|
|
 | | | |
- close
- close
- close
- close
MBIA 10-K 2009 Documents found in this filing:
Table of Contents
United States SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
Form 10-K
For the fiscal year ended December 31, 2008 or
For the transition period from to Commission File Number 1-9583
MBIA INC. (Exact name of registrant as specified in its charter)
Registrant’s telephone number, including area code: (914) 273-4545 Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨ Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company ¨ Indicate by check mark whether the Registrant is shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x The aggregate market value of the voting stock held by non-affiliates of the Registrant as of June 30, 2008 was $814,155,326. As of February 25, 2009, 208,713,676 shares of Common Stock, par value $1 per share, were outstanding. Documents incorporated by reference. Portions of the Definitive Proxy Statement of the Registrant, which will be filed on or before March 31, 2009, are incorporated by reference into Parts I and III.
Table of ContentsTABLE OF CONTENTS
Table of ContentsPart I Item 1. Business OVERVIEW OF OUR SERVICES MBIA Inc. (“we,” “us,” “MBIA” or the “Company”) provides the following financial services on a global basis: (1) financial guarantee insurance, as well as related reinsurance, advisory and portfolio services for the public and structured finance markets, and (2) investment management services, including advisory services, asset/liability products and conduits. Our financial guarantee insurance provides investors with an unconditional and irrevocable guarantee of the payment of the principal, interest or other amounts owing on insured obligations when due or, in the event that we have the right at our discretion to accelerate insured obligations upon default or otherwise, upon our acceleration. Because a financial guarantor’s ratings are generally assigned to insured obligations, the principal economic value of financial guarantee insurance for capital markets issuers has been the lower interest cost of an insured obligation relative to the same obligation on an uninsured basis. For investors, our insurance provides not only an additional level of credit protection but also the benefit of our portfolio monitoring and remediation skills throughout the life of the insurance policy. In addition, for complex financings and for obligations of issuers that are not well-known by investors, insured obligations have historically received greater market acceptance than uninsured obligations. Our investment management services business has three operating segments:
The Company was incorporated as a business corporation under the laws of the state of Connecticut in 1986. We conduct our financial guarantee business through our wholly-owned subsidiaries MBIA Corp. and MBIA Insurance Corp. of Illinois (“MBIA Illinois”) and conduct our investment management business through the Company and its subsidiaries, primarily our wholly-owned subsidiary MBIA Asset Management, LLC (“MBIA Asset Management”). MBIA Corp. is the successor to the business of the Municipal Bond Insurance Association (the “Association”), which began writing financial guarantees for municipal bonds in 1974. MBIA Corp. is the parent of Capital Markets Assurance Corporation (“CapMAC”) and until February 2009, MBIA Illinois, both financial guarantee insurance companies that were acquired by MBIA Corp. At present, no new financial guarantee insurance is being offered by CapMAC, but it is possible that it may insure transactions in the future. In February 2009, we restructured our business to re-launch MBIA Illinois as a U.S. public finance-only financial guarantee company (the “MBIA Illinois Transformation”) through a series of transactions, including the transfer of MBIA Illinois from MBIA Corp. to a newly established holding company, National Public Finance Guarantee Holdings, Inc., that is 100% owned by MBIA Inc., and the reinsurance by MBIA Illinois of the U.S. domestic public finance businesses of MBIA Corp. and a third party financial guarantor, Financial Guaranty Insurance Corporation (“FGIC”). The MBIA Illinois Transformation is described more fully under the “Our Insurance Operations—MBIA Illinois Portfolio” section below. Generally, throughout the text, references to MBIA Illinois include the portfolios assumed in connection with the MBIA Illinois Transformation. After giving effect to the MBIA Illinois Transformation, MBIA Corp.’s remaining portfolio consists of global structured finance and non-U.S. public finance business. MBIA Corp. also owns MBIA UK Insurance Limited (“MBIA UK”), a financial guarantee insurance company licensed in the United Kingdom which writes financial
1
Table of ContentsItem 1. Business (Continued)
guarantee insurance in the member countries of the European Union and other regions outside the United States. MBIA UK also insures the policies previously insured by MBIA Assurance S.A. (“MBIA Assurance”), a French insurance company owned by MBIA Corp. which was dissolved on December 28, 2007. In February 2007, MBIA Corp. incorporated a new wholly-owned subsidiary, MBIA México, S.A. de C.V. (“MBIA Mexico”), through which it writes financial guarantee insurance in Mexico. Generally, throughout the text, references to MBIA Corp. include the activities of its subsidiaries, MBIA UK, MBIA Mexico and CapMAC. OUR BUSINESS STRATEGY The Company’s insurance and funding programs, like those of other financial guarantors, have historically depended on Triple-A credit ratings. The continuing extreme disruption in global financial markets and economic conditions that began in 2007 has impacted the industry and MBIA, with resulting ratings downgrades below Triple-A for many financial guarantors. The loss of those ratings for MBIA Corp. in the second quarter of 2008 and the events and process leading to the loss of those ratings, each of which is described further under “Rating Agencies” below, resulted in a dramatic reduction of our traditional insurance and funding activities. In response to the economic and rating events described above, we are continuing efforts that we began in the fourth quarter of 2007 to strengthen our balance sheet and evaluate our business model:
Under the MBIA Illinois Transformation, the stock of MBIA Illinois was transferred by MBIA Corp. to the Company, which in turn contributed the stock to a newly established holding company, National Public Finance Guarantee Holdings, Inc., that is 100% owned by the Company. In addition, MBIA Illinois reinsured, effective January 1, 2009, all of the U.S. public finance business of MBIA Corp. through a reinsurance agreement with MBIA Corp. and an assignment by MBIA Corp. of its rights and obligations under its reinsurance agreement with FGIC. The MBIA Illinois reinsurance in each case was offered on a cut-through basis, allowing a reinsurance claim to be presented directly to MBIA Illinois. In addition, MBIA Illinois issued second-to-pay policies covering the MBIA Corp. and FGIC policies it reinsured. Each of these transactions is described in more detail in the “Our Insurance Operations—MBIA Illinois Portfolio” section below. As a result of these actions, MBIA Illinois is now a stand-alone, separately capitalized and governed insurance company with $554 billion of net par insured. Its assets are available to service the policies of its domestic public finance insureds. MBIA Corp. is now a stand-alone, separately capitalized and governed insurance company with $233 billion of net par insured. Its assets are available to service the policies of its structured finance and international infrastructure insureds. The major rating agencies have recognized this separation with their ratings decisions on these two companies to date. Following the announcement of the MBIA Illinois Transformation, the ratings assigned to the Company, MBIA Illinois, MBIA Corp. and certain of the underlying bonds that were reinsured by MBIA Illinois through the transaction were revised. Standard and Poor’s Corporation (“S&P”) announced that it had lowered its ratings on MBIA Corp. and its subsidiaries to BBB+ with a negative outlook, lowered its
2
Table of ContentsItem 1. Business (Continued)
ratings on MBIA Illinois to AA- and placed them on CreditWatch with developing implications, and lowered its rating on the Company to BB+ with a negative outlook. Moody’s Investors Service, Inc. (“Moody’s”) downgraded the ratings of MBIA Corp. and its subsidiaries to B3 with developing outlook and placed the Baa1 rating of MBIA Illinois on review for possible upgrade. Both S&P and Moody’s indicated that they would apply the ratings of MBIA Illinois to the underlying MBIA Corp.-insured bonds that were reinsured by MBIA Illinois through the transaction, and in the case of S&P, also to the underlying FGIC-insured bonds that were reinsured by MBIA Illinois, except in each case for those bonds with higher public underlying ratings. Further information on these rating actions can be found under the “Rating Agencies” section below. The next step in the MBIA Illinois Transformation will be to further position MBIA Illinois to write new U.S. public finance financial guarantee insurance policies through the achievement of high stable ratings. It is our intent to capitalize MBIA Illinois at a level well in excess of the historical capital requirements for Triple-A ratings, including potentially through the raising of sufficient new third party capital, although no assurance can be given that we will be able to achieve such ratings or raise such capital.
These steps have preserved capital for the Company and reduced its insured liabilities. In addition, because certain guaranteed investment contracts written by MBIA Inc. are subject to collateralization and/or are terminable upon ratings downgrades, we took steps in the second, third and fourth quarters of 2008 to reduce the liabilities in the asset-liability management portfolio and preserve liquidity to make payments that may become due in connection with such collateralization or termination requirements.
We continue to evaluate our business model and may pursue a different set of strategies in the future. There can be no assurance that the strategies that have been implemented or that will be pursued in the future in connection with this evaluation will result in high stable ratings for each of our businesses or for MBIA Inc., will enable us to write new financial guarantee business, will otherwise improve our financial condition, business condition or operations or will not result in a material adverse effect on the Company.
3
Table of ContentsItem 1. Business (Continued)
Statements included in this Form 10-K which are not historical or current facts are “forward-looking statements” made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The words “believe,” “anticipate,” “project,” “plan,” “expect,” “intend,” “will likely result,” or “will continue,” and similar expressions identify forward-looking statements. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. We wish to caution readers not to place undue reliance on any such forward-looking statements, which speak only to their respective dates. The following are some of the factors that could cause actual results to differ materially from estimates contained in or underlying the Company’s forward-looking statements: (1) the possibility that the Company will experience severe losses due to increased deterioration in its insurance portfolios and in particular, due to the performance of residential mortgage-backed securities (“RMBS”) and collateralized debt obligations (“CDOs”); (2) significant fluctuations in liquidity and asset values within the global credit markets; (3) our ability to fully implement our Strategic Plan, including our ability to achieve high stable ratings for each of our businesses and compete for new business; (4) further changes in the Company’s credit ratings; (5) further deterioration in the economic environment and financial markets in the United States or abroad, particularly with regard to credit spreads, interest rates and foreign currency levels; (6) competitive conditions for bond insurance, including potential entry into the public finance market of a national insurer of municipal bonds; (7) legislative, regulatory or political developments; (8) technological developments; (9) changes in tax laws; (10) the effects of mergers, acquisitions and divestitures; and (11) uncertainties that have not been identified at this time. The Company undertakes no obligation to publicly correct or update any forward-looking statement if it later becomes aware that such result is not likely to be achieved. OUR INSURANCE OPERATIONS MBIA Illinois offers financial guarantee insurance in the United States for domestic public finance bonds. MBIA Corp. has in the past offered, directly and through its subsidiaries, financial guarantee insurance in the United States, Europe, Asia, Latin America and other regions outside the United States. The primary risk in our insurance operations is that of adverse credit performance in the insured portfolio. We are compensated for our policies by insurance premiums paid upfront or on an installment basis. Historically, our financial guarantee insurance was offered in both the new issue and secondary markets on a global basis. Transactions in the new issue market were sold either through negotiated offerings or competitive bidding. In negotiated transactions, either the issuer or the underwriter purchases the insurance policy directly from an insurer. For municipal bond issues involving competitive bidding, the insurance is offered as an option to the underwriters bidding on the transaction. The successful bidder would then have the option to purchase the insurance, or at times the issuer can purchase the insurance. We guarantee the payment of principal and interest on municipal obligations which trade in the secondary market upon the request of an existing holder of uninsured bonds. The premium is generally paid by the owner of the obligation. In addition, we have provided financial guarantees to debt service reserve funds. Currently, as a result of the existing market volatility caused by the deterioration in the fixed income markets, the tightening of available liquidity, and the recent rating agency actions described under “Rating Agencies” below, the demand for our product is the lowest it has been and we wrote virtually no new direct, primary business in 2008. MBIA Illinois and MBIA Corp. seek to maintain a diversified insured portfolio and have designed each insured portfolio to manage and diversify risk based on a variety of criteria including revenue source, issue size, type of asset, industry concentrations, type of bond and geographic area. Virtually all of the insurance policies issued or reinsured by the Company’s licensed insurers (the “Insurers”) provide an unconditional and irrevocable guarantee of the payment required to be made by, on or behalf of the obligor to a designated paying agent for the holders of the insured obligations of an amount equal to the payment of the principal of, and interest or other amounts owing on, insured obligations when due or, in the event that the Insurer has the right, at its discretion, to accelerate insured obligations upon default or otherwise, upon such acceleration by the Insurer. In the event of a default in payment of principal, interest or other insured amounts by an issuer, the Insurer promises to make funds available in the insured amount generally on the next business day following notification. Our Insurers provide for this payment, in some cases through a third party bank, upon receipt of proof of ownership of the obligations due, as well as upon receipt of instruments appointing the insurer as agent for the holders and evidencing the assignment
4
Table of ContentsItem 1. Business (Continued)
of the rights of the holders with respect to the payments made by the Insurer. With respect to policies issued by FGIC and reinsured by MBIA Illinois under the FGIC Transaction, MBIA Illinois has agreed to comply with the terms of the original FGIC policies. Because we generally guarantee to the holder of the underlying obligation the timely payment of amounts due on such obligation in accordance with its original payment schedule, in the case of a default or other triggering event on an insured obligation, payments under the insurance policy cannot be accelerated against us, except in certain limited circumstances, unless MBIA Corp. consents to the acceleration. In the event of a default, however, we may have the right, in our sole discretion, to accelerate the obligations and pay them in full. Otherwise, we are required to pay principal, interest or other amounts only as scheduled payments come due. Typically, even if the holders are permitted by the terms of the insured obligations to have the full amount of principal, accrued interest or other amounts due, declared due and payable immediately in the event of a default, we are required to pay only the amounts scheduled to be paid, but not in fact paid, on each scheduled payment date. Our payment obligations after a default vary by deal and by insurance type. There are three primary types of policy payment requirements: i) timely interest and ultimate principal; ii) ultimate principal only at final maturity; and iii) payments upon settlement of individual collateral losses as they occur after parties subordinated to us in a transaction have absorbed their share of losses. With respect to the insurance of credit default swap contracts, in certain events, including the insolvency or payment default of the insurer, the credit default swap contract is subject to termination and the counterparty can make a claim for the full amount due on termination. MBIA Illinois Portfolio Through its reinsurance of U.S. public finance financial guarantees from MBIA Corp. and FGIC, MBIA Illinois’ insurance portfolio consists of municipal bonds, including tax-exempt and taxable indebtedness of Unites States 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. FGIC Transaction In the third quarter of 2008, MBIA Corp. closed the FGIC Transaction, in which MBIA Corp. assumed a significant portion of FGIC’s U.S. public finance insurance portfolio. As of the closing date, the reinsured portfolio consisted exclusively of investment grade credits, primarily in the general obligation, water and sewer, tax-backed and transportation sectors, and did not contain any credit default swap contracts, below investment grade credits or other credits that were inconsistent with our credit underwriting standards. The reinsurance was provided on a “cut-through” basis, which enabled FGIC’s policyholders to receive the benefit of MBIA Corp.’s reinsurance by allowing them to present claims directly to MBIA Corp. The FGIC reinsurance agreement is included as Exhibit 10.11 to this Form 10-K and any description of it in this Form 10-K is qualified in its entirety by the agreement. Under the FGIC Transaction, MBIA Corp. assumed a total net par of approximately $181 billion and received upfront unearned premiums, net of a ceding commission paid to FGIC, of approximately $717 million. As required by the New York State Insurance Department in connection with its approval of the reinsurance transaction, the funds were placed in a trust and will be released to MBIA Corp. upon the earlier of its removal from ratings review with its current ratings or June 30, 2009. Additionally, under the terms of the trust, the funds are released to MBIA Corp. as the premiums are earned and can be used to pay claims on policies assumed under the reinsurance agreement. On December 1, 2008, MBIA Corp. entered into an Administrative Services Agreement with FGIC allowing MBIA Corp. to administer and remediate credits in the portfolio. MBIA Corp. subsequently assigned its rights, interests, and obligations under the FGIC reinsurance agreement to MBIA Illinois as part of the MBIA Illinois Transformation discussed below. In addition, MBIA Corp. assigned all of its rights and interests in the trust to MBIA Illinois as payment to MBIA Illinois of the amount of the net unearned premium reserve (net of ceding commission) associated with the FGIC policies. MBIA Illinois Transformation Under the MBIA Illinois Transformation, the Company executed a series of transactions to establish MBIA Illinois as a U.S. public finance-only financial guarantee company. The stock of MBIA Illinois, a financial guarantee
5
Table of ContentsItem 1. Business (Continued)
insurance company domiciled in Illinois that was acquired by the Company in 1989 and was a direct subsidiary of MBIA Corp., was transferred by MBIA Corp. to the Company, then contributed by the Company to a newly established intermediate holding company, National Public Finance Guarantee Holdings, Inc., which is itself a wholly-owned subsidiary of the Company. MBIA Illinois is expected to be renamed National Public Finance Guarantee Corporation. In addition, on February 17, 2009, MBIA Corp. ceded all of its U.S. public finance business to MBIA Illinois by entering into a Quota Share Reinsurance Agreement with MBIA Illinois, effective January 1, 2009 (the “MBIA Corp. Reinsurance Agreement”), and by assigning to MBIA Illinois pursuant to a separate assignment agreement its rights, interests and obligations with respect to the U.S. public finance business of FGIC that was reinsured by MBIA Corp. pursuant to a reinsurance agreement with FGIC (the “FGIC Reinsurance Agreement”). The MBIA Corp. Reinsurance Agreement is included as Exhibit 99.2 to this Form 10-K and any description of it in this Form 10-K is qualified in its entirety by the agreement. The portfolio transferred to MBIA Illinois by reinsurance or through the assignment of the FGIC Reinsurance Agreement consists entirely of U.S. public finance business with total net par outstanding of approximately $554 billion, based on data current as of December 31, 2008. The reinsurance and assignment transactions between MBIA Corp. and MBIA Illinois, which became effective as of January 1, 2009, enable covered policyholders and certain ceding insurers to present claims for payment directly to MBIA Illinois in accordance with the terms of the cut-through provisions of the MBIA Corp. Reinsurance Agreement and the FGIC Reinsurance Agreement. Under the terms of the cut-through provision in each of those agreements, the covered policyholders and ceding insurers are granted a third party beneficiary right under the agreement with respect to the applicable cut-through provision only. The reinsurance and assignment agreements between MBIA Corp. and MBIA Illinois (including the right to present claims for payment directly to MBIA Illinois described in the previous paragraph) can be terminated upon the mutual agreement of MBIA Corp. and MBIA Illinois, which termination is subject to the receipt of insurance regulatory approvals. In addition, the MBIA Reinsurance Agreement may not be terminated if, after giving effect to the termination, the ratings assigned to the underlying securities or bonds would be downgraded or withdrawn. MBIA Illinois may also assign the MBIA Reinsurance Agreement under certain circumstances to a reinsurer rated at least as highly as MBIA Illinois, which assignment is subject to the receipt of insurance regulatory approvals. In connection with the MBIA Illinois Transformation, MBIA Corp. commuted an existing reinsurance agreement with MBIA Illinois pursuant to which MBIA Corp. reinsured 100% of all of the policies of MBIA Illinois. The commutation is effective as of January 1, 2009. No penalties were incurred in connection with the commutation. To provide additional protection for its municipal bond policyholders, MBIA Illinois has also issued a second-to-pay policy for the benefit of the policyholders covered by the FGIC Reinsurance Agreement (the “FGIC Second-to-Pay Policy”) and a second-to-pay policy for the benefit of the policyholders and ceding insurers covered by the MBIA Corp. Reinsurance Agreement (the “MBIA Corp. Second-to-Pay Policy”). The second-to-pay policies, which are direct obligations of MBIA Illinois, will be held by The Bank of New York Mellon as insurance trustee. These policies provide that if MBIA Corp. or FGIC, as applicable, does not pay valid claims to these policyholders and ceding insurers under the relevant underlying policies or assumed reinsurance agreements, as applicable, these policyholders and ceding insurers will then be able to make a claim for payment directly against MBIA Illinois under the applicable second-to-pay policy. The MBIA Corp. Second-to-Pay Policy (including the right to make claims for payment directly against MBIA Illinois) will be deemed cancelled immediately and automatically, without any further action on the part of MBIA Illinois, in the event that the MBIA Corp. Reinsurance Agreement is terminated. In addition, coverage under the MBIA Corp. Second-to-Pay Policy shall be deemed cancelled in the event that the MBIA Corp. Reinsurance Agreement is assigned in accordance with its terms and, after giving effect to such assignment, the ratings on the underlying securities will not be downgraded or withdrawn. The FGIC Second-to-Pay Policy (including the right to make claims for payment directly against MBIA Illinois) will be deemed cancelled immediately and automatically, without any further action on the part of MBIA Illinois, in the event that the assignment agreement or the underlying FGIC Reinsurance Agreement is terminated. In addition, coverage under the FGIC Second-to-Pay Policy shall be deemed cancelled in the event that MBIA Illinois’ obligations under the assignment agreement are assigned and, after giving effect to such assignment, the ratings on the underlying securities will not be downgraded or withdrawn.
6
Table of ContentsItem 1. Business (Continued)
In connection with the reinsurance and assignment transactions, MBIA Corp. paid to MBIA Illinois approximately $2.9 billion (which is equal to the net unearned premium and loss and loss adjustment expense reserves, net of the ceding commission) as a premium to reinsure the policies covered by the reinsurance and assignment agreements. MBIA Corp. received a 22 percent ceding commission on the unearned premium reserve. In addition to the $2.9 billion, MBIA Illinois has been further capitalized with $2.1 billion from funds distributed by MBIA Corp. to the Company, as a dividend and return of capital, which MBIA Inc. in turn contributed through National Public Finance Guarantee Holdings, Inc., an intermediate holding company, to MBIA Illinois. In addition to a transfer of public finance and other staff to MBIA Illinois from MBIA Corp., MBIA Illinois has entered into services agreements with MBIA Corp. in order for them to provide to each other certain administrative and other support services. MBIA Corp. and MBIA Illinois received the required regulatory approvals from the New York and Illinois insurance departments prior to executing this restructuring. MBIA Corp. will continue to insure its remaining book of structured finance and international business, as well as the Guaranteed Investment Contracts and MTNs managed by MBIA Asset Management. MBIA Inc.’s other operations consist of the existing global structured finance, non-U.S. public finance and asset management businesses. The MBIA Illinois Transformation has limited the ability of MBIA Illinois and MBIA Corp. to pay dividends to MBIA Inc. for some time, which affects the Company’s liquidity. The impact of the MBIA Illinois Transformation on the Company’s liquidity is described further in “Note 28: Subsequent Events” in the Notes to Consolidated Financial Statements of MBIA Inc. and Subsidiaries in Part II, Item 8. In general, references herein to MBIA Illinois-insured or issued policies include those policies reinsured from MBIA Corp. or under the FGIC Transaction, unless indicated otherwise. Portfolio Profile As of December 31, 2008, MBIA Corp. had 32,954 policies outstanding in the portion of its insurance portfolio that was ceded or assigned to MBIA Illinois effective January 1, 2009. Those are diversified among 12,213 “credits,” which MBIA Corp. defines as any group of issues supported by the same revenue source. At December 31, 2008 the net par amount outstanding on MBIA Corp.’s insured U.S. public finance obligations (including obligations assumed from FGIC) was $554 billion. Net insurance in force, which includes all insured debt service, at December 31, 2008 was $908 billion. The table below sets forth information with respect to the original par amount insured per issue in the MBIA Corp. portfolio as of December 31, 2008 that was assumed by MBIA Illinois effective January 1, 2009: MBIA Corp. U.S. Public Finance Original Par Amount Per Issue as of December 31, 2008(1)
7
Table of ContentsItem 1. Business (Continued)
All of the policies were underwritten on the assumption that the insurance will remain in force until maturity of the insured obligations. MBIA Illinois estimates that the average life of its domestic public finance insurance policies in force at January 1, 2009 was 11.2 years. The average life was determined by applying a weighted-average calculation, using the remaining years to contractual maturity and weighting them on the basis of the remaining debt service insured. No assumptions were made for any future refundings, early redemptions or terminations of insured issues. Average annual insured debt service on the portfolio at December 31, 2008 was $47.2 billion. The table below shows the diversification by type of U.S. public finance insurance written or assumed by MBIA Corp. in the last three years: MBIA Corp. U.S. Public Finance Net Par Amount Written by Bond Type(1)
There can be no assurance that MBIA Illinois will write business in the future at the historical rates reflected above. MBIA Illinois’ underwriting guidelines limit the net insurance in force for any one insured credit. In addition, MBIA Illinois is subject to both rating agency and regulatory single-risk limits with respect to any insured bond issue. See the “Insurance Regulation” section below for a description of these regulatory requirements. As of December 31, 2008, MBIA Corp.’s net par amount outstanding for its ten largest insured U.S. public finance credits totaled $32.5 billion, representing 5.9% of MBIA Corp.’s total U.S. public finance net par amount outstanding. MBIA Corp. Insured Portfolio MBIA Corp. has insured and reinsured structured finance and international financial obligations which are sold in the new issue and secondary markets. MBIA Corp. has guaranteed:
8
Table of ContentsItem 1. Business (Continued)
As of December 31, 2008, MBIA Corp. had 1,469 policies outstanding in the portion of its insured portfolio that was not ceded or assigned to MBIA Illinois effective January 1, 2009. In addition, MBIA Corp. has issued 425 policies relating to MBIA Asset Management transactions. MBIA Corp.’s policies are diversified among 960 “credits,” which MBIA Corp. defines as any group of issues supported by the same revenue source. In addition, certain of our insurance policies guarantee payments due under credit or other derivatives, including termination payments that may become due upon the occurrence of certain events, such as the insolvency of or a payment default by MBIA Corp. On February 25, 2008, the Company announced that it had ceased insuring new credit derivative contracts within its insurance operations except in transactions related to the reduction of existing insured credit derivative exposure. Structured Finance and Asset-Backed Obligations Structured finance obligations insured by MBIA Corp. typically are securities repayable from expected cash flows generated by a specified pool of assets, such as residential and commercial mortgages, insurance policies, consumer loans, corporate loans and bonds, trade and export receivables, leases for equipment, aircraft and real property, and infrastructure projects. Structured finance obligations are either secured by undivided interests or collateralized by the related assets. Additional policies have included payments due under credit and other derivatives, including termination payments that may become due upon certain events, including the insolvency or payment default of MBIA Corp. Structured finance transactions are often structured such that the insured obligations benefit from some form of credit enhancements such as over-collateralization, subordination, excess cash flow or first loss protection, to cover credit risks. Structured finance obligations contain risks including asset risk, which relates to the amount and quality of asset coverage, structural risk, which relates to the extent to which the transaction structure protects the interests of the investors from the bankruptcy of the originator of the underlying assets or the issuer of the securities, and servicer risk, which relates to problems with the transaction servicer (the entity which is responsible for collecting the cash flow from the asset pool) that could affect the servicing of the underlying assets. In light of the current economic environment, the cash flow or value of the assets that support the MBIA-insured transaction could deteriorate beyond the stress levels that were assumed at the time that these transactions were underwritten, and MBIA could incur material losses. On February 25, 2008, the Company announced that it had ceased insuring new credit derivative contracts except in transactions related to the reduction of existing insured credit derivative exposure. In addition, the Company announced that it had suspended the writing of all new structured finance business for approximately six months. Since that temporary suspension we have adjusted target structured finance risk sectors and criteria in this business and are continuing to track developments in the structured finance industry. Currently, the structured finance industry is generating very little new business, and it is uncertain how or when the Company may re-engage this market. International Obligations Outside the United States, financial guarantee insurance has been used by issuers of sovereign and sub-sovereign bonds, structured finance securities, utility debt and financing for public purpose projects, among others. We have insured both structured finance and public finance obligations in select international markets and the risk profile of our international exposure is similar to that in the United States, although there are unique risk factors related to each country and region that are evaluated at origination and on an ongoing basis. These factors include legal, regulatory, economic and political variables, the sophistication of and trends in local capital markets and currency exchange risks. Ongoing privatization initiatives in some regions have shifted the financing of new projects from the government to the capital markets, where investors can benefit from the default protection provided by financial guarantee insurance. The development of structured finance securitizations has varied to date by region depending on the development stage of the local capital markets and the impact of financial regulatory requirements, accounting standards and legal systems. Portfolio Profile At December 31, 2008, the net par amount outstanding on MBIA Corp.’s insured obligations, including insured obligations of MBIA UK, MBIA Mexico, and CapMAC but excluding obligations that were ceded or assigned to
9
Table of ContentsItem 1. Business (Continued)
MBIA Illinois as of January 1, 2009 and also excluding $8.4 billion of MBIA insured investment agreements and MTNs for MBIA Asset Management (the resulting portfolio, the “Structured Finance and International Portfolio”) was $233 billion. Net insurance in force for the above portfolio, which includes all insured debt service, at December 31, 2008 was $290 billion. The table below sets forth information with respect to the original par amount insured per issue in MBIA Corp.’s Structured Finance and International Portfolio as of December 31, 2008: MBIA Corp. Original Par Amount for the Structured Finance and International Portfolio Per Issue as of December 31, 2008(1)(2)
MBIA Corp. underwrites its policies on the assumption that the insurance will remain in force until maturity of the insured obligations. MBIA Corp. estimates that the average life of its structured finance and international insurance policies in force at December 31, 2008 was 7.1 years. The average life was determined by applying a weighted-average calculation, using the remaining years to contractual maturity for international obligations and estimated maturity for structured finance obligations and weighting them on the basis of the remaining debt service insured. No assumptions were made for any future refundings, early redemptions or terminations of insured issues. Average annual insured debt service on the portfolio at December 31, 2008 was $27.6 billion.
10
Table of ContentsItem 1. Business (Continued)
The table below shows the diversification by type of insurance written by MBIA Corp. in the Structured Finance and International Portfolio in each of the last three years: MBIA Corp. Net Par Amount for the Structured Finance and International Portfolio Written by Bond Type(1) (2)
11
Table of ContentsItem 1. Business (Continued)
MBIA Corp.’s underwriting guidelines limit the net insurance in force for any one insured credit. In addition, MBIA Corp. is subject to both rating agency and regulatory single-risk limits with respect to any insured bond issue. See the “Insurance Regulation” section below for a description of these regulatory requirements. As of December 31, 2008, MBIA Corp.’s net par amount outstanding for its ten largest non-U.S. public finance credits insured totaled $10.8 billion, representing 4.6% of MBIA Corp.’s total net structured finance and international par amount outstanding, and the net par outstanding for its ten largest structured finance credits (without aggregating common issuers), was $23.4 billion, representing 10.0% of the total. Risk Management The risk management function at MBIA has historically been supported by two divisions: an enterprise-wide Risk Management Division covering credit, market and operational risks in both origination and ongoing portfolio management processes and an Insured Portfolio Management (“IPM”) Division covering credit risk monitoring and remediation within the insured portfolio. As part of the Strategic Plan, the Company decentralized the Risk Management Division in January 2009, with specialist functions now placed in specific related business areas and in the IPM Division. In connection with the MBIA Illinois Transformation, primary responsibility for the credit risk management and the surveillance of the ceded U.S. public finance portfolio was transferred to MBIA Illinois. Certain transactions which require special expertise, or which were subject to more intensive remediation prior to the execution of the MBIA Illinois Transformation, will be managed by the Special Situations Group of the IPM Division under a services agreement between MBIA Corp. and MBIA Illinois. In addition, MBIA Illinois will utilize a separate credit risk committee to review underwriting decisions and processes for the MBIA Illinois insured portfolio. Enterprise-wide risk assessment continues within the risk governance framework of four central executive committees, with the Risk Oversight Committee focused on firm-wide risk review, policies and decisions related to credit, market, operational, legal, financial and business risks, the Loss Reserve Committee reviewing reserve activity and the Executive Credit and Market Risk/Investment Committees reviewing specific transactions and portfolios. The Board of Directors continues to review and track the Company’s risk profile against its risk tolerance guidelines at least annually. The Credit, Finance and Audit Committees of the Company’s Board of Directors also receive periodic reports regarding credit, market, and operational risks and the Company’s processes in each area, respectively. In 2008 the Company completed a review of mortgage-related exposures to assess our risk processes for origination, portfolio management and surveillance. This review was the basis of adjustments to our bond insurance business in 2008, including revised core principles for financial guarantees, elimination of select asset classes, updated risk selection criteria and adjustments to credit strategy, portfolio management, underwriting and risk modeling. Surveillance and Remediation We conduct surveillance and remediation of our existing insured portfolio. The nature of our underwriting and surveillance analysis varies somewhat by sector and bond type, but in all cases is focused on assessing event risk and losses under stress.
12
Table of ContentsItem 1. Business (Continued)
Key to MBIA’s ongoing surveillance is early detection of deterioration in either transaction credit quality or macroeconomic or market factors that could adversely impact an insured credit. If a problem is detected, analysts work with the issuer, trustee, bond counsel, servicer and underwriter to reduce chances of default and potential severity. We typically require the issuer, servicer and the trustee to furnish periodic financial and asset information, including audited financial statements for review. Potential problems uncovered through this review, such as poor financial results, low fund balances, covenant or trigger violations, trustee or servicer problems, or excessive litigation, could result in an immediate surveillance alert and an evaluation of possible remedial actions. Ongoing analysis, as appropriate, of general economic and regulatory conditions, state and municipal finances and budget developments is also conducted to evaluate their impact on issuers within our portfolio. For troubled credits, we develop loss mitigation strategies and in the event of significant stress may involve a dedicated workout unit, the Special Situations Group within the IPM Division, which will assess and monitor the credit and, if necessary, develop and implement a remediation strategy. In an effort to mitigate losses, the IPM Division is regularly involved in the ongoing remediation of credits that may involve, among other things, waivers or renegotiations of financial covenants or triggers, waivers of contractual provisions, the granting of consents, and the taking of various other remedial actions. The nature of any remedial action is based on the type of the insured issue and the nature and scope of the event giving rise to the remediation. In most cases, as part of any such remedial activity, we are able to improve our security position and obtain concessions from the issuer of the insured bonds. From time to time, the issuer of our insured bond may, with our consent, restructure the insured obligation by extending the term, increasing or decreasing the par amount or decreasing the related interest rate, with our insuring the restructured obligation. We use an internal credit rating system to monitor credits, with frequency of review based on risk type, internal rating, performance and credit quality. Credits with performance issues are designated as “Caution List-Low,” “Caution List-Medium” or “Caution List-High” based on the nature and extent of our concerns, but these categories do not require establishment of any case basis reserves. In the event we determine that a claim for payment by MBIA Corp. is probable and estimable with respect to an insured issue, we place the issue on the “Classified List” and establish a case basis reserve for that insured issue. Effective January 1, 2009, the Company’s accounting for losses will be revised in compliance with FAS 163, “Accounting for Financial Guarantee Insurance Contracts—An Interpretation of FASB Statement No. 60.” For a further discussion of this methodology and the revisions that will take place due to FAS 163, see “Losses and Reserves; Remediation” below and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Losses and Loss Adjustment Expenses (LAE)” in Part II, Item 7. Credit Risk Models We use credit risk models to test qualitative judgments, to design appropriate structures and to understand sensitivity within transactions and across broader portfolio exposure concentrations. Models are updated to reflect changes in both portfolio and transaction data and also in expectations of stressed future outcomes. For portfolio monitoring we use internal models based on individual deal attributes and customized structures and these models are also used to determine case basis loss reserves and, where applicable, to mark-to-market any insured obligations that are required for financial reporting. We also supplement our models with third party models, and use third party experts to consult with our internal modeling specialists from time to time. When using third party models, we perform the same review and analysis of the collateral, deal structure, performance triggers and cash flow waterfalls as when using our internal models. During 2008 we expanded the modeling of our
13
Table of ContentsItem 1. Business (Continued)
mortgage-related exposures and consulted extensively with third parties in both the assumptions and structures used to project future performance. See “Risk Factors—Credit risk modeling contains uncertainty over ultimate outcomes which make it difficult to estimate potential paid claims and loss reserves and mark-to-market” in Part I, Item 1A. Market Risk Assessment We measure and assess market risk on a consolidated basis and in the asset management business. Key market risks are changes in interest rates, credit spreads and foreign exchange. The Market Risk function measures and monitors such risks using various models and methodologies to test economic exposure under market stress, including parallel and non-parallel shifts in the yield curve, changes in credit spreads, stressed liquidity scenarios and stressed counterparty exposures. This analysis is used in testing investment portfolio guidelines and is reported to the Executive Market/Investment Committee and the Finance Committee of the Company’s Board of Directors. See “Risk Factors – Liquidity and Market Related Risk Factors” in Part I, Item 1A. Operational Risk Assessment The Operational Risk function identifies and assesses potential loss arising from processes, systems, or staff actions, as well as identifying vulnerabilities to operational disruptions caused by external events. Operational risk is generally managed using a self-assessment process across all divisions to monitor the execution of key processes. The Operational Risk group reports periodically to the Risk Oversight Committee and the Audit Committee of the Company’s Board of Directors. New Business Origination In 2008, MBIA Corp.’s bond insurance origination units were the Public Finance Division, the Structured Finance Division and the International Division. These units worked with the Risk Management and IPM Divisions in following an underwriting process of screening and analysis leading to a formal underwriting committee drawn from business, risk and insured portfolio management staff. All eligible underwriting voters were reviewed and appointed annually by MBIA’s centralized executive risk committees. Large, complex, unique, and most non-U.S. transactions including remediations were also reviewed by the Risk Oversight Committee. Premium levels for the Public Finance, Global Structured Finance and International Divisions were set by a Pricing Committee that included business and pricing staff and uses various market and capital analyses. As part of the Company’s Strategic Plan, this organizational structure will likely change in the future as our businesses are separately capitalized, subject to regulatory approvals, with separate governance structures to be developed. Losses and Reserves; Remediation We establish both loss and loss adjustment expense reserves to cover non-specific unallocated losses on our entire non-derivative insured portfolio and specific case basis reserves with respect to actual and potential losses under specific insurance policies. The unallocated loss and loss adjustment expense reserve and specific case basis reserves are established by our Insurers’ Loss Reserve Committees for each of their respective portfolios. CapMAC currently does not write new business, and MBIA Corp. has reinsured CapMAC’s net liabilities on financial guarantee insurance business and maintains required reserves in connection therewith. The unallocated loss reserve is established on an undiscounted basis with respect to our entire insured portfolio. Our Insurers’ unallocated loss reserves represent their estimate of losses that have occurred or are probable to occur as a result of credit deterioration in our insured portfolio but which have not yet been specifically identified and applied to specific insured obligations. The unallocated loss reserve is increased on a quarterly basis using a formula that applies a “loss factor” to our scheduled net earned premium for the respective quarter. Each quarter we calculate our provision for the unallocated loss reserve as a fixed percent of scheduled net earned premium. Annually, the respective Loss Reserve Committee evaluates the appropriateness of this fixed percent loss factor through a consideration of multiple factors. Effective January 1, 2009, the Company’s accounting for losses will be revised in compliance with FAS 163. In addition, the methodology used by the Company for determining when a case basis reserve is established may differ from other financial guarantee insurance companies, as well as from other property and casualty insurance enterprises. For a further discussion of this methodology and the revisions that will take place due to FAS 163, see “Management’s Discussion and Analysis of Financial Condition and
14
Table of ContentsItem 1. Business (Continued)
Results of Operations—Losses and Loss Adjustment Expenses (LAE)” in Part II, Item 7. Management believes that our reserves are adequate to cover the ultimate net cost of claims. However, because the reserves are based on management’s judgment and estimates, there can be no assurance that the ultimate liability will not exceed such estimates. From inception, we have had 152 financial guarantee insured issues requiring claim payments. In addition, there are currently 8 financial guarantee insured issues for which case loss reserves have been established for expected future claims but for which claims have not yet been paid. From inception, we have had 4 credit derivative insured issues requiring payments and there are an additional 8 credit derivative insured issues that we expect to make payments in the future. From inception until the third quarter of 2007, cumulative incurred losses on financial guarantee insured issues totaled $916 million. Beginning in the fourth quarter of 2007, the Company has recognized losses on 41 housing market-related securities that totaled $3.8 billion, including losses on 29 financial guarantee insured issues of $2.1 billion and on 12 insured credit derivatives of $1.7 billion. Cash payments have been made on 28 of the financial guarantee insured issues, which represent $2.1 billion, and there is an additional 1 insured issue for which a case loss reserve of $23 million has been established for expected future claims but for which claims have not yet been paid. Beginning in the fourth quarter of 2008, cash payments have been made on 4 insured credit derivatives issues, which represent $0.5 billion of the $1.7 billion total and there are an additional 8 insured credit derivatives issues on which payments have not been made, which represent $1.2 billion of the $1.7 billion total. The Company’s experience is that early detection and continued involvement by IPM are crucial in avoiding or minimizing potential draws on the related insurance policy. There can be no assurance, however, that there will be no material losses in the future in respect of any issues guaranteed by our Insurers or that the amount of reserves will be adequate to cover such losses. Outward Reinsurance State insurance laws and regulations, as well as the rating agencies who rate MBIA Corp. and MBIA Illinois, impose minimum capital requirements on financial guarantee companies, limiting the aggregate amount of insurance and the maximum size of any single risk exposure which may be written. Historically, MBIA Corp. has decreased the insured exposure in its portfolio and increased its capacity to write new business by reinsuring certain of its gross liabilities with third parties on an aggregate and single risk basis through treaty and facultative reinsurance. Additionally, MBIA Corp. has entered into agreements under which it is entitled to reimbursement of losses on its insured portfolio but which do not qualify as reinsurance under GAAP. The MBIA Illinois insured portfolio includes transactions that were reinsured by MBIA Corp. pursuant to treaty or facultative reinsurance agreements or reinsurance agreements entered into between FGIC and third parties. In the future, neither MBIA Corp. nor MBIA Illinois intends to utilize reinsurance to a material degree for these purposes. The degree to which MBIA Corp. reinsured its gross liabilities in the past varied from time to time depending on its own business needs and the capacity available in the reinsurance market. Historically, MBIA Corp. has entered into primarily quota share treaties under which a variable percentage of risk over a minimum size was ceded, subject to a maximum percentage specified in the related treaty. Reinsurance ceded under the treaties is for the full term of the underlying policy. As of July 2008, MBIA Corp. allowed its existing treaties to expire and elected not to enter into new treaties with third party reinsurers with respect to new policies written. MBIA Corp. has also entered into facultative reinsurance arrangements from time to time primarily in connection with issues which, because of their size, require additional capacity beyond MBIA Corp.’s retention and treaty limits in effect at a given time. Under these facultative arrangements, portions of MBIA Corp.’s liabilities are ceded on an issue-by-issue basis. MBIA Corp. also has used facultative arrangements as a means of managing its exposure to single issuers or counterparties to comply with regulatory and rating agency requirements, as well as internal underwriting and portfolio management criteria. As primary insurers, our Insurers are required to honor their obligations to their policyholders whether or not our reinsurers and others perform their agreement obligations to us. We monitor the financial position and financial strength rating of all of our reinsurers on a regular basis. Over the past several years, most of the Company’s reinsurers have been downgraded and all are now subject to more frequent rating agency review. Although there
15
Table of ContentsItem 1. Business (Continued)
was no material impact on the Company for any of the rating agency actions through February 2009 relating to its reinsurers, the overall benefit of the reinsurance to MBIA is reduced. When a reinsurer is downgraded by one or more of the rating agencies, less capital credit is given to MBIA under rating agency models. Additionally, any significant rating downgrade or financial deterioration of one or more of our reinsurers could require the establishment of reserves against any receivables due from the reinsurer. To offset the counterparty risk, MBIA requires certain unauthorized reinsurers to maintain bank letters of credit or establish trust accounts to cover liabilities ceded to such reinsurers under reinsurance contracts. As of December 31, 2008, the amount of funds held for the benefit of MBIA totaled $832 million. The Company remains liable on a primary basis for all reinsured risk, and although MBIA believes that its reinsurers remain capable of meeting their obligations, there can be no assurance of such in the future. The Company generally retains the right to reassume the business ceded to reinsurers under certain circumstances, including rating downgrades of its reinsurers. In 2008, MBIA recaptured business from four reinsurers as a result of their ratings downgrades. Additionally, business from two reinsurers was recaptured during 2008 unrelated to their ratings. The Company also maintained other reimbursement agreements with its reinsurers that were not accounted for as reinsurance, which were also commuted during 2008 and were not related to a rating downgrade. Under its commutation agreements, the Company is paid an agreed amount based on estimates of present and future exposures and taking into account the time value of money, which amount includes, but is not limited to, the unearned premium reserves and loss reserves for the policies associated with the commuted policies. In exchange for payment of the agreed amount, the reinsurer’s exposure to the ceded policies is commuted. We may also look to reduce risks embedded in our insured portfolio on an individual and portfolio-wide basis by entering into derivative transactions or other types of hedging arrangements. Channel Re Reinsurance Agreements In February 2004, the Company, together with Renaissance Re Holdings, Ltd., Koch Financial Re, Ltd. and Partner Reinsurance Company Ltd., formed Channel Re, a new Bermuda-based financial guarantee reinsurance company then rated Triple-A by S&P and Moody’s. The Company invested $63.7 million for a 17.4% ownership interest in Channel Re. In February 2004, MBIA Corp. and Channel Re entered into arrangements whereby Channel Re agreed to provide committed reinsurance capacity to MBIA Corp. at least through June 30, 2008, a date which was later extended to June 30, 2010. Under treaty and facultative reinsurance arrangements, MBIA Corp. agreed to cede to Channel Re and Channel Re agreed to assume from MBIA Corp. varying percentages of designated policies issued by MBIA Corp. The amount of any policy subject to the committed reinsurance arrangements is based on the type of risk insured and on other factors. The reinsurance arrangements provide Channel Re with certain preferential terms, including those related to ceding commissions. The treaty reinsurance arrangement was renewed in 2006 but was not renewed in 2008. In August 2008, Moody’s downgraded Channel Re to Baa1 with a negative outlook from Aa3. In September 2008, S&P downgraded Channel Re to AA-with a negative rating outlook from AA. For the year ended December 31, 2008, the Company expects Channel Re to continue to report negative shareholders’ equity on a GAAP basis primarily due to unrealized losses on ceded insured derivatives based on fair value accounting. The Company believes Channel Re has sufficient liquidity supporting its business to fund obligations related to ceded insured credit derivatives contracts. Although amounts on deposit in trust accounts for the benefit of MBIA limit the potential for Channel Re to default on its obligations to MBIA, there can be no assurance that Channel Re will not default on its obligations to MBIA that exceed the amounts already held in the trust accounts. Intercompany Reinsurance Arrangements Under the MBIA Illinois Transformation, MBIA Corp. and MBIA Illinois entered into the MBIA Corp. Reinsurance Agreement as well as an assignment agreement under which MBIA Corp. assigned its rights and obligations under the FGIC Reinsurance Agreement. In addition, MBIA Illinois entered into second-to-pay policies covering the policies covered by each of these agreements. Each of these transactions and the terms of those documents are further described under the “Our Insurance Operations—MBIA Illinois Portfolio” section above. MBIA Corp. has entered into a reinsurance agreement with MBIA UK providing for MBIA Corp.’s reimbursement of the losses incurred by MBIA UK in excess of a specified threshold and a net worth maintenance agreement in
16
Table of ContentsItem 1. Business (Continued)
which MBIA Corp. agrees to maintain the net worth of MBIA UK, to remain its sole shareholder and not to pledge its shares. Under the reinsurance agreement, MBIA Corp. has agreed to reimburse MBIA UK on an excess-of-loss basis for losses incurred in each calendar year for net retained insurance liability, subject to certain contract limitations. Under the net worth maintenance agreement, MBIA Corp. agrees to maintain a minimum capital and surplus position at MBIA UK in accordance with United Kingdom and New York State legal requirements. MBIA Corp. and CapMAC have entered into a reinsurance agreement, effective April 1, 1998, under which MBIA Corp. has agreed to reinsure 100% of the net liability and other obligations of CapMAC in exchange for CapMAC’s payment of a premium equal to the ceded reserves and contingency reserves. Pursuant to such reinsurance agreement with CapMAC, MBIA Corp. reinsured all of CapMAC’s then-current net exposure of $31.6 billion, or approximately 78% of CapMAC’s gross debt service then outstanding, the remaining 22% having been previously ceded to treaty and facultative reinsurers of CapMAC. MBIA Corp. has also entered into a reinsurance agreement and net worth maintenance agreement with MBIA Mexico pursuant to which MBIA Corp. reinsures 100% of the business underwritten by MBIA Mexico and agrees to maintain the amount of capital in MBIA Mexico required by applicable law or regulation. Insurance Regulation MBIA Corp. and CapMAC are licensed to do insurance business in, and are subject to insurance regulation and supervision by, the State of New York (their state of incorporation), the 49 other states and the District of Columbia, Guam and Puerto Rico, as well as, in the case of MBIA Corp., the Northern Mariana Islands, the U.S. Virgin Islands, the Kingdom of Spain and the Republic of France. MBIA Illinois is licensed to do insurance business in, and is subject to insurance regulation and supervision by the State of Illinois (its state of incorporation), the remaining states other than Virginia and New Hampshire (where it is in the process of applying to be licensed), as well as the District of Columbia and Puerto Rico. MBIA UK is licensed to do insurance business in the United Kingdom and is subject to the insurance regulation and supervision of the United Kingdom’s Financial Services Authority (“FSA”). MBIA UK is authorized by the FSA to carry out its activities in the European Economic Area on a cross-border services basis in accordance with Section 37 of the Financial Services and Markets Act 2000 (“FSMA”) and Part III of Schedule 3 to FSMA. MBIA UK operates in France on a branch basis, in accordance with applicable provisions of the EC third non-life insurance directive (No. 92/49/EEC). The French branch of MBIA UK is also authorized by the FSA to carry out general insurance business on a cross-border basis. MBIA Mexico is licensed to do insurance business in, and is subject to regulation and supervision by, the Mexican Ministry of Finance and Public Credit (Secretaría de Hacienda y Crédito Público or “SHCP”) and the Mexican Insurance and Bonds Commission (Comisión Nacional de Seguros y Fianzas or “CNSF”). The extent of state insurance regulation and supervision varies by jurisdiction, but New York, Illinois, the United Kingdom, Mexico and most other jurisdictions have laws and regulations prescribing minimum standards of solvency, including minimum capital requirements, and business conduct which must be maintained by insurance companies. These laws prescribe permitted classes and concentrations of investments. In addition, some state laws and regulations require the approval or filing of policy forms and rates. MBIA Corp. and MBIA Illinois are required to file detailed annual financial statements with the insurance regulator in their domiciliary state and similar supervisory agencies in each of the other jurisdictions in which it is licensed. The operations and accounts of the Insurers are subject to examination by these regulatory agencies at regular intervals. New York Insurance Regulation Our domestic Insurers are licensed to provide financial guarantee insurance under Article 69 of the New York Insurance Law. Article 69 defines financial guarantee insurance to include any guarantee under which loss is payable upon proof of occurrence of financial loss to an insured as a result of certain events. These events include the failure of any obligor on or any issuer of any debt instrument or other monetary obligation to pay principal, interest, premium, dividend or purchase price of or on such instrument or obligation when due. Under Article 69, our domestic Insurers are permitted to transact financial guarantee insurance, surety insurance and credit insurance and such other kinds of business to the extent necessarily or properly incidental to the kinds of insurance which they are authorized to transact. In addition, they are empowered to assume or reinsure the kinds of insurance described above.
17
Table of ContentsItem 1. Business (Continued)
In light of the economic environment, the NYSID issued in Circular Letter No. 19 (2008) on September 22, 2008, new “Best Practices” guidelines (the “Guidelines”) for financial guarantors, which it plans to formalize as regulation or legislation. In general, the Guidelines impose restrictions on the issuance of financial guarantee insurance policies and increase required capitalization levels. Included among the recommendations are: (1) restrictions on the issuance of policies insuring asset-backed securities that consist of other pools of asset-backed securities, as well as on policies insuring, and the underlying terms of, insured credit default swaps, a market in which the Company announced in February 2008 it would no longer participate; (2) limits on a guarantor’s exposure to not only the issuer of debt, but also the initial lender and servicer of each category of obligation, as well as increased reporting obligations regarding exposures to particular categories of debt or exposures over a calendar year period; (3) a requirement that all, rather than a subset, of insured bonds be at least 95% investment grade, based on aggregate net liability; (4) increases in the amount of paid-in capital to at least $15,000,000, the amount of paid-in surplus to at least $165,000,000 and the amount of minimum surplus to policyholders to a figure in excess of $150,000,000, as well as changes to capital and contingency reserve requirements in connection with certain asset-backed securities. Illinois Insurance Regulation MBIA Illinois is domiciled in Illinois and, in connection with the MBIA Illinois Transformation, the Company announced on February 18, 2009 that it intends for MBIA Illinois to redomesticate to New York. MBIA Illinois is licensed in Illinois to provide fidelity, surety and miscellaneous insurance. As a result of being licensed in Illinois to transact such lines of insurance, MBIA Illinois is authorized to provide financial guarantee insurance in Illinois. Illinois has promulgated a regulation that governs the transaction of municipal bond insurance. The regulation defines municipal bond insurance as insurance or reinsurance against financial loss by reason of nonpayment of principal, interest or other payment obligations pursuant to the terms of municipal bonds. Under the Illinois municipal bond regulation, MBIA Illinois is permitted to transact municipal bond insurance subject to complying with the requirements set forth in the regulation, which include establishing reserves and satisfying certain risk limitations. Contingency Reserves As financial guarantee insurers, our domestic Insurers are required by the laws and regulations of New York, California, Connecticut, Florida, Illinois, Iowa, Maryland, New Jersey and Wisconsin to maintain, as applicable, contingency reserves on their municipal bond, asset-backed securities or other financial guarantee liabilities. Under New Jersey, Illinois and Wisconsin regulations, contributions by an Insurer to its contingency reserves are required to equal 50% of earned premiums on its municipal bond business. Under New York law, an Insurer is required to contribute to contingency reserves 50% of premiums as they are earned on policies written prior to July 1, 1989 (net of reinsurance), and, with respect to policies written on and after July 1, 1989, such an insurer must make contributions over a period of 15 or 20 years (based on issue type), or until the contingency reserve for such insured issues equals the greater of 50% of premiums written for the relevant category of insurance or a percentage of the principal guaranteed, varying from 0.55% to 2.5%, depending upon the type of obligation guaranteed (net of collateral reinsurance, refunding, refinancings and certain insured securities). California, Connecticut, Florida, Iowa and Maryland laws impose a generally similar requirement, and in California the insurance commissioner can require an insurer to maintain additional reserves if the commissioner determines that the insurer’s reserves are inadequate. In each of these states, our domestic Insurers may apply for release of portions of their contingency reserves in certain circumstances. Risk Limits The laws and regulations of these states also limit both the aggregate and individual securities risks that our domestic Insurers may insure on a net basis based on the type of obligations insured. California, Connecticut, Florida, Illinois, Maryland and New York, among other things, limit insured average annual debt service on insured municipal bonds with respect to a single entity and backed by a single revenue source (net of qualifying collateral and reinsurance) to 10% of policyholders’ surplus and contingency reserves. California, Connecticut, Florida, Illinois, Maryland and New York also limit the net insured unpaid principal on a municipal bond issued by a single entity and backed by a single revenue source to 75% of policyholders’ surplus and contingency reserves. California, Connecticut, Maryland and New York, among other things, require that the lesser of the insured
18
Table of ContentsItem 1. Business (Continued)
average debt service and the insured unpaid principal (reduced by the extent to which unpaid principal of the supporting assets and, for New York and California, provided the insured risk is investment grade, exceed the insured unpaid principal), divided by nine, on each issue of asset-backed securities issued by a single entity shall not exceed 10% of policyholders’ surplus and contingency reserves, while Florida limits insured unpaid principal for any one risk to 10% of policyholders’ surplus and contingency reserves. In New Jersey, Virginia and Wisconsin, the average annual debt service on any single issue of municipal bonds (net of reinsurance) is limited to 10% of policyholders’ surplus. Other states that do not explicitly regulate financial guarantee or municipal bond insurance do impose single risk limits which are similar in effect to the foregoing. Under New York, California, Connecticut, Florida, Illinois, Maryland, New Jersey and Wisconsin law, aggregate insured unpaid principal and interest under policies insuring municipal bonds (in the case of New York, California, Connecticut, Florida, Illinois and Maryland, net of reinsurance) are limited to certain multiples of policyholders’ surplus and contingency reserves. New York, California, Connecticut, Florida, Illinois, Maryland and other states impose a 300:1 limit for insured municipal bonds, although more restrictive limits on bonds of other types do exist. For example, New York, California, Connecticut, Florida and Maryland impose a 100:1 limit for certain types of non-municipal bonds. Under New York, California, Connecticut, Florida, Maryland and New Jersey law, aggregate insured unpaid principal and interest under policies insuring asset-backed securities (again, in the case of New York, California, Connecticut, Florida and Maryland, net of reinsurance) are limited to certain multiples of policyholders’ surplus and contingency reserves. New York, Maryland, California, Connecticut, and other states impose a 150:1 limit for insured investment grade asset-backed securities, although more restrictive limits on asset-backed securities of other types exist. For example, New York, California, Connecticut, Florida and Maryland impose a 50:1 limit for non-investment grade asset-backed securities. As a result of the MBIA Illinois Transformation and the reinsurance of the MBIA Corp. and FGIC portfolios by MBIA Illinois, MBIA Illinois exceeded as of the closing date certain single and aggregate risk limits under the New York and Illinois laws and regulations, and MBIA Corp. exceeded as of the closing date certain single risk limits under New York law. These insurers obtained waivers from the insurance departments of those states of such limits. In connection with the waivers, they submitted a plan to the applicable insurance departments to achieve compliance with the applicable regulatory limits. Under the plans, they agreed not to write new financial guarantee insurance for certain issuers until they were in compliance with their single risk limits and agreed to take commercially reasonable steps, including considering reinsurance, the addition of capital and other risk mitigation strategies, in order to comply with the regulatory single and aggregate risk limits. As a condition to granting the waiver, the NYSID is requiring that, upon written notice from the NYSID, MBIA Corp. and MBIA Illinois, as applicable, will cease writing new financial guaranty insurance if the companies are not in compliance with the risk limitations by December 31, 2009. MBIA Illinois and MBIA Corp. have also agreed to provide monthly reports to the NYSID regarding the steps to achieve compliance with these regulatory limits. Holding Company Regulation MBIA Corp., MBIA Illinois, and CapMAC also are subject to regulation under the insurance holding company statutes of New York and/or Illinois. The requirements of holding company statutes vary from jurisdiction to jurisdiction but generally require insurance companies that are part of an insurance holding company system to register and file certain reports describing, among other information, their capital structure, ownership and financial condition. The holding company statutes also generally require prior approval of changes in control, of certain dividends and other inter-corporate transfers of assets, and of certain transactions between insurance companies, their parents and affiliates. The holding company statutes impose standards on certain transactions with related companies, which include, among other requirements, that all transactions be fair and reasonable and those transactions not in the ordinary course of business exceeding specified limits receive prior regulatory approval. Change of Control Prior approval by the NYSID is required for any entity seeking to acquire, directly or indirectly, “control” of MBIA Corp. or CapMAC. Prior approval by the Illinois Division of Insurance is required for any entity seeking to acquire, directly or indirectly, “control” of MBIA Illinois. In many states, including New York and Illinois, “control” is presumed to exist if 10% or more of the voting securities of the insurer are owned or controlled, directly or
19
Table of ContentsItem 1. Business (Continued)
indirectly, by an entity, although the insurance regulator may find that “control” in fact does or does not exist when an entity owns or controls either a lesser or greater amount of securities. The United Kingdom Financial Services Authority also has a requirement for prior approval of any controlling person. MBIA Corp. would require the prior approval of the Mexican SHCP in order to transfer the shares it currently holds in MBIA Mexico. Dividend Limitations The laws of New York regulate the payment of dividends by MBIA Corp. and provide that a New York domestic stock property/casualty insurance company (such as MBIA Corp. and CapMAC) may not declare or distribute dividends except out of statutory earned surplus. New York law provides that the sum of (i) the amount of dividends declared or distributed during the preceding 12-month period and (ii) the dividend to be declared may not exceed the lesser of (a) 10% of policyholders’ surplus, as shown by the most recent statutory financial statement on file with the NYSID, or (b) 100% of adjusted net investment income for such 12-month period (the net investment income for such 12-month period plus the excess, if any, of net investment income over dividends declared or distributed during the two-year period preceding such 12-month period), unless the New York Superintendent of Insurance approves a greater dividend distribution based upon a finding that the insurer will retain sufficient surplus to support its obligations and writings. As a result of the MBIA Illinois Transformation, MBIA Corp. will not be able to pay dividends without prior approval from the Superintendent until February 10, 2010. See “Note 19: Insurance Regulations and Dividends” in the Notes to Consolidated Financial Statements of MBIA Inc. and Subsidiaries in Part II, Item 8. The laws of Illinois regulate the payment of dividends by MBIA Illinois and provide that no dividend or other distribution may be declared or paid at any time except out of earned surplus, unless the Illinois Director of Insurance’s prior approval is obtained. In addition, under Illinois law, MBIA Illinois may not pay any extraordinary dividend or make any other extraordinary distribution until the Illinois Director of Insurance has approved or non-disapproved such dividend or distribution. Illinois law defines an extraordinary dividend or distribution as any dividend or distribution whose fair market value, together with that of other dividends or distributions made within the preceding 12-month period, exceeds the greater of: (a) 10% of policyholders’ surplus as of the previous December 31st; or (b) the net income of the insurance company for the preceding 12-month period, but does not include pro rata distributions of any class of the insurance company’s own securities. Under the Illinois municipal bond regulation, any change in the contingency reserve of MBIA Illinois is to be included as net income or loss for purposes of determining whether a dividend or distribution is extraordinary. As a result of the MBIA Illinois Transformation, MBIA Illinois had negative earned surplus as of the date of the transaction and thus cannot pay dividends except with regulatory approval. The foregoing dividend limitations are determined in accordance with Statutory Accounting Practices (“SAP”), which generally produce statutory earnings in amounts less than earnings computed in accordance with GAAP. Similarly, policyholders’ surplus, computed on a SAP basis, will normally be less than net worth computed on a GAAP basis. See “Note 20: Statutory Accounting Practices” in the Notes to Consolidated Financial Statements of MBIA Inc. and Subsidiaries for additional information. Insurance Guarantee Funds MBIA Corp., MBIA Illinois, and CapMAC are exempt from assessments by the insurance guarantee funds in the majority of the states in which they do business. Guarantee fund laws in most states require insurers transacting business in the state to participate in guarantee associations, which pay claims of policyholders and third-party claimants against impaired or insolvent insurance companies doing business in the state. In most states, insurers licensed to write only municipal bond insurance, financial guarantee insurance and other forms of surety insurance are exempt from assessment by these funds and their policyholders are prohibited from making claims on these funds.
20
Table of ContentsItem 1. Business (Continued)
OUR INVESTMENT MANAGEMENT SERVICES Our investment management services operations consist of three operating segments: asset/liability products, advisory services and conduits. Under our asset/liability management business, MBIA Inc. and its subsidiaries have issued debt and investment agreements which are insured by MBIA Corp. to capital markets and municipal investors and then purchased assets that largely match the duration of those liabilities. The ratings downgrades of MBIA Corp. have significantly adversely affected our funding activities in this business and resulted in the collateralization and/or termination of a substantial portion of our investment agreements. As a result of these requirements and terminations, we took steps in the second, third and fourth quarters of 2008 to reduce liabilities in the asset-liability management portfolio and preserve liquidity to meet collateralization requirements and make payments that may become due upon such termination of the contracts. Asset/Liability Products Given the ratings downgrades of MBIA Corp. in 2008 and 2009, the business prospects for our asset/liability products business are uncertain. MBIA Asset Management’s assets/liability products segment historically raised funds for investment through several sources: (1) customized investment agreements for bond proceeds and other public funds for such purposes as construction, loan origination, escrow and debt service or other reserve fund requirements; (2) customized products for funds that are invested as part of asset-backed or structured product transactions; and (3) issuance of MTNs with varying maturities by our affiliate MBIA Global Funding, LLC (“GFL”). All of these products are guaranteed by MBIA Corp. In addition, GFL would lend the proceeds of its MTN issuances to the Company (“GFL Loans”). Under agreements between the Company and MBIA Corp., the Company has invested the proceeds of the investment agreements and GFL Loans in eligible investments, which consist of investment grade securities with a minimum average Double-A credit quality rating and which are pledged to MBIA Corp. as security for its guarantees on investment agreements and MTNs. MBIA Inc. primarily purchased domestic securities and lent a portion of the proceeds from investment agreements and MTNs to Euro Asset Acquisition Limited (“EAAL”), which primarily purchased foreign assets as permitted under the Company’s investment guidelines. While MBIA Corp. enjoyed Triple-A insurer financial strength ratings, the Company generally earned a positive spread between the yield on assets and liabilities in this business, but in recent quarters the lower yield earned on greater holdings of cash and cash equivalents coupled with the increased cost of funding liabilities has resulted in a negative spread. The primary risks in the business include the risk that assets default or fall in value and are not available to service liabilities, and liquidity risk associated with any mismatch of assets and liabilities or collateral posting requirements due to ratings downgrades. For a discussion of the recent ratings downgrades that have affected our business, see the “Rating Agencies” section below. MBIA Asset Management has managed the programs within a number of risk and liquidity parameters monitored by the Risk Management Division, the Executive Market/Investment Committee and the rating agencies, and maintains cash and liquidity resources that it believes will be sufficient to make all payments due on the investment agreement and MTN obligations and to meet other financial requirements such as posting collateral and paying operating expenses. However, there can be no assurance that our liquidity resources may not decline, or be insufficient to meet our obligations, as described under “Liquidity and Market Related Risk Factors” in Part I, Item 1A. In addition, the Company and MBIA Corp. have provided funds to the asset/liability products segment which are available to use for cash needs. In particular, as a result of the illiquidity of fixed income markets during 2008, we implemented intercompany agreements to provide additional liquidity from MBIA Inc. and MBIA Corp. to the asset/liability products business, which has reduced the liquidity resources available to MBIA Inc. and MBIA Corp. for other purposes. In the event that the value of the assets in the asset/liability products business is insufficient to repay the investment agreement and MTN obligations or other financial requirements when due, the Company, or MBIA Corp. as guarantor of the investment agreements and MTNs, may incur a loss. MBIA Asset Management uses derivative financial instruments to manage interest rate risk, credit risk and foreign currency risk. Credit default swaps are also used to replicate investment in cash assets consistent with the Company’s risk objectives and credit guidelines. The Company has established policies limiting the amount, type and counterparty concentration of such instruments. The primary risks in the business include credit risk (the risk that assets default or fall in value and are not available to service liabilities), and liquidity risk associated with any mismatch of assets and liabilities or collateral posting requirements due to ratings downgrades. The ways in which MBIA Asset Management mitigates liquidity risk are discussed further in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity” in Part II, Item 7. For a discussion of the recent ratings downgrades that have affected our business, see the “Rating Agencies” section below. The Company also
21
Table of ContentsItem 1. Business (Continued)
manages its balance sheet to protect against a number of other risks inherent in its business, including market risk (principally interest rate risk), operational risk and legal risk. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Market Risk” in Part II, Item 7. Advisory Services In its advisory services segment, MBIA Asset Management offers cash management, customized asset management and investment consulting services to local governments, school districts and other institutional clients through MBIA Municipal Investors Service Corporation (“MBIA-MISC”), an SEC-registered investment adviser. MBIA Asset Management receives asset management fees as compensation for these services. MBIA Asset Management also offers fixed-income asset management services for third parties and the investment portfolios of the Company, MBIA Corp. and other affiliates on a fee-for-service basis through MBIA Capital Management Corp. (“CMC”), an SEC-registered investment adviser and Financial Industry Regulatory Authority member firm and through AM-UK, a Financial Services Authority registered investment advisor based in London. Third-party clients include corporations, pension funds, municipalities, insurance companies and investment companies, as well as structured programs such as collateralized debt obligations (“CDOs”) and funding vehicles. In 2006, AM-UK structured East-Fleet Finance Limited (“East-Fleet”), a non-consolidated funding conduit. AM-UK provides East-Fleet fee-based asset management and administrative services, acting under a management agreement and at the direction of an independent board of directors for the entity. Beginning in August 2007, adverse conditions in the asset-backed commercial paper markets reduced demand by East-Fleet clients for financing and increased the cost of East-Fleet commercial paper funding, together causing the program size to decline. However, East-Fleet continued to operate normally throughout 2008. Due to the cash-matched funding of assets and liabilities, East-Fleet is not exposed to liquidity risk. Conduits The Conduits, which have issued commercial paper and MTNs, are reflected in the consolidated financial statements of the Company. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Investment Management Services” in Part II, Item 7. The Conduits have been used by banks and other financial institutions to raise funds for their customers in the capital markets. No new MTNs were issued in 2008 and there were no outstanding issues of commercial paper at the end of the year. The Conduits have provided funding for multiple customers through special purpose vehicles that issue commercial paper and MTNs. The proceeds from these issuances were used to either make loans to customers which are secured by certain assets or to purchase assets from customers. All transactions in the Conduits are insured by MBIA Corp. and are subject to MBIA Corp.’s standard underwriting process. The Conduits receive an administrative fee as compensation for these services. The Conduits have no impact on the Company’s liquidity requirements because Triple-A One Funding Corp. independently entered into liquidity agreements with third-party providers and because the assets and liabilities of Meridian are structured on a match-funded basis. As of December 31, 2008, all of Triple-A One Funding Corp.’s liquidity agreements had been drawn. At December 31, 2008, there were $2.4 billion of assets (the majority of which are investments valued at amortized cost) in the Conduits and $2.5 billion of liabilities issued through the Conduits, including $0.3 billion of drawn commercial paper bank facilities. Investments and Investment Policy The Finance Committee of the Board of Directors of the Company approves the Company’s general investment objectives and policies, and also reviews more specific investment guidelines. CMC manages all of MBIA Corp.’s domestic consolidated investment portfolios and substantially all of the Company’s investment portfolios, and AM-UK manages the foreign assets of MBIA Corp.’s subsidiaries and EAAL. Investment objectives, policies and guidelines related to CMC’s and AM-UK’s investment activity on behalf of our Insurers are also subject to review and approval by the respective Investment Committee of their Boards of Directors.
22
Table of ContentsItem 1. Business (Continued)
To continue to provide adequate capital resources and claims-paying capabilities for our insurance operations, the investment objectives and policies for our insurance operations set preservation of capital as the primary objective, subject to an appropriate degree of liquidity. Maximization of after-tax investment income and investment returns is an important but secondary objective. The insurance operations assets are managed by CMC and AM-UK subject to agreements between these asset management entities and our Insurers. Investment objectives, policies and guidelines related to MBIA Asset Management’s asset/liability products segment are also subject to review and approval by the Finance Committee of the Board of Directors and the Executive Market/Investment Committee. The primary investment objective of MBIA Asset Management in this segment is to preserve capital and to maintain appropriate liquidity. The Company’s consolidated investment portfolio as shown on its balance sheet at December 31, 2008 was $20.6 billion, of which $3.7 billion represented held-to-maturity investments at amortized cost. The duration of the insurance fixed-income portfolio was 4.5 and 5.2 years as of December 31, 2008 and December 31, 2007. The average maturity of the insurance fixed-income portfolio, excluding short-term investments, as of December 31, 2008 and December 31, 2007 was 8.3 years and 9.3 years, respectively. The Company’s investment portfolio includes investments that are insured by MBIA Corp. (“MBIA Insured Investments”). As of December 31, 2008, MBIA Insured Investments at fair value represented $3.5 billion or 17% of the total investment portfolio. This includes conduit investments at fair value of $2.4 billion or 12% of the total investment portfolio. Investment Management Services Regulation Subsidiaries of MBIA Asset Management are subject to various federal and state securities and investment regulations. As an SEC-registered investment adviser and a Financial Industry Regulatory Authority (“FINRA”) member firm, MBIA-CMC is subject to the requirements of the Investment Advisers Act of 1940, a Federal statute which regulates registered investment advisers, and to National Association of Securities Dealers (“NASD”) rules and regulations. As an adviser to registered investment companies, MBIA-CMC is also responsible for compliance with applicable provisions of the Investment Company Act of 1940. As sponsor/administrator of pooled investment programs, MBIA-MISC and Colorado Investor Services Corporation, each of which is an SEC-registered investment adviser, are subject to the requirements of the Investment Advisers Act of 1940, as well as certain state laws governing the operation of and permitted investments in local government investment pools. The activities of AM-UK are subject to supervision by the United Kingdom’s Financial Services Authority. COMPETITION Our Insurers compete with other monoline insurance companies, as well as other forms of credit enhancement, in writing financial guarantee business. Our ability to attract and compete for financial guarantee business is largely dependent on the financial strength ratings assigned to our Insurers by the major rating agencies. During 2008, most monoline financial guarantee insurers were downgraded by one or more of the major rating agencies, and the two remaining significant Triple-A monoline financial guarantee insurers were assigned a “Review for Possible Downgrade” status by Moody’s and announced an intention to merge. A new Triple-A financial guarantee insurer began competing in the municipal finance market during the first quarter of 2008 and another received a license in October 2008 from the NYSID to write financial guarantee insurance. MBIA Illinois will be one of the only substantial insurers in the United States dedicated solely to U.S. public finance business. While we intend to capitalize MBIA Illinois at a level sufficient to achieve high stable ratings, it will face competition from the existing financial guarantors and new entrants to the market, including a potential national insurer of municipal bonds. In addition, commercial banks also provide letters of credit as a means of credit enhancement for municipal securities. The use of letters of credit within the U.S. municipal market increased substantially in 2008. The recent actions by the major rating agencies with respect to the Company’s and our Insurers’ ratings, as described further below, have adversely affected our ability to attract new financial guarantee business and compete with those competitors that have or are anticipated to experience less severe negative ratings actions. As a result, our market share of all financial guarantee insurance provided to the new issue U.S. municipal
23
Table of ContentsItem 1. Business (Continued)
finance market decreased to approximately 2.2% for the 2008 fiscal year compared with approximately 23.0% for the 2007 fiscal year. Additionally, we did not underwrite any non-U.S. public finance transactions in the 2008 fiscal year. We did not compete in the structured finance market for most of 2008 as a result of our previously announced decision to suspend the writing of all new structured finance business for approximately six months from the end of February 2008. As discussed above, the structured finance industry is generating very little new business opportunities, and it continues to be highly uncertain how or when the company may re-engage this market. The asset/liability products segment of our investment management services operations issues investment agreements and medium-term notes that are guaranteed by MBIA Corp. Due to downgrades of MBIA Corp., and the resulting decrease in demand for MBIA-insured obligations, we have not issued new investment agreements or MTNs since the second quarter of 2008. As mentioned above, financial guarantee insurance also competes with other forms of credit enhancement, including senior-subordinated structures, credit derivatives, letters of credit and guarantees (for example, mortgage guarantees where pools of mortgages secure debt service payments) provided by banks and other financial institutions, some of which are governmental agencies. Letters of credit are most often issued for periods of less than 10 years, although there is no legal restriction on the issuance of letters of credit having longer terms. Thus, financial institutions and banks issuing letters of credit compete directly with our Insurers to guarantee short-term notes and bonds with a maturity of less than 10 years. To the extent that banks providing credit enhancement may begin to issue letters of credit with commitments longer than 10 years, the competitive position of financial guarantee insurers could be adversely affected. Letters of credit are also frequently used to assure the liquidity of a short-term put option for a long-term bond issue. This assurance of liquidity effectively confers on such issues, for the short term, the credit standing of the financial institution providing the facility, thereby competing with our Insurers and other financial guarantee insurers in providing interest cost savings on such issues. Other highly rated institutions, including pension funds and government sponsored entities, also offer third-party credit enhancement on asset-backed and municipal obligations. Financial guarantee insurance and other forms of credit enhancement also compete in nearly all instances with the issuer’s alternative of foregoing credit enhancement and paying a higher interest rate. If the interest savings from insurance or another form of credit enhancement are not greater than the cost of such credit enhancement, the issuer will generally choose to issue bonds without third-party enhancement. Certain characteristics of the financial guarantee insurance business act as barriers-to-entry to potential new competitors. For example, there are minimum capital requirements imposed on a financial guarantee insurance company by the rating agencies to obtain and maintain high financial strength ratings and these capital requirements may deter other companies from entering this market. However, there can be no assurance that these capital requirements will deter potential competitors from entering this market or that the market may not increasingly accept guarantees provided by lower rated insurers who have less stringent capital requirements. In addition, under New York law, multi-line insurers are prohibited from writing financial guarantee insurance in New York State. See “Part I, Item 1. Business—Insurance Regulation.” However, there can be no assurance that major multi-line insurers or other financial institutions will not participate in financial guarantee insurance in the future, either directly or through monoline subsidiaries. RATING AGENCIES Rating agencies perform periodic reviews of our Insurers and other companies providing financial guarantee insurance. In rating financial guarantee companies, rating agencies focus on qualitative and quantitative characteristics in five key areas. Those are: (1) franchise value and business strategy; (2) insurance portfolio characteristics; (3) capital adequacy; (4) profitability; and (5) financial flexibility. Each agency has its own ratings criteria for financial guarantors and employs proprietary models to assess MBIA’s risk adjusted leverage, risk concentrations and financial performance relative to the agency’s standards. The agencies also assess MBIA’s corporate governance and factor this into their rating assessment. Currently, S&P and Moody’s rate the Company and its Insurers. Until June 2008, MBIA Corp. held Triple-A financial strength ratings from S&P, which the Association received in 1974; from Moody’s, which the Association received in 1984; from Fitch, Inc. (“Fitch”), which MBIA Corp. received in 1995; and from Rating and Investment Information, Inc. (“RII”), which MBIA Corp. received in 1998. At our
24
Table of ContentsItem 1. Business (Continued)
request, RII canceled its ratings on MBIA Corp. and CapMAC in June 2008. MBIA Inc.’s and MBIA Corp.’s current financial strength ratings from S&P, Moody’s, and Fitch are summarized below:
A summary of recent ratings actions from S&P, Moody’s and Fitch follows: S&P On February 18, 2009, following the Company’s announcement of the MBIA Illinois Transformation, S&P announced that it had lowered its counterparty credit, financial strength, and financial enhancement ratings on MBIA Corp. and its subsidiaries Capital Markets Assurance Corporation, MBIA UK Insurance Limited and MBIA Assurance S.A. to BBB+ with a negative outlook from AA with a negative outlook. At the same time, S&P lowered its counterparty credit and financial strength ratings on MBIA Illinois to AA- from AA and placed them on CreditWatch with developing implications and lowered its counterparty credit rating on the Company to BB+ with a negative outlook from A- with a negative outlook. In addition, S&P lowered its counterparty credit and financial strength ratings on the Association to AA- from AA and placed the ratings on CreditWatch developing, mirroring the action taken on MBIA Illinois. S&P also indicated that it would apply the ratings of MBIA Illinois to the underlying bonds that were reinsured by MBIA Illinois through the transaction, except those with higher public underlying ratings. S&P noted that the downgrade of MBIA Illinois reflects its view of both “its uncertain business prospects and its capital, which is marginally below our ‘AA’ standard,” and noted that “[f]rom a future business production perspective, we believe that MBIA Illinois’ competitive position may suffer from legacy MBIA performance. In addition, there is uncertainty regarding investors’ acceptance of the restructuring and ring-fencing plan.” S&P also noted that it downgraded MBIA Corp. because of its view that “its retained insured portfolio lacks sufficient sector diversity and with time could become more concentrated.” In addition, S&P cited the following factors in its downgrade decision: “[Its] 2005–2007 vintage direct RMBS, CDO of ABS, and other structured exposures are subject to continued adverse loss development that could erode capital adequacy. Supporting the debt-service needs of the holding company might also place pressure on capital adequacy. We believe that there is a strong incentive for MBIA Corp. to maintain an orderly runoff of its book of business so as not to damage the franchise value of the newly launched public finance only subsidiary. To this end, from a risk-management perspective, management has indicated that it will retain sufficient experienced staff to support surveillance and remediation efforts.” S&P also noted that the negative outlook on MBIA Corp. reflects its view that “adverse loss development on the structured finance book could continue” and that “[a] revision of the outlook to stable will depend on, among other factors, greater certainty of ultimate potential losses as well as the orderly runoff of the book of business.” S&P indicated that it could raise the rating on MBIA Illinois “if it successfully raises capital and credibly ring fences its operations from MBIA [Corp.],” but noted that “any rating action based on these factors would most likely remain within the ‘AA’ category” and that “[i]f MBIA [Illinois] is not able to raise capital or if legal challenges impair management’s restructuring efforts, we could lower the ratings.” Prior to S&P’s actions on February 18, 2009, S&P had on June 5, 2008 downgraded the insurance financial strength ratings of MBIA Corp. and its insurance affiliates to AA from AAA, MBIA Inc.’s senior debt to A- from AA- and MBIA Corp.’s North Castle Custodial Trusts I-VIII to A- from AA. The ratings remained on Credit Watch with negative implications. Prior to those actions, on February 25, 2008, S&P had affirmed the AAA insurance financial strength ratings of MBIA Corp. and its insurance affiliates, the AA- rating of MBIA Inc.’s senior debt and the AA ratings of MBIA Corp.’s North Castle Custodial Trusts I-VIII, and placed these ratings on negative outlook.
25
Table of ContentsItem 1. Business (Continued)
Moody’s On February 18, 2009, following the Company’s announcement of the MBIA Illinois Transformation, Moody’s Investors Service, Inc. (“Moody’s”) announced its affirmation of the Company’s Ba1 senior debt rating and maintenance of its developing outlook, and downgraded the following ratings of MBIA Corp. and its subsidiaries other than MBIA Illinois, whose Baa1 rating Moody’s placed on review for possible upgrade:
In its press release, Moody’s cited two primary factors for its downgrade of MBIA Corp.: “First is the guarantor’s substantial reduction in claims-paying resources relative to the remaining higher-risk exposures in its insured portfolio, given the removal of capital, and the transfer of unearned premium reserves associated with the ceding of its municipal portfolio to MBIA Illinois. Second is the continued deterioration of the firm’s insured portfolio of largely structured credits, with stress reaching sectors beyond residential mortgage-related securities.” In addition, Moody’s stated that MBIA Corp.’s developing outlook “reflects the potential for further deterioration in the insured portfolio” and “incorporates positive developments that could occur over the near to medium term, including greater visibility about mortgage performance, the possibility of commutations or terminations of certain ABS CDO exposures, and/or successful remediation efforts on poorly performing RMBS transactions.” Moody’s also noted that the developing outlook is also based on “the potential for various initiatives being pursued at the US federal level to mitigate the rising trend of mortgage loan defaults.” As a result of the ratings action, the Moody’s-rated securities that are guaranteed by MBIA Corp. are also downgraded to B3, except those with higher public underlying ratings. With respect to municipal obligations wrapped by MBIA Corp. that are reinsured by MBIA Illinois, Moody’s stated in a Special Comment published on February 20, 2008 that it would apply to those obligations the same rating as was assigned to MBIA Illinois, except for those obligations with higher public underlying ratings. With respect to FGIC-insured bonds reinsured by MBIA Illinois, Moody’s continues to evaluate whether to apply to those obligations the same rating as was assigned to MBIA Illinois. For all other transactions wrapped by MBIA Corp., Moody’s announced that it will withdraw the ratings for which there are no published underlying ratings in accordance with current rating agency policy. For these transactions, if the rating of MBIA Corp. should subsequently move back into the investment grade range, or if the agency should subsequently publish the underlying rating, Moody’s indicated that it would reinstate the rating to the wrapped instruments. Because of the large volume of rating changes resulting from the MBIA Illinois Transformation, Moody’s noted that it may take some time for Moody’s to update impacted ratings in their ratings database. Moody’s indicated that its review for upgrade of MBIA Illinois’ Baa1 insurance financial strength rating “reflects upward rating pressure following the group’s restructuring, stemming from the company’s substantial claims-paying resources relative to its insured portfolio of high-quality municipal exposures. The review also includes the possibility of improved business prospects for MBIA Illinois in light of the company’s municipal-only focus and strong risk-adjusted capital adequacy.” Moody’s said that the potential for upward rating movement is tempered, however, “by the significant challenges facing both MBIA Illinois and the financial guaranty industry in general,” and “any upward rating revision would likely be limited to the single-A range.” During its review, Moody’s indicated that it “will evaluate the impact of MBIA’s restructuring on the future business prospects of MBIA Illinois. As part of the review process, Moody’s will consider the company’s ability to regain market confidence, as well as the potential for and impact of any legal challenges coming from the counterparties of MBIA Corp.”
26
Table of ContentsItem 1. Business (Continued)
In announcing its affirmation of the Company’s Ba1 senior debt rating and maintenance of its developing outlook, Moody’s noted that the actions “reflect the group’s evolving risk profile.” Moody’s cited the following factors in the affirmation: “The corporate restructuring may strengthen MBIA Inc.’s risk profile by sheltering its investment in MBIA Illinois from the risks of MBIA Corp. The creation of a strongly capitalized and dedicated municipal insurer also increases the likelihood of regaining market traction. At the same time, continued deterioration in the group’s structured finance portfolio, as well as uncertainty about the group’s ability to firewall losses within MBIA Corp., could hurt MBIA Inc.’s credit profile.” Prior to Moody’s actions on February 18, 2009, Moody’s had on June 19, 2008 downgraded the insurance financial strength ratings of MBIA Corp. and its insurance affiliates to A2 from Aaa, MBIA Inc.’s senior debt to Baa2 from Aa3 and MBIA Corp.’s surplus notes to Baa1 from Aa2. Moody’s outlook for these ratings was negative. On September 18, 2008, Moody’s placed the insurance financial strength rating of MBIA Corp. and its insurance affiliates on review for possible downgrade, and on November 7, 2008, Moody’s downgraded the insurance financial strength ratings of MBIA Corp. and its insurance affiliates to Baa1 from A2, MBIA Inc.’s senior debt to Ba1 from Baa2 and MBIA Corp.’s surplus notes to Baa3 from Baa1, while placing these ratings on a developing outlook. On February 26, 2008, Moody’s had affirmed the Aaa insurance financial strength ratings of MBIA Corp. and its insurance affiliates, the Aa2 ratings of MBIA Corp.’s surplus notes and the Aa3 ratings of the junior obligations of MBIA Corp. and the senior debt of MBIA Inc. Moody’s outlook for these ratings was negative. Fitch On March 7, 2008, MBIA requested that Fitch withdraw its insurer financial strength ratings for MBIA Corp. and its insurance affiliates. In addition, MBIA requested that Fitch continue to rate the outstanding debt obligations of MBIA Corp. and MBIA Inc. In conjunction with the above, MBIA also requested that Fitch cease utilizing and destroy all non-public information that MBIA supplied on transactions that Fitch did not rate. Fitch’s ratings process differs in many significant respects from those of the other rating agencies, which affects how investors assess value. Fitch’s coverage of the underlying credit quality of the transactions that MBIA insures is limited, and in turbulent times, the impact of this difference becomes significant, raising the risk of misinterpretation. On June 26, 2008, Fitch withdrew its insurer financial strength ratings for MBIA Corp. and its insurance affiliates as well as all other related ratings. MBIA Corp.’s ability to attract new business and to compete with other financial guarantors has been adversely affected by all of the rating agency actions described above. The Company’s ability to implement its Strategic Plan and other future strategies, and its results of operations and financial condition, would be materially adversely affected by any further reduction, or additional suggested possibility of a reduction, in its ratings. CAPITAL FACILITIES The Company’s capital facilities are described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Capital Resources” in Part II, Item 7. FINANCIAL INFORMATION For information on the Company’s financial information by segment, see Note 15, “Business Segments,” in the Notes to the Consolidated Financial Statements of MBIA Inc. and Subsidiaries in Part II, Item 8. EMPLOYEES As of February 26, 2009, the Company had 420 employees, 257 in MBIA Corp., 41 in MBIA Illinois and 122 in MBIA Asset Management. None of the Company’s domestic employees is covered by a collective bargaining agreement. Certain of the Company’s employees outside the United States are governed by national collective bargaining or similar agreements. The Company considers its employee relations to be satisfactory. AVAILABLE INFORMATION The Company maintains a website at www.mbia.com. The Company is not including the information on its website as a part of, nor is it incorporating such information by reference into, this Form 10-K. The Company makes available through its website, free of charge, all of its SEC filings, including its annual Form 10-K, its quarterly filings on Form 10-Q and any current reports on Form 8-K, as soon as is reasonably practicable after these materials have been filed with the SEC. All such filings were timely posted to the website in 2008.
27
Table of ContentsItem 1. Business (Continued)
EXECUTIVE OFFICERS The executive officers of the Company and their present ages and positions with the Company as of March 1, 2009 are set forth below.
Joseph W. Brown is Chairman, Chief Executive Officer and Director of the Company. Mr. Brown assumed his roles in February 2008 after having retired as Executive Chairman of MBIA in May 2007. Until May 2004, Mr. Brown had served as Chairman and Chief Executive Officer of MBIA and MBIA Corp. Mr. Brown originally joined the Company as Chairman and CEO in January 1999 after having been a director since 1986. Prior to joining MBIA in 1999, Mr. Brown was Chairman and CEO of Talegen Holdings, Inc., an insurance holding company. Before his election as Chairman and CEO of Talegen, Mr. Brown was President and CEO of Fireman’s Fund Insurance Company. Mr. Brown joined Fireman’s Fund in 1974. He held numerous executive positions including Chief Financial Officer at the time of its IPO in 1985 from American Express and President and Chief Operating Officer at the time of its sale to Allianz AG in 1990. Mr. Brown served on the board of Oxford Health Plans from 2000 to 2004 and on the Board of Fireman Fund Holdings prior to the sale of its insurance subsidiary to Allianz. He served on the SAFECO board from 2001 to September 2008 and was elected Non-executive Chairman in January 2006. On November 6, 2008, the Board of Directors of MBIA Inc. appointed the other executive officers of the Company to the office set forth opposite his name above, effective as of November 6, 2008. Prior to being named President, Chief Financial Officer and Chief Administrative Officer, C. Edward Chaplin (age 52) was Vice President and Chief Financial Officer of the Company. Prior to becoming an officer of the Company in June 2006, Mr. Chaplin had served as a director of the Company from December 2002 to May 2006 and as Senior Vice President and Treasurer of Prudential Financial Inc. since November 2000, responsible for Prudential’s capital and liquidity management, corporate finance, and banking and cash management. Mr. Chaplin had been with Prudential since 1983. Prior to being named President and Chief Operating Officer, William C. Fallon (age 49) was Vice President of the Company and head of the Global Structured Finance Division. From July 2005 to March 1, 2007, Mr. Fallon was Vice President of the Company and head of Corporate and Strategic Planning. Prior to joining the Company in 2005, Mr. Fallon was a partner at McKinsey & Company and co-leader of that firm’s Corporate Finance and Strategy Practice. Prior to being named Executive Vice President and Chief Investment Officer, Clifford D. Corso (age 47) was Vice President of the Company, the Company’s Chief Investment Officer and the president of MBIA Asset Management. Mr. Corso retains the title of president of MBIA Asset Management. He joined the Company in 1994 and has served as Chief Investment Officer since 2000. Prior to being named Executive Vice President and Chief Portfolio Officer, Mitchell I. Sonkin (age 56) was Vice President of the Company and head of the IPM Division. Prior to joining the Company in April 2004, Mr. Sonkin was senior partner and co-chair of the Financial Restructuring Group of the international law firm of King & Spalding.
28
Table of ContentsItem 1. Business (Continued)
Prior to being named Executive Vice President, Chief Legal Officer and Secretary, Ram D. Wertheim (age 54) was Vice President, General Counsel and Secretary of the Company. From February of 1998 until January 2000, he served in various capacities in the Global Structured Finance Division. Mr. Wertheim was, until February of 1998, the General Counsel of CapMAC Holdings Inc. On November 6, 2008, the Board also did not reappoint Thomas G. McLoughlin, Kevin D. Silva, Christopher E. Weeks and Ruth M. Whaley as executive officers of the Company in their capacities, respectively, of Vice President and head of the Global Public Finance Division, Vice President and Chief Administrative Officer, Vice President and head of the International Division and Vice President and Chief Risk Officer. Item 1A. Risk Factors References in the risk factors to the “Company” are to MBIA Inc., together with its domestic and international subsidiaries. References to “we,” “our” and “us” are to MBIA Inc. or the Company, as the context requires. Insured Portfolio Loss Related Risk Factors Recent adverse developments in the credit markets and any potential negative impact on our Insurers’ insured portfolios may materially and adversely affect our financial condition, results of operations and future business MBIA Corp. is exposed to credit risks in its portfolio that may arise from deterioration in the credit markets, wherein such deterioration in credit performance could lead to potential erosion in the quality of assets and also the collection of cash flows from such assets within structured securities that it has guaranteed. Beginning in the second half of 2007, deterioration of the global credit markets coupled with the re-pricing of credit risk created and continues to create extremely difficult market conditions and volatility in the credit markets. Initially, the concerns on the part of market participants were focused on the subprime segment of the mortgage-backed securities market. However, these concerns have since expanded to include a broad range of mortgage- and asset-backed and other fixed income securities, including those rated investment grade, the U.S. and international credit and interbank money markets generally, and a wide range of financial institutions and markets, asset classes and sectors. During the fourth quarter of 2008, disruptions and volatility in the credit markets reached unprecedented levels. During 2008, partly as a result of concerns about exposure to these assets, some of the largest companies in the financial sector have received government support, been acquired by stronger firms or been allowed to fail. While MBIA Corp. has sought to underwrite direct RMBS, CMBS and CDOs of ABS with levels of subordination and other credit enhancements designed to protect it from loss in the event of poor performance of the underlying assets collateralizing the securities in the insured portfolio, we have since the third quarter of 2007 recorded case basis losses incurred of $2.1 billion due to projected inadequacies of such credit enhancements in securities it has guaranteed. The case basis activity was in addition to MBIA Corp.’s regular quarterly addition of 14% of scheduled earned premiums, or approximately $115 million since the third quarter of 2007. No assurance can be given that such credit enhancements will prove to be adequate to protect MBIA Corp. from incurring additional material losses in view of the current significantly higher rates of delinquency, foreclosure and losses being observed among residential mortgages and home equity lines of credit. While further deterioration in some of the asset-backed securities we insure is generally expected, the extent and duration of any future continued deterioration of the credit markets is unknown, as is the impact, if any, on potential claim payments and ultimate losses of the securities within MBIA Corp.’s portfolio. In addition, there can be no assurance that we would be successful, or that we would not be delayed, in enforcing the subordination provisions, credit enhancements or other contractual provisions of the RMBS, CMBS and CDOs of ABS that MBIA Corp. insures in the event of litigation or the bankruptcy of other transaction parties. Many of the subordination provisions, credit enhancements and other contractual provisions of the RMBS, CMBS and CDOs of ABS that MBIA Corp. insures are untested in the market and, therefore, it is uncertain how such subordination provisions, credit enhancements and other contractual provisions will be interpreted in the event of an action for enforcement.
29
Table of ContentsItem 1A. Risk Factors (Continued)
Existing difficult economic conditions may materially adversely affect our business and results of operations and we do not expect these conditions to improve in the near future Our results of operations are materially affected by general economic conditions, both in the U.S. and elsewhere around the world. Beginning in the second half of 2007 and continuing in 2008, global financial, equity and other markets experienced significant stress, which reached unprecedented levels in the fourth quarter of 2008 . See “—Recent adverse developments in the credit markets and any potential negative impact on our Insurers’ insured portfolios may materially adversely affect our financial condition, results of operations and future business.” Recently, concerns over the availability and cost of credit, the U.S. mortgage market, a declining real estate market in the U.S., inflation, energy costs, extreme volatility in fixed income and equity markets and geopolitical issues have contributed to increased volatility and diminished expectations for the global economy and the markets going forward. These factors, combined with volatile oil prices, declining business and consumer confidence and increased unemployment, have precipitated an economic slowdown and fears of a worsening recession, which continue to challenge the U.S. and global fixed income, equity and other markets and overall economies. Recessions, increases in corporate, municipal or consumer default rates and other general economic conditions may adversely impact, and the weak performance of residential mortgages backed securities has adversely impacted, and continues to impact the Company’s prospects for future business, as well as the performance of our Insurers’ insured portfolios and the Company’s investment portfolio. In particular, the deterioration of certain sectors of the credit markets has caused a significant decline in the number of structured finance securities that have been issued since the fourth quarter of 2007. There can be no assurance that the market for financial guarantee insurance will recover, and if the market fails to recover there would be a decrease in the demand for financial guarantee insurance, which may adversely affect our Insurers’ business prospects. There can be no assurance that actions of the U.S. government, Federal Reserve and other governmental and regulatory bodies for the purpose of stabilizing the financial markets and stimulating the economy will achieve the intended results In response to the financial crisis affecting the banking system, financial markets, investment banks and other financial institutions, on October 3, 2008, the Emergency Economic Stabilization Act of 2008 (the “EESA”) was signed into law. Pursuant to the EESA, the U.S. Treasury has the authority to, among other things, make equity investments in certain financial institutions and purchase mortgage-backed and other securities from financial institutions for an aggregate amount of up to $700.0 billion. On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (the “ARRA”) was signed into law. The stated purpose of the ARRA is “making supplemental appropriations for job preservation and creation, infrastructure investment, energy efficiency and science, assistance to the unemployed, and State and local fiscal stabilization” through an estimated $787 billion of government spending and tax cuts. Furthermore, on February 18, 2009 President Obama proposed a housing plan to assist homeowners refinance or modify mortgages, with an estimated cost of $275 billion. There can be no assurance that the housing plan will be adopted in its current form or at all. There can be no assurance as to what impact these or any other actions taken by the U.S. federal government, Federal Reserve or other governmental or regulatory bodies will have on the financial markets, including the extreme levels of volatility experienced in recent months, the level of defaults in the fixed income markets, in particular in the subprime sector of the RMBS market, and the lack of available credit. Such continued volatility, defaults and illiquidity could materially and adversely affect our business, financial condition and results of operations. Some of the state and local governments that issue obligations we insure are experiencing unprecedented budget shortfalls that could result in increased credit losses or impairments on those obligations We have historically experienced low levels of defaults in our public finance insured portfolio, including during the ongoing financial crisis that began in mid-2007. However, in recent months state and local governments that issue some of the obligations we insure have reported unprecedented budget shortfalls that will require them to significantly raise taxes and/or cut spending in order to satisfy their obligations. While there have been some proposals by the U.S. federal government designed to provide aid to state and local governments, there can be no assurance that any of these proposals will be adopted. If the issuers of the obligations in our public finance
30
Table of ContentsItem 1A. Risk Factors (Continued)
portfolio are unable to raise taxes, increase spending, or receive federal assistance, we may experience losses or impairments on those obligations, which would materially and adversely affect our business, financial condition and results of operations. We are required to report credit derivatives at fair value, which subjects our results of operations to volatility and losses, and could lead to negative shareholders’ equity for the Company or MBIA Corp. on a GAAP basis Any event causing credit spreads on an underlying security referenced in a credit derivative insured by MBIA Corp., or on a credit derivative referencing an MBIA Inc. security (an “MBIA credit derivative”), to either widen or tighten will affect the fair value of the credit derivative and may increase the volatility of our earnings. We apply fair value accounting for the portion of our insurance business executed in credit derivative form as required by SFAS 133 and changes in fair value are recognized immediately in earnings. In addition, under SFAS 157, effective January 1, 2008, we have been required to adjust our fair value calculation to account for our own non-performance risk by reference to spreads on MBIA credit derivatives as well as to account for the nonperformance risk of our reinsurers. Therefore, any increases or decreases in the fair value of our insured credit spreads or spreads on MBIA credit derivatives have an immediate corresponding impact on reported earnings. As changes in fair value can be caused by factors unrelated to the performance of MBIA Corp.’s business and credit portfolio, including general market conditions and perceptions of credit risk, as well as market use of credit derivatives for hedging purposes unrelated to the specific referenced credits in addition to events that affect particular credit derivative exposure, the application of fair value accounting may cause our earnings to be more volatile than would be suggested by the underlying performance of MBIA Corp.’s business operations and credit portfolio, and could lead to losses that could cause us to report negative shareholders’ equity on a GAAP basis. The global re-pricing of credit risk beginning in the fourth quarter of 2007 and continuing in 2008 and 2009 has caused unprecedented volatility and markdowns in the valuation of these credit derivatives. In addition, due to the complexity of fair value accounting and the application of SFAS 133 and SFAS 157, future amendments or interpretations of derivative and fair value accounting may cause us to modify our accounting methodology in a manner which may have an adverse impact on our financial results. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates” in Part II, Item 7 for additional information on the valuation of derivatives. Current accounting standards mandate that we measure the fair value of our insurance policies of credit default swaps. At the present time, we do not have access to the fair value estimates of the insurance beneficiaries and there can be no assurance that those counterparties (or any other market participant’s) estimates would be the same as our fair values. Since the fourth quarter of 2007, we have observed a further widening of market spreads and credit ratings downgrades of collateral underlying certain MBIA Corp.-insured CDO tranches. The mark-to-market for the insured credit derivative portfolio has fluctuated significantly over the last eight quarters, resulting in volatility in MBIA’s earnings, moving from losses of $1.8 million, $14.3 million and $342 million in the first, second and third quarters of 2007, respectively, to losses of $3.37 billion and $3.58 billion in the fourth quarter of 2007 and first quarter of 2008, respectively, then to gains of $3.32 billion and $105 million in the second and third quarters of 2008, followed by a loss of $1.67 billion in the fourth quarter of 2008. The volatility was primarily a result of changes in credit spreads, collateral erosion, rating migration and fluctuations in spreads on MBIA credit derivatives. As a result of fluctuations in those spreads, the effect of the FAS 157 non-performance risk adjustment on the mark-to-market over the last four quarters has also fluctuated, moving from gains of $3.56 billion and $2.89 billion in the first and second quarters of 2008, followed by a smaller gain of $606 million in the third quarter of 2008 and then an increase to $6.11 billion in the fourth quarter of 2008. We may report negative shareholders’ equity on a GAAP basis in a future period, which may have an impact on investors’ perceptions of the value of the Company As of December 31, 2008, the Company reported on a GAAP basis $994 million of shareholders’ equity, $30 billion of assets and $787 billion of off balance sheet liabilities, some of which are subject to fair value accounting. Volatility in our asset values, loss reserves, impairments or fair value of insured credit derivatives could cause our shareholders’ equity, and/or that of MBIA Corp., to be negative on a GAAP basis in a future period, which may adversely impact investors’ perceptions of the value of the Company.
31
Table of ContentsItem 1A. Risk Factors (Continued)
Loss reserve estimates are subject to uncertainties and loss reserves may not be adequate to cover potential claims The financial guarantees issued by our Insurers insure the financial performance of the obligations guaranteed over an extended period of time, in some cases over 30 years, under policies that we have, in most circumstances, no right to cancel. As a result of the lack of statistical paid loss data due to the low level of paid claims in our financial guarantee business and in the financial guarantee industry in general, particularly, until recently, in the structured asset-backed area, we do not use traditional actuarial approaches to determine our loss reserves. The establishment of the appropriate level of loss reserves is an inherently uncertain process involving numerous estimates and subjective judgments by management, and therefore, there can be no assurance that actual paid claims in our insured portfolio will not exceed its loss reserves. Small changes in the assumptions underlying these estimates could significantly impact loss expectations. Additionally, we use both internal models as well as models generated by third party consultants and customized by us to project future paid claims on our insured portfolio and establish loss reserves. There can be no assurance that the future loss projections based on these models are accurate. Recent unprecedented volatility in the credit markets has caused adjustments to these projections in a greater magnitude than we have previously experienced. We recorded case basis losses incurred of $2.1 billion since the third quarter of 2007 related to such exposures. The case basis activity was in addition to MBIA Corp.’s regular quarterly addition of 14% of scheduled earned premiums, or approximately $115 million since the third quarter of 2007. Additionally, further deterioration in the performance of RMBS, CMBS, CDOs of ABS or other obligations MBIA Corp. or MBIA Illinois insures or reinsures could lead to the establishment of additional loss reserves and further losses or reductions in income. There can be no assurance that the estimates of probable and estimable losses are accurate. Actual paid claims could exceed our estimate and could significantly exceed our loss reserves. If our loss reserves are not adequate to cover actual paid claims, MBIA Corp.’s results of operations and financial condition could be materially adversely affected. Effective January 1, 2009, the Company adopted FAS 163, “Accounting for Financial Guarantee Insurance Contracts—an Intepretation of FASB Statement No. 60.” For additional information on the Company’s loss reserving methodology and FAS 163, see “Note 3—Recent Accounting Pronouncements” in Part II, Item 8, and Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates” in Part II, Item 7. Credit risk modeling contains uncertainty over ultimate outcomes which make it difficult to estimate potential paid claims and loss reserves and mark-to-market The securities our Insurers insure include highly complex transactions, the performance of which depends on a wide variety of factors outside of our control, and in such transactions we must rely on financial models, generated internally and supplemented by models generated by third parties, to estimate future credit performance of the underlying assets, and to evaluate structures, rights and our potential obligations over time. These estimates can vary materially based on relatively small changes in assumptions and the use of different modeling techniques. Also, for example, the modeling of multi-sector CDOs requires analysis of both direct ABS as well as CDO collateral within the multi-sector CDOs, known as “inner securitizations,” and we do not consistently have access to all the detailed information necessary to project every component of each inner securitization. Such “inner securitizations” may themselves include CDO collateral. Therefore, in some cases we put greater reliance on the models and analysis of third party market participants and are not able to fully, independently and precisely verify each data point. Moreover, the performance of the securities that our Insurers insure and the underlying mark-to-market of our obligations depends on a wide variety of factors which are outside our control, including the liquidity and performance of the collateral underlying such securities, the correlation of assets within collateral pools, the performance or non-performance of other transaction participants (including third-party servicers) and the exercise of control or other rights held by other transaction participants. We continually monitor portfolio and transaction data and adjust these credit risk models to reflect changes in expected and stressed outcomes over time. We use internal models for ongoing portfolio monitoring and to estimate case basis loss reserves and, where applicable, to mark our obligations under our contracts to market and may supplement such models with third party models or use third party experts to consult with our internal modeling specialists. When using third party models, we perform the same review and analysis of the collateral, deal structure, performance triggers and cash flow waterfalls as when using our internal models. However, both internal and external models are subject to model risk and there can be no assurance that these models are
32
Table of ContentsItem 1A. Risk Factors (Continued)
accurate or comprehensive in estimating our potential future paid claims and related loss reserves or that they are similar to methodologies employed by our competitors, counterparties or other market participants. In addition, changes to our paid claims, loss reserve or mark-to-market models may be warranted in the future. These changes could materially impact our financial results. Our risk management policies and procedures may not detect or prevent future losses We assess our risk management policies and procedures on a periodic basis. As a result of such assessment, we may take steps to change our internal risk assessment capabilities and procedures, our portfolio management policies, systems and processes and our policies and procedures for monitoring and assessing the performance of our insured portfolio in changing market conditions. There can be no assurance, however, that these steps will be adequate to avoid future losses. Geopolitical conditions may adversely affect our Insurers’ business prospects and insured portfolio General global unrest could further disrupt the economy in this country and around the world and could have a direct material adverse impact on certain industries and on general economic activity. The Company has exposure in certain sectors that could suffer increased delinquencies and defaults as a direct result of these types of events. The Company’s exposure to domestic and international airports and to domestic enhanced equipment trust certificate aircraft securitizations have experienced increased stress as a result of global events since 2001, including a downgrading of the ratings and the bankruptcy of some of the underlying issuers, and could experience further stress in the event of general global unrest in the future. Other exposures that depend on revenues from business and personal travel, such as bonds backed by hotel taxes and car rental fleet securitizations, have experienced or may experience increased levels of delinquencies and default. In addition, certain other sectors in which the Company has insured exposure, such as consumer loan securitizations (e.g., home equity, auto loan and credit card transactions), have experienced increased delinquencies and defaults in the underlying pools of loans and could experience further defaults in the event of future global unrest. To the extent that certain corporate sectors may be vulnerable to credit deterioration and increased defaults in the event of future global unrest, CDOs backed by pools of corporate debt issuances in those stressed sectors could also be adversely impacted. The Company’s insurance operations underwrite exposures to the Company’s reasonable expectation of future performance as well as at various stress levels estimating defaults and other conditions at levels higher than are reasonably expected to occur. There can be no assurance, however, that the Company will not incur material losses if the economic stress and increased defaults in certain sectors caused by global unrest, terrorism, catastrophic events, natural disasters or similar events in the future is or will be more severe than the Company currently foresees and had assumed in underwriting its exposures. Liquidity and Market Related Risk Factors Recent adverse developments in the credit markets may materially and adversely affect our ability to meet liquidity needs As a financial services company, we are particularly sensitive to liquidity risk, which is the probability that an enterprise will not have sufficient resources to meet contractual payment obligations when due. Management of liquidity risk is of critical importance to financial services companies, and most failures of financial institutions have occurred in large part due to their inability to maintain sufficient liquidity resources under adverse circumstances. Generally, lack of sufficient resources results from an enterprise’s inability to sell assets at values necessary to satisfy payment obligations, the inability to access new capital through the issuance of equity or debt and/or an unexpected acceleration of payments required to settle liabilities. We encounter liquidity risk in our insurance operations, asset/liability products business and corporate operations. The effects of the credit crisis which began in the subprime segment of the mortgage-backed securities market and spread to a wide range of financial institutions and markets, asset losses and sectors, has caused the Company to experience material increased liquidity risk pressures in all of its operations and businesses. The insurance business experienced elevated loss payments, and with its ratings downgrades beginning in June 2008, a drop in cash from new direct insurance writings. The downgrades also had a material impact on the
33
Table of ContentsItem 1A. Risk Factors (Continued)
asset/liability segment as they triggered liability terminations and collateralization requirements, and asset sales to meet those terminations resulted in significant realized losses due to the devaluation of the asset portfolio in the segment. In addition, the impact of this crisis on the Company’s operating businesses has reduced or eliminated the ability of these subsidiaries at the present time to pay dividends to the holding company to enable it to meet its debt service and other operating expense needs. Finally, if certain of our corporate debt obligations were to become accelerated, which could occur due to MBIA Corp. entering rehabilitation proceedings, among other events, the Company would currently have insufficient assets to repay the accelerated obligations. If the current market dislocation and economic conditions persist for an extended period of time or worsen, the Company could face additional liquidity pressure in all of its operations and businesses. Further stress could increase liquidity demands on the Company or decrease its liquidity supply through additional defaulted insured exposures or devaluations and/or impairments of its invested assets. These pressures could arise from exposures beyond residential mortgage related stress, which to date has been the main cause of stress. For further discussion on the Company’s liquidity risk, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity” in Part II, Item 7. An inability to access capital could adversely affect our business, operating results and financial condition and ultimately adversely affect liquidity The Company’s access to external sources of financing, as well as the cost of such financing, is dependent on various factors, including the long term debt ratings of the Company and the insurance financial strength ratings and long term business prospects of our Insurers and the perceptions of the financial strength of our Insurers and MBIA Inc. Our debt ratings are influenced by numerous factors, either in absolute terms or relative to our peer group, such as financial leverage, balance sheet strength, capital structure and earnings trends. If we cannot obtain adequate capital on favorable terms or at all, our business, future growth, operating results and financial condition could be adversely affected. Beginning in the second half of 2008, the volatility and disruption in the global credit markets have exerted downward pressure on availability of liquidity and credit capacity for certain issuers. For example, recently credit spreads have widened considerably. As a result of the illiquidity of fixed income markets during 2008, we implemented intercompany agreements to provide additional liquidity from MBIA Inc., MBIA Corp. and MBIA Illinois to the asset/liability products business, and this has reduced the liquidity resources available to MBIA Inc., MBIA Corp. and MBIA Illinois for other purposes. Furthermore, the Company has terminated one of its credit facilities with third-party providers as discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity” in Part II, Item 7. There can be no assurance that replacement providers will be available in the future. The inability to obtain adequate replacement capital on favorable terms or at all could have an adverse impact on the Company’s business and financial condition. Because we are a holding company, our sources of liquidity primarily consist of dividend payments from our Insurers and MBIA Asset Management, investment income and the issuance of debt. To the extent that we are unable to access capital, our Insurers may not have sufficient liquidity to meet their obligations, will have less capacity to write business and may not be able to pay dividends to us without experiencing adverse rating agency action. Accordingly, our inability to maintain access to capital on favorable terms could have an adverse impact on our ability to pay losses and debt obligations, to pay dividends on our capital stock, to pay principal and interest on our indebtedness, to pay our operating expenses and to make capital investments in our subsidiaries. See “—Our holding company structure and certain regulatory and other constraints could affect our ability to pay dividends and make other payments.” Our holding company structure and certain regulatory and other constraints could affect our ability to pay dividends and make other payments We are a holding company and have no substantial operations of our own or assets other than our ownership of MBIA Corp. and MBIA Illinois, our principal operating subsidiaries, MBIA Asset Management, and certain other smaller subsidiaries. As such, we are largely dependent on dividends or advances in the form of intercompany loans from our Insurers to pay dividends on our capital stock, to pay principal and interest on our indebtedness, to pay our operating expenses and to make capital investments in our subsidiaries. Our Insurers are subject to
34
Table of ContentsItem 1A. Risk Factors (Continued)
various statutory and regulatory restrictions, applicable to insurance companies generally, that limit the amount of cash dividends, loans and advances that those subsidiaries may pay to us. Regulations relating to capital requirements affecting some of our other subsidiaries may also restrict their ability to pay dividends and other distributions and make loans to us. Under New York and Illinois law, MBIA Corp. and MBIA Illinois, respectively, may generally pay stockholder dividends only out of statutory earned surplus and subject to additional limits, as described in “Item 1. Business—Insurance Regulation” and “Item 8. Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements—Note 19: Insurance Regulations and Dividends” of this Annual Report on Form 10-K. While MBIA Corp. did not pay dividends in 2008, its payment of an extraordinary dividend in February 2009 in connection the MBIA Illinois Transformation restricted its ability to pay dividends until February 10, 2010. In addition, as a result of the MBIA Illinois Transformation, MBIA Illinois has negative earned surplus and therefore is currently unable to pay dividends to the Company. Additionally, under New York law, the Superintendent may apply for an order directing him to rehabilitate or liquidate a domestic insurance company under certain circumstances, including upon the insolvency of the company, if the company has willfully violated its charter or New York law or if the company is found, after examination, to be in such condition that further transaction of business would be hazardous to its policyholders, creditors or the public. The Superintendent may also suspend an insurer’s license, restrict its license authority, or limit the amount of premiums written in New York if, after a hearing, he determines that the insurer’s surplus to policyholders is not adequate in relation to its outstanding liabilities or financial needs. If the Superintendent were to take any such action with respect to MBIA Corp., it would likely result in the reduction or elimination of the payment of dividends to us. The inability of our Insurers to pay dividends in an amount sufficient to enable us to meet our cash requirements at the holding company level could affect our ability to repay our debt and to continue to pay a dividend on our common stock and have a material adverse effect on our operations. Furthermore, as a result of the illiquidity of fixed income markets during 2008, we implemented intercompany agreements to provide additional liquidity from MBIA Inc. and MBIA Corp. to the asset/liability products business, and this has reduced the liquidity resources available to MBIA Inc. and MBIA Corp. for other purposes. Changes in interest rates could adversely affect our financial condition and future business Increases in prevailing interest rate levels can adversely affect the value of MBIA’s investment portfolio and, therefore, our financial condition. In the event that investments must be sold in order to make payments on insured exposures, such investments would likely be sold at discounted prices. Lower interest rates can also result in lower net interest income since a substantial portion of assets are now held in cash and cash equivalents given the increased focus on liquidity. Additionally, in the insurance operations, increasing interest rates could lead to increased credit stress on transactions in our insured portfolio, while a decline in interest rates could result in larger loss reserves on a present value basis. In the asset/liability products segment of the investment management services division, higher interest rates or wider credit spreads could result in increased collateral posting requirements on investment agreements, repurchase agreements and derivative contracts, as collateral obligations are measured on a market value basis. Prevailing interest rate levels can affect demand for financial guarantee insurance. Lower interest rates are typically accompanied by narrower spreads between insured and uninsured obligations. The purchase of insurance during periods of relatively narrower interest rate spreads will generally provide lower cost savings to the issuer than during periods of relatively wider spreads. These lower cost savings could be accompanied by a corresponding decrease in demand for financial guarantee insurance. Increased interest rates may decrease attractiveness for issuers to enter into capital markets transactions, resulting in a corresponding decreasing demand for financial guarantee insurance. Revenues would be adversely impacted due to a decline in realization of installment premiums Due to the installment nature of a significant percentage of its premium income, MBIA Corp. has an embedded future revenue stream. The amount of installment premiums actually realized by MBIA Corp. could be reduced in the future due to factors such as not insuring new transactions, early termination of insurance contracts, accelerated prepayments of underlying obligations or commutation of existing financial guarantee insurance policies. Such a reduction would result in lower revenues.
35
Table of ContentsItem 1A. Risk Factors (Continued)
Strategic Plan Related Risk Factors An inability to achieve high stable insurer financial strength ratings for MBIA Illinois or any of our Insurers from the major rating agencies would materially and adversely affect our financial condition, results of operations and future business MBIA Illinois’ and our other Insurers’ ability to attract new business and to compete with other financial guarantors is largely dependent on the financial strength ratings assigned to them by the major rating agencies and the financial enhancement rating also assigned by S&P. We intend to comply with the requirements imposed by the rating agencies to achieve such ratings; however, no assurance can be given that we will successfully comply with these requirements, that these requirements will not change or that, even if we comply with these requirements, one or more of such rating agencies will not lower or withdraw its financial strength ratings of any of our Insurers or place it on “negative outlook” or “rating watch negative” status indicating that a downgrade may be considered in the future. Our Insurers’ ability to attract new business and to compete with other financial guarantors has been adversely affected by these rating agency actions. Our Insurers’ ability to attract new business and to compete with other financial guarantors and its results of operations and financial condition would be materially adversely affected by any actual reduction, or additional suggested possibility of a reduction, in its ratings. Requirements imposed by the rating agencies in order for our Insurers to maintain their insurer financial strength ratings are outside of our control, and such requirements may oblige us to raise additional capital or take other remedial actions in a relatively short timeframe in order to maintain those ratings. An inability to raise capital for our Insurers in the future may limit their ability to write business and adversely affect our financial condition, results of operations and business prospects Our Insurers’ ability to compete for financial guarantee business will depend on their financial strength and investors’ perceptions for their financial strength. To capitalize our Insurers to a level required to achieve high stable ratings in the future will require that we raise additional capital. In addition, due to regulatory and internal single and aggregate risk limits, our Insurers may not be able to write business in certain categories of risk without raising additional capital. Our inability to raise capital on favorable terms could therefore materially adversely affect the business prospects of our Insurers. In addition, it would have an adverse impact on their ability to pay losses, dividends and debt obligations. As a result of the MBIA Illinois Transformation and the reinsurance of the MBIA Corp. and FGIC portfolios by MBIA Illinois, MBIA Illinois exceeded as of the closing date certain single and aggregate risk limits under the New York and Illinois laws and regulations, and MBIA Corp. exceeded as of the closing date certain single risk limits under New York law. These insurers obtained waivers from the insurance departments of those states of such limits. In connection with the waivers, they submitted a plan to the applicable insurance departments to achieve compliance with the applicable regulatory limits. Under the plans, they agreed not to write new financial guarantee insurance for certain issuers until they were in compliance with their single risk limits and agreed to take commercially reasonable steps, including considering reinsurance, the addition of capital and other risk mitigation strategies, in order to comply with the regulatory single and aggregate risk limits. As a condition to granting the waiver, the NYSID is requiring that, upon written notice from the NYSID, MBIA Corp. and MBIA Illinois, as applicable, will cease writing new financial guaranty insurance if the companies are not in compliance with the risk limitations by December 31, 2009. MBIA Illinois and MBIA Corp. have also agreed to provide monthly reports to the NYSID regarding the steps to achieve compliance with these regulatory limits. Our inability to come into compliance with these risk limits may prevent us from writing future new business and adversely affect our business prospects. Downgrades of the ratings of securities insured by our Insurers may materially adversely affect our business, results of operations and financial condition Individual credits in our insured portfolio (including potential new credits) are assessed a rating agency “capital charge” based on a variety of factors, including the nature of the credits’ risk types, underlying ratings, tenor and expected and actual performance. In the event of an actual or perceived deterioration in creditworthiness, a reduction in the underlying rating or a change in the rating agency capital methodology, any of our Insurers may be required to hold more of its capital in reserve against credits in its insured portfolio, regardless of whether losses actually occur, or against potential new business. Significant reductions in underlying ratings of credits in
36
Table of ContentsItem 1A. Risk Factors (Continued)
an Insurer’s insured portfolio can produce significant increases in assessed “capital charges.” There can be no assurance that each of our Insurer’s capital position will be adequate to meet such increased rating agency reserve requirements or that each Insurer will be able to secure additional capital, especially at a time of actual or perceived deterioration in creditworthiness of new or existing credits. Unless an Insurer was able to increase its amount of available capital, an increase in capital charges could reduce the amount of capital available to pay claims and support its ratings and could have an adverse effect on the Insurer’s ability to write new business. In 2008 Fitch, Moody’s and S&P announced the downgrade of, or other negative ratings actions with respect to, certain transactions that MBIA Corp. insures, as well as a large number of structured finance transactions that serve as collateral in structured finance transactions that MBIA Corp. insures. There can be no assurance that additional securities in MBIA Corp.’s or MBIA Illinois’ insured portfolio will not be reviewed and downgraded in the future. Moreover, we do not know if, and when, the rating agencies might review additional securities in our insured portfolio or review again securities that have already been reviewed and/or downgraded. Downgrades of credits that one of our Insurer insures will result in higher capital charges to that Insurer under the relevant rating agency model or models. If the additional amount of capital required to support such exposures is significant, the Insurer could look to raise additional capital, if available, on terms and conditions that may not be favorable to it, curtail current business writings, or pay to transfer a portion of its in-force business to generate capital for rating agency purposes to maintain its ratings. Such capital raising may not be possible. Accordingly, additional downgrades of our insured credits could adversely affect the results of operations and financial condition of our Insurers going forward. Changes in the rating agencies’ capital models and rating methodology with respect to financial guarantee insurers may materially adversely affect our business, results of operations and financial condition Changes in the rating agencies’ capital models and rating methodology with respect to financial guarantee insurers and the risks in any of our Insurer’s investment portfolio and insured portfolio could require the Insurer to hold more capital against specified credit risks in the insured portfolio. For example, the rating agencies have recently made changes to their capital models and rating methodology in response to the deterioration in the performance of certain securities. These requirements have placed stress on our ratings and require us to raise additional capital to maintain our ratings. Demand for financial guarantee insurance will decline if investors’ confidence in financial guarantors’ financial strength or marketability declines The perceived financial strength of financial guarantee insurers also affects demand for financial guarantee insurance. In 2008 most financial guarantee insurers’ insurer financial strength ratings were downgraded, placed on review for a possible downgrade or had their outlooks changed to “negative,” which contributed to a decline in the demand for financial guarantee insurance generally. Should our Insurers or their competitors suffer from downgrades in financial strength ratings or some other deterioration in investors’ confidence in the future such as changes in the perceived benefits and/or harm caused by the use of bond insurance, demand for financial guarantee insurance would be reduced significantly. Future competition may have an adverse effect on our Insurers’ businesses The businesses in which we expect our Insurers to participate may be highly competitive. They may face competition from other financial guarantee insurance companies, other providers of third-party credit enhancement, such as multi-line insurance companies, credit derivative and swap providers and banks, and alternative financing structures that do not employ third-party credit enhancement, and in 2008 a new financial guarantee insurer began competing in the municipal finance market during the first quarter of 2008 and another received a license in October 2008 from the NYSID to write financial guarantee insurance. Increased competition, either in terms of price, alternative structures, or the emergence of new providers of credit enhancement, could have an adverse effect on our Insurers’ business prospects. In addition, an Insurer’s competitive position may suffer due to having been placed on review for a possible downgrade by a rating agency. The uncertainty created by market conditions and the related unpredictable actions of the regulators in the U.S. and foreign markets we serve may create unforeseen competitive advantages for our competitors due to, among other things, explicit or implied support from the government.
37
Table of ContentsItem 1A. Risk Factors (Continued)
Future demand for our Insurers’ products depend on market and other factors that we do not control The demand for financial guarantee insurance depends upon many factors, some of which are beyond the control of the Company. Our ability to attract and compete for financial guarantee business is largely dependent on the financial strength ratings assigned to our Insurers by the major rating agencies. During 2008, most monoline financial guarantee insurers were downgraded by one or more of the major rating agencies, and the two remaining significant Triple-A monoline financial guarantee insurers were assigned a “Review for Possible Downgrade” status by Moody’s and announced an intention to merge. A new Triple-A financial guarantee insurer began competing in the municipal finance market during the first quarter of 2008 and another received a license in October 2008 from the NYSID to write financial guarantee insurance. If demand for our insurance products increases in the future, investors from time to time distinguish among financial guarantors on the basis of various factors, including rating agency assessment, capitalization, size, insured portfolio concentration and financial performance. These distinctions may result in differentials in trading levels for securities insured by particular financial guarantors which, in turn, may provide a competitive advantage to those financial guarantors with better trading characteristics. In addition, various investors may, due to regulatory or internal guidelines, lack additional capacity to purchase securities insured by certain financial guarantors, which may provide a competitive advantage to guarantors with fewer insured obligations outstanding. Differentials in trading values or investor capacity constraints that do not favor our Insurers would have an adverse effect on their ability to attract new business at appropriate pricing levels, and our Insurers have experienced a decline in new business which are attributable to recent rating agency actions and their impact on investor perception. Additionally, in the face of the disruption in the credit markets and the 2008 ratings actions of Fitch, Moody’s and S&P concerning financial guarantee insurers generally and MBIA Corp. in particular, the price of our common stock has experienced a significant decline and there has been a widening of spreads on our credit default swaps. This widening of spreads on our credit default swaps could impact the perception of our financial condition by MBIA Corp.’s and MBIA Illinois’ insured bondholders and counterparties and could affect their willingness to purchase our insured bonds and to continue to enter into transactions with them. Regulatory regimes and changes to accounting rules may adversely impact financial results irrespective of business operations Accounting standards and regulatory changes may require modifications to our accounting methodology, both prospectively and for prior periods and such changes could have an adverse impact on our financial results. The Financial Accounting Standards Board, or “FASB,” and the International Accounting Standards Board, or “IASB,” are considering the accounting methodology to be applied by insurance companies and policyholders, including financial guarantee industry participants, for claims liability recognition and premium recognition. When the FASB and IASB reach a conclusion on this project, MBIA Corp., MBIA Illinois and other financial guarantors may be required to change some aspects of their respective loss reserving policies and the potential changes could extend to premium and expense recognition under FAS 163. We cannot currently assess how the FASB and IASB staffs’ ultimate resolution of this project will impact FAS 163. Until final guidance is issued, we intend to apply our existing methodology for reporting for the year ended December 31, 2008 and apply FAS 163 beginning with reporting for the quarterly period ended March 31, 2009. There can be no certainty, however, that the FASB or IASB will not require us to modify our current methodology, either on a going-forward basis or for prior periods. Any required modification of our existing methodology, either with respect to these issues or other issues in the future, could have an impact on our results of operations, including increased volatility of our earnings. Regulatory change could adversely affect our businesses The financial guarantee insurance industry has historically been and will continue to be subject to the direct and indirect effects of governmental regulation, including insurance laws, securities laws, tax laws and legal precedents affecting asset-backed and municipal obligations, as well as changes in those laws. Failure to comply with applicable laws and regulations could expose our Insurers to fines, the loss of their insurance licenses, and the inability to engage in certain business activity. In addition, future legislative, regulatory or judicial changes could adversely affect our Insurers’ ability to pursue business, materially impacting our financial results. The NYSID has issued best practices regarding the laws and regulations that are applicable to our Insurers and to
38
Table of ContentsItem 1A. Risk Factors (Continued)
other monoline financial guarantee insurance companies and has indicated that it expects to propose legislative and regulatory changes to codify these best practices. In addition, members of the U.S. Congress and federal regulatory bodies have suggested federal oversight and regulation of insurance, including bond insurance. See the section “Our Insurance Operations—Insurance Regulation” in Item 1 for more information on these proposed changes. As a result of any changes to such laws and regulations or the Department’s interpretation thereof, MBIA could become subject to further restrictions on the type of business that it is authorized to insure, especially in the structured finance area. Any such restrictions could have a material effect on the amount of premiums that MBIA earns in the future. Additionally, any changes to such laws and regulations could subject our Insurers to increased reserving and capital requirements or more stringent regulation generally, which could materially adversely affect our financial condition, results of operations and future business. Moreover, the downturn in the financial markets and resulting market-wide losses have caused various federal and state legislative and regulatory bodies to consider various changes to existing securities laws and the legal framework governing the financial industry. Any such changes may affect the securities we insure, and may have the affect of diminishing or eliminating the market for those securities. We cannot predict what form these changes will take or how they will affect the Company. General Risk Factors Regulatory proceedings or private litigation claims could materially adversely affect our business, results of operations and financial condition The Company has received subpoenas or informal inquiries from a variety of regulators, including the Securities and Exchange Commission, the Securities Division of the Secretary of the Commonwealth of Massachusetts, and other states’ regulatory authorities, regarding a variety of subjects, including disclosures made by the Company to underwriters and issuers of certain bonds, disclosures regarding the Company’s structured finance exposure, the Company’s communications with rating agencies, and the methodologies used by rating agencies for determining the credit rating of municipal debt. The Company is cooperating fully with each of these regulators and is in the process of satisfying all such requests. We may continue to receive additional subpoenas and other information requests from the SEC or other regulatory agencies regarding similar issues. Although no regulatory action has been initiated against us in connection with the matters described above, it is possible that one or more regulatory agencies may pursue action against us with respect to these or other similar matters. If such an action is brought, it could materially adversely affect our business, results of operations and financial condition. As further set forth in the Legal Proceedings section below, the Company is named as a defendant in a number of litigations. These include several private securities class actions where the Company is named along with certain of its current and former officers. These cases have been consolidated in the United States District Court for the Southern District of New York. A shareholder derivative lawsuit against certain of the Company’s present and former officers and directors, and against the Company, as nominal defendant was filed in the United States District Court for the Southern District of New York and a similar shareholder derivative lawsuit was filed in the Supreme Court of the State of New York, County of Westchester. In addition, a number of California municipalities filed lawsuits against MBIA and other bond insurers in 2008 in two separate complaints. The first complaint alleged (i) participation in a conspiracy in violation of California’s antitrust laws to maintain a dual credit rating scale that misstated the credit default risk of municipal bond issuers and created market demand for municipal bond insurance, (ii) participation in risky financial transactions in other lines of business that damaged each bond insurer’s financial condition (thereby undermining the value of each of their guaranties), and a failure adequately to disclose the impact of those transactions on their financial condition. These latter allegations form the predicate for five separate causes of action against each of the Insurers: breach of contract, breach of the covenant of good faith and fair dealing, fraud, negligence, and negligent misrepresentation. The second complaint alleged fraud and violations of California’s antitrust laws through bid-rigging in the sale of municipal derivatives to municipal bond issuers. Although the Company intends to vigorously defend against the aforementioned actions and against other potential actions, we cannot provide assurance that the ultimate outcome of these actions will not cause a loss or a materially adversely effect on our business, results of operations or financial condition.
39
Table of ContentsItem 1A. Risk Factors (Continued)
Adverse results from investment management services activities can adversely affect our financial position Our Investment Management Services businesses have grown as a proportion of our overall business. Events that negatively affect the performance of the Investment Management Services businesses could have a negative effect on the overall performance of the Company, separate and distinct from the performance of the Company’s financial guarantee business. Our Investment Management Services businesses manage several asset-liability programs which enable us to earn a spread between the income earned on a portfolio of assets and the interest costs associated with the liabilities incurred to fund the purchase of such assets. These asset-liability programs are managed within a number of risk and liquidity parameters, but there can be no assurance that such parameters are adequate to prevent a further decline in the value of the assets or a further decline in investment income such that the programs will be unable to service outstanding liabilities. Any resulting loss could have an adverse impact on our financial position. In 2008, events that negatively affect the performance of the Investment Management Services businesses had a negative effect on the overall performance of the Company, separate and distinct from the performance of the Company’s financial guarantee business. These primarily included reduced net interest income and realized losses from credit impairments and rebalancing of the asset portfolio into cash and short-term investments to meet current and future liquidity needs. The market value of assets in the business also declined relative to their amortized cost, resulting in a negative adjustment to Other Comprehensive Income (Loss) on the Company’s balance sheet. Ownership Change under Section 382 of the Internal Revenue Code can have adverse tax consequences In connection with our equity offering that closed on February 13, 2008, the Warburg Pincus investments and other transactions in our shares from time to time, we may experience an “ownership change” within the meaning of Section 382 of the Internal Revenue Code. In general terms, an ownership change may result from transactions increasing the aggregate ownership of certain stockholders in our stock by more than 50 percentage points over a testing period (generally three years). If an ownership change were to occur, our ability to use certain tax attributes, including certain losses, credits, deductions or tax basis, may be limited. We cannot give any assurance that we will not undergo an ownership change at a time when these limitations would have a significant effect. Any impairment in the Company’s back-book earnings can materially affect the recoverability of our deferred tax assets The basis for evaluating the recoverability of a deferred tax asset is the existence of future taxable income of appropriate character. To the extent that the Company’s ability to recognize future taxable income from its back-book earnings becomes impaired, the recoverability of certain deferred tax assets may be materially affected by a corresponding increase to its valuation allowance. A different view of the Internal Revenue Service from our current tax treatment of realized losses relating to insured CDS contracts can adversely affect our financial position As part of the Company’s financial guarantee business, MBIA Corp. has sold credit protection by insuring derivative contracts with various financial institutions. MBIA Corp. treats these insured derivative contracts as insurance contracts for statutory accounting purposes, which is the basis for computing MBIA Corp’s U.S. Federal taxable income. As such, the realized losses in connection with a credit event are considered loss reserve activities for tax purposes. Because the federal income tax treatment of CDS contracts is an unsettled area of tax law, in the event that the Internal Revenue Service has a different view with respect to the tax treatment, MBIA Corp.’s results of operations and financial condition could be materially adversely affected. Servicer risk could adversely impact performance of Structured Finance transactions Structured finance obligations contain certain risks including servicer risk, which relates to problems with the transaction servicer (the entity which is responsible for collecting the cash flow from the asset pool) that could
40
Table of ContentsItem 1A. Risk Factors (Continued)
affect the servicing of the underlying assets. Structural risks primarily involve bankruptcy risks, such as whether the servicer of the assets may be required to delay the remittance of any cash collections held by it or received by it after the time it becomes subject to bankruptcy or insolvency proceedings. Structured finance transactions are usually structured to reduce the risk to the investors from the bankruptcy or insolvency of the servicer. The ability of the servicer to properly service and collect on the underlying assets is a factor in determining future asset performance. MBIA Corp. addresses these issues through its servicer due diligence and underwriting guidelines, its formal credit review and approval process and its post-closing servicing review and monitoring, however, no assurance can be given that the servicer will properly effect its duties. A default by one or more of our key reinsurers or by a financial guarantee insurance company in which we hold an investment could adversely impact our capital position, financial strength rating and ability to write new business Our Insurers have used reinsurance to cede exposure for purposes of syndicating risk and increasing its capacity to write new business while complying with its single risk and credit guidelines. Reinsurers and counterparties under other reimbursement agreements may default on their obligations to us due to bankruptcy, insolvency, lack of liquidity, adverse economic conditions, operational failure, fraud or other reasons. Such defaults could have a material adverse effect on our business or profitability or require us to raise additional capital. MBIA Corp. remains liable on a primary basis for all reinsured risk, and although MBIA Corp. believes that its reinsurers remain capable of meeting their obligations, there can be no assurance of such in the future. MBIA Corp. generally retains the right to recapture the business ceded to reinsurers under certain circumstances, including rating downgrades of its reinsurers. In addition to reliance on key financial guarantee reinsurers, MBIA has certain other exposures to financial guarantee insurance companies. Portions of MBIA Corp.’s investment portfolio, as well as the investments held in relation to our asset management businesses, are insured by other monoline financial guarantee insurance companies. Further, we own a small amount of direct investments in debt and other securities of the holding companies of other monoline financial guarantee insurance companies. A significant financial deterioration of one or more of those companies could impact the market value of investments and increase the amount of capital required to maintain our Insurers’ insurance financial strength ratings. Item 1B. Unresolved Staff Comments The Company received comment letters from the Securities and Exchange Commission (the “SEC”) Division of Corporation Finance dated April 10, 2008, June 27, 2008, August 27, 2008, October 14, 2008, January 15, 2009, and February 24, 2009 regarding its Annual Report on Form 10-K for the fiscal year ended December 31, 2007 and Quarterly Reports on Form 10-Q for the quarters ended March 31, 2008, June 30, 2008 and September 30, 2008. These comments are unresolved as of March 2, 2009. However, we have filed with the SEC responses to the first five comment letters and we are in the process of responding to the sixth comment letter. Additionally, we have incorporated into our subsequent periodic filings with the SEC additional disclosures that we believe are responsive to the SEC’s comments. In general, the unresolved staff comments relate to the methodologies and inputs underlying our fair value measurements of credit default swap contracts and management’s judgment and assumptions, including in connection with the recoverability of the deferred tax assets primarily as a result of the cumulative unrealized losses on insured credit derivatives, and management’s judgment and assumptions included in our loss reserving methodology. We believe that the ultimate resolution of these comments will not have a material impact on the consolidated financial statements and/or related footnotes. Item 2. Properties MBIA Corp. owns the 273,417 square foot office building on approximately 38 acres of property in Armonk, New York, in which the Company, MBIA Corp. and MBIA Asset Management have their headquarters. MBIA Corp. also has offices with approximately 32,590 square feet of rental space in New York, New York; San Francisco, California; Paris, France; Madrid, Spain; Sydney, Australia; London, England; Tokyo, Japan; and Mexico City, Mexico. MBIA Asset Management has 7,607 square feet of office space in Denver, Colorado. The Company believes that these facilities are adequate and suitable for its current needs.
41
Table of ContentsItem 3. Legal Proceedings In the normal course of operating its businesses, the Company may be involved in various legal proceedings. The Company was named as a defendant, along with certain of its current and former officers, in private securities actions that were consolidated in the United States District Court for the Southern District of New York as In re MBIA Inc. Securities Litigation; (Case No. 05 CV 03514(LLS); S.D.N.Y.) (filed October 3, 2005). The plaintiffs asserted claims under Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), Rule 10b-5 promulgated thereunder, and Section 20(a) of the Exchange Act. The lead plaintiffs purport to be acting as representatives for a class consisting of purchasers of the Company’s stock during the period from August 5, 2003 to March 30, 2005 (the “Class Period”). The lawsuit asserts, among other things, violations of the federal securities laws arising out of the Company’s allegedly false and misleading statements about its financial condition and the nature of the arrangements entered into by MBIA Corp. in connection with the Allegheny Health, Education and Research Foundation (“AHERF”) loss, and about the effectiveness of the Company’s internal controls. The plaintiffs allege that, as a result of these misleading statements or omissions, the Company’s stock traded at artificially inflated prices throughout the Class Period. The defendants, including the Company, filed motions to dismiss this lawsuit on various grounds. On February 13, 2007, the Court granted those motions, and dismissed the lawsuit in its entirety, on the grounds that these claims are barred by the applicable statute of limitations. The Court did not reach the other grounds for dismissal argued by the Company and the other defendants. On November 12, 2008, the United States Court of Appeals for the Second Circuit affirmed the Court’s dismissal on statute of limitations grounds, but remanded the case to allow the plaintiffs to file an amended complaint. The Second Consolidated Amended Class Action Complaint was filed on February 18, 2009. Defendants’ motion to dismiss is due on April 17, 2009. On October 17, 2008, a consolidated amended class action complaint in a separate shareholder class action lawsuit against the Company and certain of its officers, In re. MBIA, Inc. Securities Litigation, No. 08-CV-264, (KMK) (the “Consolidated Class Action”) was filed in the United States District Court for the Southern District of New York, alleging violations of the federal securities laws. Lead plaintiff the Teachers’ Retirement System of Oklahoma seeks to represent a class of shareholders who purchased MBIA stock between July 2, 2007 and January 9, 2008. The amended complaint alleges that defendants MBIA Inc., Gary C. Dunton and C. Edward Chaplin violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. Among other things, the complaint alleges that defendants issued false and misleading statements with respect to the Company’s exposure to losses stemming from the Company’s insurance of CDOs containing RMBS, specifically its exposure to so-called “CDO-squared” securities, which allegedly caused the Company’s stock to trade at inflated prices. Defendants filed a motion to dismiss on January 30, 2009. Plaintiffs’ response is due on March 16, 2009. On February 13, 2008, a shareholder derivative lawsuit against certain of the Company’s present and former officers and directors, and against the Company, as nominal defendant, Trustees of the Police and Fire Retirement System of the City of Detroit v. Clapp et al., No. 08-CV-1515, (the “Detroit Complaint”), was filed in the United States District Court for the Southern District of New York. The gravamen of the Detroit Complaint is similar to the aforementioned Consolidated Class Action, except that the legal claims are against the directors for breach of fiduciary duty and related claims. The Detroit Complaint purports to relate to a so-called “Relevant Time Period” from February 9, 2006, through the time of filing of the complaint. A Special Litigation Committee of two independent directors of MBIA Inc. (the “SLC”) has determined after a good faith and thorough investigation that pursuit of the allegations set out in the Detroit Complaint is not in the best interests of MBIA and its shareholders. On January 23, 2009, the SLC served a motion to dismiss the Detroit Complaint. On August 11, 2008, shareholder derivative lawsuit Crescente v. Brown et al., No. 08-17595 (the “Crescente Complaint”) was filed in the Supreme Court of the State of New York, County of Westchester against certain of the Company’s present and former officers and directors, and against the Company, as nominal defendant. The gravamen of this complaint is similar to the Detroit Complaint except that the time period assertedly covered is from January, 2007, through the time of filing of this complaint. The derivative plaintiff has agreed to stay the action pending the outcome of the SLC’s motion to dismiss the Detroit Complaint. The Company has received subpoenas or informal inquiries from a variety of regulators, including the Securities and Exchange Commission, the Securities Division of the Secretary of the Commonwealth of Massachusetts, the Attorney General of the State of California, and other states’ regulatory authorities, regarding a variety of subjects, including disclosures made by the Company to underwriters and issuers of certain bonds, disclosures regarding
42
Table of ContentsItem 3. Legal Proceedings (Continued)
the Company’s structured finance exposure, the Company’s communications with rating agencies, and the methodologies used by rating agencies for determining the credit rating of municipal debt. The Company is cooperating fully with each of these regulators and is in the process of satisfying all such requests. The Company may receive additional inquiries from these or other regulators and expects to provide additional information to such regulators regarding their inquiries in the future. On July 23, 2008, the City of Los Angeles filed two complaints in the Superior Court of the State of California for the County of Los Angeles against the Company and others. The first, against the Company, AMBAC Financial Group, Inc., XL Capital Assurance Inc., ACA Financial Guaranty Corp., Financial Guaranty Insurance Company, and CIFG Assurance North America, Inc., alleged (i) participation in a conspiracy in violation of California’s antitrust laws to maintain a dual credit rating scale that misstated the credit default risk of municipal bond issuers and created market demand for municipal bond insurance and (ii) participation in risky financial transactions in other lines of business that damaged each bond insurer’s financial condition (thereby undermining the value of each of their guarantee), and a failure adequately to disclose the impact of those transactions on their financial condition. These latter allegations form the predicate for five separate causes of action against each of the Insurers: breach of contract, breach of the covenant of good faith and fair dealing, fraud, negligence, and negligent misrepresentation. Complaints making the same allegations against the Company and nearly all of the same co-defendants were filed in Superior Court, San Francisco County, by the City of Stockton on July 23, 2008, by the City of Oakland on August 28, 2008, by the City of San Francisco on October 8, 2008, by the County of San Mateo on October 23, 2008, by the County of Alameda on October 30, 2008, by the City of Los Angeles Department of Water and Power on December 31, 2008, by the Sacramento Municipal Utility District on December 31, 2008, and by the City of Sacramento on January 6, 2009. These cases are in the process of being coordinated as Ambac Bond Insurance Cases in San Francisco Superior Court (Judicial Council Coordination Proceeding No. 4555). The City of Los Angeles’s second complaint named as defendants certain other financial institutions as well as bond insurers, including the Company, AMBAC Financial Group, Inc., Financial Security Assurance, Inc., Financial Guaranty Insurance Company and Security Capital Assurance Inc., and alleged fraud and violations of California’s antitrust laws through bid-rigging in the sale of municipal derivatives to municipal bond issuers. Complaints making the same allegations against the Company and nearly all of the same co-defendants were filed in Superior Court, Los Angeles County, by the County of San Diego on August 28, 2008, and in Superior Court, San Francisco County, by the City of Stockton on July 23, 2008, by the County of San Mateo on October 7, 2008, and by the County of Contra Costa on October 8, 2008. The City of Los Angeles and City of Stockton actions were removed to federal court and transferred by order dated November 26, 2008, to the Southern District of New York for inclusion in the multidistrict litigation In re Municipal Derivatives Antitrust Litigation, M.D.L. No. 1950; the San Diego County, San Mateo County, and Contra Costa County actions were removed to federal court and the issue of their transfer to the Southern District of New York for inclusion in In re Municipal Derivatives Antitrust Litigation is currently before the Judicial Panel on Multidistrict Litigation. On September 30, 2008, MBIA Corp. commenced an action in the New York State Supreme Court against Countrywide Home Loans, Inc., Countrywide Securities Corp. and Countrywide Financial Corp. (collectively, “Countrywide”). The complaint alleges fraudulent conduct in the origination and sale of home equity loans included in MBIA Corp.-backed securitizations of pools of home equity loans and breaches of both Countrywide’s representations and warranties and its contractual obligation to cure or repurchase ineligible loans as well as its sales and servicing obligations, among other things. In addition, on October 15, 2008, MBIA Corp. commenced an action in the United States District Court for the Southern District of New York (“SDNY”) against Residential Funding Company, LLC (“RFC”). On December 5, 2008, a notice of voluntary dismissal without prejudice was filed in the SDNY and the complaint was re-filed in the Supreme Court of the State of New York, New York County. The complaint alleges that RFC fraudulently induced MBIA Corp. to provide financial guarantee policies with respect to five RFC closed end home equity second-lien and HELOC securitizations, and that RFC breached its contractual representations and warranties, as well as its obligation to repurchase ineligible loans, among other things. There can be no assurance that the Company will prevail in either the Countrywide or RFC actions. On October 16, 2008, MBIA Corp. received a demand for arbitration by a third-party reinsurer relating to cessions made to it under reinsurance treaty agreements entered into with the reinsurer by MBIA Corp. and certain of its subsidiary insurers in 2006 and 2007. The demand alleged that MBIA Corp. engaged in violations of the terms of
43
Table of ContentsItem 3. Legal Proceedings (Continued)
the treaty agreements and of its duty of utmost good faith. Certain of the policies ceded pursuant to the treaties include those on which MBIA Corp. has identified loss reserves. Effective November 30, 2008, MBIA Corp. and the reinsurer entered into an agreement to terminate the arbitration. We intend to vigorously defend against the aforementioned actions in which the Company is a defendant and against other potential actions, and we do not expect the outcome of these matters to have a materially adverse effect on the Company’s business, results of operations or financial condition. We cannot provide assurance, however, that the ultimate outcome of these actions will not cause a loss or have a materially adversely effect on our business, results of operations or financial condition. There are no other material lawsuits pending or, to the knowledge of the Company, threatened, to which the Company or any of its subsidiaries is a party. Item 4. Submission of Matters to a Vote of Security Holders None.
44
Table of ContentsPart II
The Company’s common stock is listed on the New York Stock Exchange under the symbol “MBI.” As of February 25, 2009 there were 933 shareholders of record of the Company’s common stock. The information concerning dividends on the Company’s common stock is under “Item 1. Business—Insurance Regulation” in this annual report. The high and low stock prices and dividends with respect to the Company’s common stock for the last two years are presented below:
On January 9, 2008, the Company announced that its Board of Directors authorized a revised shareholder dividend policy, pursuant to the Company’s capital strengthening plan, which was expected to reduce quarterly shareholder dividends from $.34 per share to $.13 per share. On February 25, 2008, the Company announced that its Board of Directors authorized the elimination of quarterly shareholder dividends to further strengthen the Company’s resources and to increase its operating flexibility. On January 30, 2008, the Company issued 16.1 million shares of MBIA common stock to Warburg Pincus at $31 per share per an investment agreement, subsequently amended on February 6, 2008, with Warburg Pincus. In addition, under the agreement with Warburg Pincus, the Company granted Warburg Pincus warrants to purchase 8.7 million shares of MBIA common stock at an exercise price of $40 per share and “B” warrants, which, upon obtaining certain approvals, will become exercisable to purchase 7.4 million shares of common stock at a price of $40 per share. On February 13, 2008, the Company completed a public offering of 94.65 million shares of MBIA common stock at $12.15 per share. Warburg Pincus informed the Company that it purchased $300 million in common stock as part of the offering. The Company did not use the $750 million Warburg Pincus backstop. In addition, Warburg Pincus did not exercise its right to purchase up to $300 million in preferred stock. Pursuant to the amended agreement with Warburg Pincus, Warburg Pincus was granted 4 million of “B2” warrants at a price of $16.20 per share. In addition, under anti-dilution provisions in the agreement with Warburg Pincus, the terms of the warrants issued to Warburg Pincus on January 30, 2008 were amended, which resulted in (a) the 8.7 million of warrants exercisable at $40 per share were revised to 11.5 million warrants exercisable at $30.25 per share and (b) the 7.4 million of “B” warrants exercisable at $40 per share were revised to 9.8 million “B” warrants exercisable at $30.25 per share. See Note 24, “Common and Preferred Stock” in the Notes to the Consolidated Financial Statements of MBIA Inc. and Subsidiaries in Part II, Item 8 for additional information on the agreement with Warburg Pincus and the common stock offering. In July 2004, the Company received authorization from its Board of Directors to repurchase 1 million shares of common stock under a share repurchase program. On August 5, 2004, the Company’s Board of Directors authorized the repurchase of an additional 14 million shares of common stock in connection with this program. As of December 31, 2006, the Company had repurchased a total of 10 million shares under the program. On February 1, 2007, the Company’s Board of Directors authorized the repurchase of common stock up to $1 billion under a new share repurchase program, which superseded the previously authorized program. However, due to the Company’s decision in the third quarter of 2007 to suspend share repurchases under the program in light of concerns and uncertainties regarding the housing markets, the structured finance sector and the U.S. economy, no shares were repurchased during the first six months of 2008.
45
Table of Contents
In August 2008, the Company’s Board of Directors approved the resumption of the share repurchase program. Repurchases of common stock may be made from time to time in the open market or in private transactions as permitted by securities laws and other legal requirements. We believe that share repurchases can be an appropriate deployment of capital in excess of amounts needed to maintain the claims-paying ratings of MBIA Corp. and support the growth of MBIA’s businesses. As of December 31, 2008, the Company repurchased 40 million shares under the program at an average price of $21.79 per share and $119 million remains available under the $1 billion share buyback program. The table below presents repurchases made by the Company in each month during the fourth quarter of 2008, all of which were purchased by the Company for settling awards under the Company’s long-term incentive plans. See “Note 22: Long-term Incentive Plans” in the Notes to the Consolidated Financial Statements of MBIA, Inc. and Subsidiaries in Part II, Item 8 for a further discussion on long-term incentive plans.
As of December 31, 2008, 273,199,801 shares of Common Stock of the Company, par value $1 per share, were issued and 207,920,897 shares were outstanding. Stock Performance Graph The following graph compares the cumulative total shareholder return (rounded to the nearest whole dollar) of our common stock, the S&P 500 Stock Index (“S&P 500 Index”) and the S&P 500 Diversified Financials Index (“S&P Financials Index”) for the last five fiscal years. The graph assumes a $100 investment at the closing price on December 31, 2003 and reinvestment of dividends on the respective dividend payment dates without commissions. This graph does not forecast future performance of our common stock.
46
Table of ContentsItem 6. Selected Financial Data
47
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations FORWARD-LOOKING AND CAUTIONARY STATEMENTS This annual report of MBIA Inc. (“MBIA”, the “Company” or “we”) includes statements that are not historical or current facts and are “forward-looking statements” made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The words “believe,” “anticipate,” “project,” “plan,” “expect,” “intend,” “will likely result,” “looking forward” or “will continue,” and similar expressions identify forward-looking statements. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. MBIA cautions readers not to place undue reliance on any such forward-looking statements, which speak only to their respective dates. The following are some of the factors that could affect financial performance or could cause actual results to differ materially from estimates contained in or underlying the Company’s forward-looking statements:
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 Company undertakes no obligation to publicly correct or update any forward-looking statements. EXECUTIVE OVERVIEW MBIA operates the largest financial guarantee insurance business in the industry and a substantial asset/liability management program. MBIA also provides asset management and other specialized financial services. These activities are managed through two principal business operations: insurance and investment management services. Corporate operations include revenues and expenses that arise from general corporate activities. Our insurance and certain investment management services programs have historically relied upon triple-A credit ratings. The loss of those ratings in the second quarter of 2008 resulted in a dramatic reduction in the Company’s business activities. In February 2008, we announced our intention to reorganize our insurance operations in a manner that would provide public finance and structured finance insurance from separate operating entities. In February 2009, after receiving the required regulatory approvals, we restructured our principal insurance subsidiary, MBIA Insurance Corporation, and established a separate U.S. public finance financial guarantee insurance company using MBIA Insurance Corp. of Illinois (“MBIA Illinois”), an existing public finance financial guarantee insurance company wholly owned by MBIA. Refer to the following “Business Description” section for information about this reorganization. As a financial guarantee insurance and investment management services company, our business is materially affected by conditions in global financial markets and has been adversely affected by the deteriorating performance of RMBS and CDOs.
48
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
Concerns about monoline insurers and the collapse of certain financial institutions, together with unprecedented levels of volatility and uncertainty in markets around the world, have materially affected our business, with a particular impact from the following events: Economic and Financial Market Trends
Credit Ratings
MBIA’s Strategic Review and Transformation
MBIA’s Capital Strengthening
49
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
Financial Results For the year ended December 31, 2008, we recorded a net loss of $2.7 billion, or $12.29 per share, compared with a net loss of $1.9 billion, or $15.17 per share, for the year ended December 31, 2007 and net income of $819 million, or $5.99 per share, for the year ended December 31, 2006. Consolidated revenues in 2008 were a loss of $857 million compared with a loss of $284 million in 2007 and revenues of $2.7 billion in 2006. The increase in our consolidated loss in 2008 compared with 2007 reflects an increase in net realized losses related to sales and impairments of securities and a decrease in net investment income within our investment management services operations, partially offset by a decrease in losses on credit derivatives within our insurance operations and net gains on the repurchase of debt within our investment management services operations. The decrease in consolidated revenues in 2007 compared with 2006 reflects an increase in losses on credit derivatives within our insurance operations, partially offset by an increase in net investment income within our investment management services operations. Consolidated expenses were $2.9 billion in 2008 compared with $2.8 billion in 2007 and $1.6 billion in 2006. The increase in our consolidated expenses in 2008 compared with 2007 reflects an increase in losses and loss adjustment expenses related to our mortgage exposure and an increase in operating and interest expenses within our insurance operations, partially offset by a decrease in interest expense within our investment management services operations. Our consolidated book value (total shareholders’ equity) was $994 million as of December 31, 2008, down 73% from $3.7 billion as of December 31, 2007. Consolidated book value per share as of December 31, 2008 was $4.78, down 84% from $29.16 as of December 31, 2007. A further discussion of our financial results is presented within the “Results of Operations” section included herein. Business Description Insurance Operations MBIA’s insurance operations have been principally conducted through MBIA Insurance Corporation and its subsidiaries (“MBIA Corp.”). MBIA Corp.’s guarantees insure municipal bonds, asset-backed and mortgage-backed securities (“ABS” and “MBS”, respectively), 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 asset-backed securities 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 mortgage-backed securities include collateral consisting of residential and commercial mortgages. Additionally, MBIA Corp. has insured credit default swaps (“CDSs”) on structured pools of corporate obligations, residential mortgage-backed securities, and commercial real estate backed securities and loans. The financial guarantees issued by MBIA Corp. provide unconditional and irrevocable guarantees of the payment of the principal of, and interest or other amounts owing on, insured obligations when due. The obligations are generally not subject to acceleration, except that MBIA Corp. may have the right, at its discretion, to accelerate insured obligations upon default or otherwise. Certain investment agreement contracts written by MBIA Inc. and insured by MBIA Corp. are terminable upon ratings downgrades, and if MBIA Inc. were to have insufficient assets to pay the termination payments, MBIA Corp. would make such payments. In certain cases, the Company may be required to consolidate entities established as part of securitizations when it insures the assets or liabilities of those entities. These entities typically meet the definition of a variable interest entity (“VIE”) under Financial Accounting Standards Board (“FASB”) Interpretation No. (“FIN”) 46(R), “Consolidation of Variable Interest Entities—an interpretation of ARB No. 51.” We do not believe there is any difference in the risks and profitability of financial guarantees provided to VIEs compared with other financial guarantees written by the Company. Additional information relating to VIEs is contained in the “Variable Interest Entities” section included herein. On February 18, 2009, the Company announced that it had restructured MBIA Insurance Corporation and established a separate U.S. public finance financial guarantee insurance company using MBIA Illinois, an existing public finance financial guarantee insurance company wholly owned by MBIA Insurance Corporation. As part of
50
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
the restructuring, the stock of MBIA Illinois was transferred to a newly established intermediate holding company, which is wholly owned by MBIA Inc. Additionally, MBIA Illinois was further capitalized with approximately $2.1 billion from funds distributed by MBIA Insurance Corporation to MBIA Inc. as a dividend and return of capital, which MBIA Inc. contributed to MBIA Illinois through the intermediate holding company. Our new operating structure will facilitate both transparency of business lines and future capital raising efforts. As part of the restructuring, MBIA Insurance Corporation entered into a quota share reinsurance agreement effective January 1, 2009 pursuant to which MBIA Insurance Corporation ceded all of its U.S. public finance exposure to MBIA Illinois, including assigning its rights and obligations with respect to the U.S. public finance business that MBIA Insurance Corporation assumed from FGIC. The exposure transferred to MBIA Illinois under the reinsurance and assignment agreements totaled $554 billion of net par outstanding. The reinsurance and assignment enables covered policyholders and certain ceding reinsurers to make claims for payment directly against MBIA Illinois in accordance with the terms of these agreements. In connection with the reinsurance and assignment agreements, MBIA Insurance Corporation paid to MBIA Illinois approximately $2.9 billion, which is equal to the statutory net unearned premium, net of a ceding commission and loss and loss adjustment expense reserves, as premium to reinsure the policies covered by these agreements. The ceding commission paid to MBIA Insurance Corporation equaled 22% of the net unearned premium reserve ceded. To provide additional protection to its policyholders, MBIA Illinois has also issued second-to-pay policies for the benefit of the policyholders covered by the above reinsurance and assignment agreements. These second-to-pay policies, which are direct obligations of MBIA Illinois, are held by a trustee and provide that if MBIA Insurance Corporation or FGIC, as applicable, do not pay valid claims of their policyholders, the policyholders will then be able to make claims directly against MBIA Illinois. MBIA Insurance Corporation will retain its structured finance and international insured exposure, as well as its guarantee of investment agreement contracts and medium-term notes (“MTNs”) issued by the Company’s investment management services operations, and plans to resume business in these markets when its credit ratings and market conditions permit. As a result of these actions, MBIA Illinois, which is expected to be renamed National Public Finance Guarantee Corporation, is now a stand-alone, separately capitalized and governed insurance company with $554 billion of net par insured. Its assets are available to service the policies of its domestic public finance insureds. MBIA Insurance Corporation is now a stand-alone, separately capitalized and governed insurance company with $233 billion of net par insured. Its assets are available to service the policies of its structured finance and international infrastructure finance insureds. The major rating agencies have recognized this separation with their ratings decisions on these two companies to date. We believe that the separation of our U.S. public finance business from our structured finance and international businesses is a significant step towards re-entering and competing in these markets while preserving the interests of all policyholders. Refer to “Note 28: Subsequent Events” in the Notes to Consolidated Financial Statements for further information about the reorganization of the Company’s insurance operations. Investment Management Services Operations MBIA’s investment management services operations include a substantial asset/liability management business, in which it has issued debt and investment agreements, which are insured by MBIA Corp., to capital markets and municipal investors and then initially purchased assets that largely matched the duration of those liabilities. The ratings downgrades of MBIA Corp. have resulted in the termination of certain investment agreements and, together with the cost and availability of funding, have significantly adversely affected this business. Our investment management services operations also provide cash management, discretionary asset management and structured products to the public, not-for-profit, corporate and financial sectors. Discontinued Operations In December 2006, MBIA completed the sale of Capital Asset Holdings GP, Inc. and certain affiliated entities (“Capital Asset”). The sale of Capital Asset also included three VIEs established in connection with MBIA-insured
51
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
securitizations of Capital Asset tax liens, which were consolidated within the Company’s insurance operations in accordance with FIN 46(R). 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. CRITICAL ACCOUNTING ESTIMATES The Company prepares its financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”), which requires the use of estimates and assumptions. The following accounting estimates are viewed by management to be critical because they require significant judgment on the part of management. Management has discussed and reviewed the development, selection and disclosure of the critical accounting estimates with the Company’s Audit Committee. Financial results could be materially different if alternate methodologies were used or if management modified its assumptions. Loss and Loss Adjustment Expenses Loss and loss adjustment expense (“LAE”) reserves are established by the Company’s Loss Reserve Committee, which consists of members of senior management. This estimate requires the use of judgment and estimates with respect to the occurrence, timing and amount of a loss on an insured obligation. Loss and LAE reserves relate only to MBIA’s non-derivative financial guarantees. The Company establishes two types of loss and LAE reserves: an unallocated loss reserve and case basis reserves. The unallocated loss reserve is established with respect to the Company’s entire non-derivative insured portfolio. The Company’s unallocated loss reserve represents the Company’s estimate of losses that have occurred or are probable to occur as a result of credit deterioration in the Company’s insured portfolio but which have not yet been specifically identified and applied to specific insured obligations. Case basis reserves represent the Company’s estimate of probable losses on specifically identified credits that have defaulted or are expected to default. As of December 31, 2008, the Company reported total loss reserves, net of reinsurance, of $1.5 billion, representing 0.14% of its outstanding non-derivative net debt service insured of $1.1 trillion. We believe that these reserves are adequate to cover ultimate net losses. Given that the reserves are based on estimates, there can be no assurance that the ultimate liability will not exceed such estimates resulting in the Company recognizing additional loss and LAE in earnings. While the underlying principles applied to loss reserving are consistent across the financial guarantee industry, differences exist with regard to the methodology and measurement of loss reserves. Alternative methods may produce different estimates than the method used by the Company. Additionally, the accounting for non-derivative financial guarantee loss reserves changed on January 1, 2009 when the Company adopted SFAS 163, “Accounting for Financial Guarantee Insurance Contracts – an interpretation of FASB Statement No. 60.” Under SFAS 163, the Company will no longer record an unallocated loss reserve but instead recognize and measure claim liabilities for each policy equal to the present value of expected net cash outflows using a risk-free rate. Loss reserves will only be recorded in amounts that exceed the unearned premium revenue. Refer to the “Recent Accounting Pronouncements” section included herein for additional information on the adoption of SFAS 163 and refer to “Note 2: Significant Accounting Policies” and “Note 12: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements for further information about the Company’s loss and loss adjustment expense and reserves. Unallocated Loss Reserve Each quarter we calculate our provision for the unallocated loss reserve as a fixed percent of scheduled net earned premium of the insurance operations. Prior to the first quarter of 2008, scheduled net earned premium of
52
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
the insurance operations included premiums from both our non-derivative insured portfolio and our insured derivative portfolio. Effective January 1, 2008, premiums from insured derivative contracts are no longer included as part of scheduled net earned premium but are rather reported as part of “Realized gains (losses) and other settlements on insured derivatives.” As a result, we have increased our loss factor to 14.5% from 12% in order to maintain a loss and LAE provision consistent with that calculated using historical scheduled net earned premium. On an annual basis, the Loss Reserve Committee evaluates the appropriateness of the fixed percent loss factor. In performing this evaluation, the Loss Reserve Committee considers the composition of the Company’s insured portfolio by public finance sector, structured asset class, remaining maturity and credit quality, along with the latest industry data, including historical default and recovery experience for the relevant sectors of the fixed-income market. In addition, the Company considers its own historical loss activity and how those losses developed over time. The Loss Reserve Committee reviews the results of its annual evaluation over a period of several years to determine whether any long-term trends are developing that indicate the loss factor should be increased or decreased. Therefore, case basis reserves established in any year may be above or below the loss factor without requiring an increase or decrease to the loss factor. However, if a catastrophic or unusually large loss occurred in a single year or if the Loss Reserve Committee determined that any change to one or more of the variables that influence the loss factor is likely to have an impact on the level of probable losses in its insured portfolio, the Loss Reserve Committee will increase or decrease the loss factor accordingly, which will result in an increase or decrease in the Company’s provision for loss and LAE. Alternatively, the Loss Reserve Committee may establish additional reserves for sectors within the Company’s insured portfolio that it believes have a significantly higher risk of loss relative to the insured portfolio taken as a whole and not increase the loss factor. Several variables are considered by the Loss Reserve Committee when evaluating the adequacy of the loss factor over an extended period of time. For example, as external and internal statistical data are applied to the various sectors of the Company’s insured portfolio, a shift in business written toward sectors with high default rates would likely increase the loss factor, while a shift toward sectors with low default rates would likely decrease the loss factor. Additionally, increases in statistical default rates relative to the Company’s insured portfolio and in the Company’s actual loss experience or decreases in statistical recovery rates and in the Company’s actual recovery experience would likely increase the Company’s loss factor. Conversely, decreases in statistical default rates relative to the Company’s insured portfolio and in the Company’s actual loss experience or increases in statistical recovery rates and in the Company’s actual recovery experience would likely decrease the Company’s loss factor. During the years ended December 31, 2008, 2007 and 2006, the Company’s loss and LAE provision for the unallocated loss reserve based on a loss factor of 14.5%, 12% and 12% was $92 million, $86 million and $81 million, respectively. These amounts are recorded within loss and loss adjustment expenses on the Company’s statements of operations. In 2008 and 2007, the Company recorded $1.2 billion and $814 million, respectively, of additional loss and LAE to increase case loss reserves on its RMBS exposure as a result of stress in the mortgage markets and an increase in defaults on MBS. Therefore, our provision for loss and LAE for the years ended December 31, 2008 and 2007 totaled $1.3 billion and $900 million, respectively. We believe that the current loss factor of 14.5% provides an adequate reserve for probable losses in our non-derivative insured portfolio, excluding the RMBS exposure that we have separately reserved for. For the year ended December 31, 2006, the Company’s additions to specific case basis reserves were less than the loss and LAE provision calculated from its loss factor. Conversely, additions to specific case basis reserves in the years ended December 31, 2005, 2007 and 2008 exceeded the Company’s loss and LAE provision calculated from its loss factor. However, with the exception of the additional loss and LAE recorded in 2008 and 2007 related to MBIA’s RMBS exposure, the Company has calculated its provision for the unallocated loss reserve at a consistent percentage of scheduled net earned premium of its insurance operations since 2002. Given the increased level of specific case basis losses recorded in the last several years, such as those related to our RMBS exposure, if none of the other variables used in deriving the loss factor had changed, the Company’s cumulative loss factor through December 31, 2008 would approximate 42%, which would have generated loss and LAE of $268 million, $265 million and $261 million for the years ended December 31, 2008, 2007 and 2006, respectively. However, another variable that changed over the last several years and that affects the determination of the loss factor is the mix of business among different sectors. During the last several years, the Company had ceased writing business in certain sectors in which loss experience has been high relative to its total portfolio, such as tax liens, lower rated high yield collateralized bond obligations, manufactured housing and
53
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
certain direct corporate obligations, which offset the impact that the higher case basis incurred activity would have on the loss factor. Excluding actual loss experience incurred in the sectors listed above and the reserves established for RMBS exposure in 2008 and 2007 in addition to its loss factor, the Company’s cumulative loss factor through December 31, 2008 would approximate 10%, which would have generated loss and LAE of $61 million, $60 million and $59 million for the years ended December 31, 2008, 2007 and 2006, respectively. Considering all of the assumptions used in the assessment of the adequacy of the loss factor, including the higher case basis incurred activity and the offsetting effect of observed changes in the variables described above, we believe that our current loss factor of 14.5% continues to represent a reasonable estimate of losses that have occurred or are probable to occur as a result of credit deterioration in our insured portfolio, excluding our RMBS exposure, but which have not yet been specifically identified and applied to specific insured obligations. In addition, we believe that the amount of unallocated loss reserves recorded on our balance sheet at December 31, 2008 are adequate to cover specific losses that may develop from our existing insured portfolio, although a prolonged recession could result in incurred losses within our non-RMBS insured portfolio that exceed our unallocated loss reserve. However, we do not believe that reasonably likely changes in the assumptions used to calculate the loss factor and the unallocated loss reserve would have a material impact on the amount of our unallocated loss reserve. Loss reserving for our RMBS exposure is discussed below. Case Basis Reserves A number of variables are taken into account in establishing specific case basis reserves for individual policies that depend primarily on the nature of the underlying insured obligation. These variables include the nature and creditworthiness of the underlying issuer of the insured obligation, whether the obligation is secured or unsecured and the expected recovery rates on the insured obligation, the projected cash flow or market value of any assets that support the insured obligation and the historical and projected loss rates on such assets. Factors that may affect the actual ultimate realized losses for any policy include economic conditions and trends, changes in interest rates, rates of inflation, changes in borrower behavior, and the default rate and salvage values of specific collateral. In establishing case basis reserves, we present value estimated loss payments, net of estimated recoveries, using a discount rate equal to the yield-to-maturity of MBIA Insurance Corporation’s fixed-income investment portfolio, excluding investments in money market funds and including intercompany loans under repurchase agreements, as of the current reporting date. The discount rate used to calculate case basis reserves of December 31, 2008 was 5.03%. If the Company were to reference a different discount rate, its case basis reserves may have been higher or lower than those established as of December 31, 2008. For example, a higher discount rate would have decreased the amount of case basis reserves established by the Company and a lower rate would have increased the amount of reserves established by the Company. However, we believe that the discount rate used represents the most appropriate rate of return for present valuing our reserves as it reflects the rate of return on the assets supporting future claim payments by the Company. In 2008, additions to case basis reserves totaled $1.9 billion, of which $1.8 billion related to our RMBS exposure. Additions to case basis reserves have been partially offset by the establishment of salvage and subrogation receivables and collections totaling $406 million as of December 31, 2008. RMBS case basis reserves, net of salvage and subrogation receivables, have been principally established from the additional loss and LAE provisions recorded in 2008 and 2007. Refer to “Loss and Loss Adjustment Expenses” included in the Results of Operations section herein for further information regarding case basis reserve activity. RMBS Reserves In determining the RMBS case basis reserves recorded in 2008 which relate to home equity lines of credit (“HELOCs”) and closed-end second mortgages (“CES”) RMBS, the Company employed a multi-step process using a database of loan level information which allowed the Company to determine borrower payment status, including delinquencies and charge-offs. The Company relied upon this database to determine the likelihood of a delinquent loan being charged off. The information was then used in conjunction with a proprietary internal cash flow model and a commercially available model to estimate ultimate cumulative losses to our insured bonds. The Company establishes a case basis reserve for any transaction to the extent that cumulative losses exceed credit support available to its insured bonds and, as such, results in a claim on our financial guarantee policy for which we do not expect a full recovery.
54
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
The Company continues to use the general procedure described above. However, based upon our review of the data, in the third quarter of 2008 we made one change related to our methodology for estimating future defaults for loans that are current (not delinquent) by utilizing the “Current to Loss” approach described below, versus the current three-month or derived conditional default rate (“CDR”) approach used in prior quarters. The change for this one component in our methodology was due to the increased unpredictability and volatility of loss timing observed in the third quarter of 2008 under the CDR approach, which rendered future outcomes under that approach increasingly unreliable. The following are the principal assumptions used with respect to the underlying loans to determine the projected performance of our insured RMBS transactions:
In addition, for transactions secured by HELOCs, the model considered borrower draws and repayment rates. For HELOCs, the current three-month average draw rate was used to project future draws on the line. For HELOCs and transactions secured by fixed rate CES, the three-month average conditional repayment rate (“CRR”) was used to project voluntary principal repayments. Cash flows also assumed a constant basis spread between floating rate assets and floating rate insured debt obligations (the difference between Prime and LIBOR interest rates, minus any applicable fees). For all transactions, cash flows considered allocations and other structural aspects of a transaction, including managed amortization periods, rapid amortization periods and claims against MBIA’s insurance policy consistent with such policy’s terms and conditions. The assumptions and cash flow structure referenced above resulted in a forecasted cumulative collateral loss that was added to existing actual cumulative collateral losses. The resulting estimated net claims on MBIA’s insurance policies were discounted to a net present value reflecting MBIA’s obligation to pay claims over time and not on an accelerated basis. The above assumptions represent MBIA’s best estimate of how transactions will perform over time. 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. We have not reflected any potential recoveries as salvage or subrogation resulting from either (i) the repurchase of defective loans by the originators of the RMBS transactions with respect to which the Company has established case basis reserves, (ii) the potential impact of existing litigation and (iii) impact of future legislative changes. We believe that the existing litigation has the potential to result in recoveries of loss payments, which could
55
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
significantly reduce the impact of current reserves and/or potential increases to reserves in future periods due to elevated peak loss rates. Valuation of Financial Instruments Fair value is defined as an exit price, which is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at a specified measurement date. The degree of judgment used to determine the fair values of financial instruments generally correlates to the degree of pricing observability. Financial instruments in liquid markets with readily available and actively quoted prices, or with such prices for comparable instruments usually have the most pricing observability. Financial instruments rarely traded or not quoted have less observability and are usually measured by valuation models that require judgment. Pricing observability is affected by type of financial instrument, whether the instrument is well established in the market, by characteristics unique to individual transactions and by overall market conditions, including whether prices are generated as distressed transactions. We have categorized our financial instruments measured at fair value into the three-level classification of SFAS 157, “Fair Value Measurements,” which considers this issue of pricing observability. Fair value measurements of financial instruments that use quoted prices in active markets for identical assets or liabilities are generally categorized as Level 1, and fair value measurements of financial instruments where significant inputs are not observable are generally categorized as Level 3. We categorize our financial instruments conservatively using the lowest level category at which we can generate reliable fair values. The determination of reliability requires management to exercise judgment. The fair market values of financial instruments held or issued by the Company are determined through the use of observable market data when available. Market data is obtained from a variety of third-party sources, including dealer quotes. If dealer quotes are not available for an instrument that is infrequently traded, we use alternate valuation methods, including either dealer quotes for similar contracts or modeling using market data inputs. Using alternate valuation methods generally requires considerable judgment in the estimates and assumptions used and changes to these variables may produce materially different values. The fair value pricing of assets and liabilities is a function of many components which includes interest rate risk, market risk, liquidity risk and credit risk. For financial instruments that are internally valued by the Company, as well as those for which the Company uses broker quotes or pricing services, credit risk is typically incorporated by using appropriate credit spreads or discount rates as inputs. 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. 1. Financial Assets The Company’s financial assets are primarily debt and equity investments. The majority of these are accounted for in accordance with SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities.” SFAS 115 requires all debt instruments and certain equity instruments to be classified in the Company’s balance sheet according to their purpose and, depending on that classification, to be carried at either amortized cost or fair value. Most valuations of the Company’s financial assets use observable market-based inputs, including dealer quotes when available. However, since mid 2007, illiquidity in the credit markets has significantly reduced the availability of observable market data. Other financial assets that require fair value reporting or disclosures within the Company’s notes to the financial statements are valued based on the estimated value of the underlying collateral or the Company’s estimate of discounted cash flows. Assets with fair value derived from broker quotes or pricing services can be within Level 1, 2 or 3 of the SFAS 157 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 as a basis for classification within the three levels of the SFAS 157 fair value hierarchy. For example, broker quoted prices are classified as Level 3 if we consider the inputs used are not market-based and observable. Pricing service data is received monthly and on a
56
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
quarterly basis, 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. Financial assets recorded on the Company’s balance sheet at fair value as of December 31, 2008 totaled $18.4 billion, of which $16.3 billion were valued using pricing services or broker quotes. The following table presents the type, amount and fair value hierarchy classification for financial assets for which pricing services or broker quotes were used by the Company in determining fair value as of December 31, 2008:
The Company monitors investments in which fair value is less than amortized cost in order to assess if declines in value are other-than-temporary and should therefore be reflected as a realized loss in net income. Such assessments include identifying the cause of the decline and whether we have the ability and intent to hold the investment to maturity or until the value recovers to at least the amortized cost. It also includes judgment as to whether an investment is impaired based on market conditions, and trends and the availability of relevant data. Refer to “Note 6: Investment Income and Gains and Losses” in the Notes to Consolidated Financial Statements for further information regarding other-than-temporary losses recorded in net income. 2. Financial Liabilities The Company’s financial instruments categorized as liabilities primarily consist of investment agreements and MTNs issued by the asset/liability products and conduit segments within our investment management services operations, as well as debt issued for general corporate purposes. Such liabilities are typically recorded at face value adjusted for premiums or discounts. The fair values of these financial instruments are generally not reported within the Company’s financial statements but disclosed in the accompanying notes. However, financial liabilities which qualify as part of fair value hedging arrangements under SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended are reported in the Company’s balance sheet at a value that reflects changes in the risks being hedged, which offsets changes in the value of the hedging instrument. MBIA uses cash flow modeling techniques to estimate the value of its liabilities that qualify as hedged obligations under SFAS 133, incorporating current market data. Financial liabilities that the Company has elected to fair value under SFAS 155, “Accounting for Certain Hybrid Financial Instruments” or that require fair value reporting or disclosures within the
57
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
Company’s notes to its financial statements are valued based on either estimated value of the underlying collateral, the Company’s or a third-party’s estimate of discounted cash flows or quoted market values for similar transactions. The following table presents the type, amount and fair value hierarchy classification for financial liabilities for which pricing services or broker quotes were used by the Company in determining fair value as of December 31, 2008:
3. Derivatives MBIA has entered into derivative transactions both within its financial guarantee insurance business and in hedging risks associated with its assets and liabilities. CDS contracts are also used in the investment management services operations to replicate investments in cash assets consistent with the risk tolerance and criteria for this business. We account for derivative transactions in accordance with SFAS 133, which requires that all such transactions be recorded on the Company’s balance sheet at fair value. The fair value of derivative instruments is determined as the amount that would be received to sell the derivative when in an asset position (when the Company would be owed money under the derivative in a termination) or transfer the derivative when in a liability position (when the Company would owe money under the derivative in a termination). Changes in the fair value of derivatives, exclusive of insured derivatives, are recorded each period in current earnings within “Net gains (losses) on financial instruments at fair value and foreign exchange” or in shareholders’ equity within “Accumulated other comprehensive income (loss)” depending on whether the derivative is designated as a hedge, and if so designated, the type of hedge. 4. Insured Derivatives The majority of our derivative exposure lies in credit derivative instruments insured by MBIA Corp. Prior to 2008, MBIA Corp. insured CDSs entered into by LaCrosse Financial Products LLC (“LaCrosse”), an entity that is consolidated into MBIA’s GAAP financial statements under the FIN 46(R) criteria. In February 2008, we stopped insuring such derivative instruments except in transactions reducing our existing insured derivative exposure. 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. Description of MBIA’s Insured Credit Derivatives The majority of MBIA’s insured credit derivatives referenced structured pools of cash securities and CDSs. We generally insured the most senior liabilities of such transactions, and at transaction closing our exposure generally had more subordination than needed to achieve triple-A ratings from credit rating agencies (referred to as “Super Triple-A” exposure). The collateral backing our insured derivatives was cash securities and CDSs referencing primarily corporate, asset-backed, residential mortgage-backed, commercial mortgage-backed, commercial real estate loans, and CDO securities. A portion of MBIA’s insured CDS contracts require that MBIA make payments for losses of the principal outstanding under the contracts when losses on the underlying referenced collateral exceed a predetermined
58
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
deductible. The total notional amount and MBIA’s maximum payment obligation under these contracts as of December 31, 2008 was $81.2 billion. The underlying referenced collateral for contracts executed in this manner largely consist of investment grade corporate debt CDOs, structured commercial mortgage-backed securities (“CMBS”) pools and, to a lesser extent, multi-sector CDO-squared transactions. We have guarantees under principal protection fund programs, which are also accounted for as derivatives. Under these programs we guaranteed the return of principal to investors and are protected by a daily portfolio rebalancing obligation that is designed to minimize the risk of loss to MBIA. As of December 31, 2008, the maximum amount of future payments that the Company would be required to make under these guarantees was $90 million, but we have not made any payments to date relating to these guarantees. The unrealized gains (losses) on these derivatives for the years ended 2006, 2007 and 2008 were $0, reflecting the extremely remote likelihood that MBIA will incur a loss. The total changes in fair value of the insured derivatives are recorded in “Net change in fair value of insured derivatives.” “Realized gains (losses) and other settlements on insured derivatives” include (i) net premiums received and receivable on written CDS contracts, (ii) net premiums paid and payable to reinsurers in respect of CDS contracts, (iii) net amounts received or paid on reinsurance commutations, (iv) losses paid and payable to CDS contract counterparties due to the occurrence of a credit event or settlement agreement, (v) losses recovered and recoverable on purchased CDS contracts due to the occurrence of a credit event or commutation agreement and (vi) fees relating to CDS contracts. The “Unrealized gains (losses) on insured derivatives” include all other changes in fair value of the derivative contracts. Considerations Regarding an Observable Market for MBIA’s Insured Derivatives In determining fair value, our valuation approach always uses observable market prices when available and reliable. Market prices are generally available for traded securities and market standard CDSs but are less available or accurate for highly customized CDSs. Most of the derivative contracts we insure are the latter as they are non-traded structured credit derivative transactions. In contrast, typical market CDSs are standardized, liquid instruments that reference tradable securities such as corporate bonds that themselves have observable prices. These market standard CDSs also involve collateral posting, and upon a default of the underlying reference obligation, can be settled in cash. MBIA’s insured CDS contracts do not contain typical CDS market standard features as they have been designed to replicate our financial guarantee insurance policies. Our insured CDS instruments provide protection on a pool of securities or CDSs with either a stated deductible or subordination beneath the MBIA-insured tranche. We are not required to post collateral in any circumstances. At default of an underlying reference obligation, payment is only due after the aggregate amount of such losses exceed the deductible or subordination in the transaction. Some contracts also provide for further deferrals of payment at our option. There is usually no requirement for fair value termination payments except for termination events related to MBIA Corp.’s failure to pay or insolvency and, in some cases, other fair value termination payments for events within our control, such as the sale of all or substantially all of the assets of MBIA Corp. An additional difference between our CDS and typical market standard contracts is that our contract, like our financial guarantee contracts, cannot be accelerated by the counterparty in the ordinary course of business, unless we elect to do so. Similar to our financial guarantee insurance, all insured CDS policies are unconditional and irrevocable and cannot be transferred to most other capital market participants unless they are also licensed to write financial guarantee insurance policies. Note that since insured CDS contracts are accounted for as derivatives under SFAS 133, the Company did not defer the charges associated with underwriting the CDS policies and they were expensed at origination. Our payment obligations are structured to prevent large one-time claims upon an event of default of underlying reference obligations and to allow for payments over time (i.e. “pay-as-you-go” basis) or at final maturity. However, the size of payments will ultimately depend on the timing and magnitude of losses. There are three types of payment provisions:
59
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
MBIA had transferred some of the risk of loss on these contracts using reinsurance to other financial guarantee insurance and reinsurance companies. The fair value of the transfer under the reinsurance contract with the reinsurers is accounted for as a derivative asset. These derivative assets are valued consistently with our SFAS 157 valuation policies as described in “Note 2: Significant Accounting Policies” in the Notes to Consolidated Financial Statements. Valuation Modeling of MBIA Insured Derivatives As a result of these significant differences between market standard CDS contracts and the CDS contracts insured by MBIA, we believe there are no relevant third-party exit value market observations for our insured structured credit derivative contracts, and therefore no principal market as described in SFAS 157. In the absence of a principal market, we value these insured credit derivatives in a hypothetical market where market participants are assumed to be other comparably-rated primary financial guarantors. Since there are no observable transactions in the financial guarantee market that could be used to value our transactions, we generally use internal and third-party models, depending on the type and structure of the contract, to estimate the fair value of our insured derivatives. Our primary model for insured CDSs simulates what a bond insurer would charge to guarantee a transaction at the measurement date, based on the market-implied default risk of the underlying collateral and the remaining structural protection in a deductible or subordination. This approach assumes that bond insurers would be willing to accept these contracts from us at a price equal to what they could issue them for in the current market. While the premium charged by financial guarantors is not a direct input into our model, the model estimates such premium and this premium increases as the probability of loss increases, driven by various factors including rising credit spreads, negative credit migration, lower recovery rates, lower diversity score and erosion of deductible or subordination. 1. Valuation Model Overview Approximately 99.6% of the balance sheet fair value of insurance derivatives as of December 31, 2008 is valued using the Binomial Expansion Technique (“BET”), which is a probabilistic approach to calculate expected loss on our exposure based on market variables for underlying referenced collateral. The BET was originally developed by Moody’s to estimate a probability distribution of losses on a diverse pool of assets. We have made modifications to this technique in an effort to incorporate more market information and provide more flexibility in handling pools of dissimilar assets: a) we use market credit spreads to determine default probability instead of using historical loss experience, and b) for collateral pools where the spread distribution is characterized by extremes, we model each segment of the pool individually instead of using an overall pool average. There are three steps within BET modeling to arrive at fair value for a structured transaction: pool loss estimation, loss allocation to separate tranches of the capital structure and calculation of the change in value.
60
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
Additional structural assumptions of the model worth noting are listed below:
The Company reviews the model results on a quarterly basis to assess the appropriateness of the assumptions and results in light of current market activity and conditions. This review is performed by internal staff with relevant expertise. If live market spreads are observable for similar transactions, those spreads are an integral part of the analysis. For example, new insured transactions that resemble existing (previously insured) transactions would be considered, as would negotiated settlements of existing transactions. However, this data has been scarce or non-existent in recent periods. As a result, our recent reviews have focused more on internal consistency and relativity, as well as the reasonableness of modeled results given current market conditions. 2. Model Strengths and Weaknesses The primary strengths of this CDS valuation model are:
The primary weaknesses of this insured CDS model are:
3. Model Inputs Specific detail regarding these model inputs are listed below: a. Credit spreads The average spread of collateral is a key input as we assume credit spreads reflect the market’s assessment of default probability for each piece of collateral. Spreads are obtained from market data sources published by third parties (e.g. dealer spread tables for assets most closely resembling collateral within our transactions) as well as
61
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
collateral-specific spreads on the underlying reference obligations provided by trustees or market sources. Also, when these sources are not available, we benchmark spreads for collateral against market spreads, including in some cases, assumed relationships between the two spreads. This data is reviewed on an ongoing basis for reasonableness and applicability to our derivative portfolio. The actual calculation of pool average spread varies depending on whether we are able to use collateral-specific credit spreads or generic spreads as an input.
We use the spread hierarchy listed below in determining which source of spread information to use, with the rule being to use CDS spreads where available and cash security spreads as the next alternative. Cash spreads reflect trading activity in funded fixed-income instruments while CDS spreads reflect trading levels for non-funded derivative instruments. While both markets are driven partly by an assessment of the credit quality of the referenced security, there are factors which create significant differences: CDS spreads can be driven by speculative activity since the CDS market facilitates both long and short positions without ownership of the underlying security, allowing for significant leverage. Spread Hierarchy:
For example, if current market-based spreads are not available then we apply either sector-specific spreads from spread tables provided by dealers or corporate cash spread tables. The sector-specific spread applied depends on the nature of the underlying collateral. Transactions with corporate collateral use the corporate spread table. Transactions with asset-backed collateral use one or more of the dealer asset-backed tables. If there are no observable market spreads for the specific collateral, and sector-specific and corporate spread tables are not appropriate to estimate the spread for a specific type of collateral, we use the fourth alternative in our hierarchy. An example is tranched corporate collateral, where we apply corporate spreads as an input with an adjustment for our tranched exposure.
62
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
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. Over time the data inputs change as new sources become available, existing sources are discontinued or are no longer considered to be reliable or the most appropriate. It is always our objective to move to higher levels on the hierarchy, but we sometimes move to lower priority inputs because of discontinued data sources or because we consider higher priority inputs no longer representative of market spreads. This occurs when transaction volume changes such that a previously used spread index is no longer viewed to reflect current market levels, as was the case for CMBS collateral in insured CDSs during 2008. Refer to section “Input Adjustments for Insured CMBS Derivatives in the Current Market” below. b. Diversity Scores The diversity score is a measure to estimate 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. For example, if a portfolio of 100 assets had a diversity score of 50, this means that the 100 correlated assets are assumed to have the same loss distribution as 50 uncorrelated assets. A lower diversity score represents higher assumed correlation, increasing the chances of a large number of defaults, and thereby increasing the risk of loss in the senior tranche. A lower diversity score will generally have a negative impact on the valuation for our senior tranche. The calculation methodology for a diversity score includes the extent to which a portfolio is diversified by industry or asset class, which is either calculated internally or reported by the trustee on a regular basis. Diversity scores are calculated at transaction origination, and adjusted as the collateral pool changes over time. MBIA’s internal modeling of the diversity score is based on Moody’s methodology but uses MBIA’s internal assumptions on default correlation, including variables such as collateral rating and amount, asset type and remaining life. c. Recovery Rate The recovery rate represents the percentage of par expected to be recovered after an asset defaults, indicating the severity of a potential loss. MBIA generally uses rating agency recovery assumptions which may be adjusted to account for differences between the characteristics and performance of the collateral used by the rating agencies and the actual collateral in MBIA-insured transactions. We may also adjust rating agency assumptions based on the performance of the collateral manager and on empirical market data. For example, in the first quarter of 2008, new S&P research used a lower recovery rate for securities backed by Alternative A-paper (“ALT-A”) and subprime real estate collateral and in the same period trading spreads widened materially for these assets, so we adjusted the recovery rates in our mortgage-backed collateral by approximately 10 percentage points. We did this even though the collateral backing MBIA’s transactions is on average a better credit quality than the assets used in S&P’s research. Also in the fourth quarter of 2008 MBIA began using a distribution of potential recovery rates instead of a single point estimate. d. Input Adjustments for Insured CMBS Derivatives in the Current Market Approximately $47 billion gross par of MBIA’s insured derivative transactions include substantial amounts of CMBS and commercial mortgage collateral. In prior years, we had used spreads drawn from CMBX indices and CMBS spread tables as pricing input on the underlying referenced collateral in these transactions. In 2008 as the financial markets became illiquid, we saw a significant disconnect between cumulative loss expectations of market analysts on underlying commercial mortgages, which were based on the continuation of low default and loss rates, and loss expectations implied by the CMBX indices and CMBS spread tables. CMBS collateral in MBIA’s insured credit derivatives has performed in line with the market analysts assessments and continue to be rated triple-A by Moody’s or S&P.
63
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
In addition, due to financial market uncertainty this past year, transaction volume in CMBS and trading activity in the CMBX were both dramatically lower than in prior periods. We also considered that the implied loss rates within the CMBX index were much higher than that forecast by fundamental researchers and MBIA’s internal analysis. Also, the implied illiquidity premium on the index was very high and the model assumed that all of this would influence monoline pricing. This has not been the case in other periods of market illiquidity (because monoline insurers have “buy and hold” portfolios, spread changes that reflect illiquidity versus changes in perceived credit fundamentals are not typically fully reflected in pricing). As a result of these issues, we concluded that the CMBX indices and the CMBS spread tables were unreliable model inputs for the purpose of estimating fair value in our hypothetical market among monoline insurers. In the first quarter of 2008 we modified the spread used for these transactions to reflect a combination of market spread pricing and third-party fundamental analysis of CMBS credit. Our revised spread input is a CMBX index analog that combines expectations for CMBS credit performance (as forecasted by the average of three investment banks’ research departments) together with the illiquidity premium implied by the CMBX indices. The illiquidity premium we use is the senior triple-A tranche spread of the CMBX index that matches the origination vintage of collateral in each transaction. For example, collateral originated in the second half of 2006 uses the triple-A tranche spread of the CMBX series 1 as the illiquidity premium. The sum of the illiquidity premium plus the derived credit spread based on the average cumulative net loss estimates of three investment bank’s research department is used as a CMBX analog index. Over time as market data and research changes we also update our techniques to reflect the change in data and estimates. This was required in 2008 regarding our assumption for average life in the CMBX analog index. Our preferred approach is to use an average life that is known to be consistent with the Cumulative Net Loss assumptions, but published research on loss assumptions does not disclose underlying corresponding average life. Initially we had used tranche duration for average life, also as published by third-party independent market research considering this appropriate as it was produced by research based on a wide variety of market transactions. During the third quarter of 2008 as credit spreads continued to widen to unprecedented levels, it became clear that these tranche duration assumptions were not compatible with the expectations of future losses that most market participants would use. We determined that an internally developed tranche weighted average life based on our own transactions would be more consistent with the characteristics of our portfolio. We believe this change results in a measurement more representative of fair value in the current market. e. Nonperformance Risk Adjustment In compliance with the requirements of SFAS 157, effective January 1, 2008, we updated our valuation methodology for insured credit derivative liabilities to incorporate the Company’s own nonperformance risk and the nonperformance risk of its reinsurers. We calculated this adjustment by discounting the estimated market value loss on insured CDSs at MBIA Corp.’s and the reinsurers’ CDS spreads at December 31, 2008. The calculation resulted in a pre-tax $13.2 billion reduction in the fair value of the derivative liability. Nonperformance risk is a fair value concept and does not contradict the Company’s internal view, based on fundamental credit analysis of our economic condition, that the Company will be able to pay all claims when due. The Company believes that it is important to consistently apply its valuation techniques. However, we may consider making changes in the valuation technique if the change results in a measurement that is equally or more representative of fair value under current circumstances. Prior to the third quarter of 2008, the difference between the MBIA nonperformance credit adjusted value of certain portions of the derivative liability related to collateral defaults in excess of subordination and the unadjusted value of those same portions of the derivative liability was immaterial relative to the Company’s unrealized gains (losses) on insured derivatives reported on the Company’s statement of operations. As a result, the Company made no nonperformance risk adjustment for this portion of the derivative liability. During the third quarter of 2008, the magnitude of the difference between the MBIA nonperformance credit adjusted value of this portion of the derivative liability and the unadjusted value of the same portion of the derivative liability was material relative to the Company’s unrealized gains (losses) on insured derivatives reported on the Company’s statement of operations. The Company recognized that losses related to collateral defaults that exceeded the attachment point in certain transactions could be paid over time as opposed to immediately at MBIA’s option. Therefore, the Company adjusted its estimate of nonperformance risk to reflect the longer exposure period for this portion of the liability. The formula the Company used was the same as what it uses to adjust other unrealized losses for counterparty risk. It takes into account the upfront and annual cost of buying CDS protection in MBIA’s name in the marketplace as well as the average life of the transactions where the losses occurred.
64
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
Fair Value Hierarchy – Level 3 SFAS 157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The objective of a fair value measurement is to determine the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Instruments that trade infrequently and therefore have little or no price transparency are classified within Level 3 of the fair value hierarchy. Also included in Level 3 are financial instruments that have significant unobservable inputs deemed significant to the instrument’s overall fair value. The following table presents the fair values of assets and liabilities recorded on our balance sheet that are classified as Level 3 within the fair value hierarchy, along with a brief description of the valuation technique for each type of asset and liability:
Level 3 assets were $3.8 billion as of December 31, 2008, and represented approximately 21% of total assets measured at fair value. Level 3 liabilities were $6.5 billion as of December 31, 2008, and represented approximately 89% of total liabilities measured at fair value. Transfers into and out of Level 3 were $1.2 billion and $959 million for the year ended December 31, 2008, respectively. These transfers were principally for available-for-sale securities where inputs, which are significant to their valuation, became unobservable or observable during the year. Foreign governments, corporate obligations, MBS and ABS constituted the majority of the affected instruments. The net unrealized loss related to the transfers into and out of Level 3 as of December 31, 2008 were $25 million and $82 million, respectively.
65
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
Fair Value Control Processes The majority of pricing for investments is provided by third-party providers who use their own data sources and models to arrive at fair value pricing for each security. Refer to “Financial Assets” above for a discussion on the use of pricing services and brokers, as well as the validation procedures performed. With respect to insured credit derivatives, we use a fair value validation process. We review the model results on a quarterly basis to assess the appropriateness of the assumptions and results in light of current market activity and conditions. This review is performed by internal staff with relevant expertise. If live market spreads are observable for similar transactions, those spreads are an integral part of the analysis. For example, new insured transactions that resemble existing (previously insured) transactions would be considered, as would negotiated settlements of existing transactions. However, this data has been scarce or non-existent in recent periods. As a result, our recent reviews have focused more on internal consistency and relativity, as well as the reasonableness of modeled results given current market conditions. Refer to the “Market Risk” section included herein for a further discussion of how the Company manages the risks inherent in valuing financial instruments. Premium Revenue Recognition Upfront premiums are earned in proportion to the expiration of the related principal balance of an insured obligation. Therefore, for transactions in which the premium is received upfront, premium earnings are greater in the earlier periods when there is a higher amount of principal outstanding. The upfront premiums are apportioned to individual sinking fund payments of a bond issue according to an amortization schedule. After the premiums are allocated to each scheduled sinking fund payment, they are earned on a straight-line basis over the period of that sinking fund payment. Accordingly, deferred premium revenue represents the portion of premiums written that is applicable to the unexpired risk of insured bonds and notes. When an MBIA-insured obligation is retired early, is called by the issuer, or is in substance paid in advance through a refunding accomplished by placing U.S. Government securities in escrow, the remaining deferred premium revenue is earned at that time since there is no longer risk to the Company. Installment premiums are earned on a straight-line basis over each installment period, generally one year or less. As the outstanding principal of an installment-based policy is paid down by the issuer of an MBIA-insured obligation, less premium is collected and recognized by the Company. Both upfront and installment premium recognition methods recognize premiums over the term of an insurance policy in proportion to the remaining outstanding principal balance of the insured obligation. The effect of the Company’s upfront premium earnings policy is to recognize greater levels of upfront premiums in the earlier years of each policy insured, thus matching revenue recognition with exposure to the underlying risk. Recognizing premium revenue on a straight-line basis over the life of each policy without allocating premiums to the sinking fund payments would materially affect the Company’s financial results. Premium earnings would be more evenly recorded as revenue throughout the period of risk than under the current method, but the Company does not believe that the straight-line method would appropriately match premiums earned to the Company’s exposure to the underlying risk. Therefore, the Company believes its upfront premium earnings methodology is the most appropriate method to recognize its upfront premiums as revenue. The premium earnings methodology currently used by the Company is similar to that used throughout the financial guarantee industry. Effective January 1, 2009, premium revenue recognition changed as a result of the adoption of SFAS 163. Refer to the “Recent Accounting Pronouncements” section included herein for additional information on the adoption of SFAS 163. Goodwill Under SFAS 142, “Goodwill and Other Intangible Assets,” goodwill and intangible assets with indefinite lives are tested for impairment at least annually. This test includes a two-step process aimed at determining the amount, if any, by which the carrying value of a reporting unit exceeds its fair value and should be charged as an expense through net income. As of December 31, 2008, goodwill totaled $77 million and was related to our insurance
66
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
operations. In the fourth quarter of 2008, goodwill related to our investment management services operations of $2 million was written off. As of December 31, 2007, goodwill totaled $79 million, of which $77 million was related to our insurance operations and $2 million was related to our investment management services operations. In performing the impairment test of goodwill of our insurance operations, we determined the best measure of fair value of the insurance reporting segment is its book value calculated under GAAP (shareholders’ equity) adjusted for the after-tax effects of net deferred premium revenue and the present value of future installment premiums less the after-tax effects of deferred acquisition costs and a provision for losses, and by excluding the after-tax effects of cumulative unrealized net gains or losses, net of credit impairments, to arrive at adjusted book value. Adjusted book value is a measure commonly provided by financial guarantee companies, which we believe provides a comprehensive measure of the value of the Company since we expect that the adjustments to book value will affect future results and, in general, do not require any additional future performance on the part of the Company. The assumptions used to estimate the fair value of the insurance operations are (i) its statutory income tax rate of 35%, (ii) the yield-to-maturity of MBIA Insurance Corporation’s fixed-income investment portfolio, excluding investments in money market funds and including intercompany loans under repurchase agreements , of 5.03%, (iii) its 14.5% loss factor to arrive at the provision for losses, and (iv) an estimate of the present value of payments under insured derivatives. Goodwill within our investment management services operations was related to MBIA Municipal Investors Service Corporation (“MBIA-MISC”). MBIA-MISC’s fair value is estimated by using a multiple of its earnings before interest, income tax, depreciation and amortization (“EBITDA”), which is a common method used to value investment management companies. The assumption used to arrive at MBIA-MISC’s fair value is a multiple of seven times EBITDA as of December 31, 2008 and ten times EBITDA as of December 31, 2007. The change in the earnings multiple is based on current market conditions for investment management companies. We performed our annual impairment testing of goodwill 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. As of January 1, 2008, the fair value of MBIA-MISC also exceeded its carrying value indicating that goodwill was not impaired. However, on January 1, 2009, the fair value of MBIA-MISC was less than its carrying value indicating that goodwill was impaired. The impairment of MBIA-MISC’s goodwill resulted from a decrease in EBITDA due to a write-down of a receivable in 2008. As a result, as of December 31, 2008, the Company recorded an impairment loss for the full amount of MBIA-MISC’s goodwill. Alternate valuation methods used to assess goodwill would have likely produced different fair values. However, we believe that the valuation methods described above provide the best estimates of fair value. Refer to “Note 13: Goodwill” in the Notes to Consolidated Financial Statements for further information about our accounting for goodwill. Deferred Income Taxes Deferred income taxes are recorded with respect to the temporary differences between the tax bases of assets and liabilities and the reported amounts in the Company’s financial statements that will result in deductible or taxable amounts in future years when the reported amounts of assets and liabilities are recovered or settled. Such temporary differences relate principally to premium revenue recognition, deferred acquisition costs, unrealized appreciation or depreciation of investments and derivatives, and MBIA Corp.’s statutory contingency reserve. Valuation allowances are established to reduce deferred tax assets to an amount that more likely than not will be realized and the offset is reflected as a provision for income taxes in the statement of operations. Determining whether to establish a valuation allowance and, if so, the amount of the valuation allowance requires management to exercise judgment and make assumptions regarding whether such tax benefits will be realized in future periods. All evidence, both positive and negative, needs to be identified and considered in making the determination. Future realization of the existing deferred tax asset ultimately depends on management’s estimate of the future profitability and existence of sufficient taxable income of appropriate character (for example, ordinary income versus capital gains) within the carry-forward period available under the tax law. In the event that the Company’s estimate of taxable income is less than that required to utilize the full amount of any deferred tax asset, a valuation allowance would be established.
67
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
As of December 31, 2008, we reported a net deferred tax asset of $2.4 billion primarily related to the unrealized losses recorded on the Company’s derivative and investment portfolios. With respect to temporary differences related to insured CDS contracts, on a pre-tax basis, the Company estimates that it is more likely than not the entire amount of such benefit will be utilized in future periods as an offset to ordinary income and has not established a valuation allowance. However, since the Federal income tax treatment for CDS contracts is an unsettled area of tax law, in the event that the Internal Revenue Service has a different view than the Company, such that insured CDS losses are considered capital losses, the Company would be required to establish a valuation allowance against substantially all of the deferred tax asset related to these losses. With respect to realized capital losses on the disposal and impairment of investments in the asset/liability products segment’s investment portfolio, the Company established a valuation allowance of $351 million as of December 31, 2008, which is included in the net deferred tax asset of $2.4 billion. Refer to “Note 14: Income Taxes” in the Notes to Consolidated Financial Statements for additional information about the Company’s deferred income taxes. RECENT ACCOUNTING PRONOUNCEMENTS Recently Adopted Accounting Standards 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. In December 2008, the FASB issued FSP FAS 140-4 and FIN 46(R)-8, “Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities,” which requires enhanced disclosures about transfers of financial assets and involvement with variable interest entities. The Company adopted FSP FAS 140-4 and FIN 46(R)-8 for financial statements prepared as of December 31, 2008. Since FSP FAS 140-4 and FIN 46(R)-8 only requires additional disclosures concerning transfers of financial assets and interests in variable interest entities, adoption of FSP FAS 140-4 and FIN 46(R)-8 did not affect the Company’s consolidated balance sheets, results of operations or cash flows. Refer to “Note 8: Variable Interest Entities” in the Notes to Consolidated Financial Statements for disclosures required by FSP FAS 140-4 and FIN 46(R)-8. In October 2008, the FASB issued FSP FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for that Asset is Not Active: An Amendment of FASB Statement No. 157.” FSP FAS 157-3 clarifies the application of SFAS 157 in an inactive market and provides an illustrative example to demonstrate how the fair value of a financial asset is determined when the market for that financial asset is not active. The provisions are effective upon issuance, including prior periods for which financial statements have not been issued. The adoption of FSP FAS 157-3 did not affect the Company’s consolidated balance sheets, results of operations or cash flows. In September 2008, the FASB issued FSP FAS 133-1 and FIN 45-4, “Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161.” FSP FAS 133-1 and FIN 45-4 requires enhanced disclosures about credit derivatives and guarantees and amends FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” to exclude derivative instruments accounted for at fair value under SFAS 133. The Company adopted FSP FAS 133-1 and FIN 45-4 for financial statements prepared as of December 31, 2008. Since FSP FAS 133-1 and FIN 45-4 only requires additional disclosures concerning credit derivatives and guarantees, adoption of FSP FAS 133-1 and FIN 45-4 did not affect the Company’s consolidated balance sheets, results of operations or cash flows. Refer to “Note 7: Derivative Instruments” in the Notes to Consolidated Financial Statements for disclosures required by FSP FAS 133-1 and FIN 45-4. 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
68
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
permits the fair value option election on an instrument-by-instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument. The Company applies the disclosure requirements of SFAS 159 for certain eligible instruments which it previously elected to fair value under SFAS 155. These instruments included certain MTNs and certain available-for-sale securities which contained embedded derivatives requiring bifurcation. The Company did not elect the fair value option under SFAS 159 for any eligible financial instruments. The Company adopted the provisions of SFAS 157, excluding non-financial assets and liabilities per FSP FAS 157-2, “Effective Date of FASB Statement No. 157,” beginning January 1, 2008. SFAS 157 defines fair value as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. In February 2008, the FASB issued FSP FAS 157-2, which delayed the effective date of SFAS 157 to fiscal years beginning after November 15, 2008, for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). A transition adjustment to opening retained earnings was not required. In April 2007, the FASB issued FSP FIN 39-1, “Amendment of FASB Interpretation No. 39.” FSP FIN 39-1 permits a reporting entity that is a party to a master netting agreement to offset fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral against fair value amounts recognized for derivative instruments that have been offset under the same master netting agreement. FSP FIN 39-1 is effective for fiscal years beginning after November 15, 2007 and is required to be applied retrospectively for all financial statements presented unless it is impracticable to do so. The Company adopted the provisions of the FSP beginning January 1, 2008 and elected not to offset fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral under a master netting agreement against fair value amounts recognized for derivative instruments that have been offset under the same master netting agreement. The Company may reevaluate in the future its election to not offset the fair value amounts recognized for derivative contracts executed with the same counterparty under a master netting agreement. Recent Accounting Developments In May 2008, the FASB issued SFAS 163 which requires financial guarantee insurance (and reinsurance) contracts issued by reporting entities considered insurance enterprises under SFAS 60, “Accounting and Reporting by Insurance Enterprises” to recognize and measure premium revenue based on the amount of insurance protection provided and the period in which it is provided and to recognize and measure claim liabilities based on the present value of expected net cash outflows to be paid, using a risk-free rate, in excess of the unearned premium revenue. SFAS 163 does not apply to financial guarantee insurance contracts accounted for as derivative instruments within the scope of SFAS 133. SFAS 163 is effective for the Company prospectively as of January 1, 2009, except for the presentation and disclosure requirements related to claim liabilities effective for financial statements prepared on or after September 30, 2008, as presented and disclosed in “Note 12: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements. The cumulative effect of initially applying SFAS 163 will be recognized as an adjustment to the opening balance of retained earnings for the fiscal year beginning January 1, 2009. The Company expects the adoption of SFAS 163 to have a material impact on the Company’s consolidated balance sheets and results of operations. However, the amount is not known or reasonably estimable at this time as the Company is currently evaluating the required changes to its accounting processes and systems, which are significant. In March 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133.” SFAS 161 expands the disclosure requirements about an entity’s derivative instruments and hedging activities. The disclosure provisions of SFAS 161 apply to all entities with derivative instruments subject to SFAS 133 and its related interpretations. The provisions also apply to related hedged items, bifurcated derivatives, and non-derivative instruments that are designated and qualify as hedging instruments. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company will adopt the disclosure provisions of SFAS 161 on January 1, 2009. Since SFAS 161 requires only additional disclosures concerning derivatives and hedging activities, adoption of SFAS 161 will not affect the Company’s consolidated balance sheets, results of operations or cash flows.
69
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
In February 2008, the FASB issued FSP FAS 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions.” FSP FAS 140-3 requires an initial transfer of a financial asset and a repurchase financing that was entered into contemporaneously with or in contemplation of the initial transfer to be evaluated as a linked transaction under SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities” unless certain criteria are met. FSP FAS 140-3 was effective for the Company beginning January 1, 2009, and will be applied to new transactions entered into after the date of adoption. Early adoption is prohibited. The Company does not expect the adoption of FSP FAS 140-3 will have a material impact on the Company’s consolidated balance sheets, results of operations or cash flows. In December 2007, the FASB issued SFAS 160, “Noncontrolling Interests in Consolidated Financial Statements,” an amendment of Accounting Research Bulletin No. 51. SFAS 160 requires reporting entities to present noncontrolling (minority) interest as equity (as opposed to liability or mezzanine equity) and provides guidance on the accounting for transactions between an entity and noncontrolling interests. The presentation and disclosure requirements are to be applied retrospectively. SFAS 160 is effective January 1, 2009 for the Company and earlier adoption is prohibited. The adoption of SFAS 160 will result in preferred stock issued by a subsidiary to be reclassified from minority interests to a separate component of equity. The Company does not expect the adoption of SFAS 160 will have a material impact on the Company’s consolidated balance sheets, results of operations or cash flows.
70
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
RESULTS OF OPERATIONS Summary of Consolidated Results The following table presents a summary of our consolidated financial results for 2008, 2007 and 2006. Items listed under “Other per share information (effect on net income (loss))” are items that we commonly identify for the readers of our financial statements because they are a by-product of the Company’s operations or due to general market conditions beyond the control of the Company.
The Company recorded a net loss for 2008 of $2.7 billion compared with a net loss of $1.9 billion for 2007. Net loss per diluted share was $12.29 for 2008 compared with a net loss per diluted share of $15.17 for 2007. The decrease in net loss per diluted share resulted from an increase of approximately 90.9 million weighted average shares outstanding as a result of issuing common stock in the first quarter of 2008. Consolidated revenues from continuing operations decreased to a loss of $857 million in 2008 from a loss of $284 million in 2007. The decrease in insurance losses principally resulted from a $1.4 billion decrease in net losses on insured derivatives, an increase in gains on the Company’s Money Market Committed Preferred Custodial Trust (“CPCT”) securities facility and an increase in premiums earned principally due to greater refunding activity. Refer to the discussion under “Net Change in Fair Value of Insured Credit Derivatives” included herein for the Company’s estimate of credit impairments on insured derivatives. The decrease in investment management services operations’ revenues resulted from realized losses from security sales and other-than-temporary impairments of available-for-sale securities and a decrease in interest income within our asset/liability products segment, partially offset by gains related to debt repurchases. The increase in corporate revenues principally resulted from gains related to debt repurchases and an increase in interest income attributable to an increase in invested assets.
71
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
Consolidated expenses from continuing operations increased 3% to $2.9 billion in 2008 from $2.8 billion in 2007. The increase in consolidated expenses was principally due to additional loss and LAE incurred of $1.2 billion related to our insured second-lien RMBS exposure and interest expense on surplus notes issued in the first quarter of 2008 in our insurance operations. The increase in insurance expenses was partially offset by a decrease in interest expense within our investment management services operations resulting from a decline in investment agreement and MTN balances. Corporate interest expense decreased slightly due to the effect of extinguishing debt during 2008. The Company recorded a net loss for 2007 of $1.9 billion compared with net income of $819 million for 2006. Net loss per diluted share was $15.17 for 2007 compared with net income per diluted share of $5.99 for 2006. Consolidated revenues from continuing operations decreased to a loss of $284 million in 2007 compared with income of $2.7 billion in 2006. The decline in insurance revenues resulted from a $3.6 billion loss on insured derivatives, which was primarily the result of adverse changes in the fair value of the Company’s insured credit derivative portfolio and an adjustment to the Company’s carrying value of its investment in Channel Reinsurance Ltd. (“Channel Re”), partially offset by an unrealized gain on the Company’s CPCT facility. The investment management services operations’ revenues increased primarily due to an increase in interest income resulting from growth in the asset/liability products segment, higher fees in the advisory services segment due to growth in assets under management and an increase in gains on financial instruments at fair value and foreign exchange due to gains on total return swaps resulting from declines in underlying bond prices. Consolidated expenses from continuing operations increased 77% to $2.8 billion in 2007 from $1.6 billion in 2006. The increase in consolidated expenses was principally due to an increase in loss and LAE incurred in the insurance operations reflecting $614 million of specific case basis reserves and $200 million of non-specific unallocated reserves related to MBIA’s second-lien RMBS exposure. In addition, investment management services’ interest expense increased due to growth in the asset/liability products segment, commensurate with the increase in interest income. Our book value (total shareholders’ equity) was $994 million as of December 31, 2008, down from $3.7 billion as of December 31, 2007. The decrease in book value resulted from our 2008 net loss of $2.7 billion and an aggregate $1.3 billion unrealized depreciation in the value of our investment portfolios, partially offset by $1.6 billion of proceeds from the issuance of common stock. Book value per share as of December 31, 2008 was $4.78, down 84% from $29.16 as of December 31, 2007. The decrease in book value per share was due to the decline in book value and an increase in shares outstanding from the issuance of common stock during 2008. In addition to book value per share, we also analyze adjusted book value per share (“ABV”) when evaluating the value of the Company. ABV is a non-GAAP measure of book value inclusive of items that are expected to impact shareholders’ equity in future periods and, in general, do not require any additional future performance obligation on the Company’s part. Additionally, ABV excludes gains and losses due to market value changes that have not been realized through sales or impairments of assets or extinguishment of liabilities. While ABV is not a substitute for GAAP book value, we believe it provides a comprehensive measure of the embedded value of the Company and is meaningful to investors and analysts when viewed in conjunction with GAAP book value. As of December 31, 2008, ABV per share was $40.06, down 49% from $77.89 as of December 31, 2007. The following provides a reconciliation of book value per share to ABV per share:
72
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
Insurance Operations The following table presents the financial results of the insurance operations for 2008, 2007 and 2006. These results include revenues and expenses from transactions with the Company’s investment management services and corporate operations. Effective January 1, 2008, net premiums written no longer include premiums from insured derivatives. Additionally, premiums earned and fees related to insured derivatives are no longer reported within “Premiums earned” and “Fees and reimbursements,” respectively, but are instead reported within “Realized gains (losses) and other settlements on insured derivatives” and changes in the fair values of insured derivatives are no longer reported within “Net gains (losses) on financial instruments at fair value and foreign exchange” but are instead reported within “Unrealized gains (losses) on insured derivatives.” These reclassifications resulted from an industry-wide effort, in consultation with the SEC, to present the results of financial guarantees written in derivative form consistently. Prior periods have been adjusted to conform to the current presentation, which had no effect on total revenues or total expenses.
In 2008, total revenues from the Company’s insurance operations were a loss of $534 million compared with loss of $2.1 billion in 2007. The decrease in the insurance operations’ loss was principally due to a $1.4 billion reduction in net losses on insured derivatives, an $88 million increase in net gains on financial instruments at fair value and foreign exchange, driven by the change in the fair value of our CPCT facility, and an $140 million increase in premiums earned, primarily due to refunded insured obligations. Total insurance expenses increased 51% to $1.8 billion in 2008 from $1.2 billion in 2007. The increase in insurance expenses was due to approximately $400 million of additional loss and LAE related to our second-lien RMBS exposure. Additionally, operating expenses increased as a result of a decline in deferrable acquisition costs and interest expense increased as a result of the issuance of our surplus notes. Gross operating expenses (expenses before ceding commission income and the deferral and amortization of acquisition costs) decreased 20% to $198 million in 2008 compared with the 2007 as a result of a reversal of prior years’ compensation expenses related to long-term incentive awards and bonuses. The reversal of expenses associated with performance-based long-term incentive awards totaled $45 million in 2008 and related to awards granted in 2007, 2006, and 2005. Gross operating expenses in 2008 were less than operating expenses reported in the preceding table as a result of the reversal of compensation expenses that were previously deferred as acquisition costs.
73
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
In 2007, total revenues from the Company’s insurance operations were a loss of $2.1 billion compared with income of $1.5 billion in 2006. The decrease in insurance operations’ revenues in 2007 compared with 2006 resulted from a $3.7 billion unrealized losses on insured derivatives, which was primarily the result of adverse changes in the fair value of our insurance credit derivative portfolio and an $86 million adjustment to the carrying value of our investment in Channel Re. The adjustment to the carrying value of our investment in Channel Re contributed to the loss on the net change in fair value of our insured derivatives as a result of eliminations the Company was required to make under the equity method of accounting. These losses were partially offset by a $110 million unrealized gain on the Company’s CPCT facility. In addition, there was a decline in fees and reimbursements and net investment income in 2007 compared with 2006. Partially offsetting the impact of the decreases in insurance revenues were increases in net realized gains and premiums earned. Total insurance expenses increased 212% to $1.2 billion in 2007 from $380 million in 2006. The increase in insurance expenses was due to the $614 million of case basis reserves and $200 million of non-specific unallocated reserves related to our second-lien RMBS exposure. Partially offsetting the increase in losses and LAE was a decrease in operating expenses due to an increase in costs allocated from the insurance segment to other segments and a decline in loss prevention expenses. Gross operating expenses (expenses before ceding commission income and the deferral or amortization of acquisition costs) decreased 8% in 2007 compared with 2006 as a result of an increase in costs allocated to our investment management services and corporate operations and a decrease in loss prevention costs. Gross premiums written (“GPW”), net premiums written (“NPW”) and net premiums earned on non-derivative financial guarantees for the last three years are presented in the following table:
GPW reflects premiums received and accrued for in the period and does not include the present value of future cash receipts expected from installment premium policies originated during the period. NPW represents gross premiums written net of premiums ceded to reinsurers. Net premiums earned include scheduled premium earnings as well as premium earnings from refunded issues. In the third quarter of 2008, we closed a reinsurance transaction between MBIA Corp. and FGIC in which MBIA assumed a significant portion of FGIC’s U.S. public finance insurance portfolio. As of the closing date, the reinsured portfolio consisted exclusively of investment grade credits, primarily in the general obligation, water and sewer, tax-backed and transportation sectors, and did not contain any CDS contracts, below investment grade credits or other credits that were inconsistent with our credit underwriting standards. The reinsurance was provided on a “cut-through” basis, which enables FGIC’s policyholders to receive the benefit of MBIA’s reinsurance by allowing them to present claims directly to MBIA.
74
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
Under the FGIC reinsurance transaction, MBIA assumed total par of approximately $181 billion and received upfront unearned premiums, net of a ceding commission paid to FGIC, of approximately $717 million. As required by the New York State Insurance Department (“NYSID”) in connection with its approval of the reinsurance transaction, the funds have been placed in a trust and will be released to MBIA upon the earlier of its removal from ratings review with its then current ratings or nine months from the closing date of the transaction. Additionally, under the terms of the trust, the funds will be released to MBIA as the premiums are earned and can be used to pay claims on policies assumed under the reinsurance agreement. MBIA evaluates the premium rates it charges for insurance guarantees through the use of internal and external rating agency quantitative models. These quantitative models assess the Company’s premium rates and return on capital results on a risk adjusted basis. In addition, market research data is used to evaluate pricing levels across the financial guarantee industry for comparable risks, as well as pricing for similar risks in the bank loan, bond and CDS markets, when available. Since 2005, domestic municipal spreads contracted to tighter levels through mid-2007. Since mid-2007, credit spreads have reached historically wide levels and bond insurance rates have increased to historically high levels. CREDIT QUALITY 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, S&P and Fitch). All references to insured credit quality distributions contained herein reflect the underlying rating levels from these third-party sources. Other companies within the financial guarantee industry may report credit quality information based upon internal ratings that would not be comparable to our presentation. During 2008, total net par insured rated A or above, before giving effect to MBIA’s guarantee, was 94% compared with 82% during 2007 and 77% during 2006. These percentages reflect a change in the mix of business written during each year among sectors with varying levels of risk. Additionally, 2008 includes a significant amount of par assumed from FGIC, which comprised high-quality domestic public finance exposure. At December 31, 2008, 84% of the Company’s outstanding net par insured was rated A or above before giving effect to MBIA’s guarantee compared with 83% at December 31, 2007. The following table presents the credit quality distribution of MBIA’s outstanding net par insured as of December 31, 2008 and 2007. All ratings are as of the period presented and represent S&P ratings. If transactions are not rated by S&P, a Moody’s equivalent rating is used. If transactions are not rated by either S&P or Moody’s, an MBIA equivalent rating is used.
75
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
GLOBAL PUBLIC FINANCE MARKET MBIA’s premium writings and premium earnings in both the new issue and secondary global public finance markets on non-derivative financial guarantees are presented in the following table:
In 2008, global public finance GPW increased 100% to $1.1 billion from $538 million in 2007. This increase was due to a 161% increase in U.S. business written as a result of the reinsurance transaction with FGIC in which the Company received $916 million of U.S. public finance upfront premiums. GPW related to the FGIC transaction was partially offset by a decrease in direct U.S. and non-U.S. business written during 2008 compared with 2007. In 2008, the number and net par amount of public finance transactions directly insured by MBIA decreased 77% and 94%, respectively, compared with 2007. The decrease in direct business written resulted from a sharp decline in demand for bond insurance within the municipal bond market, particularly from insurance companies that have had their insurance financial strength ratings downgraded, as well as an overall decline in municipal issuances during 2008 related to the disruption in the financial markets. NPW increased 117% in 2008 to $1.1 billion from $504 million in 2007 as a result of the 100% increase in GPW and a decrease in premiums ceded to reinsurers. Excluding the effects of the FGIC transaction, net premiums written during 2008 decreased 65% to $179 million compared with $504 million during 2007. During 2008, the Company commuted reinsured premium of $43 million from several of its reinsurers, which resulted in a negative cession rate, excluding the FGIC portfolio, of 11% compared with a positive cession rate of 6% in 2007. In 2008, global public finance net premiums earned increased 32% to $622 million from $470 million in 2007. The increase in net premiums earned was due to a 125% increase in refunded premiums earned and a 5% increase in scheduled premiums earned. The increase in refunded premiums earned was consistent with an observed overall increase in the refunding of debt obligations by municipal issuers compared with 2007. Excluding premiums earned from policies reinsured from FGIC, premiums earned were $579 million during 2008, a 23% increase from 2007. In 2007, global public finance GPW increased 5% to $538 million from $512 million in 2006. This increase was due to a 29% increase in U.S. business written primarily in the transportation, higher education and military housing sectors, as well as three credits insured in Puerto Rico. Partially offsetting this increase was a 26% decrease in non-U.S. business written primarily due to the impact of a $55 million non-U.S. public finance upfront policy written in the second quarter of 2006 with no comparatively large upfront policy written in 2007. Non-U.S. business written in the second half of 2007 was adversely affected by growing concerns about the U.S. mortgage and housing markets. NPW increased 5% in 2007 to $504 million from $479 million in 2006 as a result of the increase in GPW. The global public finance cession rate for business written during 2007 and 2006 remained flat at 6%. Global public finance net premiums earned decreased 7% to $470 million in 2007 compared with $503 million in 2006. A 27% decrease in refunded premiums earned was partially offset by a 2% increase in scheduled premiums earned. Refunded premiums declined primarily due to an increase in interest rates on new tax exempt issuances in 2007 as compared to 2006. Global public finance net par insured rated A or above, before giving effect to the Company’s guarantee, represented 94% of global public finance business written by the Company during 2008, compared with 88%
76
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
during 2007 and 84% during 2006. These percentages reflect a change in the mix of business written during each year among sectors with varying levels of risk. Additionally, 2008 includes a significant amount of par assumed from FGIC, which comprised high-quality domestic public finance exposure. At December 31, 2008, 88% of the outstanding global public finance net par insured was rated A or above before the Company’s guarantee, up from 84% at December 31, 2007. GLOBAL STRUCTURED FINANCE MARKET MBIA’s premium writings and premium earnings in both the new issue and secondary global structured finance markets on non-derivative financial guarantees are presented in the following table:
In 2008, global structured finance GPW decreased 8% to $293 million from $319 million in 2007. As announced on February 25, 2008, we suspended the writing of all new structured finance business for approximately six months. Given the dislocation in the financial markets, the decline in demand for MBIA-insured obligations, and the lack of structured financing transactions, we did not write any new structured finance business in the remainder of 2008. Therefore, premiums written during 2008 were principally generated from installment-based policies closed in prior periods. NPW in 2008 decreased 8% to $250 million from $272 million in 2007 due to the decrease in GPW. The global structured finance cession rate for business written during 2008 and 2007 remained flat at 15%. Global structured finance net premiums earned in 2008 of $258 million were 4% lower than 2007. The decrease in net premiums earned reflects the maturity and termination of policies in the absence of new business. In 2007, global structured finance GPW decreased 1% to $319 million from $321 million in 2006. NPW in 2007 increased 3% to $272 million from $263 million in 2006 due to a decline in premiums ceded to reinsurers, which offset the decline in GPW. The global structured finance cession rate for business written during 2007 was 15% compared with 18% for 2006. Global structured finance net premiums earned of $270 million in 2007 were 1% higher than 2006. Global structured finance net par insured rated A or above, before giving effect to MBIA’s guarantee, was 78% during 2007 and 71% during 2006. There was no comparable percentage for 2008 as a result of MBIA not writing structured finance business. At December 31, 2008, 75% of the outstanding global structured finance net par insured was rated A or above before giving effect to the Company’s guarantee, down from 80% as of December 31, 2007. This decrease is principally a result of ratings downgrades on our mortgage-related exposure.
77
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
INVESTMENT INCOME The insurance segment’s net investment income for the last three years and ending investment asset balances at amortized cost as of December 31, 2008 and 2007 are presented in the following tables:
In 2008, our insurance segment’s pre-tax net investment income, excluding net realized gains and losses, increased 2% to $584 million from $573 million in 2007. The increase in pre-tax net investment income reflects growth in average invested assets from the proceeds of our surplus notes and the Warburg Pincus equity transactions and, to a lesser extent, proceeds from our reinsurance transaction with FGIC. The effect of the increase in average invested assets was partially offset by a decrease in yields on tax-exempt and short-term investments. The decrease in ending assets as of December 31, 2008 compared with December 31, 2007 was the result of liquidating investments into cash for purposes of enhancing short-term liquidity, including providing a $2 billion repurchase agreement to our investment management services operations, and paying claims on insurance policies. After-tax net investment income increased only 1% in 2008 as the proportion of taxable investments increased compared with 2007. VIE interest income is generated from interest bearing assets held by such entities and supports the payment of interest expense on debt issued by these entities. The decrease in VIE interest income primarily resulted from a decline in floating interest rates on VIE assets. Excluding interest income related to VIEs and interest income related to Northwest Airlines’ enhanced equipment trust certificates (“EETCs”) received as part of a remediation, which the Company sold in June 2007, insurance-related net investment income decreased 4% on a pre-tax basis and 10% on an after-tax basis in 2008 compared with 2007. Ending asset balances at amortized cost, excluding VIE assets, were $8.2 billion and $10.1 billion at December 31, 2008 and 2007, respectively. Tax-exempt investments represented 40% and 58% of ending asset balances, excluding VIE and Northwest Airlines’ EETCs assets, at December 31, 2008 and 2007, respectively. In 2007, our insurance segment’s pre-tax net investment income, excluding net realized gains and losses, decreased 1% to $573 million from $581 million in 2006. The decline in pre-tax net investment income reflects a decrease in average invested assets in 2007 compared with 2006, as well as an $11 million decrease in investment income related to Northwest Airlines’ EETCs, which the Company received in connection with a remediation and subsequently sold in the second quarter of 2007. However, pre-tax net investment income benefited from a $16 million increase in VIE interest income. After-tax net investment income decreased 1% in 2007 as the proportion of taxable investments remained relatively consistent with 2006.
78
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
In 2007, excluding interest income related to VIEs and the Northwest Airlines’ EETCs and interest received on reimbursed expenses, insurance-related net investment income decreased 1% on a pre-tax and after-tax basis compared with 2006. These decreases were attributable to a decline in average invested assets as a result of dividends paid from MBIA Corp. to MBIA Inc. in December 2006 and April 2007 and claim payments made in the fourth quarter of 2006 to call two MBIA–insured transactions. Average investment yields decreased slightly in 2007 compared with 2006. Ending asset balances at amortized cost, excluding VIE and Northwest Airlines’ EETC assets, were $10.1 billion and $9.6 billion at December 31, 2007 and 2006, respectively. Tax-exempt investments represented 58% and 55% of ending asset balances, excluding VIE and Northwest Airlines’ EETC assets, at December 31, 2007 and 2006, respectively. FEES AND REIMBURSEMENTS In 2008, fees and reimbursements in our insurance operations of $9 million decreased 54% compared with 2007. In 2007, fees and reimbursements of $20 million decreased 38% compared with 2006. Decreases in both years primarily resulted from decreases in expense reimbursements associated with loss prevention efforts. Due to the transaction-specific nature inherent in fees and reimbursements, these revenues can vary significantly from year to year. NET CHANGE IN FAIR VALUE OF INSURED CREDIT DERIVATIVES MBIA has sold credit protection by insuring derivative contracts with various financial institutions. In certain cases, the Company reinsured these policies thereby purchasing credit protection on a portion of the risk written. Changes in fair value of the insured derivatives are recorded in “Net change in fair value of insured derivatives” in the Consolidated Statements of Operations. The “Realized gains (losses) and other settlements on insured derivatives” include (i) net premiums received and receivable on written CDS contracts, (ii) net premiums paid and payable to reinsurers in respect of CDS contracts, (iii) net amounts received or paid on reinsurance commutations, (iv) losses paid and payable to CDS contract counterparties due to the occurrence of a credit event or settlement agreement, (v) losses recovered and recoverable on purchased CDS contracts due to the occurrence of a credit event or settlement agreement, and (vi) fees relating to CDS contracts. The “Unrealized gains (losses) on insured derivatives” include all other changes in fair value of the derivative contracts. The following table presents the net premiums written related to derivatives and the components of the net change in fair value of insured derivatives in 2008, 2007 and 2006:
| |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
