National prices new business opportunities in both the competitive and negotiated markets. During the year ended December 31, 2014, National insured $343 million of par, which included approximately $300 million of Detroit Water Supply System Revenue Bonds and Detroit Sewage Disposal Bonds (together, the “DWSD Bonds”) issued through the Michigan Finance Authority. National’s insurance facilitated successful execution of these transactions and provided a lower cost of borrowing for the issuers.
As of December 31, 2014 and 2013, the liquidity position of MBIA Inc. and its corporate segment, was $498 million and $359 million, respectively. In 2014, positive cash flows to MBIA Inc. consist largely of dividends and releases of escrowed tax payments from National. Positive cash flows enabled debt and share repurchases in addition to covering operating expenses and scheduled debt service. During 2014, $220 million was released to MBIA Inc. under the MBIA group’s tax sharing agreement (the “Tax Escrow Account”) and in January of 2015, $228 million was released. During 2014, National declared and paid a dividend of $220 million to its ultimate parent, MBIA Inc.
As of December 31, 2014, adjusted book value (“ABV”) per share (a non-GAAP measure) was $24.87, up from $24.05 as of December 31, 2013. Refer to the following “Results of Operations” section for a further discussion of ABV and a reconciliation of GAAP book value per share to ABV per share.
Consolidated total revenues for the year ended December 31, 2014 included $459 million of net gains on insured derivatives compared with $232 million and $1.5 billion of net gains for 2013 and 2012, respectively. The net gains on insured derivatives in 2014 were principally the result of commuting derivative liabilities at prices below their fair values, partially offset by settlement and claim payments. The net gains on insured derivatives in 2013 were principally the result of changes in the weighted average life of transactions, commuting derivative liabilities at prices below their fair values and favorable changes in spreads and pricing on collateral, partially offset by the favorable effects of changes in the market’s perception of MBIA Corp.’s nonperformance risk on its derivative liabilities. The net gains on insured derivatives in 2012 were principally associated with the unfavorable effects of changes in the market’s perception of MBIA Corp.’s nonperformance risk on its derivative liabilities, commuting derivative liabilities at prices below their fair values and the result of favorable changes in spreads and pricing on collateral.
(3)-The discount rate on financial guarantee installment premiums was the risk-free rate as defined by the accounting principles for financial guarantee insurance contracts and the discount rate on insured derivative installment revenue and impairments was 5% as of December 31, 2014 and 2013.
Gross expenses represent total insurance expenses before the deferral of any policy acquisition costs. Gross expenses decreased for the year ended December 31, 2014 compared with 2013 due to decreases in consulting fees and legal and litigation related costs. Gross expenses decreased for the year ended December 31, 2013 compared with 2012 due to decreases in legal and litigation related costs.
INSURED PORTFOLIO EXPOSURE Financial guarantee insurance companies use a variety of approaches to assess the underlying credit risk profile of their insured portfolios. MBIA uses both an internally developed credit rating system as well as third-party rating sources in the analysis of credit quality measures of its insured portfolio. In evaluating credit risk, we obtain, when available, the underlying rating of the insured obligation before the benefit of its insurance policy from nationally recognized rating agencies, Moody’s and S&P. Other companies within the financial guarantee industry may report credit quality information based upon internal ratings that would not be comparable to our presentation. We maintain internal ratings on our entire portfolio, and our ratings may be higher or lower than the ratings assigned by Moody’s or S&P.
OTHER NET REALIZED GAINS (LOSSES) Other net realized gains (losses) for 2014 primarily related to an insurance recovery received on an errors and omissions liability policy.
For the years ended December 31, 2014, 2013 and 2012, losses and LAE incurred included the elimination of a $20 million expense, a $56 million benefit and a $140 million expense, respectively, as a result of the consolidation of VIEs. The $20 million expense elimination for the year ended December 31, 2014 included gross losses related to expected payments of $21 million, partially offset by gross recoveries of expected payments of $1 million. The $56 million benefit for the year ended December 31, 2013 included gross recoveries of expected payments of $98 million, partially offset by gross losses related to expected payments of $42 million. The $140 million expense for the year ended December 31, 2012 included gross losses related to expected payments of $100 million and recoveries of expected payments of $40 million.
The following table presents information about our insurance reserves and recoverable as of December 31, 2014 and 2013. The Company’s insurance loss recoverable represents expected potential recoveries of paid claims based on probability-weighted net cash inflows discounted at applicable risk-free rates as of the measurement date.
MBIA Inc.’s corporate debt, investment agreements, derivatives and GFL loans and GFL MTNs may be accelerated by the holders of such instruments upon the occurrence of certain events, such as a breach of covenant or representation, and in the following circumstances: (i) for corporate debt, the bankruptcy of MBIA Inc. or, for certain instruments, the filing of an insolvency proceeding with respect to National; (ii) for investment agreements, the bankruptcy of MBIA Inc. or the filing of an insolvency proceeding with respect to MBIA Corp., and in certain circumstances the bankruptcy of MBIA Inc. and the filing of an insolvency proceeding with respect to MBIA Corp.; (iii) for derivatives and GFL Loans to MBIA Inc., the bankruptcy of MBIA Inc.; and (iv) for GFL MTNs, the bankruptcy of GFL or the filing of an insolvency proceeding with respect to MBIA Corp.
As of December 31, 2014 and 2013, the liquidity position of MBIA Inc. comprised cash and liquid assets for general corporate liquidity purposes, excluding the amounts held in escrow under its tax sharing agreement, were $498 million and $359 million, respectively.
As of December 31, 2014, MBIA Corp. held cash and AFS investments of $1.2 billion, of which $443 million comprised cash and highly liquid assets that were immediately available to MBIA Corp. Included in the $1.2 billion was $701 million of cash and AFS investments held by MBIA Insurance Corporation’s subsidiaries. As of December 31, 2013, MBIA Corp. held cash and AFS investments of $1.6 billion, of which $827 million comprised cash and highly liquid assets that were immediately available to MBIA Corp. Included in the $1.6 billion was $693 million of cash and AFS investments held by MBIA Insurance Corporation’s subsidiaries.
Information about our consolidated cash flows by category is presented on our consolidated statements of cash flows. The following table summarizes our consolidated cash flows for the years ended December 31, 2014, 2013 and 2012:
As of December 31, 2014, the weighted average credit quality of the Company’s AFS investment portfolios, excluding short-term and other investments, as presented in the preceding table are as follows:
MBIA’s consolidated investment portfolio includes investments that are insured by various financial guarantee insurers (“Insured Investments”), including investments insured by National and MBIA Corp. (“Company-Insured Investments”). As of December 31, 2014, Insured Investments at fair value represented $498 million or 7% of consolidated investments, of which $312 million or 5% of consolidated investments were Company-Insured Investments. As of December 31, 2014, based on the actual or estimated underlying ratings of our consolidated investment portfolio, without giving effect to financial guarantees, the weighted average rating of only the Insured Investments in the investment portfolio would be in the A range.
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of comprehensive income (loss), of changes in shareholders’ equity and of cash flows present fairly, in all material respects, the financial position of MBIA Inc. and its subsidiaries at December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2014 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, 2014, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
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, 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 is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for instruments categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety.
Financial statement assets and liabilities denominated in foreign currencies are translated into U.S. dollars generally using rates of exchange prevailing as of the balance sheet date. Operating results are translated at average rates of exchange prevailing during the year. Unrealized gains or losses, net of deferred taxes, resulting from translation of the financial statements of a non-U.S. operation, when the functional currency is other than the U.S. dollar, are included in “Accumulated other comprehensive income (loss)” in shareholders’ equity. Foreign currency remeasurement gains and losses resulting from transactions in non-functional currencies are recorded in earnings. Exchange gains and losses resulting from foreign currency transactions are recorded in earnings.
The Company’s insured portfolio management groups within its U.S. public finance insurance and international and structured finance insurance businesses (collectively, “IPM”) monitor MBIA’s outstanding insured obligations with the objective of minimizing losses. IPM meets this objective by identifying issuers that, because of deterioration in credit quality or changes in the economic, regulatory or political environment, are at a heightened risk of defaulting on debt service of obligations insured by MBIA. In such cases, IPM works with the issuer, trustee, bond counsel, servicer, underwriter and other interested parties in an attempt to alleviate or remedy the problem and avoid defaults on debt service payments. Once an obligation is insured, MBIA typically requires the issuer, servicer (if applicable) and the trustee to furnish periodic financial and asset-related information, including audited financial statements, to IPM for review. IPM also monitors publicly available information related to insured obligations. Potential problems uncovered through this review, such as poor financial results, low fund balances, covenant or trigger violations and trustee or servicer problems, or other events that could have an adverse impact on the insured obligation, could result in an immediate surveillance review and an evaluation of possible remedial actions. IPM also monitors and evaluates the impact on issuers of general economic conditions, current and proposed legislation and regulations, as well as sovereign, state and municipal finances and budget developments.
The gross claim liability in the preceding tables represents the Company’s estimate of undiscounted probability-weighted future claim payments. As of December 31, 2014, the gross claim liability primarily related to insured first and second-lien RMBS issues, high yield corporate CDOs and an international road transaction. As of December 31, 2013, the gross claim liability primarily related to insured first and second-lien RMBS issues, ABS CDOs and an international road transaction.
Approximately 93% of the balance sheet fair value of insured credit derivatives as of December 31, 2014 was valued based on the Binomial Expansion Technique (“BET”) Model. Approximately 7% of the balance sheet fair value of insured credit derivatives as of December 31, 2014 was valued based on the internally developed Direct Price Model and the Dual Default model. The valuation of insured derivatives includes the impact of its credit standing. All of these derivatives are categorized as Level 3 of the fair value hierarchy as their fair value is derived using significant unobservable inputs.
Diversity scores are a means of estimating the diversification in a portfolio. The diversity score estimates the number of uncorrelated assets that are assumed to have the same loss distribution as the actual portfolio of correlated assets. While diversity score is a required input into the BET model, due to current high levels of default within the collateral of the structures, diversity score does not have a significant impact on valuation.
The following tables present the gross unrealized losses related to AFS and HTM investments as of December 31, 2014 and 2013:
Gross unrealized losses on AFS securities decreased as of December 31, 2014 compared with December 31, 2013 primarily due to market price appreciation caused by declining interest rates. Gross unrealized losses on HTM securities increased as of December 31, 2014 compared with December 31, 2013 primarily due to market price depreciation caused by the widening of credit spreads.
Investment agreements have been issued with either fixed or floating interest rates in U.S. dollars. As of December 31, 2014, the annual interest rates on these agreements ranged from 3.48% to 7.38% and the weighted average interest rate was 5.50%. As of December 31, 2013, the annual interest rates on these agreements ranged from 0.21% to 7.38% and the weighted average interest rate was 5.10%. Expected principal payments due under these investment agreements in each of the next five years ending December 31 and thereafter, based upon contractual maturity dates, are as follows:
A reconciliation of the U.S. federal statutory tax rate of 35% to the Company’s effective income tax rate for the years ended December 31, 2014, 2013 and 2012 is presented in the following table:
During the fourth quarter of 2012, the Company completed a balance sheet focused analysis to enhance efficiency and accuracy with its deferred income tax balances, and as a result, identified errors to the current and deferred income tax balances. The Company evaluated the materiality of these errors in accordance with SEC Staff Accounting Bulletin No. 99, Materiality, and SEC Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements, and concluded that these errors, individually and in the aggregate, were immaterial to the year ended December 31, 2012 and all prior periods to which these errors relate. Accordingly, the Company recorded these adjustments in its consolidated financial statements for the year ended December 31, 2012 by increasing “Net income (loss)” by $60 million.
The Company manages its businesses across five operating segments: 1) U.S. public finance insurance; 2) international and structured finance insurance; 3) corporate; 4) advisory services; and 5) conduit. The Company’s U.S. public finance insurance business is operated through National, its international and structured finance insurance business is operated through MBIA Corp. and its advisory services business is primarily operated through Cutwater. During 2014, the Company dissolved its conduit segment by extinguishing the remaining liabilities of the segment and liquidating the Company’s remaining conduit, Meridian Funding Company, LLC (“Meridian”). In addition, in the fourth quarter of 2014, the Company entered into an agreement to sell Cutwater to a subsidiary of The Bank of New York Mellon Corporation. This transaction was effective on January 1, 2015 in which, the Company exited its advisory services business.
The Company’s corporate segment consists of general corporate activities, including providing general support services to MBIA’s other operating businesses and asset and debt management. General support services are provided by the Company’s service company, MBIA Services Corporation (“MBIA Services”), formerly Optinuity Alliance Resources Corporation. MBIA Services provides various support services including, among others, management, legal, accounting, treasury, information technology, and insurance portfolio surveillance, on a fee-for-service basis. Debt management includes activities related to servicing obligations issued by MBIA Inc. and its subsidiaries, IMC and GFL. MBIA Inc. issued debt to finance the operations of the MBIA group. IMC, along with MBIA Inc., provided customized investment agreements, guaranteed by MBIA Corp., for bond proceeds and other public funds for such purposes as construction, loan origination, escrow and debt service or other reserve fund requirements. It also provided customized products for funds that are invested as part of asset-backed or structured product transactions. GFL raised funds through the issuance of MTNs with varying maturities, which were in turn guaranteed by MBIA Corp. GFL lent the proceeds of these MTN issuances to MBIA Inc. The company ceased issuing these investment agreements and MTNs and the outstanding liability balances and corresponding asset balances have declined over time as liabilities mature, terminate or are retired. All of the debt within the corporate segment is managed collectively and is serviced by the financial resources available to MBIA Inc. Asset management activities support the Company’s funded liabilities, provide for opportunities in investments and provide general liquidity support to MBIA Inc.
The advisory services segment primarily consists of the operations of Cutwater Investor Services Corp. (“Cutwater-ISC”) and Cutwater Asset Management Corp. (“Cutwater-AMC”) and is a fee-for-service investment management business focused on fixed-income markets. Cutwater-ISC and Cutwater-AMC are Securities and Exchange Commission registered investment advisers. In October of 2014, the Company entered into an agreement to sell Cutwater to a subsidiary of The Bank of New York Mellon Corporation. Effective with the January 1, 2015 sale of Cutwater, MBIA has no business activities within its advisory services segment.
(1) Includes 412,769, 629,896 and 506,714 of participating securities that met the service condition and were eligible to receive nonforfeitable dividends or dividend equivalents for the years ended December 31, 2014, 2013 and 2012, respectively.
The following table presents the details of the reclassifications from AOCI for the years ended December 31, 2014, 2013, and 2012:
On December 14, 2009, MBIA Corp. commenced an action in New York State Supreme Court, New York County, against Credit Suisse. The complaint seeks damages for fraud and breach of contractual obligations in connection with the procurement of financial guarantee insurance on the HEMT Series 2007-2 securitization. On January 30, 2013, MBIA Corp. filed an amended complaint. The amended complaint alleges, among other claims, that Credit Suisse falsely represented: (i) the attributes of the securitized loans; (ii) that the loans complied with the governing underwriting guidelines; and (iii) that Credit Suisse had conducted extensive due diligence on and quality control reviews of the securitized loans to ensure compliance with the underwriting guidelines. The complaint further alleges that the defendants breached their contractual obligations to cure or repurchase loans found to be in breach of the representations and warranties applicable thereto and denied MBIA the requisite access to all records and documents regarding the securitized loans. On August 13, 2014, the court issued an order scheduling expert discovery to run through the middle of 2015.