Standard and Poor’s (“S&P”), Moody’s Investors Services, Inc. (“Moody’s”), and Fitch, Inc. (“Fitch”) downgraded MBIA’s triple-A insurance financial strength ratings in the second quarter of 2008.
Ceased insuring new credit derivative contracts except in transactions related to the reduction of existing derivative exposure.
Raised over $2.6 billion in new capital through the issuance of common stock and surplus notes.
In December 2006, MBIA completed the sale of MBIA MuniServices Company and certain of its wholly owned subsidiaries (“MuniServices”) to an investor group led by the management of MuniServices. MBIA’s municipal services operations consisted of the activities of MuniServices and Capital Asset. As a result of the sale of MuniServices and Capital Asset, the Company no longer reports municipal services operations and the assets, liabilities, revenues and expenses of these entities have been reported within discontinued operations for 2006 in accordance with Statement of Financial Accounting Standards No. (“SFAS”) 144, “Accounting for the Impairment or Disposal of Long-lived Assets.” Refer to “Note 16: Discontinued Operations” in the Notes to Consolidated Financial Statements for information relating to the Company’s discontinued operations.
We monitor portfolio performance on a monthly basis against projected performance, reviewing delinquencies, roll rates, prepayment rates (including voluntary and involuntary) and CDR trends. In the event of a material deviation in actual performance from projected performance, we would increase or decrease our case basis reserves accordingly. We made such a change in the third quarter of 2008. Consequently, we have also revised our sensitivity analysis of those reserves. If defaults and losses remained at the peak levels we are now modeling for six months longer than in our base case, the addition to our case basis loss and LAE reserve would be approximately $500 million.
Refer to “Note 2: Significant Accounting Policies” and “Note 4: 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.
In most cases, our insured credit derivatives are measured at fair value as they do not qualify for the financial guarantee scope exception under SFAS 133. Because they are highly customized there is generally no observable market for these derivatives, and as a result we estimate their value in a hypothetical market based on internal and third-party models simulating what a bond insurer would charge to guarantee the transaction. This pricing would be based on expected loss of the exposure calculated using the value of the underlying collateral within the transaction structure.
In January 2009, the FASB issued FASB Staff Position No. (“FSP”) EITF 99-20-1 “Amendments to the Impairment Guidance of EITF Issue No. 99-20” which amends the impairment guidance in Emerging Issues Task Force (“EITF”) Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets,” to achieve more consistent determination of whether an other-than-temporary impairment has occurred with that of SFAS 115. The adoption of FSP EITF 99-20-1 did not have a material affect on the Company’s consolidated balance sheets, results of operations or cash flows.
The Company adopted the provisions of SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” effective January 1, 2008. SFAS 159 provides entities the option to measure certain financial assets and financial liabilities at fair value with changes in fair value recognized in earnings each period. SFAS 159
NET GAINS AND LOSSES ON FINANCIAL INSTRUMENTS AT FAIR VALUE AND FOREIGN EXCHANGE Net gains and losses on financial instruments at fair value and foreign exchange in our insurance operations primarily represents changes in the fair value of our CPCT facility and foreign exchange gains and losses on the sale of investments and translation of non-functional currency activities. In 2008, net gains on financial instruments at fair value and foreign exchange were $209 million compared with net gains of $121 million in 2007 and $6 million in 2006. Net gains in 2008 were largely due to a $250 million gain resulting from the change in value of our CPCT facility. Net gains in 2007 primarily consisted of a $110 million gain resulting from the change in value of our CPCT facility. Gains on our CPCT facility in 2008 and 2007 were due to an increase in the differential between the Company’s CDS spreads and the yield applicable to the CPCT facility. Net gains in 2006 were largely due to foreign exchange gains related to the sale of foreign denominated securities, partially offset by derivative losses on deals that were terminated early.
In the event MBIA determines that it must pay a claim or that a claim is probable and estimable with respect to an insured issue, it places the issue on its “Classified List” and establishes a case basis reserve for that insured issue. As of December 31, 2008, MBIA had 82 open case basis issues on its “Classified List” that had $1.3 billion in aggregate case basis reserves, net of reinsurance. The Company does not establish any case basis reserves for issues that are listed as “Caution List-Low,” “Caution List-Medium” or “Caution List-High” until such issues are placed on the Company’s “Classified List.”
Multi-sector CDOs are transactions that include a variety of structured finance asset classes in their collateral pools. As of December 31, 2008, $27.7 billion, or approximately 4%, of the Company’s total insured net par outstanding of $786.5 billion comprised multi-sector CDOs. Additionally, as of December 31, 2008, 22% of the Company’s $124.9 billion CDO and related instruments portfolio insured net par outstanding comprised multi-sector CDOs. The collateral in the multi-sector CDOs includes subprime RMBS and other RMBS, CDOs of ABS (multi-sector CDOs), Corporate CDOs, Collateralized Loan Obligations (“CLOs”), other ABS (e.g. securitizations of auto receivables, credit cards, etc.), Commercial Real Estate CDOs, CMBS, and Corporate credits.
The multi-sector CDO portfolio is comprised of transactions that rely on underlying collateral originally rated single-A or above (CDOs of High Grade U.S. ABS) and transactions that rely on collateral primarily rated triple-B (CDOs of Mezzanine U.S. ABS). The multi-sector CDO portfolio is also comprised of CDOs of multi-sector high-grade collateral (also referred to as CDO-squared transactions), which are diversified CDOs primarily comprised of collateral originally rated single-A and above. The collateral in MBIA’s insured CDO-squared transactions comprises primarily tranches of CLOs, CDOs of ABS, and RMBS.
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 January 31, 2009 have been reflected in the current subordination levels.
High Yield Corporate CDOs: Collateral Composition, Subordination, and Net Derivative Asset/Liability
The Company’s $44.9 billion net par Structured CMBS Pools and CRE CDO portfolio at December 31, 2008 did not contain any CDOs of ABS exposures, and the Structured CMBS Pools did not contain any Subprime and Non-subprime RMBS exposures. The underlying credit ratings of the collateral that support the Subprime RMBS, Non-subprime RMBS exposures along with their vintage are presented for the CRE CDO portfolio in the following tables.
During 2008, we repurchased $127 million par value of outstanding corporate debt at a discount to carrying value and recognized net gains of $30 million, net of costs associated with the debt.
Prior to the Company exercising its option under the CPCT facility, the CPCT securities were remarketed every 28 days with the interest rate set by means of an auction and with two trusts remarketing each week. In the event that there were insufficient bids at any auction to remarket all of the CPCT securities of any trust, the rate was reset for the next 28 days at the maximum prescribed rate with the investors of the CPCT securities continuing to
together with the cost and availability of funding, have significantly adversely affected this business. MBIA’s investment management services operations also provide cash management, discretionary asset management and structured products to the public, not-for-profit, corporate and financial sectors.
the security’s fair value is less than current book value by a magnitude of 20% or greater.
Goodwill represents the excess of the cost of acquiring a business enterprise over the fair value of the net assets acquired. Under SFAS 142, “Goodwill and Other Intangible Assets,” goodwill is tested for impairment at least annually. An impairment loss is triggered if the estimated fair value of an operating segment is less than its carrying value. Refer to “Note 13: Goodwill” for an explanation of the Company’s annual impairment test.
Certain of the Company’s financial guarantees that meet the definition of a derivative are subject to a financial guarantee scope exception, as defined in SFAS 133. This scope exception provides that financial guarantee contracts are not subject to SFAS 133 only if:
Payments are required based on changes in the creditworthiness of a referenced credit, rather than failure of that debtor to pay when due (i.e., default);
Level 2-Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly. Level 2 assets include debt securities with quoted prices that are traded less frequently than exchange-traded instruments, securities which are priced using observable inputs and derivative contracts whose values are determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. Assets and liabilities utilizing Level 2 inputs include: U.S. government and agency MBSs; most over-the-counter (“OTC”) derivatives; corporate and municipal bonds; and certain MBSs or ABSs.
U.S. Treasury and government agency-U.S. Treasury securities are liquid and have quoted market prices. Fair value of U.S. Treasuries is based on live trading feeds. U.S. Treasury securities are categorized in Level 1 of the fair value hierarchy. Government agency securities include debentures and other agency mortgage pass-through certificates as well as to-be-announced (“TBA”) securities. TBA securities are liquid and have quoted market prices based on live data feeds. Fair value of mortgage pass-through certificates is obtained via a simulation model, which considers different rate scenarios and historical activity to calculate a spread to the comparable TBA security. Government agency securities use market-based and observable inputs. As such, these securities are classified as Level 2 of the fair value hierarchy.
The held-to-maturity investments consist of fixed and floating rate fixed-maturity assets. The fair value of the fixed rate investments is determined by calculating the net present value of estimated future cash flows assuming prepayments, defaults and discount rates that the Company believes market participants would use for similar assets. The carrying value of the floating rate investments approximates their fair value.
2) The model is a well-documented, consistent approach to marking positions that minimizes the level of subjectivity. Model structure, inputs and operation are well-documented both by Moody’s and by MBIA’s internal controls, creating a strong controls process in execution of the model. The Company has also developed a hierarchy for usage of various market-based spread inputs that reduces the level of subjectivity, especially during periods of high illiquidity.
As of December 31, 2008, actual collateral credit spreads were used in one transaction. Sector-specific spreads were used in 22% of the transactions. Corporate spreads were used in 32% of the transactions and spreads benchmarked from the most relevant spread source (number 4 above) were used for 45% 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 majority of the average spread was from actual collateral-specific spreads. WARF-sourced credit spread was used for 95% of the transactions.
Investments that are held-to-maturity are reported on the Company’s balance sheet at amortized cost. These investments, which relate to the Company’s conduit segment and consolidated VIEs, primarily consist of ABS and loans issued by major national and international corporations and other structured finance clients. As of December 31, 2008, the amortized cost and fair value of held-to-maturity investments totaled $3.7 billion and $3.6 billion, respectively. Unrecognized gross gains were $1 million and unrecognized gross losses were $62 million. As of December 31, 2007, the amortized cost and fair value of held-to-maturity investments totaled $5.6 billion. There were no unrecognized gross gains and unrecognized gross losses were $18 million. The following table presents the distribution of held-to-maturity investments by contractual maturity at amortized cost and fair value as of December 31, 2008:
Net unrealized gains (losses), including related deferred income taxes, reported in accumulated other comprehensive income (loss) within shareholders’ equity consisted of:
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 and forecasted transactions. CDSs are also entered into in the investment management services operations to replicate investments in cash assets consistent with the Company’s risk objectives and credit guidelines for its investment management business. The Company accounts for derivative transactions in accordance with SFAS 133, as amended, which requires that all such transactions be recorded on the Company’s balance sheet at fair value. Fair value of derivative instruments is defined as the price that would be received to sell a derivative asset or paid to transfer a derivative liability (an exit price) in an orderly transaction between market participants at the measurement date.
The Company routinely pledges securities it owns in accordance with the terms of its collateralized transactions. Securities pledged in connection with investment agreement activities may not be repledged by the investment agreement counterparty. Securities pledged as part of repurchase agreements may be repledged or rehypothecated by the counterparty of the contract or by MBIA. As of December 31, 2008 and 2007, the fair value of financial assets pledged as collateral under repurchase agreements in which the counterparties have the right to repledge or rehypothecate the securities were $846 million and $1.2 billion, respectively. In addition to security collateral, MBIA also had $31 million of cash collateral pledged under these agreements, which is included in “Other assets” on the Company’s consolidated balance sheet.
On January 16, 2008, MBIA Corp. issued $1 billion of 14% fixed-to-floating rate surplus notes due January 15, 2033. The surplus notes have an initial interest rate of 14% until January 15, 2013 and thereafter at an interest rate of three-month LIBOR plus 11.26%. Interest payments on the surplus notes are subject to prior approval by the Superintendent of the NYSID. The surplus notes are callable at par at MBIA Corp.’s option on the fifth anniversary of the date of issuance and every fifth anniversary thereafter, subject to prior approval by the Superintendent and other restrictions. The cash received from the issuance of surplus notes was used for general business purposes and the deferred debt issuance costs are being amortized over the term of the surplus notes. During the third quarter of 2008, MBIA Corp. repurchased $47 million par value outstanding of its surplus notes at an average price of 77.00. Net gains from repurchasing the surplus notes totaled $10 million.
During the course of 2008, conditions in the asset-backed commercial paper market deteriorated and it became increasingly difficult as the year progressed for Triple-A One to issue commercial paper at commercially acceptable rates. Accordingly, as the market for its paper dried up, Triple-A One began drawing down on its liquidity facilities to repay maturing commercial paper. By September 2008, these facilities were drawn in full and Triple-A One ceased issuing commercial paper. All commercial paper holders have been repaid in full.
The Company may buyback and extinguish debt originally issued by either MBIA Inc. or its subsidiaries. Purchase prices are generally negotiated with the counterparty, similar to buying or selling an asset in the open market. The Company repurchases its debt at discounted prices in an effort to improve its own economic position while also providing liquidity to investors of MBIA debt. In all cases, debt buybacks were executed in response to investor or dealer inquiries. During 2008, the Company recognized gains associated with medium-term note repurchases, net of losses associated with investment agreement terminations, of $341 million.
The carrying amount and estimated fair value of the Company’s insurance operations were $4.5 billion and $9.4 billion as of December 31, 2007, respectively, and $3.4 billion and $9.2 billion as of December 31, 2008, respectively. The Company performed its annual impairment testing of goodwill within its insurance operations as of January 1, 2008 and January 1, 2009. On both dates, the fair value of the insurance reporting unit exceeded its carrying value indicating that goodwill was not impaired.
After reviewing all of the evidence available, both positive and negative, MBIA believes that it has appropriately valued the recoverability of its deferred tax assets, net of the valuation allowance, as of December 31, 2008. The Company continues to assess the need for additional valuation allowances as additional evidence becomes available.
MBIA’s major tax jurisdictions include the U.S., the United Kingdom (“U.K.”) and France. MBIA and its U.S. subsidiaries file a U.S. consolidated federal income tax return. U.S. federal income tax returns have been examined through 2005 by the IRS. The Company is under a partnership audit related to an adjustment that must be accounted for by MBIA Inc. during tax years 2004 through 2006.
The Company’s corporate operations are a reportable segment and include revenues and expenses that arise from general corporate activities, such as net investment income, net gains and losses, interest expense on MBIA Inc. debt and general corporate expenses.
The following table summarizes the segments within the investment management services operations for the years ended December 31, 2008, 2007 and 2006:
sector clients nationwide consisting of discovery, audit, collections/recovery and information services. The sale of MuniServices was completed in December 2006 and resulted in an after-tax gain of $0.6 million.
In addition to the above plans, the Company maintains a non-qualified deferred compensation plan. Contributions to the above qualified plans that exceed limitations established by federal regulations are then contributed to the non-qualified deferred compensation plan. The non-qualified contributions included in the above stated pension and profit-sharing/401(k) expense and contribution amounts totaled $3 million for the pension plan, and $0.9 million, $0.8 million and $0.4 million for the profit-sharing/401(k) plan for the years ended December 31, 2008, 2007 and 2006, respectively. In addition, the interest credited to the non-qualified deferred compensation plans totaled $3 million for each of the years ended December 31, 2008, 2007, and 2006.
In 2008, 2,859,000 options were granted and 3,297,867 options were canceled or expired. In 2008, 1,125,388 restricted shares were granted and 583,439 restricted shares were canceled. This restricted share activity affects the available share balance for future grants under the Omnibus Plan at a two for one ratio. There were 3,552,010 shares available for future grants under the Omnibus Plan as of December 31, 2008.
As of December 31, 2008, MBIA Corp. had 2,759 shares of the preferred stock issued and outstanding. In accordance with MBIA’s fixed-rate election, the dividend rate on the preferred stock was determined using a fixed-rate equivalent of LIBOR plus 200 basis points. Each share of preferred stock has a par value of $1,000 with a liquidation preference of $100,000. The holders of the preferred stock are not entitled to any voting rights as shareholders of MBIA Corp. and their consent is not required for taking any corporate action. Subject to certain requirements, the preferred stock may be redeemed, in whole or in part, at the option of MBIA Corp. at any time or from time to time for cash at a redemption price equal to the liquidation preference per share plus any accrued and unpaid dividends thereon at the date of redemption for the then current dividend period and any previously accumulated dividends payable without interest on such unpaid dividends. As of December 31, 2008, no dividends have been declared on the preferred stock. Payment of dividends on MBIA Corp.’s preferred stock is subject to the same restrictions that apply to dividends on common stock under New York State insurance law.
MBIA Insurance Corporation had, on a statutory basis, total policyholders’ surplus of approximately $3.5 billion as of December 31, 2008. Had the restructuring of MBIA Insurance Corporation occurred on December 31, 2008, total policyholders’ surplus of MBIA Insurance Corporation and MBIA Illinois would have been approximately $3.1 billion and $0.4 billion, respectively.