The above factors and other factors that could affect our financial performance and business are discussed under “Risk Factors” in Part I, Item 1A of this annual report on Form 10-K.
The establishment of National as a separate U.S. public finance-only financial guarantee insurance company was a key step in achieving our strategic plan announced in February 2008. National provides MBIA with greater resilience and financial flexibility because we expect it will enable MBIA to resume writing financial guarantee insurance in the domestic public finance sector. National’s separate capitalization and operations respond to the substantial issuer and investor demand that MBIA has observed for bond insurance to be provided by a monoline bond insurer devoted exclusively to public finance transactions in the U.S. Through National, we expect to provide lower-cost funds to public issuers and to facilitate issuance in the public finance and infrastructure markets. The establishment of National is expected to give us a platform from which to write new business in the active U.S. public finance market once pending litigation challenging National’s establishment is resolved and high stable credit ratings are achieved for the operating subsidiary. We expect that this will lead to increased profitability and additional sources of liquidity for MBIA Inc. to support its own operations or those of its other subsidiaries. As of December 31, 2009, National had $5.5 billion of claims-paying resources.
Assets with fair values derived from broker quotes or pricing services can be classified within Level 1, 2 or 3 of the fair value hierarchy, depending on the observability of inputs. Typically we receive one broker quote or pricing service value for each instrument, which represents a non-binding indication of value. We review the assumptions, inputs and methodologies used by pricing services to obtain reasonable assurance that the prices used in our valuations reflect fair value and as a basis for classification within the three levels of the fair value hierarchy. For example, broker quoted prices are classified as Level 3 if we consider the inputs used not to be market-based and observable. Pricing service data is received monthly and quarterly, and we use a variety of methods to analyze the reasonableness of these third-party valuations, including comparisons to similar quality and maturity assets, internal modeling of implied credit spreads by sector and quality, comparison to published spread estimates, and assessment relative to comparable dealer offerings or any actual transactions from a recent time period. When we believe a third-party quotation differs significantly from our internal value, whether higher or lower, we review our data or assumptions with the provider. The price provider may subsequently provide an updated price. We do not make any internal adjustments to prices provided by a broker or pricing service.
There were four factors that led to the development of the Direct Price Model. (1) Market spreads for RMBS and ABS CDO collateral were no longer available. RMBS and ABS CDO collateral comprised the majority of the collateral for the multi-sector CDOs that were transitioned to a new marking model. Although market prices were available for the collateral, the BET model requires a spread input and the conversion from price to spread can be subjective for securities that trade substantially below par, which was the case for most of the collateral in these
The model uses market inputs with the most relevant being credit spreads for underlying referenced collateral, assumed recovery rates specific to the type and rating of referenced collateral, the diversity score of the entire collateral pool, and MBIA’s CDS and derivative recovery rate level. These are key parameters affecting the fair value of the transaction and all inputs are market-based whenever available and reliable.
If collateral-specific credit spreads are not available, we use generic spread tables based on asset class and average rating of the collateral pool. Average credit rating for the collateral is calculated from the
If there is a high dispersion of ratings within a collateral pool, the collateral is segmented into different rating buckets and each bucket is used in calculating the overall average.
As of December 31, 2009, actual collateral credit spreads were used in one transaction. Sector-specific spreads were used in 12% of the transactions valued using the BET model. Corporate spreads were used in 28% of the transactions and spreads benchmarked from the most relevant spread source (number 4 above) were used for 59% of the transactions. When determining the percentages above, there were some transactions where MBIA incorporated multiple levels within the hierarchy. For example, for some transactions MBIA used actual collateral-specific credit spreads (number 1 above) in combination with a calculated spread based on an assumed relationship (number 4 above). In those cases, MBIA classified the transaction as being benchmarked from the most relevant spread source (number 4 above) even though the
MBIA was able to obtain broker quotes for the majority of the collateral. For any collateral not directly priced, a matrix pricing grid was used based on security type and rating. For each security that was not directly priced, an average was used based on securities with the same rating and security type categories.
Transfers into and out of Level 3 were $114 million and $871 million, respectively, for the year ended December 31, 2009. Transfers into and out of Level 3 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, yield curves observable at commonly quoted intervals, and market corroborated inputs. Foreign governments and corporate obligations 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.
Transfers into and out of Level 3 were $1.2 billion and $959 million, respectively, for the year ended December 31, 2008. Transfers into and out of Level 3 were principally for available-for-sale securities where
In connection with the establishment of National in the first quarter of 2009, the Company changed the composition of its insurance reporting unit. As a result, the $77 million of goodwill recorded in our insurance operations was allocated between our U.S public finance insurance and our structured finance and international insurance reporting units based on the relative fair values of each reporting unit as of January 1, 2009. Of the $77 million, $46 million was allocated to our structured finance and international insurance business and $31 million was allocated to our U.S. public finance insurance business.
On February 27, 2010, the Republic of Chile was affected by an earthquake measuring 8.8 on the Richter scale. MBIA Corp. has $2.2 billion of net par exposure in the country, including to the major north/south highway and the Santiago airport, and it is apparent that there has been some damage to these infrastructure assets. Although we believe that the liquidity and other protections built into our insured transactions, including insurance, and the essentiality of the underlying assets provide adequate protection against loss, there can be no assurance that there will be no disruptions in cash flow or that we will not experience ultimate losses associated with this event.
For the Investment Grade CDOs, the next four tables provide breakdowns of the collateral composition and ratings of subprime RMBS collateral, non-subprime RMBS collateral, and CDOs of ABS collateral by vintage year and rating. Years in which no exposure was insured were omitted. CDOs of ABS may contain exposure to various types of collateral, including RMBS. The collateral level detail presented for each year insured was calculated using a weighted average of the total collateral as of December 31, 2009 for deals closed for the insured year. The range represents the minimum and maximum subordination for deals written in that year. The impact of all credit events delivered and settled as of December 31, 2009 have been reflected in the current subordination levels. We also present the net derivative asset/ (liability) related to CDS deals written in that year. Not all insurance contracts included in the following tables are accounted for as derivatives. Refer to “Note 5: Fair Value of Financial Instruments” and “Note 8: Derivative Instruments” in the Notes to Consolidated Financial Statements for information about the Company’s derivatives (including CDS on CDOs). The tables do not provide collateral level detail on 11 investment grade CDOs totaling $0.2 billion of net par. These deals were insured in the secondary market prior to 2003. The CDO collateral composition contains CDOs of ABS, CLOs, and Collateralized Bond Obligations (“CBOs”). Lastly, BIG denotes collateral credit ratings of below BBB-.
Our investment management services operations consist of three operating segments: advisory services, asset/liability products and conduits. In our advisory services segment, our registered investment advisors provide fixed-income asset management services to third parties and to our other segments on a fee-for-service basis. In our asset/liability products segment, MBIA Inc. and certain of its subsidiaries have issued debt and investment agreements, which are insured by MBIA Corp., and then initially purchased assets that largely matched the duration of those liabilities. Our conduit segment funded transactions by issuing debt, which is insured by MBIA Corp. The ratings downgrades of MBIA Corp. in 2008 and 2009 resulted in the cessation of debt and investment agreement issuance and the termination and collateralization of most investment agreements, causing the Company to begin winding down its asset/liability products and conduit businesses. Beginning in 2010 and in connection with the wind-down of our asset/liability products and conduit segments, we will no longer report our advisory services, asset/liability products, and conduit segments within a single operations group.
Average assets under management in our investment management services operations decreased 25% to $42.6 billion for the year ended December 31, 2009 from $56.8 billion for the year ended December 31, 2008. Total average assets under management as of December 31, 2008 decreased 14% from $66.0 billion at December 31, 2007. These decreases were primarily due to declines in assets managed within our asset/liability products and conduit segments.
MBIA Corp. maintained a $450 million limited recourse standby line of credit facility with a group of major banks to provide funds for the payment of claims in excess of the greater of $500 million of cumulative claims, net of recoveries, or 5% of average annual debt service with respect to U.S. public finance transactions. As a result of the reinsurance of all of MBIA Corp.’s U.S. public finance insurance exposure by National, MBIA Corp. voluntarily terminated the facility effective March 31, 2009. MBIA Corp. had no outstanding borrowings under the facility, and there were no early termination fees or premiums paid as a result of terminating the facility.
However, if the current market dislocation and economic conditions persist or worsen, the Company’s liquidity resources will experience further stress.
As of December 31, 2009, the corporate activities of MBIA Inc. had $332 million of cash and highly liquid assets available for general corporate liquidity purposes, of which $306 million comprised cash and short-term investments, compared with estimated debt service, including maturities, and operating expenses of $138 million through year-end 2010. In addition MBIA Inc. expects to receive a $222 million tax refund in April 2010 associated with its 2009 tax return which will significantly increase its liquidity resources.
The following table presents the fair values and gross unrealized losses by credit rating category of direct corporate obligations included in our consolidated investment portfolio as of December 31, 2009 for which fair value was less than amortized cost:
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, 2009. Estimated changes in fair value are calculated using the valuation methods described in the “Critical Accounting Estimates” section included herein. In scenarios where credit spreads decreased, a floor of zero was used.
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, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009 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, 2009, 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.
As described above, since February 2009, MBIA’s U.S. public finance insurance business has been 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. In 2009, National began publishing periodic comprehensive studies on select public finance sectors, including sectors in which it has exposure.
MBIA’s investment management services operations consist of an asset management advisory business which provides discretionary asset management, cash management and structured products to the public, not-for-profit, corporate and financial sectors. The advisory services segment primarily consists of the operations of Cutwater Investor Services Corp. (“Cutwater-ISC”, formerly known as MBIA Municipal Investor Service Corporation), Cutwater Asset Management Corp. (“Cutwater-AMC”, formerly known as MBIA Capital Management Corp.), and Cutwater Asset Management UK Limited (“Cutwater-UK”, formerly known as MBIA Asset Management UK). Cutwater-ISC and Cutwater-AMC provide fee-based asset management services, including pooled investments products and customized asset management services to third-party institutional clients and to MBIA Inc. and its subsidiaries, as well as portfolio accounting and reporting services. Cutwater-ISC and Cutwater-AMC are Securities and Exchange Commission (“SEC”)-registered investment advisers. Cutwater-AMC is also a Financial Industry Regulatory Authority member firm. Cutwater-UK provides fee-based asset management services to the Company’s foreign insurance affiliates and Euro Asset Acquisition Limited (“EAAL”), and to third-party institutional clients and investment structures. Cutwater-UK is registered with the Financial Services Authority in the United Kingdom (“U.K.”).
commissions paid by the Company in connection with assuming business from other financial guarantors. Deferred acquisition costs, net of ceding commissions received, related to non-derivative insured financial guarantee transactions are deferred and amortized over the period in which the related premiums are earned. Acquisition costs related to insured derivative transactions are expensed as incurred.
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.
The Company’s claim liability, insurance loss recoverable, and accruals for loss adjustment expenses (“LAE”) incurred are disclosed in “Note 12: Loss and Loss Adjustment Expense Reserves.”
In April 2009, the FASB issued amended accounting guidance to require disclosures about the fair value of financial instruments in interim and annual financial statements, including the method(s) and significant assumptions used to estimate the fair value of those financial instruments. The Company adopted this standard in the second quarter of 2009. As the standard requires only additional disclosures, the adoption did not have an impact on the Company’s consolidated balance sheets, results of operations or cash flows. Refer to “Note 5: Fair Value of Financial Instruments” for further information.
The following table presents the carrying value and fair value of financial instruments reported on the Company’s consolidated balance sheets as of December 31, 2009 and 2008:
Benchmark from most relevant spread source (for example, if no specific spreads are available and corporate spreads are not directly relevant, an assumed relationship is used between corporate spreads or sector-specific spreads and collateral spreads). Benchmarking can also be based on a combination of market spread data and fundamental credit assumptions.
financial guarantee policies for which case basis reserves have been established, (iii) the cost of capital reserves required to support the financial guarantee liability, and (iv) the discount rate. The MBIA Corp. CDS spread and recovery rate are used as the discount rate for MBIA Corp., while the Assured Guaranty Corp. CDS spread and recovery rate are used as the discount rate for National. The discount rates incorporate the nonperformance risk of the Company. As the Company’s gross financial guarantee liability represents its obligation to pay claims under its insurance policies, the Company’s calculation of fair value does not consider future installment premium receipts or returns on invested upfront premiums as inputs.
(1)-Represents the amount of other-than-temporary losses recognized in accumulated other comprehensive income (loss).
The following tables present the gross unrealized losses of held-to-maturity investments as of December 31, 2009 and 2008. 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.
(1)-Represents future expected credit losses on impaired assets expressed as a percentage of total current outstanding balance.
As of December 31, 2009, the total fair value of the Company’s derivative assets, after counterparty netting, was $874 million, of which $866 million was reported within “Derivative assets” on the Company’s consolidated balance sheets, and the total fair value of the Company’s derivative liabilities, after counterparty netting, was $4.7 billion, of which $4.6 billion was reported within “Derivative liabilities” on the Company’s consolidated balance sheet. As of December 31, 2008, the total fair value of the Company’s derivative assets, after counterparty netting, was $944 million, of which $911 million was reported within “Derivative assets” on the Company’s consolidated balance sheets, and the total fair value of the Company’s derivative liabilities, after counterparty netting, was $6.5 billion and was reported within “Derivative liabilities” on the Company’s consolidated balance sheets.
In the third quarter of 2009, the Company sponsored and formed an entity designed to issue beneficial interests that are held primarily by the Company and by third parties and to purchase MBSs transferred by MBIA. The entity is a VIE. MBIA is exposed to the majority of the expected losses and expected residual returns and is, therefore, the primary beneficiary and is required to consolidate the entity. As of December 31, 2009, total assets and liabilities were $194 million and $8 million, respectively.
During 2009, MBIA recognized estimated potential recoveries, net of reinsurance, of $1.5 billion related to reviewed transactions. These recoveries were based on the expected values of transaction-specific distributions of possible outcomes (factoring in all known uncertainties). The outcomes include: 1) recovery of amounts related to charged off loan files that the Company has already reviewed and found to breach representations; 2) recovery of amounts related to currently performing loans expected to be charged off in the future, assuming breach rates on those loans are consistent with breach rates on the population of loans the Company has reviewed; and 3) recoveries assuming sellers/servicers repurchase all loans that were deemed to be in breach of the sellers/servicers’ representations, estimated by applying the breach rates on loans the Company has reviewed to the entire population of loans, including those not expected to be charged off. Probabilities are then assigned to each scenario, based on the extent of actual file reviews supporting the estimated recoveries, the risk of litigation, risk of error in determining breach rates, counterparty credit risk, the cost of litigation and potential for delay, and other sources of uncertainty. The sum of the probabilities assigned to all scenarios is 100 percent. Expected cash inflows from recoveries are discounted using the current risk-free rate associated with the underlying credit, which ranged from 1.75% to 3.78% depending upon the transaction’s expected average life.
“Caution List - Medium”-Includes issuers where debt service protection is adequate under current and anticipated circumstances, although adverse trends have developed and are more pronounced than for “Caution List - Low.” Issuers in this category may have breached one or more covenants or triggers. These issuers are more closely monitored by IPM but generally take remedial action on their own.
As of December 31, 2009, the Company had approximately $421 million in deferred tax assets related to unrealized losses on investments. The Company intends to hold these investments until maturity or until such time as the value recovers. As such, the Company expects that its deferred tax assets will reverse over the life of the securities.
The change in the unrecognized tax benefit (“UTB”) as of December 31, 2009 and 2008 is as follows:
The Company’s structured finance and international insurance operations have been principally conducted through MBIA Corp. The financial guarantees issued by MBIA Corp. provide unconditional and irrevocable guarantees of the payment of principal of, and interest or other amounts owing on, global structured finance and non-U.S. public finance insured obligations when due, or in the event MBIA Corp. has the right, at its discretion, to accelerate insured obligations upon default or otherwise, upon MBIA Corp.’s acceleration. Certain guaranteed investment contracts written by MBIA Inc. are insured by MBIA Corp., and if MBIA Inc. were to have insufficient assets to pay amounts due upon maturity or termination, MBIA Corp. would make such payments. MBIA issues financial guarantees for municipal bonds, ABSs and MBSs, investor-owned utility bonds, bonds backed by publicly or privately funded public-purpose projects, bonds issued by sovereign and sub-sovereign entities, and bonds backed by other revenue sources such as corporate franchise revenues. Insured ABS include collateral consisting of a variety of consumer loans, corporate loans and bonds, trade and export receivables, aircraft, equipment and real property leases and insured MBS include collateral consisting of residential and commercial mortgages. In previous years, MBIA had insured CDSs on structured pools of corporate obligations, RMBS, and commercial real estate backed securities and loans.
The following tables summarize the Company’s operations for the years ended December 31, 2009, 2008 and 2007. As discussed above, the Company separated its insurance operations into U.S. public finance insurance and structured finance and international insurance, thereby creating two discrete segments. The Company has determined that it is impracticable to restate prior period results to conform to the current period presentation since, based on the way management has historically assessed the performance and resource requirements of its segments, prior period discrete financial information is not available. However, in order to provide comparable information to the prior period, the Company has combined its U.S. public finance insurance segment results and its structured finance and international insurance segment results for the current period under the heading “Combined Insurance Operations.”
While it is impractical for the Company to restate all revenues and expenses comprising its insurance results for prior periods, the Company is able to restate certain revenues and expenses included within the preceding tables for the years ended December 31, 2008 and 2007. The following table presents those revenues and expenses that the Company is able to restate, along with comparable amounts for the year ended December 31, 2009:
As of December 31, 2009, net insurance in force, which represents principal and interest or other amounts owing on insured obligations, net of cessions to reinsurers, had an expected maturity range of 1-47 years. The distribution of MBIA Corp.’s and National combined net insurance in force by geographic location, excluding $7.3 billion and $8.5 billion relating to transactions guaranteed by MBIA Corp. on behalf of various investment management services affiliated companies as of December 31, 2009 and 2008, respectively, is presented in the following table:
The aggregate amount of insurance in force ceded by MBIA to reinsurers under reinsurance agreements was $60.2 billion and $76.2 billion as of December 31, 2009 and 2008, respectively. The distribution of ceded insurance in force by geographic location is presented in the following table:
A summary of the Company’s stock options outstanding at December 31, 2009, 2008 and 2007, and changes during the years ended on those dates, is presented in the following tables:
Trusts for the benefit of employees, such as pension and profit-sharing trusts that are managed by or under the trusteeship of management.