s fraud claims against the Countrywide, RFC, GMAC and Credit Suisse Securities defendants to proceed;
5. the favorable outcome for MBIA on its motion to present evidence of Countrywide’s liability and damages through the introduction of a statistically valid random sample of loans rather than on a loan-by-loan basis; and
The Company will continue to consider all relevant facts and circumstances, including the factors described above, 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 as developments in the pending litigation proceedings occur or new litigation is initiated. While the Company believes it will be successful in realizing recoveries from contractual and other claims, the ultimate amounts recovered may be materially different from those recorded by the Company given the inherent uncertainty of the manner of resolving the claims (e.g., litigation) 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 Company’s losses and LAE for the year ended December 31, 2010 are presented in the following table:
During 2010, the Company incurred $232 million of loss and LAE expenses, which was primarily driven by ABS CDO transactions and U.S. public finance transactions. Loss and LAE expenses related to ABS CDOs was $118 million, after the elimination of a $71 million expense as a result of consolidating VIEs, and was driven by continued credit deterioration within the sector. Loss and LAE expenses related to U.S. public finance
transactions was $73 million and principally related to three housing transactions, two student loan transactions, a not-for-profit transaction and a health care transaction. These losses were partially offset by a net benefit of $3 million related to RMBS transactions, which is net of the elimination of a $60 million net benefit as a result of consolidating VIEs. The $656 million of RMBS recoveries of actual and expected payments in the preceding table comprised $609 million in actual and expected recoveries resulting from ineligible mortgages included in insured second-lien residential mortgage and Alt-A securitization exposures that are subject to contractual obligations by sellers/servicers to repurchase or replace such mortgages and $47 million related to excess interest cash flows within the securitizations. Current period changes in the Company’s estimate of potential recoveries may impact the amount recorded as an asset for insurance loss recoverable, the amount of expected recoveries on unpaid losses netted against the gross loss and LAE reserve liability, or both.
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, 2009:
The gross claim liability of $2.8 billion and gross potential recoveries of $3.4 billion reported in the preceding table primarily relate to insured RMBS transactions.
The following tables present changes in the Company’s loss and LAE reserve for the years ended December 31, 2010 and 2009. Changes in the loss and LAE reserve attributable to the accretion of the claim liability discount, changes in discount rates, changes in assumptions, changes in the timing and amounts of estimated payments and recoveries, and changes in LAE are recorded in “Losses and loss adjustment” expenses in the Company’s statement of operations. As of December 31, 2010 and 2009, the weighted average risk-free rate used to discount the Company’s loss reserve (claim liability) was 2.73% and 3.14%, respectively. LAE reserves are expected to be settled within a one year period and are not discounted.
The following table presents changes in the Company’s insurance loss recoverable and changes in recoveries on unpaid losses reported within the Company’s claim liability for the year ended December 31, 2010. Changes in insurance loss recoverable attributable to the accretion of the discount on the recoverable, changes in discount rates, changes in assumptions, changes in the timing and amounts of estimated collections and changes in LAE are recorded in “Losses and loss adjustment” expenses in the Company’s consolidated statements of operations.
Since insured credit derivatives have similar terms, conditions, risks, and economic profiles to financial guarantee insurance policies, they are evaluated for economic impairment periodically in the same way that loss and LAE reserves are estimated for financial guarantee insurance policies. Credit impairments on insured derivatives represent the present value of estimated expected future claim payments, net of recoveries, for such transactions using a discount rate of 5.93%, the same rate used to calculate statutory loss reserves. These credit impairments may differ from the fair values recorded in the Company’s consolidated financial statements. Although the Company’s statement of operations includes the changes in the fair values of these transactions, the Company regards the changes in credit impairment estimates as critical information for investors as it provides information about loss payments the Company expects to make.
In the CRE CDO portfolio, transaction specific structures require managers to report reduced enhancement according to certain guidelines which often include downgrades even when the bond is still performing. Because of this, as well as additional collateral defaults, reported enhancement has been reduced significantly in some CRE CDOs. However, because of this many of the CRE CDO positions are amortizing more quickly than originally expected as most or all interest that would have been allocated to more junior classes within the CDO has been diverted and redirected to pay down the senior most classes insured by MBIA.
The Company has developed multiple scenarios to consider the range of potential outcomes in the CRE market and their impact on MBIA. The approaches require substantial judgments about the future performance of the underlying loans. The first approach considers the range of commutations achieved in the course of 2010, which included commutations of nineteen structured CMBS pools and CRE CDO policies totaling $7.0 billion of gross insured exposure. Additionally, one structured CMBS pool with $1.0 billion of gross insured exposure was contractually terminated. This approach results in an estimated price to commute the remaining policies with price estimates based on this experience. The second approach considers current delinquency rates and uses current and projected net operating income (“NOI”) and capitalization rates (“Cap Rates”) to project losses under two scenarios. In the first scenario, NOI and Cap Rates remain flat with no improvement over the remaining life of the loans (often six to seven more years). In the second scenario, loans are stratified by size with larger loans being valued utilizing lower Cap Rates than for smaller loans. This scenario also assumes that Cap Rates and NOIs remain flat for the near term and then begin to improve slowly. Additionally, in this scenario, any loan with a balance greater than $75 million with a debt service coverage ratio less than 1.0x or that was reported as being in any stage of delinquency, was reviewed individually so that performance and loss severity could be more accurately determined. Specific loan level assumptions for this large loan subset were then incorporated into this scenario.
A fourth approach stratifies loans into buckets based on delinquency status (including a “current” bucket) and utilizes recent Roll Rates actually experienced within each of the commercial mortgage-backed index (“CMBX”) series in order to formulate an assumption to predict future delinquencies. Ultimately, this generates losses over a projected time horizon based on the assumption that loss severities will remain at the peak level for a given time period and then decrease over time. This approach was applied in two scenarios. In the first scenario, the Company assumes that 90% of the loans greater than 90 days delinquent (and those projected to roll into late stage delinquency from the current and lesser stage levels of delinquency) are liquidated. In the second scenario, the Company assumes that 75% of these loans are liquidated and that 25% are modified and returned to current. These estimates are based on the levels of modifications that took place in the fixed-rate conduit universe in 2010. Whether CMBS collateral is included in a structured pool or in a CRE CDO, the Company believes the modeling related to the
Fixed-Maturity Securities (including short-term investments) Held as Available-For-Sale and Fixed-Maturity Securities Held at Fair Value
Corporate obligations-Corporate obligations are valued using recently executed transaction prices or quoted market prices where observable. When observable price quotations are not available, fair value is determined using a valuation model based on observable inputs including interest rate yield curves, CDS spreads for similar instruments, and diversity scores. Corporate obligations are generally categorized in Level 2 of the fair value hierarchy or categorized in Level 3 when significant inputs are unobservable. Corporate obligations are classified as Level 1 of the fair value hierarchy when quoted market prices in an active market for identical financial instruments are available.
State and municipal bonds-State and municipal bonds are valued using recently executed transaction prices, quoted prices or valuation models based on observable inputs including interest rate yield curves, bond or CDS spreads, and volatility. State and municipal bonds are generally categorized in Level 2 of the fair value hierarchy, or categorized in Level 3 when significant inputs are unobservable.
Other investments include the Company’s interest in equity securities. Fair values of other investments are determined by using quoted prices, or valuation models that use market-based and observable inputs. Other investments are categorized in Level 1, Level 2, or Level 3 of the fair value hierarchy.
Cash and Cash Equivalents, Receivable for Investments Sold and Payable for Investments Purchased
Loans receivable at fair value comprise loans held by consolidated VIEs consisting of residential mortgage loans, commercial mortgage loans and other whole business loans. Fair values of residential mortgage loans are determined using quoted prices for MBS with similar characteristics and adjusted for the fair values of the financial guarantee obligations provided by MBIA Corp. on the related MBS. Fair values of commercial mortgage loans are valued based on quoted prices of similar collateralized MBS. Loans receivable at fair value are categorized in Level 3 of the fair value hierarchy.
Loan repurchase commitments are obligations owed by the sellers/servicers of mortgage loans to RMBS trusts consolidated under the amended accounting principles for the consolidation of VIEs. This asset represents the rights of the trusts against the sellers/servicers for representations and warranties that the securitized residential mortgage loans sold to the trust comply with stated underwriting guidelines and for the sellers/servicers to cure, replace, or repurchase mortgage loans that fail to comply. Fair value measurements of loan repurchase commitments represent the amounts owed by the sellers/servicers to the trusts. Loan repurchase commitments are not securities and no quoted prices or comparable market transaction information are observable or available. Loan repurchase commitments at fair value are categorized in Level 3 of the fair value hierarchy. Fair values of loan repurchase commitments are determined using discounted cash flow techniques based on observable inputs including:
The fair values of investment agreements are determined using discounted cash flow techniques based on observable interest rates currently being offered for similar agreements with comparable maturity dates. Investment agreements contain collateralization and termination agreements that substantially mitigate the nonperformance risk of the Company.
The fair values of securities sold under agreements to repurchase are determined using discounted cash flow techniques based on observable inputs including interest rates on similar repurchase agreements. Securities sold under agreements to repurchase include term reverse repurchase agreements that contain credit enhancement provisions including over-collateralization agreements to sufficiently mitigate the nonperformance risk of the Company.
As of December 31, 2010, the Company had $110.2 billion of gross par outstanding on insured derivatives. The majority of MBIA’s insured derivatives are “credit derivatives” that reference structured pools of cash securities and CDS. The Company generally insured the most senior liabilities of such transactions and, at transaction closing, the Company’s exposure generally had more subordination than needed to achieve triple-A ratings from credit rating agencies (referred to as “Super Triple-A” exposure). The collateral backing the Company’s insured derivatives was cash securities and CDS referencing primarily corporate, asset-backed, residential mortgage-backed, commercial mortgage-backed, CRE loans, and CDO securities. As of December 31, 2010, the gross par outstanding of the Company’s insured credit derivatives totaled $99.5 billion. The remaining $10.7 billion of gross par outstanding on insured derivatives as of December 31, 2010 primarily related to insured “interest rate” and “inflation-linked” swaps for which the Company has insured counterparty credit risk.
Most of MBIA’s insured CDS contracts require MBIA to make payments for losses of the principal outstanding under the contracts when losses on the underlying referenced collateral exceed a predetermined deductible. MBIA’s gross par outstanding and maximum payment obligation under these contracts as of December 31, 2010 was $76.6 billion. The underlying referenced collateral for contracts executed in this manner largely consist of investment grade corporate debt, structured CMBS pools and, to a lesser extent, corporate and multi-sector CDOs (in CDO-squared transactions). MBIA’s multi-sector and CDO-squared transactions contain substantial RMBS-related collateral. As of December 31, 2010, MBIA also had $22.9 billion of gross par outstanding on insured CDS contracts that require MBIA to make timely interest and ultimate principal payments.
Insured derivatives are not transferable, and quoted prices or market transactions are generally not available for identical or similar contracts. While market prices are generally available for traded securities and market standard CDS contracts, MBIA’s insured derivatives are unique which make comparisons to market standard CDS contracts unreliable. Market standard CDS contracts are instruments that reference securities, such as corporate bonds, in which quoted prices are observable for the underlying reference obligation. Market standard CDS contracts also include provisions requiring collateral posting, and cash settlement upon default of the underlying reference obligation.
MBIA’s insured CDS contracts are designed to replicate the Company’s financial guarantee insurance policies, and do not contain typical CDS market standard features for collateral posting or cash settlement upon default of the underlying reference obligation. The Company’s insured CDS contracts provide credit protection on collateralized securities or reference portfolios of securities, and benefit from credit enhancement, including a stated deductible or subordination. The Company is not required to post collateral in any circumstance. MBIA payments under an insured derivative contract are due after an aggregate amount of losses are incurred on the underlying reference obligations in excess of the deductible or subordination amounts. Once such losses exceed the deductible or subordination amounts, MBIA is generally obligated to pay the losses, net of recoveries, on any subsequent defaults on the reference obligations. Certain insured CDS contracts also provide for further deferrals of payment at the option of MBIA. In the event of a failure to pay an amount due under the insured CDS by MBIA
Corp. or the insolvency of MBIA Corp., the counterparty may terminate the insured CDS and make a claim for the amount due, which would be based on the fair value of the insured CDS at such time. An additional difference between the Company’s insured derivatives and typical market standard CDS contracts is that the Company’s contract, like its financial guarantee contracts, generally cannot be accelerated by the counterparty in the ordinary course of business but only upon the occurrence of certain events including the failure to pay an amount due under the CDS or the insolvency of the financial guarantee insurer of the CDS, MBIA Corp. or MBIA UK Insurance Ltd (“MBIA UK”). Similar to the Company’s financial guarantee insurance contracts, all insured CDS policies are unconditional and irrevocable obligations of the Company and are not transferable unless the transferees are also licensed to write financial guarantee insurance policies. Since insured CDS contracts are accounted for as derivatives under relevant accounting guidance for derivative instruments and hedging activities, MBIA Corp. did not defer the charges associated with underwriting the CDS policies and they were expensed at origination.
The BET Model estimates what a bond insurer would charge to guarantee a transaction at the measurement date, based on the market-implied default risk of the underlying collateral and the remaining structural protection in a deductible or subordination. This approach assumes that bond insurers would be willing to accept these contracts from the Company at a price equal to what the Company could issue them for in the current market. While the premium charged by financial guarantors is not a direct input into the Company’s model, the model estimates such premium and this premium increases as the probability of loss increases, driven by various factors including rising credit spreads, negative credit migration, lower recovery rates, lower diversity score and erosion of deductible or subordination.
Estimates of aggregated collateral losses are calculated by reference to the following (described in further detail under “BET Model Inputs” below):
The unrealized gain or loss on a transaction inception to date is the difference between the original price of the risk (the original market-implied expected loss) and the current price of the risk based on the assumed market-implied expected losses derived from the model.
If current market-based spreads are not available, the Company applies either sector-specific spreads from spread tables provided by dealers or corporate spread tables. The sector-specific spread applied depends on the nature of the underlying collateral. Transactions with corporate collateral use the corporate spread table. Transactions with asset-backed collateral use one or more of the dealer asset-backed tables. If there are no observable market spreads for the specific collateral, and sector-specific and corporate spread tables are not appropriate to estimate the spread for a specific type of collateral, the Company uses the fourth alternative in its hierarchy. This includes using tranched corporate collateral, where the Company applies corporate spreads as an input with an adjustment for its tranched exposure.
As of December 31, 2010, sector-specific spreads were used in 7% of the transactions valued using the BET Model. Corporate spreads were used in 36% of the transactions and spreads benchmarked from the most relevant spread source were used for 57% of the transactions. When determining the percentages above, there were some transactions where MBIA incorporated multiple levels within the hierarchy, including using actual collateral-specific credit spreads in combination with a calculated spread based on an assumed relationship. In those cases, MBIA classified the transaction as being benchmarked from the most relevant spread source even though the majority of the average spread was from actual collateral-specific spreads. The spread source can also be identified by whether or not it is based on collateral WARF. No collateral-specific spreads are based on WARF, sector-specific and corporate spreads are based on WARF, and some benchmarked spreads are based on WARF. WARF-sourced and/or ratings-sourced credit spreads were used for 86% of the transactions.
Over time the data inputs change as new sources become available, existing sources are discontinued or are no longer considered to be reliable or the most appropriate. It is always the Company’s objective to move to higher levels on the spread hierarchy table defined above. However, the Company may on occasion move to lower priority inputs due to the discontinuation of data sources or due to the Company considering higher priority inputs no longer representative of market spreads
Approximately $39.1 billion gross par of MBIA’s insured derivative transactions as of December 31, 2010 includes substantial amounts of CMBS and commercial mortgage collateral. Since the CMBX is now quoted in price terms and the BET model requires a spread input, it is necessary to convert CMBX prices to spreads. Through the third quarter of 2010, the Company assumed that a portion of the CMBX price reflected market illiquidity. The Company assumed this illiquidity component was the difference between par and the price of the highest priced CMBX triple-A series. The Company assumed that the price of each CMBX index has two components: an illiquidity component and a loss component. The market implied losses were assumed to be the difference of par less the liquidity adjusted price. These loss estimates were converted to spreads using an internal estimate of duration. Beginning in the fourth quarter of 2010, the Company determined that it would not be appropriate to continue to use a CMBS illiquidity component in the models due to increased liquidity in the marketplace. This adjustment increased the Company’s derivative liability by approximately $119 million.
The Direct Price Model was developed internally to address weaknesses in the Company’s BET model specific to valuing insured multi-sector CDOs, as previously discussed. There are three significant model inputs used in determining fair value using the Direct Price Model. Significant inputs include market prices obtained or estimated for all collateral within a transaction, the present value of the market-implied potential losses calculated for the transaction, and the impact of nonperformance risk.
The present value of the market-implied potential losses was calculated assuming that MBIA deferred all principal losses to the legal final maturity. This was done through a cash flow model that calculated potential interest payments in each period and the potential principal loss at the legal final maturity. These cash flows were discounted using the LIBOR flat swap curve.
As of December 31, 2010 and 2009, the Company’s net insured derivative liability was $4.4 billion and $3.8 billion, respectively, and was primarily related to the fair values of insured credit derivatives, based on the results of the aforementioned pricing models. In the current environment the most significant driver of changes in fair value is nonperformance risk. In aggregate, the nonperformance calculation results in a pre-tax net insured derivative liability which is $12.1 billion and $14.8 billion lower than the net liability that would have been estimated if the Company excluded nonperformance risk in its valuation as of December 31, 2010 and 2009, respectively. Nonperformance risk is a fair value concept and does not contradict the Company’s internal view, based on fundamental credit analysis of the Company’s economic condition, that the Company will be able to pay all claims when due.
The following fair value hierarchy tables present information about the Company’s assets (including short-term investments) and liabilities measured at fair value on a recurring basis as of December 31, 2010 and 2009:
Level 3 assets were $5.2 billion and $2.4 billion as of December 31, 2010 and 2009, respectively, and represented approximately 24% and 17% of total assets measured at fair value, respectively. Level 3 liabilities were $10.6 billion and $4.7 billion as of December 31, 2010 and 2009, respectively, and represented approximately 78% and 99% of total liabilities measured at fair value, respectively. The following tables present information about changes in Level 3 assets (including short-term investments) and liabilities measured at fair value on a recurring basis for the years ended December 31, 2010 and 2009:
Transfers into and out of Level 3 were $115 million and $871 million, respectively, for the year ended December 31, 2009. These transfers were principally for available-for-sale securities where inputs, which are significant to their valuation, became observable or unobservable during the period. These inputs included spreads, prepayment speeds, default speeds, default severities, yield curves observable at commonly quoted intervals, and market corroborated inputs. Corporate obligation, other ABS and CDOs comprised the majority of the transferred instruments. For the year ended December 31, 2009, the net unrealized gains related to the transfers into Level 3 was $15 million and the net unrealized gains related to the transfers out of Level 3 was $81 million.
The following tables present the changes in fair value included in the Company’s consolidated statement of operations for the year ended December 31, 2010 for all financial instruments for which the fair value option was elected.
The following table reflects the difference between the aggregate fair value and the aggregate remaining contractual principal balance outstanding as of December 31, 2010 for loans and long-term debt for which the fair value option has been elected.
The Company’s fixed-maturity portfolio consists of high-quality (average rating double-A) taxable and tax-exempt investments of diversified maturities. Other investments primarily comprise equity investments, including those accounted for under the equity method and highly rated perpetual securities that bear interest and are callable by the issuer. The following tables present the amortized cost, fair value and other-than-temporary impairments of fixed-maturity investments and other investments designated as available for sale in the consolidated investment portfolio of the Company as of December 31, 2010 and 2009:
During the third quarter of 2010, the Company transferred certain securities previously classified as held-to-maturity to available-for-sale. The classification change was due to the Company’s current intention to sell securities as a part of its ongoing plan to wind down its conduit business. As of the December 31, 2010, the securities that were transferred had a carrying value of $189 million and there was an immaterial amount of net unrealized gains recognized in accumulated other comprehensive income in connection with the transfer.
As of December 31, 2010 and 2009, the Company recorded net unrealized losses of $584 million and $1.4 billion, respectively, on available-for-sale securities, comprised of fixed-maturity and other investments, which included $804 million and $1.6 billion, respectively, of gross unrealized losses. The following tables present the gross unrealized losses included in accumulated other comprehensive income (loss) as of December 31, 2010 and 2009, related to available-for-sale fixed-maturity and other investments. These tables segregate investments that have been in a continuous unrealized loss position for less than twelve months from those that have been in a continuous unrealized loss position for twelve months or longer.
Gross unrealized losses on available-for-sale securities, comprised of fixed-maturity and other investments, of $804 million as of December 31, 2010 decreased from $1.6 billion as of December 31, 2009 primarily as a result of increased market prices on securities held by the Company resulting from an improvement in market related conditions. Gross unrealized losses as of December 31, 2010 are primarily related to ABS, MBS, and corporate obligations.
The following table presents the fair values and gross unrealized losses by credit rating category of ABS included in the Company’s consolidated investment portfolio as of December 31, 2010 for which fair value was less than amortized cost. Of the total $958 million of fair value and $310 million of unrealized losses of ABS, $783 million of fair value and $222 million of unrealized losses relates to ABS included in the Company’s asset/liability products investment portfolio. Fair values include the benefit of guarantees provided by financial guarantors, including MBIA. The credit ratings are based on ratings from Moody’s as of December 31, 2010 or an alternate ratings source, such as S&P, when a security is not rated by Moody’s. For investments that are insured by various third party guarantee insurers, the credit rating reflects the higher of the insurer’s rating or the underlying bond’s rating.
The following table presents the fair values and gross unrealized losses by credit rating category of MBS included in the Company’s consolidated investment portfolio as of December 31, 2010 for which fair value was less than amortized cost. Fair values include the benefit of guarantees provided by financial guarantors, including MBIA. The credit ratings are based on ratings from Moody’s as of December 31, 2010 or an alternate ratings source, such as S&P, when a security is not rated by Moody’s. For investments that are insured by various third party guarantee insurers, the credit rating reflects the higher of the insurer’s rating or the underlying bond’s rating.
Eighty-seven percent of the Company’s investments in MBS reported in the preceding table were rated investment grade with 71% rated Aaa. Of the $1.3 billion of MBS investments reported in the preceding table, $24 million include the benefit of guarantees provided by MBIA Corp. and $268 million include the benefit of guarantees provided by third-party financial guarantors. The average credit rating of all guaranteed MBS investments using the higher of the guarantors’ ratings or the underlying bond ratings was Aa1 and the average underlying credit rating of guaranteed MBS investments, without giving effect to the guarantees, was Aa3. Without giving effect to the benefit of guarantees provided by financial guarantors, including MBIA Corp., $307 million or 24% of the securities included in the preceding table were rated below investment grade.
The following table presents the fair values and gross unrealized losses by credit rating category of direct corporate obligations included in the Company’s consolidated investment portfolio as of December 31, 2010 for which fair value was less than amortized cost. Fair values include the benefit of guarantees provided by financial guarantors, including MBIA. The credit ratings are based on ratings from Moody’s as of December 31, 2010 or an alternate ratings source, such as S&P, when a security is not rated by Moody’s. For investments that are insured by various third party guarantee insurers, the credit rating reflects the higher of the insurer’s rating or the underlying bond’s rating.
Ninety-four percent of the Company’s investments in corporate obligations reported in the preceding table were rated investment grade with 6% rated Aaa. Of the $1.3 billion of corporate obligations reported in the preceding table, $17 million include the benefit of guarantees provided by National, $22 million include the benefit of guarantees provided by MBIA Corp., and $70 million include the benefit of guarantees provided by third-party financial guarantors. The average credit rating of all guaranteed corporate obligations included in the preceding table using the higher of the guarantors’ ratings or the underlying bond ratings was Aaa and the average underlying credit rating of these guaranteed corporate obligations without giving effect to the guarantees was Aaa. Without giving effect to the benefit of guarantees provided by financial guarantors, including MBIA Corp. and National, $60 million or 5% of the securities included in the preceding table were rated below investment grade.
The following tables present the gross unrealized losses of held-to-maturity investments as of December 31, 2010 and 2009. Held-to-maturity investments are reported at amortized cost on the Company’s consolidated balance sheets. The tables segregate investments that have been in a continuous unrealized loss position for less than twelve months from those that have been in a continuous unrealized loss position for twelve months or longer.
As of December 31, 2010 and 2009, the Company’s available-for-sale fixed-maturity investment, other investment and held-to-maturity investment portfolios’ gross unrealized losses totaled $1.1 billion and $1.9 billion, respectively. The weighted average contractual maturity of securities in an unrealized loss position as of December 31, 2010 and 2009 was 20 years and 19 years, respectively. As of December 31, 2010, there were 412 securities that were in an unrealized loss position for a continuous twelve-month period or longer with aggregate unrealized losses of $941 million. Within the 412 securities, the book value of 321 securities exceeded market value by more than 5% as presented in the following table:
Investments for which the Company has recorded unrealized losses are tested quarterly for other-than-temporary impairments. For each security that meets the threshold of either 20% impaired at the time of review or 5% impaired at the time of review with a fair value below amortized cost for a consecutive 12-month period, a further analysis of the security is performed to assess if the impairment is other than temporary. As of December 31, 2010, the fair value and related unrealized loss of available-for-sale securities totaled $7.0 billion and $804 million, respectively, and consisted primarily of ABS, MBS, and corporate obligations. Based on its evaluation, the Company realized other-than-temporary impairments of $64 million for the year ended December 31, 2010, primarily related to RMBS, CDOs and corporate obligations.