In July of 2017, Puerto Rico defaulted on scheduled debt service for National insured bonds. National paid gross claims in the aggregate of $242 million during 2017. On January 1, 2018, Puerto Rico also defaulted on scheduled debt service for National insured bonds and National paid gross claims in the aggregate of $69 million. As of December 31, 2017, National had $3.4 billion of gross insured par outstanding ($3.9 billion of gross insured par outstanding when including accreted interest on insured capital appreciation bonds (“CABs”)) related to Puerto Rico. Refer to the “U.S. Public Finance Insurance Puerto Rico Exposures” section for additional information on our Puerto Rico exposures.
(4)-Adjusted net income (loss) per diluted common share is calculated by taking adjusted net income (loss) divided by GAAP weighted average number of diluted common shares outstanding.
NET PREMIUMS EARNED Net premiums earned on financial guarantees represent gross premiums earned net of premiums ceded to reinsurers, and include scheduled premium earnings and premium earnings from refunded issues. The decrease in net premiums earned for 2017 compared with 2016 resulted from decreases in refunded premiums earned of $41 million and scheduled premiums earned of $21 million. The decrease in net premiums earned for 2016 compared with 2015 resulted from decreases in refunded premiums earned of $42 million and scheduled premiums earned of $26 million. Scheduled premium earnings declined due to the refunding and maturity of insured issues in prior periods. Refunding activity over the past several years has accelerated premium earnings in prior periods and reduced the amount of scheduled premiums that would have been earned in the current period.
On September 20, 2017, Hurricane Maria made landfall in Puerto Rico as a Category 4 hurricane resulting in catastrophic damage to much of the island’s basic infrastructure, including its electrical transmission and distribution grid, telecommunications network, housing, roads, bridges, water and sewer systems. On September 21, 2017, the President of the United States approved a Major Disaster Declaration for Puerto Rico and FEMA made federal disaster assistance available to Puerto Rico to supplement its recovery efforts. Many residents of Puerto Rico continue to lack access to basic necessities such as clean water, food and health care. The lack of passable roads and compromised infrastructure has complicated recovery efforts. Given the significant physical barriers to assistance, the Department of Defense took over much of the initial search, rescue and restoration effort. The U.S. Army Corps of Engineers has taken the lead in the effort to rebuild the Island’s infrastructure, in cooperation with FEMA and Puerto Rico. Damage estimates vary widely, but a preliminary report from Moody’s Analytics places the upper bound of the range at $95 billion. This estimate includes lost economic activity and physical damage to infrastructure. Given the numerous estimates of physical damage and the extent of insurance coverage, uninsured damages are not reasonably estimable at this time. On October 12, 2017, the House of Representatives passed legislation providing $36.5 billion in emergency disaster assistance for areas of the U.S. impacted by recent hurricanes and wildfires including California, Texas, Louisiana, Florida, Puerto Rico and the U.S. Virgin Islands. This amount includes $4.9 billion in community disaster loans which will be, in part, made available to Puerto Rico. Under the Stafford Act, the legislation that directs federal emergency disaster response, that portion of the $4.9 billion made available to Puerto Rico may be directed to activities that directly mitigate the impacts of the disaster. The measure was approved by the U.S. Senate and has been signed by the President of the United States. As of February 12, 2018, no monies have been advanced to Puerto Rico under this authorization. On February 9, 2018, the U.S. Congress approved, and the President of the United States signed into law, a new supplemental spending authorization totaling approximately $90.0 billion to cover necessary expenses related to the consequences of Hurricanes Harvey, Irma and Maria and wildfires that occurred in 2017. Of this amount, Puerto Rico expects to receive approximately $16.5 billion in federal funds, including up to $4.8 billion for healthcare, $10.0 billion for housing and $2.0 billion for improvements to the island’s electrical power systems. Refer to the following “PREPA” section below for further information about Hurricane Maria’s impact to Puerto Rico.
On November 13, 2017, the Oversight Board filed a motion to confirm the scope of the COFINA and Commonwealth Agents’ authority and to determine whether certain claims exceeded the scope of the Commonwealth-COFINA Dispute. The Court also received additional filings relating to the scope of the agents’ authority in connection with the Commonwealth-COFINA Dispute.
Other than Inter American University of Puerto Rico Inc., S&P, Fitch Ratings and/or Moody’s have downgraded the ratings of all Puerto Rico issuers to below investment grade with a negative outlook due to narrowing liquidity, sluggish economic growth and persistent structural deficits. Additionally, subsequent to the declaration of a state of emergency and suspension of debt service payments by the then Governor of Puerto Rico, S&P revised its rating for Puerto Rico, its GO, PREPA and PRHTA’s subordinated transportation revenue bonds, series 1998, state infrastructure bank, to “D” (default). On June 6, 2017, S&P further downgraded COFINA from “CC” to “D” based on court motions that directed the trustee to withhold scheduled monthly payments until property interest disputes have been resolved.
PROVISION (BENEFIT) FOR INCOME TAXES The provision for income taxes for 2017 was driven by the establishment of a full valuation allowance against the Company’s net deferred tax asset. Refer to the following “Taxes” section and “Note 11: Income Taxes” in the Notes to Consolidated Financial Statements for further information about this valuation allowance on our net deferred tax asset. The 2016 benefit for income taxes was impacted by foreign tax credit adjustments, the fluctuation of the value of nontaxable warrants issued by the Company and nondeductible equity-based compensation expense. The 2015 provision for income taxes was impacted by nondeductible equity-based compensation expense.
Payment of a claim in November of 2015 on MBIA Corp.’s policy insuring the class A-1 and A-2 notes issued by Zohar CDO 2003-1, Limited (“Zohar I”) and satisfying the Zohar II Claim entitles MBIA Corp. to reimbursement of such amounts plus interest and expenses and/or to exercise certain rights and remedies to seek recovery of such amounts. In connection with the exercise of its rights and remedies, MBIA Corp. directed the trustee for Zohar I to commence an auction (the “Auction”) of all of the assets of Zohar I, which occurred on December 21, 2016. MBIA Corp. was the winning bidder in the Auction, and in connection therewith, acquired the beneficial ownership of the Zohar I assets, which include loans made to, and equity interests in, companies purportedly controlled by the sponsor and former collateral manager of Zohar I and Zohar II. As of December 31, 2017, the recoveries of Zohar I and Zohar II are included in “Loans receivable at fair value” which are presented in “Assets of consolidated variable interest entities” on our consolidated balance sheets. Refer to “Note 6: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements for a further discussion on the Zohar I and Zohar II recoveries.
Gross expenses represent total insurance expenses before the deferral of any policy acquisition costs. Gross expenses decreased for 2017 compared with 2016 primarily due to decreases in compensation expense. Gross expenses decreased for 2016 compared with 2015 primarily due to decreases in premium taxes and assessments, compensation expense and building related expenses. Operating expenses decreased for 2017 compared with 2016 and 2015 due to decreases in gross expenses.
The credit quality of our international and structured finance insured portfolio is assessed in the same manner as our U.S. public finance insured portfolio. As of December 31, 2017 and 2016, 33% and 25%, respectively, of our international and structured finance insured portfolio, was rated below investment grade, before giving effect to MBIA’s guarantees, based on MBIA’s internal ratings, which are generally more current than the underlying ratings provided by S&P and Moody’s for this subset of our insured portfolio.
Refer to “Note 11: Income Taxes” in the Notes to Consolidated Financial Statements for a further discussion of income taxes, including the valuation allowance against the Company’s net deferred tax asset and its accounting for tax uncertainties.
National’s CPR and components thereto, as of December 31, 2017 and 2016 are presented in the following table:
payments of operating expenses, taxes and funding purchases of MBIA Inc. shares;
MBIA Inc., National, MBIA Insurance Corporation and certain other affiliates are party to an intercompany advances agreement (the “MBIA Advances Agreement”). The MBIA Advances Agreement permits National to make advances to MBIA Inc. and other MBIA group companies that are party to the agreement at a rate per annum equal to LIBOR plus 0.25%. The agreement also permits other affiliates to make advances to National or MBIA Insurance Corporation at a rate per annum equal to LIBOR minus 0.10%. Advances by National cannot exceed 3% of its net admitted assets as of the last quarter end. As of December 31, 2017 and 2016, there were no amounts drawn under the agreement.
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. The discussion below highlights the significant risks and uncertainties that could have a material effect on the Company’s financial statements and business objectives in future periods.
The Company classifies its investments as available-for-sale (“AFS”), held-to-maturity (“HTM”), or trading. AFS investments are reported in the consolidated balance sheets at fair value with unrealized gains and losses, net of applicable deferred income taxes, reflected in accumulated other comprehensive income (loss) (“AOCI”) in shareholders’ equity. Investments carried at fair value are reported in the consolidated balance sheets at fair value and changes in fair value and realized gains and losses from the sale of these securities are reflected in earnings as part of “Net gains (losses) on financial instruments at fair value and foreign exchange.” Investments carried at fair value consist of certain investments elected under the fair value option. Short-term investments held as AFS include all fixed-maturity securities with a remaining maturity of less than one year at the date of purchase, commercial paper and money market securities. HTM investments are reported in the consolidated balance sheets at amortized cost. Debt securities are classified as HTM investments when the Company has the ability and intent to hold such investments to maturity. Investment income is recorded as earned. Bond discounts and premiums are amortized using the effective yield method over the remaining term of the securities and reported in “Net investment income.” For mortgage-backed securities (“MBS”) and asset-backed securities (“ABS”), discounts and premiums are amortized using the retrospective method. Realized gains and losses represent the difference between the amortized cost value and the sale proceeds.
For 2015, losses and LAE primarily related to increases in expected payments on CDOs and insured first-lien RMBS transactions and decreases in projected collections from excess spread within insured second-lien RMBS securitizations. These were partially offset by increases in recoveries of expected payments related to CDOs and increases in projected collections from excess spread within insured second-lien RMBS securitizations due to an anticipated sale of loans within certain securitizations that had been previously charged off by the servicer.
Gross Financial Guarantees-The fair value of gross financial guarantees is determined using discounted cash flow techniques based on inputs that include (i) assumptions of expected losses on financial guarantee policies where loss reserves have not been recognized, (ii) amount of losses expected on financial guarantee policies where loss reserves have been established, net of expected recoveries, (iii) the cost of capital reserves required to support the financial guarantee liability, (iv) operating expenses, and (v) discount rates which reflect the expected nonperformance risk and recovery rates of the Company.
The following tables present the fair values and carrying values of the Company’s assets and liabilities that are disclosed at fair value but not reported at fair value on the Company’s consolidated balance sheets as of December 31, 2017 and 2016:
The following table presents the distribution of securities in an unrealized loss position for a continuous twelve-month period or longer where fair value was below book value by more than 5% as of December 31, 2017:
The Company concluded that it does not have the intent to sell securities in an unrealized loss position and it is more likely than not, that it would not have to sell these securities before recovery of their cost basis. In making this conclusion, the Company examined the cash flow projections for its investment portfolios, the potential sources and uses of cash in its businesses, and the cash resources available to its business other than sales of securities. It also considered the existence of any risk management or other plans as of December 31, 2017 that would require the sale of impaired securities. Impaired securities that the Company intends to sell before the expected recovery of such securities’ fair values have been written down to fair value.
Gross realized gains and losses are recorded within “Net gains (losses) on financial instruments at fair value and foreign exchange” on the Company’s consolidated statements of operations. The proceeds and the gross realized gains and losses from sales of fixed-maturity securities held as AFS for the years ended December 31, 2017, 2016 and 2015 are as follows:
The Company has entered into derivative instruments to provide financial guarantee insurance to structured finance transactions that do not qualify for the financial guarantee scope exception and, therefore, are accounted for as derivatives. These insured CDS contracts, primarily referencing CMBS, are intended to be held for the entire term of the contract unless a settlement with the counterparty is negotiated. The Company no longer insures new CDS contracts except for transactions related to the restructuring or reduction of existing derivative exposure. The Company’s derivative exposure within its international and structured finance insurance segment also includes insured interest rate and inflation-linked swaps related to insured debt issues.
VIEs consolidated by the Company have entered into derivative instruments consisting of cross currency swaps. Cross currency swaps are entered into to manage the variability in cash flows resulting from fluctuations in foreign currency rates.
During 2017, National purchased from MBIA Inc., $129 million principal amount of MBIA Inc. 5.700% Senior Notes due 2034 that were previously repurchased by MBIA Inc. and had not been retired. In addition to the preceding table, as of December 31, 2017, National owned $264 million principal amount of the 5.700% Senior Notes due 2034 and MBIA Inc., through its corporate segment, owned $13 million of MBIA Corp. surplus notes and owned an additional $54 million of Senior Notes that were previously repurchased but not retired. These amounts are eliminated on a consolidated basis.
Included in the preceding tables, as of December 31, 2016, were $18.6 billion of insurance in force and $12.0 billion of insured gross par outstanding related to MBIA UK, which was sold to Assured in January of 2017. Refer to “Note 1: Business Developments and Risks and Uncertainties” for a discussion on the sale of MBIA UK.
In the fourth quarter of 2014, the Company’s Board of Directors authorized the repurchase of common stock up to $200 million under a new share repurchase program. On July 29, 2015, the Company’s Board of Directors authorized the repurchase by the Company or National of up to $100 million of its outstanding shares under a new share repurchase program, which superseded and terminated the prior fourth quarter 2014 authorization. The prior authorization had approximately $61 million of unused capacity at the time it was terminated. On October 28, 2015, the Company’s Board of Directors authorized the repurchase by the Company or National of up to $100 million of its outstanding common stock under a new share repurchase program, as the Company’s July 29, 2015 authorization was fully exhausted. During 2016, the Company exhausted any remaining capacity under the October 28, 2015 repurchase program.
MBIA Insurance Corp. v. J.P. Morgan Securities LLC (f/k/a Bear, Stearns & Co. Inc.); Index No. 64676/2012 (N.Y. Sup. Ct., County of Westchester)