Consolidation of Variable Interest Entities

3 Months Ended

Mar. 31, 2011

Consolidation of Variable Interest Entities

Consolidation of Variable Interest Entities

8. Consolidation of Variable Interest Entities

The Company provides financial guaranties with respect to debt obligations of special purpose entities, including VIEs. The Company has not originated any VIEs nor acted as the servicer or collateral manager for any VIE deals that it insures. The transaction structure generally provides certain financial protections to the Company. This financial protection can take several forms, the most common of which are over-collateralization, first loss protection (or subordination) and excess spread. In the case of over-collateralization (i.e., the principal amount of the securitized assets exceeds the principal amount of the structured finance obligations guaranteed by the Company), the structure allows defaults of the securitized assets before a default is experienced on the structured finance obligation guaranteed by the Company. In the case of first loss, the financial guaranty insurance policy only covers a senior layer of losses of multiple obligations issued by special purpose entities, including VIEs. The first loss exposure with respect to the assets is either retained by the seller or sold off in the form of equity or mezzanine debt to other investors. In the case of excess spread, the financial assets contributed to special purpose entities, including VIEs, generate cash flows that are in excess of the interest payments on the debt issued by the special purpose entity. Such excess spread is typically distributed through the transaction’s cash flow waterfall and may be used to create additional credit enhancement, applied to redeem debt issued by the special purpose entities, including VIEs (thereby, creating additional over-collateralization), or distributed to equity or other investors in the transaction.

The Company is not primarily liable for the debt obligations issued by the VIEs it insures and would only be required to make payments on these debt obligations in the event that the issuer of such debt obligations defaults on any principal or interest due. The Company’s creditors do not have any rights with regard to the assets of the VIEs.

Consolidated VIEs

During First Quarter 2011, the Company determined that based on the assessment of its control rights over servicer or collateral manager replacement, given that servicing/managing collateral were deemed to be the VIEs’ most significant activities, 29 VIEs required consolidation consistent with the total number of VIEs consolidated at December 31, 2010.

The total unpaid principal balance for the VIEs’ assets that were over 90 days or more past due was approximately $1,165.4 million and $1,199.1 million as of March 31, 2011 and December 31, 2010, respectively. The change in the instrument-specific credit risk of the VIEs’ assets for First Quarter 2011 and 2010 was a gain of $383.2 million and a loss of $49.8 million, respectively. The difference between the aggregate unpaid principal and aggregate fair value of the VIEs’ liabilities was approximately $1,818.3 million and $2,053.0 million at March 31, 2011 and December 31, 2010, respectively.

The financial reports of the consolidated VIEs are prepared by outside parties and are not available within the time constraints that the Company requires to ensure the financial accuracy of the operating results. As such, the financial results of the VIEs are consolidated on a one quarter lag; however, the Company does adjust the financial statements for the effects of material events occurring from the lag period until the balance sheet date. The Company has elected the fair value option for assets and liabilities classified as financial guaranty variable interest entities’ assets and liabilities. Upon consolidation of financial guaranty VIEs, the Company elected the fair value option because the carrying amount transition method was not practical.

Consolidated VIEs

By Type of Collateral

	As of March 31, 2011				As of December 31, 2010
	Assets		Liabilities		Assets		Liabilities
	(in millions)
			(restated)				(restated)
HELOCs	$	840.6	$	1,088.9	$	857.1	$	1,126.1
First liens:
Subprime	550.0		584.9		528.7		616.5
Option ARMs	700.4		929.5		626.6		909.4
Alt-A second liens	773.2		829.1		747.4		818.4
Automobile loans	388.7		388.7		486.8		486.8
Life insurance	319.2		319.2		304.8		304.8
Credit card loans	106.9		106.9		106.1		106.1
Total	$	3,679.0	$	4,247.2	$	3,657.5	$	4,368.1

The table below shows the income statement activity of the consolidated VIEs:

Effect of Consolidating Financial Guaranty VIEs on Net Income

and Shareholders’ Equity

	First Quarter
	2011			2010
	(in millions)
	(restated)			(restated)
Net earned premiums	$	(19.1	)	$	(10.9	)
Net investment income	(0.3		)	—
Net realized investment gains	0.3			—
Net change in financial guaranty variable interest entities	119.6			(8.9		)
Loss and loss adjustment expenses	50.7			24.1
Total pre-tax effect on net income	151.2			4.3
Less: tax provision (benefit)	53.0			1.5
Total effect on net income	$	98.2		$	2.8

	As of March 31, 2011			As of December 31, 2010
	(in millions)
	(restated)			(restated)
Total effect on shareholders’ equity	$	(273.2	)	$	(371.4	)

The table below summarizes the contractual obligations of the Company’s consolidated VIEs’ liabilities with recourse:

Contractual Maturity Schedule of Financial Guaranty VIE Liabilities with Recourse

Gross Par Outstanding

Contractual Maturity	As of March 31, 2011
	(in millions)
2012	$	27.6
2013	31.3
2014	234.5
2015	92.8
Thereafter	3,069.9
Total	$	3,456.1

Non-Consolidated VIEs

To date, the Company’s analyses have indicated that it does not have a controlling financial interest in any other VIEs and, as a result, they are not consolidated in the Company’s consolidated financial statements. The Company’s exposure provided through its financial guaranties with respect to debt obligations of special purpose entities is included within net par outstanding in Note 4.