10-K 1 d332634d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K

 

 

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2016

or

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to            

Commission File Number 1-9583

 

 

MBIA INC.

(Exact name of registrant as specified in its charter)

 

 

 

Connecticut   06-1185706
(State of incorporation)  

(I.R.S. Employer

Identification No.)

1 Manhattanville Road, Suite 301,

Purchase, New York

  10577
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (914) 273-4545

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange

on which registered

Common Stock, par value $1 per share   New York Stock Exchange

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      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  

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      No  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes      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.    

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.

Large accelerated filer      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  

The aggregate market value of the voting stock held by non-affiliates of the Registrant as of June 30, 2016 was $882,439,647.

As of February 23, 2017, 134,398,145 shares of Common Stock, par value $1 per share, were outstanding.

Documents incorporated by reference:

Portions of the Definitive Proxy Statement of the Registrant for its 2016 Annual Meeting, which will be filed on or before March 31, 2017, are incorporated by reference into Part III of this Form 10-K.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

  PART I   

Item 1.

  Business      1  

Item 1A.

  Risk Factors      17  

Item 1B.

  Unresolved Staff Comments      29  

Item 2.

  Properties      29  

Item 3.

  Legal Proceedings      29  

Item 4.

  Mine Safety Disclosures      29  
  PART II   

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     30  

Item 6

  Selected Financial Data      32  

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     34  

Item 7A.

  Quantitative and Qualitative Disclosures About Market Risk      81  

Item 8.

  Financial Statements and Supplementary Data      85  

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     176  

Item 9A.

  Controls and Procedures      176  

Item 9B.

  Other Information      176  
  PART III   

Item 10.

  Directors, Executive Officers and Corporate Governance      177  

Item 11.

  Executive Compensation      177  

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     177  

Item 13.

  Certain Relationships and Related Transactions, and Director Independence      178  

Item 14.

  Principal Accounting Fees and Services      178  
  PART IV   

Item 15.

  Exhibits, Financial Statement Schedules      179  
 

Signatures

     184  
 

Schedule I

     185  
 

Schedule II

     186  
 

Schedule IV

     192  
 

Exhibit Index

     193  


Table of Contents

FORWARD-LOOKING AND CAUTIONARY STATEMENTS

This annual report of MBIA Inc., together with its consolidated subsidiaries, (collectively, “MBIA”, the “Company”, “we”, “us” or “our”) 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”, “estimate”, “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. We undertake no obligation to publicly correct or update any forward-looking statement if the Company later becomes aware that such result is not likely to be achieved.

The following are some of the general 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:

 

    increased credit losses or impairments on public finance obligations that National Public Finance Guarantee Corporation (“National”) insures issued by state, local and territorial governments and finance authorities and other providers of public services, located in the U.S. or abroad, that are experiencing fiscal stress;

 

    the possibility that loss reserve estimates are not adequate to cover potential claims;

 

    a disruption in the cash flow from our subsidiaries or an inability to access the capital markets and our exposure to significant fluctuations in liquidity and asset values in the global credit markets as a result of collateral posting requirements;

 

    our ability to fully implement our strategic plan, including our ability to maintain high stable credit ratings for National and generate investor demand for our financial guarantees;

 

    the possibility that MBIA Insurance Corporation will have inadequate liquidity or resources to timely pay claims as a result of higher than expected losses on certain structured finance transactions or as a result of a delay or failure in collecting expected recoveries, which could lead the New York State Department of Financial Services (“NYSDFS”) to put MBIA Insurance Corporation into a rehabilitation or liquidation proceeding under Article 74 of the New York Insurance Law and/or take such other actions as the NYSDFS may deem necessary to protect the interests of MBIA Insurance Corporation’s policyholders;

 

    deterioration in the economic environment and financial markets in the United States or abroad, real estate market performance, credit spreads, interest rates and foreign currency levels; and

 

    the effects of changes to governmental regulation, including insurance laws, securities laws, tax laws, legal precedents and accounting rules.

The above factors provide a summary of and are qualified in their entirety by the risk factors discussed under “Risk Factors” in Part I, Item 1A of this annual Report on Form 10-K. The Company encourages readers to review these risk factors in their entirety.

This annual report of MBIA Inc. also includes statements of the opinion and belief of MBIA management which may be forward-looking statements subject to the preceding cautionary disclosure. Unless otherwise indicated herein, the basis for each statement of opinion or belief of MBIA management in this report is the relevant industry or subject matter experience and views of certain members of MBIA’s management. Accordingly, MBIA cautions readers not to place undue reliance on any such statements, because like all statements of opinion or belief they are not statements of fact and may prove to be incorrect. We undertake no obligation to publicly correct or update any statement of opinion or belief if the Company later becomes aware that such statement of opinion or belief was not or is not then accurate. In addition, readers are cautioned that each statement of opinion or belief may be further qualified by disclosures set forth elsewhere in this report or in other disclosures by MBIA.


Table of Contents

PART I

Item 1. Business

As used in this Annual Report on Form 10-K, (i) “MBIA,” the “Company,” “we,” “our” and “us” refer to MBIA Inc., a Connecticut corporation incorporated in 1986, together with its subsidiaries, and (ii) unless otherwise indicated or the context otherwise requires, references to “MBIA Corp.” are (i) for any references relating to the period ended January 10, 2017, to MBIA Insurance Corporation, together with its subsidiaries, MBIA UK Insurance Limited (“MBIA UK”), and MBIA Mexico S.A. de C.V. (“MBIA Mexico”) and (ii) for any references relating to the period after January 10, 2017, to MBIA Insurance Corporation together with MBIA Mexico.

OVERVIEW

MBIA’s primary business is to provide financial guarantee insurance to the United States’ public finance markets through our indirect, wholly-owned subsidiary, National Public Finance Guarantee Corporation (“National”).

National’s financial guarantee insurance policy provides investors with unconditional and irrevocable guarantees of the payment of the principal, interest or other amounts owing on insured obligations when due. The principal economic value of our financial guarantee insurance for capital markets issuers is to lower the interest cost of an insured obligation relative to the interest cost on the obligation if it had been issued without the insurance. In addition, for certain complex financings and for obligations of certain issuers that are not well-known by investors, insured obligations have historically received greater market acceptance than uninsured obligations. 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.

MBIA has also provided financial guarantee insurance in the international and structured finance markets through its MBIA Corp. subsidiary. MBIA Corp. continues to manage its insured portfolio, which has been reduced substantially from $331.2 billion as of December 31, 2007 to $30.9 billion as of December 31, 2016. Effective on January 10, 2017, MBIA Corp.’s wholly-owned subsidiary, MBIA UK (Holdings) Limited (“MBIA UK Holdings”), the parent company to MBIA UK, sold MBIA UK, to Assured Guaranty Corp. (“Assured”), a subsidiary of Assured Guaranty Ltd. Included in the $30.9 billion was $12.0 billion of gross par outstanding related to MBIA UK. We do not expect MBIA Corp. to write any significant new policies in the foreseeable future in light of its current ratings, accumulated losses and non-policy claims related to our subordinate preferred stock holders, surplus note holders and other lenders.

Given MBIA Corp.’s capital structure and business prospects, we do not expect its financial performance to have a material impact on MBIA Inc., except for any impact it may have on the consolidated deferred tax asset relating to the Company’s net operating loss carryforwards. Refer to “Results of Operations—Capital Resources” in Part II, Item 7 of this Form 10-K for a further discussion of MBIA Corp.’s insurance statutory capital, and “Note 11: Income Taxes” in the Notes to Consolidated Financial Statements in Part II, Item 8 of this Form 10-K for a further discussion of income taxes.

MBIA Inc. also owns MBIA Services Corporation (“MBIA Services”), a service company which provides support services such as surveillance, risk management, legal, accounting, treasury and information technology, among others, to our businesses on a fee-for-service basis.

MBIA completed a sale of its asset management advisory services business operated under Cutwater Holdings LLC, during the first quarter of 2015.

 

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Item 1. Business (continued)

 

OUR BUSINESS STRATEGY

National Ratings and New Business Opportunities

National is the largest U.S. public finance-only bond insurer in the financial guarantee industry as measured by total gross insured par outstanding of $110.4 billion as of December 31, 2016. Our primary activity is to insure new issue and secondary market municipal bonds while providing ongoing surveillance of National’s existing insured portfolio. National’s ability to write new business and to compete with other financial guarantors is largely dependent on the financial strength ratings assigned to National by the rating agencies. As of December 31, 2016, National was rated AA+ with a stable outlook by Kroll Bond Rating Agency (“Kroll”), AA- with a stable outlook by Standard & Poor’s Financial Services LLC (“S&P”), and A3 with a negative outlook by Moody’s Investors Services, Inc. (“Moody’s”).

National pursues opportunities for new business in most municipal sectors. Based on our underwriting and pricing criteria, the majority of our new business is in the general obligation, tax-backed and revenue bond sectors. In addition to the new issue market, we are pursuing opportunities in the secondary market with respect to bonds issued in recent years that were not insured and that meet our underwriting criteria.

National seeks to generate shareholder value at appropriate risk-adjusted pricing; however, current market conditions and the competitive landscape limit National’s new business opportunities and our ability to price and underwrite risk with attractive returns.

For the issuer, the primary value of financial guarantee insurance is largely determined by the spread between the interest rate on insured versus uninsured debt. The recent environment of low interest rates reduces the value of insurance to a level which may be unattractive to the issuer (insufficient reduction in interest costs to offset the premium on the insurance) as well as the guarantor (insufficient premium relative to the risk assumed and capital deployed). Furthermore, investors may choose to purchase uninsured bonds to increase their returns. An environment of higher interest rates and/or wider spreads would likely enhance the new business opportunities for National. We also believe the current stress in certain sectors of the municipal bond market reinforces the value of National’s guarantee of timely payment of interest and principal.

MBIA Inc. Capital Management

The Company manages its capital and liquidity in order to ensure that it can service its debt and other financial obligations and pay its operating costs while maintaining an adequate cushion against adverse events. As a result of consistent dividends from National and releases from the tax escrow account, MBIA Inc. maintains a stable liquidity position which allows it more strategic flexibility in deploying its capital. Our capital management strategy is to balance leverage by (i) repurchasing outstanding MBIA Inc. common shares when management deems such action appropriate taking into account the price of the stock and its anticipated liquidity needs and (ii) reducing our unsecured debt through calls and repurchases, while continuing to move toward an investment-grade capital structure.

During 2016, the Company repurchased 16.6 million shares at a cost of $105 million under repurchase authorizations approved by the Board in October of 2015 and February of 2016. During 2015, the Company repurchased 31.9 million shares at a cost of $233 million under repurchase authorizations approved by the Board in October of 2014 and July of 2015. In addition, National purchased eight million shares at a cost of $70 million under a one-time authorization approved by the Board in May of 2015. At each time of repurchase, management and the Board viewed such use of available capital as the best alternative for capital management.

During the fourth quarters of 2016 and 2015, National declared and paid dividends of $118 million and $114 million, respectively, to its ultimate parent, MBIA Inc. In addition, during the first quarters of 2017 and 2016, MBIA Inc. received a total of $94 million and $105 million, respectively in cash and securities from an escrow account held by MBIA Inc. under the MBIA group’s tax sharing agreement as described further under “Results of Operations—Liquidity––MBIA Inc. Liquidity.” Unsecured debt includes MBIA Inc.’s senior notes and medium-term notes (“MTNs”) issued by MBIA Global Funding, LLC (“GFL”). During 2016, we repurchased $6 million of debt issued by GFL. In addition, $123 million of debt issued by GFL matured during 2016. During 2015, we repurchased $50 million of debt issued by MBIA Inc. or its subsidiary GFL. In addition, $78 million of debt issued by GFL matured during 2015.

 

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Item 1. Business (continued)

 

MBIA Corp. Risk Mitigation

MBIA Corp. has not written a meaningful amount of new business since 2008 as a result of declining financial capacity, ratings downgrades and regulatory limitations placed on its business. Since that time it has experienced considerable stress as a result of unprecedented levels of delinquency and loss in its structured finance insurance business, primarily in its residential mortgage-backed securities (“RMBS”), commercial mortgage-backed securities (“CMBS”) pools, and collateralized debt obligation (“CDO”) portfolios. As a result, since 2008, MBIA Corp.’s strategy has focused primarily on recovering losses on insured RMBS transactions related to the failure of certain RMBS sellers/servicers to honor their contractual obligations to repurchase ineligible mortgage loans from securitizations that MBIA Corp. insured, reducing future expected economic losses in the insured portfolio through commutations and other risk mitigation strategies, and managing liquidity. To date, MBIA Corp. has settled the majority of its claims related to the improper inclusion of ineligible mortgage loans in insured securitizations, except with regards to its claims against Credit Suisse, which it estimates as totaling $435 million as of December 31, 2016. Refer to “Note 6: Loss and Loss Adjustment Expense “ in the Notes to Consolidated Financial Statements in Part II, Item 8 of this Form 10-K for further information regarding loss reserves and recoveries.

Our liquidity and capital forecasts for MBIA Corp. and projected collections of the remaining put-back recoverable and excess spread (the difference between interest inflows on assets and interest outflows on liabilities in our insured RMBS transactions) reflect resources that we expect to be adequate to pay expected claims. However, there can be no assurance that MBIA Corp. will realize its expected recoveries in full or on its projected timeframe. Refer to “Risk Factors—MBIA Corp. Risk Factors—Continuing elevated loss payments and delay or failure in realizing expected recoveries on insured transactions may materially and adversely affect MBIA Insurance Corporation’s statutory capital and its ability to meet liquidity needs and could cause the New York State Department of Financial Services (the “NYSDFS”) to put MBIA Insurance Corporation into a rehabilitation or liquidation proceeding if the NYSDFS concludes that MBIA Insurance Corporation will not be able to pay expected claims,” in Item 1A of this Form 10-K. Given the separation of MBIA Inc. and MBIA Corp. as distinct legal entities, the absence of any cross defaults between the entities, and the lack of reliance by MBIA Inc. on MBIA Corp. for the receipt of dividends, we do not believe that a rehabilitation or liquidation proceeding of MBIA Insurance Corporation by the NYSDFS would have any significant long-term liquidity impact on MBIA Inc. or result in a liquidation or similar proceeding of MBIA Mexico.

OUR INSURANCE OPERATIONS

Our U.S. public finance insurance business is conducted through National, and our international and structured finance insurance portfolios are managed through MBIA Corp. We anticipate that for the foreseeable future virtually all of our new insurance business will be written through National in the U.S. public finance sector. We expect the credit ratings of MBIA Insurance Corporation and its remaining subsidiary will continue to constrain their ability to write new business in the foreseeable future.

We are compensated for our insurance policies by insurance premiums paid upfront or on an installment basis. Our financial guarantee insurance is offered in both the new issue and secondary markets. Transactions in the new issue market may be sold either through negotiated offerings or competitive bidding. We also issue insurance policies to guarantee the payment of principal and interest on municipal obligations being traded in the secondary market upon the request of a broker or an existing holder of uninsured bonds, where the premium is generally paid by the owner of the obligation. In addition, we have provided financial guarantees or sureties to debt service reserve funds. The primary risk in our insurance operations is that of adverse credit performance in the insured portfolio. We seek to maintain a diversified insured portfolio and have insured transactions with the aim of managing and diversifying risk based on a variety of criteria including revenue source, issue size, type of asset, industry concentrations, type of bond and geographic area. Despite this objective, there can be no assurance that we will avoid losses on multiple credits as a result of a single event or series of events.

 

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Item 1. Business (continued)

 

Because we generally guarantee to the holder of an underlying obligation the timely payment of amounts due on the 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 generally cannot be accelerated against us unless we consent 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, 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.

Our payment obligations after a default vary by deal and by insurance type. Our public finance insurance generally insures scheduled interest and principal. Our structured finance policies generally insure (i) timely interest and ultimate principal; (ii) ultimate principal only at final maturity; or, (iii) payments upon settlement of individual collateral losses as they occur after any deductible or subordination has been exhausted. With respect to the insurance of certain derivative transactions, including credit default swap (“CDS”) contracts written in the international and structured finance insurance segment, in certain circumstances, including the occurrence of certain insolvency or payment defaults under the CDS contracts, the CDS contracts may be subject to termination by the counterparty, triggering a claim for the fair value of the contract. Our U.S. public finance segment did not write insurance in CDS form and therefore its policies do not feature this potential trigger.

In the event of a default in the payment of principal, interest or other insured amounts by an issuer, the insurance company will make funds available in the insured amount generally within one to three business days following notification. Longer timeframes may apply for international transactions. Generally, our insurance companies provide for this payment 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 of the rights of the holders with respect to the payments made by the insurer or other appropriate documentation.

National Insured Portfolio

National’s insured portfolio consists of municipal bonds, including tax-exempt and taxable indebtedness of U.S. political subdivisions and territories, as well as utilities, 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, user fees or tariffs related to the use of these projects, lease payments or other similar types of revenue streams.

Portfolio Profile

As of December 31, 2016, National had $110.4 billion of insured gross par outstanding on U.S. public finance obligations covering 6,469 policies and diversified among 3,417 “credits,” which we define as any group of issues supported by the same revenue source. Insurance in force, which includes all insured debt service, as of December 31, 2016 was $191.5 billion.

All of the policies were underwritten on the assumption that the insurance will remain in force until maturity or early retirement of the insured obligations. National estimates that the average life of its domestic public finance insurance policies in force as of December 31, 2016 was 10 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 as of December 31, 2016 was $11.5 billion.

 

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Item 1. Business (continued)

 

The table below shows the diversification by type of U.S. public finance insurance that was outstanding as of December 31, 2016:

National U.S. Public Finance Gross Par Amount Outstanding by Bond Type

 

     Gross Par  

In millions

   Amount  

Bond Type

  

Public finance: United States

  

General obligation

   $ 38,306  

General obligation—Lease

     8,698  

Municipal utilities

     17,352  

Tax backed

     16,690  

Transportation

     11,056  

Health care

     2,735  

Higher education

     4,466  

Municipal housing

     439  

Military housing

     7,410  

Investor-owned utilities

     2,280  

Other

     935  
  

 

 

 

Total United States—public finance

   $       110,367  
  

 

 

 

National’s underwriting guidelines limit the insurance in force for any one insured credit, and for other categories such as geography. In addition, National is subject to regulatory single-risk limits and its ratings are subject to rating agency single-risk limits with respect to any insured bond issue. Refer to “Insurance Regulation” below for a description of these regulatory requirements. As of December 31, 2016, National’s gross par amount outstanding for its ten largest insured U.S. public finance credits totaled $12.0 billion, representing 10.9% of National’s total U.S. public finance gross par amount outstanding.

MBIA Corp. Insured Portfolio

MBIA Corp.’s insured portfolio consists of policies that insure various types of international public finance and structured finance obligations that were sold in the new issue and secondary markets or are referenced in CDS contracts. International public finance obligations include bonds and loans extended to entities located outside of the U.S., including utilities, infrastructure projects and sovereign-related and sub-sovereign issuers, such as regions, authorities or their equivalent as well as sovereign owned entities that might be supported by a sovereign state, region or authority. Sovereign-related includes Private Finance Initiative transactions that involve private entities that receive contractual payments for providing services to public sector entities. Structured finance obligations include asset-backed transactions and financing of commercial activities that are typically secured by undivided interests or collateralized by the related assets or cash flows or, in the case of certain CDS transactions, reference the underlying obligations. Certain policies cover payments potentially due under CDS, including termination payments that may become due in certain circumstances, including the occurrence of certain insolvency or payment defaults under the CDS or derivatives contracts by the insured counterparty or by the guarantor. Effective on January 10, 2017, MBIA UK Holdings sold MBIA UK to Assured.

As of December 31, 2016, MBIA Corp. had 494 policies outstanding in its insured portfolio. In addition, MBIA Corp. had 79 insurance policies outstanding relating to liabilities issued by MBIA Inc. and its subsidiaries, which are described further under the section “Other Financial Obligations” below. MBIA Corp.’s total policies in its insured portfolio are diversified among 309 “credits,” which we define as any group of policies supported by the same revenue source. Included in the number of policies and credits outstanding was 73 policies and 31 credits issued by MBIA UK.

Portfolio Profile

As of December 31, 2016, the gross par amount outstanding of MBIA Corp.’s insured obligations (excluding $1.3 billion of MBIA insured investment agreements and MTNs, and $3.4 billion of U.S. public finance debt ceded to National), was $30.9 billion. Insurance in force for the above portfolio, which includes all insured debt service, as of December 31, 2016 was $44.4 billion.

 

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Item 1. Business (continued)

 

MBIA Corp. underwrote its policies on the assumption that the insurance would remain in force until maturity of the insured obligations. MBIA Corp. estimates that the average life of its international and structured finance insurance policies in force as of December 31, 2016 was 9 years. The average life was determined by applying a calculation using the remaining years to contractual maturity for international public finance 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 as of December 31, 2016 was $3.3 billion.

The table below shows the diversification by type of insurance that was outstanding as of December 31, 2016:

MBIA Corp. Gross Par Amount Outstanding for the International and Structured Finance

Portfolio by Bond Type (1)

 

     Gross Par  

In millions

   Amount  

Bond Type

  

Public finance: non-United States

  

Sovereign-related and sub-sovereign

   $ 7,490  

International utilities

     6,523  

Transportation

     5,247  

Local governments (2)

     106  

Tax backed

     80  
  

 

 

 

Total public finance—non-United States

     19,446  
  

 

 

 

Global structured finance:

  

Collateralized debt obligations (3)

     2,550  

Mortgage-backed residential

     4,721  

Mortgage-backed commercial

     345  

Consumer asset-backed

     940  

Corporate asset-backed(4)

     2,856  
  

 

 

 

Total global structured finance

     11,412  
  

 

 

 

Total (5)

   $     30,858  
  

 

 

 

 

(1)—Excludes $1.3 billion relating to investment agreements and MTNs issued by affiliates of the Company which are guaranteed by MBIA Corp.

(2)—Includes municipal-owned entities backed by the sponsoring local government.

(3)—Includes transactions (represented by structured pools of primarily investment grade corporate credit risks, CMBS or other CRE assets) that may not include typical CDO structuring characteristics, such as tranched credit risk, cash flow waterfalls, or interest and over-collateralization coverage tests.

(4)—Includes $1.3 billion of structured insurance securitizations.

(5)—Includes $12.0 billion of gross par outstanding insured by MBIA UK, which was sold to Assured on January 10, 2017.

MBIA Inc. Financial Obligations Insured by MBIA Corp.

Prior to 2008, MBIA Inc. and its subsidiaries raised funds for investment through the issuance of customized investment agreements by MBIA Inc. and one of its subsidiaries and the issuance of MTNs with varying maturities issued by our subsidiary, GFL. Each of these obligations is guaranteed by MBIA Corp. GFL lent the proceeds of its GFL MTN issuances to MBIA Inc. As a result of ratings downgrades of MBIA Corp., MBIA Inc. is required to post collateral for the remaining investment agreements. Since the ratings downgrades of MBIA Corp. that began in 2008, we have not issued new MTNs or investment agreements. The investment agreements are currently fully collateralized with high quality assets. We believe the outstanding investment agreements and MTNs and corresponding asset balances will continue to decline over time as the liabilities mature, terminate, or are repurchased by the Company.

 

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Item 1. Business (continued)

 

Risk Management

Our largest risk is the credit exposure in our insured portfolio. MBIA’s credit risk management and remediation functions are managed through committees and units that oversee risks both at transaction origination and in ongoing portfolio monitoring, surveillance and remediation. MBIA’s Insured Portfolio Management Division monitors and remediates structured finance and international infrastructure risks while National’s Portfolio Surveillance Group performs this function with respect to U.S. public finance transactions. The Restructuring and Remediation Group is responsible for certain transactions that require intensive remediation. National and MBIA Insurance Corporation each has a risk committee to review underwriting decisions. On an enterprise-wide basis, executive committees provide risk oversight.

The Company’s Risk Oversight Committee (the “Risk Oversight Committee”) reviews transactions not otherwise reviewable by the subsidiary risk committees, and provides firm-wide review of policies and decisions related to credit, market, operational, legal, financial and business risks. The Company’s Loss Reserve Committees review reserve activity, and its Investment Committees review investment decisions and portfolios.

The Board of Directors and its Committees oversee risks faced by the Company and its subsidiaries. The Board regularly evaluates and discusses risks associated with strategic initiatives. On an annual basis, the Board also evaluates and approves the Company’s risk tolerance guidelines. The purpose of the risk tolerance guidelines is to delineate the types and amounts of risks the Company is prepared to accept. This policy provides the basis upon which risk criteria and procedures are developed and seeks to have these applied consistently across the Company. The Board’s Audit Committee and Finance and Risk Committee meaningfully participate in the oversight of risks faced by the Company.

The Audit Committee oversees risks associated with financial and other reporting, auditing, legal and regulatory compliance, and risks that may otherwise result from the Company’s operations. The Audit Committee oversees these risks by monitoring (i) the integrity of the financial statements of the Company and of other material financial disclosures made by the Company, (ii) the qualifications, independence and performance of the Company’s independent auditor, (iii) the performance of the Company’s internal audit function, (iv) the Company’s compliance policies and procedures and its compliance with legal and regulatory requirements, and (v) the performance of the Company’s operational risk management function.

The Finance and Risk Committee oversees the Company’s credit risk governance framework, market risk, liquidity risk and other material financial risks. The Finance and Risk Committee oversees these risks by monitoring the Company’s: (i) capital and liquidity, (ii) proprietary investment portfolios, (iii) exposure to changes in the market value of assets and liabilities, (iv) credit exposures in the Insured Portfolios, and (v) financial risk policies and procedures, including regulatory requirements and limits.

At each regular meeting of the Board, the Chairs of each of these committees report to the full Board regarding the meetings and activities of their respective committees.

The Company’s Risk Oversight Committee has designated a Models Governance Team. Given the significance of models in the Company’s insurance underwriting, surveillance financial reporting and corporate treasury operations, among other activities, the Company established a Models Risk Governance Policy to enhance the reliability, maintainability and transparency of its models so that models risk can be mitigated on an enterprise-wide basis. The Models Governance Team is responsible for the Models Risk Governance Policy as well as other Models Governance related initiatives.

 

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Insurance Monitoring and Remediation

We monitor and remediate our existing insured portfolios on an ongoing basis. Although our monitoring and remediation activities vary somewhat by sector and bond type, in all cases we focus on assessing event risk and possible losses under stress.

 

    U.S. Public Finance: For U.S. public finance, our underwriting at origination and ongoing monitoring focuses on economic and political trends, issuer or project debt and financial management, construction and start up risk, adequacy of historical and anticipated cash flows under stress, satisfactory legal structure and bond security provisions, viable tax and economic bases, including consideration of tax limitations and unemployment trends, adequacy of stressed loss coverage and project feasibility, including satisfactory reports from consulting engineers, traffic advisors and others, if applicable. Depending on the transaction, specialized cash flow analyses may be conducted to understand loss sensitivity. In addition, specialized credit analysts consider the potential event risk of natural disasters or headline events on both single transactions and across a sector, as well as regulatory issues. U.S. public finance transactions are monitored by reviewing trustee, issuer and project financial and operating reports as well as reports provided by technical advisors and counsel. Projects may be periodically visited by National personnel.

 

    International Public Finance: International public finance transactions are monitored and remediated in a manner relatively consistent with U.S. public finance transactions. In addition, credit analysts consider country risk, including economic and political factors, the type and quality of local regulatory oversight, the strength of the legal framework in each country and the stability of the local institutional framework. Analysts also monitor local accounting and legal requirements, local financial market developments, the impact of exchange rates and local demand dynamics. Furthermore, exposures are reviewed periodically; the frequency and scope of review is often increased when an exposure is downgraded. MBIA personnel may periodically visit projects or issuers to meet with management.

 

    Structured Finance Transactions: For structured finance transactions, we focus on the historical and projected cash flows generated by the assets, the credit and operational strength of the originator, servicer, manager and/or operator of the assets, and the transaction’s structure (including the degree of protection from bankruptcy of the originator or servicer). We may use both probability modeling and cash flow sensitivity analysis (both at the transaction and asset specific levels) to test asset performance assumptions and performance covenants, triggers and remedies. In addition, the Insured Portfolio Management Division may use various quantitative tools and qualitative analyses to test for credit quality, correlation, liquidity and capital sensitivity within the insured portfolio.

Key to our ongoing monitoring is early detection of deterioration in either transaction credit quality or macroeconomic or market factors that could adversely impact an insured credit. If deterioration is detected, analysts generally evaluate possible remedial actions and, in the event of significant stress, we may involve a dedicated workout unit, the Restructuring and Remediation Group, to assess and monitor the credit and, if necessary, help develop and implement a remediation strategy. The nature of any remedial action is based on the type of 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 work with the issuer, trustee, legal counsel, financial advisors, servicer, other creditors, underwriters and/or other related parties to reduce chances of default and the potential severity of loss if a default should occur.

We use an internal credit rating system to rank 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 is expected with respect to an insured issue using probability-weighted expected cash flows based on available information, including market data, we place the issue on the “Classified List” and establish a case basis loss reserve for that insured issue. Refer to “Losses and Reserves” below for information on our loss reserving process.

 

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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 and third-party models based on individual transaction 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 as may be required for financial reporting. When using third-party models, we generally perform the same review and analyses of the collateral, transaction structure, performance triggers and cash flow waterfalls as when using our internal models. Refer to “Risk Factors—Insured Portfolio Loss Related Risk Factors—Financial modeling involves uncertainty over ultimate outcomes which makes it difficult to estimate liquidity, potential paid claims, loss reserves and fair values” in Item 1A of this Form 10-K.

Market Risk Assessment

We measure and assess market risk on a consolidated basis as well as at the holding company and subsidiaries on a stand-alone basis. Key market risks are changes in interest rates, credit spreads and foreign exchange. We use various models and methodologies to test exposure under market stress scenarios, including parallel and non-parallel shifts in the yield curve, changes in credit spreads, and changes in foreign exchange rates. We also analyze stressed liquidity scenarios and stressed counterparty exposures. The analyses are used in testing investment portfolio guidelines. The Risk Oversight Committee and the Finance and Risk Committee of the Company’s Board of Directors receive periodic reports on market risk.

Operational Risk Assessment

The Operational Risk function assesses potential economic loss or reputational impact arising from processes and controls, systems, or staff actions and seeks to identify vulnerabilities to operational disruptions caused by external events. The Operational Risk framework is generally managed using a self-assessment process across our business units, with controls associated with the execution of key processes monitored through Internal Audit reviews. The Operational Risk function reports periodically to the Risk Oversight Committee and the Audit Committee of the Company’s Board of Directors. The Audit Committee reviews the Company’s operational risk profile, risk event activity and ongoing risk mitigation efforts.

Losses and Reserves

Loss and loss adjustment expense (“LAE”) reserves are established by Loss Reserve Committees in each of our operating insurance companies and are reviewed by our executive Loss Reserve Committee, which consists of members of senior management. The Company’s loss and LAE reserves as of December 31, 2016 represent case basis reserves and estimates for LAE to be incurred. Case basis reserves represent the Company’s estimate of expected losses to be paid under its insurance contracts, net of potential recoveries and discounted using a current risk-free interest rate, for contracts where the estimated loss amount exceeds the unearned premium revenue on the related insurance contract. The Company estimates expected losses net of potential recoveries using the present value of probability-weighted estimated loss payments and recoveries, discounted at a rate equal to the risk-free rate applicable to the currency and weighted average remaining life of the insurance contract as required by accounting principles for financial guarantee contracts. We record case basis loss reserves on insured obligations which have defaulted or are expected to default during the remaining life of the obligation.

For a further discussion of the methodology used by the Company for determining when a case basis reserve is established, refer to “Results of Operations—Critical Accounting Estimates—Loss and Loss Adjustment Expense Reserves” in Part II, Item 7 of this Form 10-K. 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 or that the timing of claims payments and the realization of recoveries will not create liquidity issues for the corresponding insurance company.

 

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Reinsurance

We currently have third-party reinsurance agreements in place covering 3% of our insured par outstanding. At this time we do not intend to utilize reinsurance to decrease the insured exposure in our portfolio or increase our capacity to write new business; however, we may, from time to time, look to enter into transactions to reduce risks embedded in our insured portfolios on an individual and portfolio-wide basis.

Intercompany Reinsurance Arrangements

MBIA Corp. and National are parties to a reinsurance agreement pursuant to which National reinsures certain public finance financial guarantee policies originally written by MBIA Corp., as well as an assignment agreement under which MBIA Corp. assigned to National its rights and obligations under public finance financial guarantee policies of Financial Guaranty Insurance Company (“FGIC”) which were originally reinsured by MBIA Corp., and ultimately novated to National pursuant to a novation agreement between National and FGIC effective August of 2013. In addition, National entered into second-to-pay policies covering the policies covered by each of these agreements. The reinsurance agreement pursuant to which MBIA Corp. had reinsured the FGIC public finance guarantee policies was terminated in 2013 in connection with the novation to National of the policies covered by the agreement.

MBIA Insurance Corporation maintains a reinsurance agreement and net worth maintenance agreement with MBIA Mexico pursuant to which MBIA Insurance Corporation 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, subject to certain New York State regulatory requirements as well as certain contract restrictions. In December of 2015, MBIA Insurance Corporation terminated its reinsurance agreement and its net worth maintenance agreement with MBIA UK by mutual consent.

Insurance Regulation

National and MBIA Insurance Corporation are incorporated in and subject to primary insurance regulation and supervision by the State of New York. MBIA Mexico is organized and subject to primary regulation and supervision in Mexico. The Company’s insurance subsidiaries are also licensed to issue financial guarantee policies in multiple jurisdictions as needed to conduct their business activities.

The extent of state and national insurance regulation and supervision varies by jurisdiction, but New York, 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, and if our insurance companies fail to meet such requirements our regulators may impose certain remedial actions. Among other regulated conduct, these laws and regulations 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 Insurance Corporation and National each are required to file detailed annual financial statements with the NYSDFS and similar supervisory agencies in each of the other jurisdictions in which it is licensed. The operations and accounts of the insurance companies are subject to examination by regulatory agencies at regular intervals. In addition to being subject to the insurance laws in the jurisdictions in which we operate, as a condition to obtaining required insurance regulatory approvals to enter into certain transactions and take certain other corporate actions, including the release of excessive contingency reserves in MBIA Insurance Corporation described below under “Contingency Reserves” and entry into the asset swap between MBIA Inc. and National described under “Liquidity––MBIA Inc. Liquidity” in Part II, Item 7 of this Form 10-K, MBIA Inc. and its operating insurance subsidiaries have and may in the future agree to provide notice to the NYSDFS or other applicable regulators prior to entering into transactions or taking other corporate actions (such as paying dividends when applicable statutory tests are satisfied) that would not otherwise require regulatory approval.

 

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New York Insurance Regulation

Our domestic insurance companies are licensed to provide financial guarantee insurance under Article 69 of the New York Insurance Law (the “NYIL”). 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 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 insurance companies 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. Amendments to the statutes or regulations governing financial guarantee insurers are possible, but the adoption or timing of any such amendments is uncertain.

New York State Dividend Limitations

The laws of New York regulate the payment of dividends by National and MBIA Insurance Corporation and provide that a New York domestic stock property/casualty insurance company 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 NYSDFS, 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 Superintendent of Financial Services of the State of New York (the “Superintendent”) approves a greater dividend distribution based upon a finding that the insurer will retain sufficient surplus to support its obligations and writings.

National declared and paid a dividend of $118 million to its ultimate parent, MBIA Inc., during the fourth quarter of 2016.

Due to its significant negative earned surplus, MBIA Insurance Corporation has not had the statutory capacity to pay dividends since December 31, 2009 and is not expected to have any statutory capacity to pay any dividends for the foreseeable future. In connection with MBIA Insurance Corporation obtaining approval from the NYSDFS to release excessive contingency reserves as of September 30, 2011, December 31, 2011 and March 31, 2012, MBIA Corp. agreed that it would not pay any dividends without receiving prior approval from the NYSDFS.

The foregoing dividend limitations are determined in accordance with statutory accounting principles (“U.S. STAT”), which generally produce statutory earnings in amounts less than earnings computed in accordance with accounting principles generally accepted in the U.S. (“GAAP”). Similarly, policyholders’ surplus, computed on a U.S. STAT basis, will normally be less than net worth computed on a GAAP basis.

Contingency Reserves

As financial guarantee insurers, our domestic insurance companies are required by the laws and regulations of New York and other states to maintain, as applicable, contingency reserves on their municipal bond, asset-backed securities (“ABS”) or other financial guarantee liabilities. Under New York law, a financial guarantee insurance company 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). Other states maintain similar requirements. The contribution to, and maintenance of, the contingency reserve limits the amount of earned surplus that might otherwise be available for the payment of dividends. In each state, our domestic insurance companies may apply for release of portions of their contingency reserves in certain circumstances.

 

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Risk Limits

Insurance laws and regulations also limit both the aggregate and individual securities risks that our domestic insurance companies may insure on a net basis based on the type of obligations insured. The individual limits are generally on the amount of insured par and/or annual debt service for a given insured issue, entity or revenues source and stated as a percentage of the insurer’s policyholders’ surplus and contingency reserves. The aggregate risk limits limit the aggregate amount of insured par to a stated multiple of the insurer’s policyholders’ surplus and contingency reserves based on the types of obligations insured. The aggregate risk limits can range from 300:1 for certain municipal obligations to 50:1 for certain non-municipal obligations.

National is in compliance with the relevant aggregate and single risk limits. During 2016 and 2015, MBIA Insurance Corporation reported single risk limit overages to the NYSDFS due to changes in its statutory capital. MBIA Insurance Corporation is currently in compliance with its aggregate risk limits as of December 31, 2016.

Holding Company Regulation

MBIA Inc., National and MBIA Insurance Corporation also are subject to regulation under the insurance holding company statutes of New York. 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 NYSDFS is required for any entity seeking to acquire, directly or indirectly, “control” of National or MBIA Insurance Corporation. In many states, including New York, “control” is presumed to exist if 10% or more of the voting securities of the insurer are owned or controlled, directly or 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. MBIA Insurance Corporation would require the prior approval of MBIA Mexico’s regulator in order to transfer the shares it currently holds in MBIA Mexico. To the Company’s knowledge, no MBIA Inc. shareholder owns 10% or more of MBIA Inc.’s outstanding common stock as of December 31, 2016, and thus no shareholder has had to receive appropriate approvals or determinations of non-control in connection with its investment.

Insurance Guarantee Funds

National and MBIA Insurance Corporation 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.

 

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Insured Credit Default Swaps

Certain of our insurance policies guarantee payments due under CDS and other derivatives. In July of 2010, the Dodd-Frank Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law for the purpose of enacting broad financial industry regulatory reform, including by enhancing regulation of the over-the-counter derivatives markets. Among other reforms, the Dodd-Frank Act requires “swap dealers” and “major swap participants” to register with either or both of the Commodity Futures Trading Commission (“CFTC”) and the Securities and Exchange Commission (“SEC”), and to be subject to enhanced regulation, including capital requirements. Previously, MBIA Corp. was registered with the CFTC as a major swap participant and had been required to comply with the CFTC’s business conduct rules as applied to portfolios in place prior to the enactment of the Dodd-Frank Act. In May of 2015, MBIA Corp. de-registered as a major swap participant as the notional amount and fair value of its CDS exposures declined below the registration thresholds. As of December 31, 2016, MBIA Corp. insured 4 CDS policies with $588 million of gross par outstanding.

OUR ADVISORY SERVICES

Until January of 2015, we conducted our asset management advisory services business through two registered investment adviser subsidiaries of Cutwater Holdings, LLC (together, “Cutwater”), a wholly-owned subsidiary of MBIA Inc. The Company had $21.3 billion in institutional assets under management as of December 31, 2014, including $10.1 billion from the Company and its subsidiaries. Effective January 1, 2015, we completed the sale of Cutwater to the Bank of New York Mellon Corporation. This transaction had a positive but immaterial impact on the Company’s financial position and results of operations. In connection with the sale, the Company and its subsidiaries entered into investment management agreements with Cutwater (now known as “Insight Investment”) to manage their respective fixed-income investment portfolios for the next five years.

Other Advisory Services

During 2014, we exited the advisory and asset management services business in the European Union.

OUR CONDUIT BUSINESS

During 2014, our conduit segment was operated primarily through Meridian Funding Company, LLC (“Meridian”). Meridian was used by banks and other financial institutions to raise funds through MTN issuances. The proceeds from these issuances were used to either make loans to customers that were secured by certain assets or to purchase assets from customers. During 2014, we retired Meridian’s remaining $129 million outstanding MTNs, and completed the liquidation of Meridian.

INVESTMENTS AND INVESTMENT POLICY

Investment objectives, policies and guidelines related to the Company’s businesses are generally subject to review and approval by the Finance and Risk Committee of the Board of Directors. Investment objectives, policies and guidelines related to investment activity on behalf of our insurance companies are also subject to review by the respective Investment Committee of their Boards of Directors or similar body.

Insight Investment manages the proprietary investment portfolios of the Company and its subsidiaries in accordance with the guidelines adopted for each such portfolio. The agreements with Insight Investment provide generally that Insight Investment will have the exclusive right to manage the fixed-income investment portfolios of the Company and its subsidiaries until 2020 and guarantee certain minimum revenues thereunder. The agreements are subject to early termination under certain conditions including if certain performance objectives are not met.

 

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To continue to optimize capital resources and provide for claims-paying capabilities, the investment objectives and policies of our insurance operations are tailored to reflect their various strategies and operating conditions. The investment objectives of MBIA Corp. are primarily to maintain adequate liquidity to meet claims-paying and other corporate needs and secondarily to maximize after-tax income within defined investment risk limits. The investment objectives of National set preservation of capital as the primary objective, subject to an appropriate degree of liquidity, and optimization of after-tax income and total return as secondary objectives. The investment objectives of the corporate segment are to provide sufficient liquidity to meet maturing liabilities and, in the case of the investment agreement business collateral posting obligations, while maximizing the total long-term return. The investment portfolio of each subsidiary is managed by Insight Investment under separate investment services agreements.

COMPETITION

National competes with other monoline insurance companies, as well as other forms of credit enhancement, in writing financial guarantee business. We anticipate that for the foreseeable future all of our new insurance business in the U.S. public finance sector will be written by National.

Our ability to attract and compete for U.S. public finance financial guarantee business is dependent in part on the financial strength ratings assigned to National by the rating agencies. Refer to “Rating Agencies” below for information on the Company’s current financial strength ratings.

There are currently two other bond insurers actively engaged in selling insurance policies in the U.S. public finance insurance market. We have observed significant competition for business between these financial guarantors, and as a result opportunities to write new business with attractive returns have been limited. In addition, National’s rating differential from its competitors and absence from the municipal market for several years resulting in the need to build National’s name recognition has also affected its ability to write new business. We expect the impact of this factor on National’s ability to attract new business to decline as National writes more new business. In addition, the percentage of new public finance issuances with financial guarantee insurance remains significantly lower than before the financial crisis, and the inability of financial guarantee insurers to maintain or achieve high ratings could diminish acceptance of the product and enhance the appeal of other forms of credit enhancement.

Financial guarantee insurance competes with other forms of credit enhancement. Commercial banks provide letters of credit as a means of credit enhancement for municipal securities. During 2016, the use of letters of credit as an alternative to financial guarantee insurance within the U.S. municipal market was far below its peak in 2009; however, letters of credit have remained a presence in the market. Direct lending by banks to municipal issuers also reduces demand for credit enhancement. Other highly rated institutions, including pension funds and government sponsored entities, also offer third-party credit enhancement on 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. 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. All of these alternative forms of credit enhancement or alternative executions could also affect our ability to write new business with attractive returns.

RATING AGENCIES

Rating agencies perform periodic reviews of our insurance companies and other companies providing financial guarantee insurance. In rating financial guarantee companies, rating agencies focus on qualitative and quantitative characteristics in certain key areas, including: (1) franchise value and business strategy; (2) insurance portfolio characteristics; (3) capital adequacy; (4) profitability; (5) financial flexibility; and (6) risk management framework. Each agency has its own ratings criteria for financial guarantors and employs proprietary models to assess our risk adjusted leverage, risk concentrations and financial performance relative to the agency’s standards. The agencies also assess our corporate governance and factor this into their rating assessment.

 

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The current financial strength ratings from Kroll, S&P, and Moody’s, as applicable, are summarized below:

 

Agency    Rating / Outlook
     National    MBIA Insurance Corporation    MBIA Inc.

Kroll

   AA+ / Stable outlook    Not rated    Not rated

S&P

   AA- / Stable outlook    CCC / Negative outlook    A- / Stable outlook

Moody’s

   A3 / Negative outlook    Caa1 / Developing outlook    Ba1 / Negative outlook

CAPITAL FACILITIES

The Company does not currently maintain a capital facility. For a discussion of the Company’s capital resources refer to “Capital Resources” in Part II, Item 7 of this Form 10-K.

FINANCIAL INFORMATION

Refer to “Note 12: Business Segments” in the Notes to Consolidated Financial Statements in Part II, Item 8 of this Form 10-K for information on the Company’s financial information by segment and premiums earned by geographic location.

EMPLOYEES

As of December 31, 2016, the Company had 164 employees, including 13 in Trifinium Services Limited, our services company in the U.K. None of the Company’s employees are covered by collective bargaining 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 under the “SEC Filings” tab, free of charge, all of its SEC filings, including annual reports on Form 10-K, quarterly filings on Form 10-Q, current reports on Form 8-K and amendments to those reports as soon as is reasonably practicable after these materials have been filed with or furnished to the SEC.

As a courtesy, the Company posts on its website under the section “Legal Proceedings,” selected information and documents in reference to selected legal proceedings in which the Company is the plaintiff or the defendant. The Company will not necessarily post all documents for each proceeding and undertakes no obligation to revise or update them to reflect changes in events or expectations. The complete official court docket can be publicly accessed by contacting the clerk’s office of the respective court where each litigation matter is pending.

The Company is providing public access to certain non-confidential information regarding the assets securing the facility extended by its subsidiary, MZ Funding LLC (“MZ Funding”), on the Company’s MZ Funding web page. It will also make available certain confidential information subject to the execution of a non-disclosure agreement. Instructions for accessing the information are available on the MZ Funding web page. A description of the MZ Funding facility, as well as several documents pertaining thereto, including, among others, the Senior Note Indenture, the Credit Agreement, and the Security Agreement, can be found on the Form 8-K filed by the Company on January 10, 2017, available on the Company’s website at www.mbia.com.

 

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EXECUTIVE OFFICERS OF THE REGISTRANT

The executive officers of the Company and their present ages and positions with the Company as of March 1, 2017 are set forth below:

 

Name

   Age     

Position and Term of Office

Joseph W. Brown

     68      Chief Executive Officer and Director (officer since February 2008)

William C. Fallon

     57      President and Chief Operating Officer (officer since July 2005)

Ram D. Wertheim

     62      Executive Vice President, Chief Legal Officer and Secretary (officer since January 2000)

Anthony McKiernan

     47      Executive Vice President and Chief Financial Officer (officer since
August 2011)

Joseph W. Brown is Chief Executive Officer and a director of the Company. Mr. Brown assumed the roles of Chairman, CEO and director in February of 2008 after having retired as Executive Chairman of MBIA in May of 2007. In May of 2009, the Company’s Board of Directors accepted Mr. Brown’s recommendation to separate the roles of Chairman and CEO and elected Daniel P. Kearney as Non-Executive Chairman, with Mr. Brown continuing in the roles of CEO and director. Mr. Brown also serves as Chairman of MBIA Corp. Until May of 2004, Mr. Brown had served as Chairman and CEO of MBIA and MBIA Corp. Mr. Brown originally joined the Company as CEO in January of 1999 after having been a director since 1986, and became Chairman in May of 1999.

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’s Fund Holdings prior to the sale of its insurance subsidiary to Allianz. He served on the Safeco Corporation board from 2001 to September of 2008 and was elected Non-executive Chairman in January of 2006.

Prior to being named President and Chief Operating Officer, William C. Fallon was Vice President of the Company and head of the Global Structured Finance Division. Mr. Fallon also serves as President and Chief Executive Officer of National. From July of 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, Chief Legal Officer and Secretary, Ram D. Wertheim was Vice President, General Counsel and Secretary of the Company. Mr. Wertheim also serves as General Counsel and Secretary of MBIA Corp. and MBIA Services Corporation. From February of 1998 until January of 2000, he served in various capacities in the Global Structured Finance Division. Mr. Wertheim was, until February of 1998, the General Counsel of CMAC Holdings Inc.

Prior to being named Executive Vice President and Chief Financial Officer on May 1, 2012 and March 11, 2016, respectively, Anthony McKiernan was Vice President and Chief Portfolio Officer of the Company. Mr. McKiernan is also the President and Chief Financial Officer of MBIA Corp. Mr. McKiernan joined MBIA in 2000 as a vice president in the Credit Analytics Group, and managed the Corporate Insured Portfolio Management Group prior to becoming the Head of the Structured Finance Insured Portfolio Management Group in 2007. Before working at MBIA, Mr. McKiernan was with Fleet Financial Group where he began his career as a Credit Analyst/ Lender in asset-based lending.

The Board of Directors of MBIA Inc. appointed Messrs. Fallon, and Wertheim to the offices set forth opposite their names above on November 6, 2008 and appointed Mr. McKiernan to the offices set forth opposite his name above on May 1, 2012 and March 11, 2016.

Effective March 2, 2017, Mr. Wertheim will step down from his position as Chief Legal Officer and Secretary of the Company, and Mr. Jonathan C. Harris will be appointed the Company’s General Counsel and Secretary. Mr. Wertheim will remain an employee of the Company until January 1, 2018 to provide transition and other services as may be required.

 

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Item 1. Business (continued)

 

Mr. Harris is Deputy General Counsel and Managing Director of the Company’s subsidiaries, MBIA Services Corporation, National and MBIA Insurance Corporation, and Assistant Vice President and Assistant Secretary of the Company. Mr. Harris joined the Company as Head of Litigation in 2009. Since that time, Mr. Harris has expanded his responsibilities to work on various corporate and regulatory matters. Prior to joining the Company, Mr. Harris was litigation counsel at Lehman Brothers, and practiced in the litigation department of Willkie Farr & Gallagher.

In addition, effective as of May 11, 2017 (the day after the date on which the Company expects to file its report on Form 10-Q for the first quarter of 2017), Mr. Douglas Hamilton, the Company’s Assistant Vice President and Controller, will be stepping down from his position as Controller of the Company. It is expected that the Company will appoint Mr. Joseph Schachinger as Controller to replace Mr. Hamilton. Mr. Hamilton will remain an employee of the Company until January 1, 2018 to provide transition and other services as may be required.

Mr. Schachinger is a Managing Director of MBIA Services Corporation and Deputy Controller. As Deputy Controller, Mr. Schachinger is involved in accounting and finance matters for the Company and its subsidiaries with a focus on accounting policy and operations, financial reporting, financial control, tax, budgeting and financial analysis. Since joining MBIA in January of 2000, Mr. Schachinger has managed a variety of accounting and financial reporting functions within the Company’s insurance and non-insurance businesses.

The Company entered into a Separation Agreement with Mr. Wertheim, the material terms of which are described below (the “Separation Agreement”). Under the Separation Agreement, Mr. Wertheim will receive, subject to the execution of an acceptable general release, a one-time severance payment of $750,000 (which is consistent with the Company’s severance practices for employees) following his last day of employment. In addition, in exchange for his agreement to forfeit the outstanding performance based restricted stock awarded to him as part of the cash retention and restricted stock award made to him on December 21, 2012 and to comply with the non-compete covenant that is part of the Separation Agreement, Mr. Wertheim will receive an additional payment of $250,000. For the 2017 performance year, Mr. Wertheim will be entitled to receive, at such time as such payments are made to other employees of the Company, a cash performance bonus for the 2017 performance year, and, in lieu of the long term incentive (“LTI”) restricted stock award for the year, a cash payment at the target LTI amount. The Separation Agreement contains certain customary covenants regarding non-competition with the Company’s financial guarantee business for a period of five years, confidentiality, a two year non-solicitation of Company employees and a non-disparagement covenant.

A copy of the Separation Agreement is filed as Exhibit 10.14 hereto.

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. Our risk factors are grouped into categories and are presented in the following order: “Insured Portfolio Loss Related Risk Factors”, “Strategic Plan Related and Other Risk Factors”, “Capital, Liquidity and Market Related Risk Factors” and “MBIA Corp. Risk Factors.” Risk factors are listed in order of significance within each category.

Insured Portfolio Loss Related Risk Factors

Some of the state, local and territorial governments and finance authorities and other providers of public services, located in the U.S. or abroad, that issue public finance obligations we insure are experiencing fiscal stress that could result in increased credit losses or impairments on those obligations

Although the financial conditions of many state, local and territorial governments and finance authorities that issue the obligations we insure have improved since the financial crisis, some issuers continue to report fiscal stress that has resulted in a significant increase in taxes and/or a reduction in spending or other measures in efforts to satisfy their financial obligations. In particular, certain jurisdictions have significantly underfunded pension liabilities which are placing additional stress on their finances and are particularly challenging to restructure either through negotiation or under Chapter 9 of the United States Bankruptcy Code. If the issuers of the obligations in our public finance portfolio are unable to raise taxes, or increase other revenues, cut spending, reduce liabilities, and/or receive state or federal assistance, we may experience losses or impairments on those obligations, which could materially and adversely affect our business, financial condition and results of operations. The financial stress experienced by certain municipal issuers could result in the filing of Chapter 9 proceedings in states where municipal issuers are permitted to seek bankruptcy protection. In these proceedings, which remain rare, the resolution of bondholder claims (and by extension, those of bond insurers) may be subject to legal challenge by other creditors.

 

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Item 1A. Risk Factors (continued)

 

The Commonwealth of Puerto Rico and certain of its instrumentalities (“Puerto Rico”) is experiencing fiscal stress and constrained liquidity due to, among other things, Puerto Rico’s structural budget imbalances, no access to the capital markets, a prolonged stagnating local economy, net migration of people out of Puerto Rico and high debt burdens. The previous Governor of Puerto Rico stated in 2015 and again in 2016 that Puerto Rico’s approximately $70 billion in debt is “not payable” and he actively lobbied the U.S. Congress for bankruptcy reform and other Federal support. Furthermore, the former Governor formed a working group to study and make recommendations regarding Puerto Rico’s short- and long-term challenges. In September of 2015, this working group released a report that projected a sizable deficit of available cash resources to expenses and debt service over the next five years absent meaningful fiscal and structural reform, and concluded that a voluntary adjustment of the terms of the Commonwealth’s debt is necessary. On June 30, 2016, after passage by the United States Congress, the President of the United States signed into law the Puerto Rico Oversight, Management and Economic Stability Act (“PROMESA”). PROMESA provides a statutory framework for the creation of an independent oversight board with powers relating to, among other things, the development and implementation of fiscal plans for Puerto Rico, as well as collective action and judicial processes—separate from the Federal Bankruptcy Code—by which Puerto Rico may restructure its debt on a consensual or non-consensual basis. While National anticipates consensual negotiations with the oversight board and Puerto Rico pursuant to PROMESA, there can be no assurance that National will be able to avoid a non-consensual outcome which could result in unanticipated losses to National which could be material.

We continue to believe, based on our analysis of Puerto Rico’s fiscal and structural circumstances, the details of our insured exposures, and our legal and contractual rights, that all of our insured Puerto Rico related debt will ultimately be substantially repaid. As of December 31, 2016, National had $3.6 billion of gross insured par outstanding ($4.1 billion of gross insured par outstanding when including accreted interest on insured capital appreciation bonds) related to Puerto Rico. Puerto Rico may be unable or unwilling to pay their obligations as and when due, in which case National would be required to pay claims of unpaid principal and interest when due under its insurance policies, which could be material. On July 1, 2016, Puerto Rico defaulted on scheduled debt service for National insured bonds and National paid gross claims in aggregate of $173 million as a result of these defaults. Subsequent to December 31, 2016, National paid another $24 million on debt service that came due under its insurance policies for certain insured Puerto Rico debt. While National will seek to recover any claim payments it makes under its guarantees, there is no assurance that it will be able to recover such payments. To the extent that its claims payments are ultimately substantially greater than its claims recoveries, National would experience losses on those obligations, which could materially and adversely affect our business, financial condition and results of operations. Refer to the “U.S. Public Finance Insurance Puerto Rico Exposures” section in Part II, Item 7 of this Form 10-K for additional information on our Puerto Rico exposures.

Loss reserve estimates and credit impairments are subject to additional uncertainties and loss reserves may not be adequate to cover potential claims.

Our insurance companies issue financial guarantee policies that insure the financial performance of the obligations guaranteed over an extended period of time, in some cases over more than 30 years, and which are unconditional and irrevocable. Under substantially all of our policies, we do not have a right to cancel the policy. We do not use actuarial approaches that are customarily used by other types of insurance companies to determine our loss reserves. The establishment of the appropriate level of loss reserves is an inherently uncertain process involving numerous assumptions, estimates and subjective judgments by management, and therefore, there can be no assurance that actual paid claims in our insured portfolio will not exceed our loss reserves. If our loss reserves are not adequate to cover actual paid claims, our results of operations and financial condition could be materially adversely affected. We use financial models to project future paid claims on our insured portfolio, including insured credit derivatives, and to establish loss reserves and estimate impairments and related recoveries on insured credit derivatives. There can be no assurance that the future loss projection and impairments based on these models will ultimately reflect the actual losses and impairment and recovery that we experience. Additionally, small changes in the assumptions underlying these estimates could significantly impact loss expectations. For example, our loss reserves are discounted to a net present value reflecting our general obligation to pay claims over time and not on an accelerated basis. Risk-free rates are used to discount our loss reserves under accounting principles generally accepted in the U.S., and the yield-to-maturity of each insurer’s investment fixed-income portfolio (excluding cash and cash equivalents and other investments not intended to defease long-term liabilities) as of year-end is used to discount each insurer’s loss reserves under statutory accounting principles. Accordingly, changes in the risk-free rates or the yield in our insurance companies’ fixed-income investment portfolios may materially impact loss reserves.

 

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Item 1A. Risk Factors (continued)

 

Political and economic conditions in the United States, the Eurozone and elsewhere may materially adversely affect our business and results of operations.

As a financial guarantee company, our insured exposures and our results of operations can be materially affected by general political and economic conditions, both in the U.S. and around the world. General global unrest, fraud, terrorism, catastrophic events, natural disasters, pandemics or similar events could disrupt the economy in the U.S. and other countries where we have insured exposure or operate our businesses. In certain jurisdictions outside the U.S. we face higher risks of governmental intervention through nationalization or expropriation of assets, changes in regulation, an inability to enforce our rights in court or otherwise and corruption, which may cause us to incur losses on the exposures we insure or reputational harm. For a discussion of the Company’s exposure to sovereign debt, refer to the “Results of Operations—European Sovereign Debt Exposure” section in Part II, Item 7 of this Form 10-K.

Budget deficits at all levels of government in the U.S., recessions, increases in corporate, municipal, sovereign, sub-sovereign or consumer default rates and other general economic conditions may adversely impact the Company’s prospects for future business, as well as the performance of our insured portfolios and the Company’s investment portfolio. In addition, we are exposed to correlation risk as a result of the possibility that multiple credits will experience losses as a result of any such event or series of events, in particular exposures that are backed by revenues from business and personal travel, such as aircraft securitizations and bonds backed by hotel taxes.

Financial modeling involves uncertainty over ultimate outcomes, which makes it difficult to estimate liquidity, potential paid claims payments, loss reserves and fair values.

The Company uses third-party and internal financial models to estimate liquidity, potential claims payments, loss reserves and fair values. We use internal financial models to conduct liquidity stress-scenario testing to ensure that we maintain cash and liquid securities sufficient to meet our payment requirements. These measurements are performed on a legal entity and operating segment basis. We also rely on financial models, generated internally and supplemented by models generated by third parties, to estimate factors relating to the highly complex securities we insure, including future credit performance of the underlying assets, and to evaluate structures, rights and our potential obligations over time. We also use internal models for ongoing insurance portfolio monitoring and to estimate case basis loss reserves and, where applicable, to report our obligations under our contracts at fair value. We may supplement such models with third-party models or use third-party experts to consult with our internal modeling specialists. Both internal and external models are subject to model risk and information risk, and there can be no assurance that the inputs into the models received from third parties will be accurate or that the models themselves are accurate or comprehensive in estimating our liquidity, potential future paid claims, related loss reserves and fair values or that they are similar to methodologies employed by our competitors, counterparties or other market participants. Estimates of our claims payments, in particular, may materially impact our liquidity position. We may make changes to our estimated claims payments, loss reserves or fair value models from time to time. These changes could materially impact our financial results.

Our risk management policies and procedures may not adequately 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, 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. In some cases, losses can be substantial, particularly if a loss occurs on a transaction in which we have a large notional exposure or on a transaction structured with large, bullet-type maturities.

 

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Item 1A. Risk Factors (continued)

 

Strategic Plan Related and Other Risk Factors

An inability to maintain high stable insurer financial strength ratings for National may adversely affect our results of operations and business prospects.

There is no assurance that we will be able to maintain or improve National’s insurer financial strength ratings. Many requirements imposed by the rating agencies in order for National to maintain high ratings are outside of our control, and such requirements may necessitate raising additional capital or taking other remedial actions in a relatively short time frame in order to achieve or maintain the ratings necessary to attract new business and compete with other financial guarantee insurers, which could make the conduct of the business uneconomical or materially adversely affect our business prospects. Furthermore, there is no assurance that we will successfully comply with rating agency requirements, that these requirements or the related models and methodologies will not change or that, even if we comply with these requirements, a rating agency will not lower or withdraw its financial strength ratings with respect to any of our insurance companies.

Finally, our inability to comply with any rating agency and regulatory risk limits tests may also prevent us from writing future new business in the categories of risks that are exceeded in the case of the regulatory limits, or result in an inability to achieve or maintain our desired ratings, in the case of rating agency limits, and may adversely affect our business prospects.

Future demand for National’s financial guarantee insurance depends 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 in the municipal market is largely dependent on the financial strength ratings assigned to National by one or more of the rating agencies. It is also affected by the overall amount of new municipal bonds issued as well as the level of interest rates and the spread between insured and uninsured bonds. In addition, the perceived financial strength of other financial guarantee insurers may also affect the demand for financial guarantee insurance and/or the demand for insurance from National. The impact of the financial crisis on certain participants in the financial guarantee industry may have eroded investors’ confidence in the benefits of bond insurance. Based on current market penetration levels and overall market conditions, we do not expect the demand for municipal financial guarantee insurance to regain its pre-financial crisis level in the near term, if ever.

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 us would have an adverse effect on our ability to attract new business at appropriate pricing levels.

Competition may have an adverse effect on our businesses.

National faces competition from other financial guarantee insurance companies and other forms of credit enhancement, including senior-subordinated structures, credit derivatives, letters of credit and guarantees provided by banks and other financial institutions for example, mortgage guarantees where pools of mortgage loans secure debt service payments. We have observed increased competition for business among the active financial guarantors, and opportunities to write new business with attractive returns may be limited. 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 insurance companies’ business prospects.

We believe that issuers and investors distinguish among financial guarantors on the basis of various factors, including rating agency assessments, capitalization, size, insured portfolio concentrations 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 whose insured bonds experience better trading characteristics.

 

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Item 1A. Risk Factors (continued)

 

Downgrades of the ratings of securities that we insure 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, tenors 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, we may be required to hold more capital in reserve against credits in the insured portfolio, regardless of whether losses actually occur, or against potential new business. Significant reductions in underlying ratings of credits in an insured portfolio can produce significant increases in assessed “capital charges.” There can be no assurance that each of our insurance companies’ capital position will be adequate to meet any increased rating agency capital requirements or that each insurance company will be able to secure additional capital necessary to maintain its ratings, especially at a time of actual or perceived deterioration in the creditworthiness of new or existing credits. If National suffered material increases in capital charges and was unable to increase capital that resulted in inadequate capital to support its ratings, it could have an adverse effect on its ability to write new business.

Regulatory change could adversely affect our businesses, and regulations limit investors’ ability to effect a takeover or business combination that shareholders might consider in their best interests.

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, legal precedents and accounting rules affecting asset-backed and municipal obligations, as well as changes in those laws. Also, the failure to comply with applicable laws and regulations could expose our insurance companies, their directors or shareholders to fines, the loss of their insurance licenses, and the inability to engage in certain business activity, as the case may be. In addition, future legislative, regulatory or judicial changes could adversely affect National’s ability to pursue new business, materially impacting our financial results. These laws also limit investors’ ability to affect a takeover or business combination without the approval of our insurance regulators.

Changes to laws and regulations or the interpretation thereof could subject us to further restrictions on the type of business that we are authorized to insure. Any such restrictions could have a material effect on the amount of premiums that we could write and earn in the future. Additionally, any changes to such laws and regulations could subject our insurance companies to increase loss reserves and capital requirements or more stringent regulation generally, which could materially adversely affect our financial condition, results of operations and future business. Finally, changes to accounting standards and regulations may require modifications to our accounting methodology, both prospectively and for prior periods; such changes could have an adverse impact on our reported financial results and/or make it more difficult for investors to understand the economics of our business and may thus influence the types or volume of business that we may choose to pursue.

Our insurance companies could become subject to regulatory action.

Our insurance companies are subject to various statutory and regulatory restrictions that require them to maintain qualifying investments to support their reserves and required minimum surplus. Furthermore, our insurance companies may be restricted from making commutations or other payments if doing so would cause them to fail to meet such requirements, and the NYSDFS may impose other remedial actions on us as described further below to the extent our insurance companies do not meet such requirements.

Under the NYIL, the Superintendent of Financial Services may apply for an order directing the rehabilitation or liquidation of a domestic insurance company under certain circumstances, including upon the insolvency of the company, if the company has willfully violated its charter or the NYIL, 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 of Financial Services 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, the Superintendent 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, it could result in the reduction or elimination of the payment of dividends to MBIA Inc.

 

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Item 1A. Risk Factors (continued)

 

In addition to the Superintendent’s authority to commence a rehabilitation or liquidation proceeding, if the Superintendent finds that the liabilities of MBIA Insurance Corporation exceed its admitted assets, the Superintendent could use its authority under Section 1310 of the NYIL to order MBIA Insurance Corporation to cease making claims payments (a “1310 Order”). Continuing elevated loss payments and delay or failure in realizing expected recoveries on insured RMBS transactions as well as certain other factors may materially and adversely affect MBIA Insurance Corporation’s liquidity and its ability to timely meet its insurance obligations, and could cause the NYSDFS to put MBIA Insurance Corporation into a rehabilitation or liquidation proceeding, or issue a 1310 Order, if it does not believe MBIA Insurance Corporation will be able to pay expected claims. Refer to “Risk Factors—MBIA Corp. Risk Factors—An MBIA Insurance Corporation rehabilitation or liquidation proceeding could accelerate certain of the Company’s other obligations and have other adverse consequences” for the potential impacts of an MBIA Insurance Corporation rehabilitation or liquidation proceeding, or a 1310 Order.

Interruption in information technology and other operational systems, or a failure to maintain the security, confidentiality or privacy of sensitive data residing on such systems, could harm our business.

We depend heavily on our information technology and other operational systems and on the integrity and timeliness of data we use to run our businesses. These systems may fail to operate properly or become disabled as a result of events or circumstances wholly or partly beyond our control. Further, we face the risk of operational and technology failures by others, including various financial intermediaries and of vendors and parties to which we outsource the provision of services or business operations. If this risk is realized, we may experience operational difficulties, increased costs and other adverse effects on our business.

Despite our implementation of a variety of security measures, our information technology and other systems could be subject to physical or electronic break-ins, unauthorized tampering or other security breaches, resulting in a failure to maintain the security, confidentiality or privacy of sensitive data.

Interruption in information technology and other operational systems, or a failure to maintain the security, confidentiality or privacy of sensitive data residing on such systems, whether due to actions by us or others, could delay or disrupt our ability to do business, harm our reputation, subject us to regulatory sanctions and other claims, lead to a loss of clients and revenues and otherwise adversely affect our business.

Any impairment in the Company’s future taxable income can materially affect the recoverability of our deferred tax asset.

The recoverability of a deferred tax asset is based on an assessment of the existence of future taxable income of appropriate character. To the extent that the Company’s ability to recognize future taxable income from its existing insurance portfolio through scheduled premium earnings and net investment income becomes impaired the recoverability of certain deferred tax asset may be materially affected by a corresponding increase to its valuation allowance.

Private litigation claims could materially adversely affect our reputation, business, results of operations and financial condition.

As further set forth in “Note 20: Commitments and Contingencies” in the Notes to Consolidated Financial Statements in Part II, Item 8 of this Form 10-K, the Company and/or its subsidiaries are named as defendants in certain litigations, and in the ordinary course of business, may be a defendant in or party to a new or threatened legal action. Although the Company intends to vigorously defend against any current or future action, there can be no assurance that it will prevail in any such action, and any adverse ultimate outcome could result in a loss and/or have a material adverse effect on our reputation, business, results of operations or financial condition.

 

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Item 1A. Risk Factors (continued)

 

The Company is dependent on key executives and the loss of any of these executives, or its inability to retain other key personnel, could adversely affect its business.

The Company’s success substantially depends upon its ability to attract and retain qualified employees and upon the ability of its senior management and other key employees to implement its business strategy. The Company believes there are only a limited number of available qualified executives in the business lines in which the Company competes. The Company relies substantially upon the services of Joseph W. Brown, Chief Executive Officer, and other senior executives. There is no assurance that the Company will be able to retain the services of key executives. While the Company has a succession plan for key executives and does not expect the departure of any key executives to have a material adverse effect on its operations, there can be no assurance that the loss of the services of any of these individuals or other key members of the Company’s management team would not adversely affect the implementation of its business strategy.

Changes in U.S. federal income tax law could materially adversely affect the value of the Company’s deferred tax assets.

MBIA Inc. carries a deferred tax asset whose value is calculated by application of the federal corporate taxation rates in effect at the time of determination. As corporate income tax rates rise, in general, the value of the deferred tax asset will rise. Similarly, if corporate rates fall, as a general matter, the value of the deferred tax asset will decline. Whether federal corporate income tax rates rise, lower, or remain unchanged is typically a function of the priorities of and choices by the administration and Congress at a particular point in time. The current administration and Congress have indicated that they plan to reduce the current corporate income tax rate. If such a reduction is enacted, the carrying value of the Company’s deferred tax asset will decline, and there can be no assurance that such decrease would not have a materially adverse effect on the Company’s financial condition.

An ownership change under Section 382 of the Internal Revenue Code could have materially adverse tax consequences.

In connection with transactions in our shares from time to time, we may in the future 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. There can be no assurance that MBIA Inc. will not undergo an ownership change at a time when these limitations could have a materially adverse effect on the Company’s financial condition.

Capital, Liquidity and Market Related Risk Factors

We are a holding company and rely to a significant degree on cash flow from our principal operating subsidiaries and access to third-party capital. A disruption in the cash flow from our subsidiaries or an inability to access capital could materially and adversely affect our business, operating results and financial condition and ultimately adversely affect liquidity.

As a holding company, MBIA Inc. is largely dependent on dividends and payments under our tax sharing agreement to pay principal and interest on our indebtedness, and pay dividends, to the extent payable, on our capital stock, among other items. We expect that for the foreseeable future National will be the primary source of dividends and tax sharing agreement payments. National is subject to various statutory and regulatory restrictions, applicable to insurance companies generally, that limit the amount of cash dividends, loans and advances that it may pay. Refer to “New York State Dividend Limitations” in Item 1 and “Note 14: Insurance Regulations and Dividends” in the Notes to Consolidated Financial Statements in Part II, Item 8 of this Form 10-K for a further discussion of dividends.

 

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Item 1A. Risk Factors (continued)

 

We may also from time to time seek to raise capital from external sources. The Company’s access to external sources of financing, as well as the cost of such financing, is dependent on various factors, including (i) the long-term debt ratings of the Company, (ii) expected dividends from our subsidiaries, (iii) the insurance financial strength ratings, financial condition and long-term business prospects of our insurance companies and (iv) the perceptions of the financial strength of our insurance companies 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.

To the extent that we are unable to access external capital necessary to support our insurance companies, our insurance companies may not have sufficient liquidity to meet their obligations, may have less capacity to write business and may not be able to pay dividends to us without experiencing adverse rating agency action. Consequently, 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. In addition, future capital raises for equity or equity-linked securities could result in dilution to the Company’s shareholders. In addition, some securities that the Company could issue, such as preferred stock or securities issued by the Company’s operating subsidiaries may have rights, preferences and privileges that are senior to those of its common shares.

MBIA Inc. has substantial indebtedness, and may incur substantial additional indebtedness, which could adversely affect our financial condition, and/or our ability to obtain financing in the future, react to changes in our business and/or satisfy our obligations.

As of December 31, 2016, MBIA Inc. had $895 million of medium-term note liabilities, $576 million of Senior Notes liabilities and $399 million of investment agreement liabilities. Our substantial indebtedness and other liabilities could have material consequences because:

 

    we may be unable to obtain additional financing, should such a need arise, which may limit our ability to satisfy obligations with respect to our debt;

 

    a large portion of MBIA Inc.’s financial resources must be dedicated to the payment of principal and interest on our debt, thereby reducing the funds available to use for other purposes;

 

    it may be more difficult for us to satisfy our obligations to our creditors, resulting in possible defaults on, and acceleration of, such debt;

 

    we may be more vulnerable to general adverse economic and industry conditions;

 

    our ability to refinance debt may be limited or the associated costs may increase;

 

    our flexibility to adjust to changing market conditions could be limited, or we may be prevented from carrying out capital spending that is necessary or important to our growth strategy and efforts to improve operating margins of our businesses; and

 

    we are exposed to the risk of fluctuations in interest rates and foreign currency exchange rates because a portion of our liabilities are at variable rates of interest or denominated in foreign currencies.

Adverse developments in the credit markets may materially and adversely affect MBIA Inc.’s ability to post collateral and meet other liquidity needs.

Currently, the majority of the cash and securities of MBIA Inc. are pledged against investment agreement liabilities, intercompany financing arrangements and derivatives, which limit its ability to raise liquidity through asset sales. If the market value or rating eligibility of the assets which are pledged against MBIA Inc.’s obligations were to decline, we would be required to pledge additional eligible assets in order to meet minimum required collateral amounts against these liabilities. In such event, we may sell assets, potentially with substantial losses, finance unencumbered assets through intercompany facilities, or use free cash or other assets, although there can be no assurance that these strategies will be available or adequate to meet liquidity requirements.

 

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Item 1A. Risk Factors (continued)

 

The level of interest rates and foreign currency exchange rates could materially and adversely affect our financial condition and future business.

Increases in prevailing interest rate levels can adversely affect the value of our investment portfolios and, therefore, our financial condition. In the event that investments must be sold in order to make payments on insured exposures or other liabilities, such investments would likely be sold at discounted prices. Increases in interest rates also adversely affect the values of investments collateralizing our investment agreement liabilities in our corporate operations, which would require the Company to post additional collateral to its counterparties. 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. Finally, increased interest rates could also result in a decreased volume of capital markets transactions.

Lower interest rates can 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. Lower interest rates would also adversely impact the value of our interest rate swap contracts in our corporate operations, and would require the Company to post additional collateral to its counterparties. Additionally, since 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.

In addition, the Company is exposed to foreign currency exchange rate fluctuation risk in respect of assets and liabilities denominated in currencies other than U.S. dollars. In addition to insured liabilities denominated in foreign currencies, some of the remaining liabilities in our corporate segment are denominated in currencies other than U.S. dollars and the assets of our corporate segment are predominantly denominated in U.S. dollars. Accordingly, the weakening of the U.S. dollar versus foreign currencies could substantially increase our potential obligations and statutory capital exposure. Conversely, the Company makes investments denominated in a foreign currency and the weakening of the foreign currency versus the U.S. dollar will diminish the value of such non-U.S. dollar denominated asset. Exchange rates have fluctuated significantly in recent periods and may continue to do so in the future, which could adversely impact the Company’s financial position, results of operations and cash flows.

MBIA Corp. Risk Factors

As described further and for the reasons stated herein, we believe that MBIA Corp. will not provide significant economic or shareholder value to MBIA Inc. For additional information on MBIA Corp., refer to “Executive Overview—MBIA Corp.” in Part II, Item 7 of this Form 10-K. Additionally, also as described further herein, given the separation of MBIA Inc. and MBIA Corp. as distinct legal entities, the absence of any cross defaults between the entities, and the lack of reliance by MBIA Inc. on MBIA Corp. for the receipt of dividends, we do not believe that a rehabilitation or liquidation proceeding of MBIA Insurance Corporation by the NYSDFS would have any significant long-term impact on the financial condition or liquidity of MBIA Inc. However, there can be no assurance that the financial condition or a rehabilitation or liquidation proceeding of MBIA Insurance Corporation would not have an adverse impact on MBIA Inc. The risk factors described below with respect to MBIA Corp. are set forth for that reason, as well as for an independent understanding of the risks to MBIA Corp.

 

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Item 1A. Risk Factors (continued)

 

Continuing elevated loss payments and delay or failure in realizing expected recoveries on insured transactions may materially and adversely affect MBIA Insurance Corporation’s statutory capital and its ability to meet liquidity needs and could cause the NYSDFS to put MBIA Insurance Corporation into a rehabilitation or liquidation proceeding if the NYSDFS concludes that MBIA Insurance Corporation will not be able to pay expected claims.

MBIA Insurance Corporation is particularly sensitive to the risk that it will not have sufficient capital or liquid resources to meet contractual payment obligations when due or to make settlement payments in order to terminate insured exposures to avoid losses. While management’s expected liquidity and capital forecasts for MBIA Insurance Corporation reflect adequate resources to pay expected claims, there are risks to the capital and liquidity forecasts as MBIA Insurance Corporation’s remaining insured exposures and its expected salvage recoveries are potentially volatile. Such volatility exists in the amount of excess spread and put-back recoverable that MBIA Insurance Corporation may collect, its ability to recover the approximately $919 million in aggregate claims it paid in respect of the insured notes (the “Zohar I Notes”) issued by Zohar CDO 2003-1, Limited (“Zohar I”) and in respect of the insured notes (the “Zohar II Notes”) issued by Zohar II 2005-1 CDO (“Zohar II”), as described in more detail below, and the exposure in its remaining insured portfolio, which could deteriorate and result in significant additional loss reserves and claim payments, including claims on insured exposures that in some cases may require large bullet payments.

Regarding the recoveries on the payments on the Zohar I Notes and Zohar II Notes, on November 20, 2015 MBIA Insurance Corporation paid a $149 million claim on the Zohar I Notes. On January 20, 2017 (the “Zohar II Maturity Date”), it paid, in the manner described further below, a claim of approximately $770 million (the “Zohar II Claim Payment”) on the Zohar II Notes (collectively, the “Zohar Claims Payments”). MBIA Insurance Corporation is entitled to reimbursement of the Zohar Claims Payments plus interest and certain costs and expense and to exercise certain rights and remedies to seek recovery of such claim.

In order to make the Zohar II Claim Payment, MBIA Insurance Corporation entered into two related transactions. In the first transaction, MBIA Insurance Corporation’s wholly-owned subsidiary, MBIA UK (Holdings) Limited, sold its operating subsidiary, MBIA UK Insurance Limited (“MBIA UK”), to Assured Guaranty Corp. (“Assured”), a subsidiary of Assured Guaranty Ltd, in exchange for a cash payment of $23 million to Assured and the receipt by MBIA UK (Holdings) Limited of certain notes owned by Assured that were issued by Zohar II (the “Assured Zohar II Notes”), which had an aggregate outstanding principal amount of approximately $347 million as of December 31, 2016 (the “UK Sale”). Subsequent to the UK Sale, and prior to the Zohar II Maturity Date, MBIA UK Holdings transferred all the Assured Zohar II Notes to MBIA Insurance Corporation as a dividend. MBIA Insurance Corporation therefore owned, and was entitled to all amounts payable in respect of, the Assured Zohar II Notes on the Zohar II Maturity Date.

In the second transaction, MBIA Insurance Corporation consummated a financing facility, which is described in more detail in “Liquidity—MBIA Corp. Liquidity” in Part II, Item 7 of this Form 10-K (the “Facility”), with affiliates of certain holders of its 14% Fixed-to-Floating Rate Surplus Notes (collectively, the “Senior Lenders”), and with the Company, pursuant to which the Senior Lenders have provided $325 million of senior financing and the Company has provided $38 million of subordinated financing to MZ Funding LLC, a newly formed wholly-owned subsidiary of the Company, which in turn lent the proceeds of such financing to MBIA Insurance Corporation. MBIA Insurance Corporation issued financial guarantee insurance policies insuring MZ Funding LLC’s obligations to the Lenders under the Facility.

Under the Facility the Company has also agreed to provide an additional $50 million of subordinated financing to MZ Funding, which MZ Funding will lend to MBIA Insurance Corporation if needed by MBIA Insurance Corporation for liquidity purposes. The loans to MBIA Insurance Corporation under the Facility mature on January 20, 2020 and bear interest at 14% per annum. The Facility is secured by a first priority security interest in all of MBIA Insurance Corporation’s right, title and interest in to recovery of its claims from the assets of Zohar I and Zohar II which include, among other things, loans made to, and equity interests in, companies purportedly controlled by the sponsor and former collateral manager of Zohar I and Zohar II Zohar (the “Zohar Sponsor”) and any claims that MBIA may have against the Zohar Sponsor (collectively, the “Zohar Collateral”).

MBIA Insurance Corporation satisfied the insurance claim of approximately $770 million under the policy it had issued on the Zohar II Notes (the “Zohar II Policy”) as follows:

(a) approximately $60 million was paid by MBIA Insurance Corporation from its own resources (the “MBIA Corp. Payment”);

 

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Item 1A. Risk Factors (continued)

 

(b) approximately $363 million was paid by MBIA Insurance Corporation from amounts received under the Facility; and

(c) approximately $347 million was satisfied as an offset of amounts payable to MBIA Insurance Corporation, in its capacity as the owner of the Assured Zohar II Notes that it had received as a dividend from MBIA UK Holdings, against amounts payable by MBIA Insurance Corporation under the Zohar II Policy in respect of the Assured Zohar II Notes. This offset was agreed to and deemed to be in satisfaction of the insurance claim due by MBIA Insurance Corporation under the Zohar II Policy pursuant to an agreement between MBIA Insurance Corporation and the trustee for the Zohar II Issuer. The offset arrangement was entered into solely as an administrative convenience. The above resulted in the satisfaction and discharge in full of all payment obligations owed by MBIA Insurance Corporation pursuant to the Zohar II Policy.

MBIA Insurance Corporation believes that the primary source of funds for the repayment of its obligations under the Facility and for reimbursement for the Zohar Claims Payments will come from the liquidation or refinancing of the Zohar Collateral. Any proceeds from the Zohar Collateral will first be used to repay MBIA Corporation’s obligations under the Facility, before MBIA Insurance Corporation can use any such proceeds as reimbursement for the Zohar Claims Payments, except that any payments on or recoveries made on the Zohar II Collateral will be allocated on a pro-rata basis to repayment of the senior notes of the Facility and the MBIA Corp. Payment.

Referring to the description of the Facility in “Liquidity—MBIA Corp. Liquidity” in Part II, Item 7 of this Form 10-K, the Company’s ability to collect the principal and interest on the Insured Subordinated Notes will be based primarily on the amount recovered by MBIA Insurance Corporation with respect to the Collateral, after payment in full of the Insured Senior Notes and other related payment obligations that are senior to the Insured Subordinated Notes, pursuant to the Intercreditor Agreement. Based on the estimated value of the Collateral in relation to the amount of the Senior Insured Notes and the Subordinated Insured Notes, the Company expects that the recoveries from the Collateral will be sufficient to enable the payment in full of the Subordinated Insured Notes. There is uncertainty, however, with respect to the realizable value of the Collateral and there can be no assurance that recoveries on the Collateral will be sufficient to pay the Subordinated Insured Notes in full or that, in the event that recoveries on the Collateral are not sufficient to pay the Subordinated Insured Notes in full, that MBIA Insurance Corporation will be able to pay any shortfall necessary to pay the Subordinated Insured Notes in full under the policy insuring the Subordinated Insured Notes.

Similarly, while MBIA Insurance Corporation believes there will be sufficient recoveries on the Zohar Collateral to both repay amounts due under the Facility and to substantially reimburse it for the Zohar Claims Payments, there is significant uncertainty with respect to the realizable value of the Zohar Collateral, and there can be no assurance that recoveries on the Zohar Collateral will be sufficient to pay the Facility, together with accrued interest and other costs in full, particularly in light of the substantial interest and associated costs to be incurred in connection with the Facility, and to reimburse MBIA Insurance Corporation for the Zohar Claims Payments. If the amount of recoveries on the Zohar Collateral are not sufficient to repay amounts due under the Facility on or before its maturity date and to reimburse MBIA Insurance Corporation for a substantial portion of the Zohar Claims Payments, MBIA Insurance Corporation would likely incur substantial additional losses, which could materially impair its statutory capital and liquidity.

MBIA Insurance Corporation believes that if the NYSDFS concludes at any time that MBIA Insurance Corporation will not be able to satisfy its obligations under the Facility and under its other issued policies, the NYSDFS would likely put MBIA Insurance Corporation into a rehabilitation or liquidation proceeding under Article 74 of the NYIL and/or take such other actions as the NYSDFS may deem necessary to protect the interests of MBIA Insurance Corporation’s policyholders. The determination to commence such a proceeding or take other such actions is within the exclusive control of the NYSDFS. The NYSDFS enjoys broad discretion in this regard, and any determination they may make would not be limited to consideration of the matters described above. As noted, however, given the separation of MBIA Inc. and MBIA Corp. as distinct legal entities, the absence of any cross defaults between the entities, and the lack of reliance by MBIA Inc. on MBIA Corp. for the receipt of dividends, we do not believe that a rehabilitation or liquidation proceeding of MBIA Insurance Corporation by the NYSDFS would have any significant long-term liquidity impact on MBIA Inc.

 

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Item 1A. Risk Factors (continued)

 

MBIA Corp. insures certain transactions that continue to perform poorly and increased losses or a delay or failure in collecting expected recoveries may materially and adversely affect its financial condition and results of operations.

MBIA Corp. insures certain structured finance transactions that remain volatile and could result in additional losses, which could be substantial, including RMBS, CDOs, and one CMBS pool transaction.

With respect to RMBS transactions, MBIA Corp. has recorded reserves on a number of transactions, including transactions where it has reached settlements with the sellers/servicers but continues to insure the transactions. Currently, unpredicted losses on these transactions and in other transactions could occur. MBIA Corp. has also recorded significant loss reserves on its CDO exposures, and there can be no assurance that these reserves will be sufficient, in particular if the economy deteriorates. These transactions are also subject to servicer risks, which relates to problems with the transaction’s servicer that could adversely affect performance of the underlying assets. Furthermore, MBIA Corp. has recorded substantial expected recoveries on certain RMBS, and the timing and amount of those recoveries are subject to risk. Any delay or failure in collecting expected recoveries may materially and adversely affect MBIA Corp.’s financial condition and results of operations. As of December 31, 2016, it recorded expected receipts of $439 million on pre-VIE elimination basis (on a present value basis) from excess spread (the difference between interest inflows on assets and interest outflows on liabilities) in our RMBS transactions, in reimbursement of our past and future expected claims. Of this amount, $392 million is included in “Insurance loss recoverable” and $47 million is included in “Loss and loss adjustment expense reserves” on the Company’s consolidated balance sheets. The amount of excess spread depends on future interest rates, borrower refinancing and defaults and mortgage insurance payments. There can be no assurance that this recovery will be received in its entirety or in the expected timeframe. In addition, the Company has recorded a recovery on a transaction containing ineligible loans securitized by Credit Suisse. The Company is pursuing recovery of its losses on this transaction in a litigation in which its assessment of the ineligibility of individual mortgage loans has been challenged by Credit Suisse, and there is no assurance that the Company’s determinations will prevail, or that the Company will be successful in collecting its estimated recoveries in the anticipated timeframe. The litigation may take several years to resolve, during which time we will continue to be required to pay losses on the subject transaction, which may exceed the reserves established for the transaction.

With respect to the one remaining insured static CMBS pool transaction, it has experienced ratings erosion of the pool’s CMBS collateral. Since 2013, MBIA Corp. has paid claims on this transaction after the deductible was eliminated, and we expect to experience additional claims on this transaction in the future. The ultimate loss rate on this transaction remains uncertain. It is possible that MBIA Corp. will experience losses or near-term liquidity needs on this transaction, particularly if the economy does not continue to improve, there is a new recession, increased delinquencies, higher levels of liquidations of delinquent loans, or higher severities of loss upon liquidation.

An MBIA Insurance Corporation rehabilitation or liquidation proceeding could accelerate certain of the Company’s other obligations and have other adverse consequences.

As noted above, MBIA Insurance Corporation continues to face a number of significant risks and contingencies, which could, if realized, result in MBIA Insurance Corporation being placed into a rehabilitation or liquidation proceeding by the NYSDFS. In the event of an MBIA Insurance Corporation rehabilitation or liquidation proceeding, the Company may be subject to, among other things, the following:

 

    MTNs issued by GFL, which are insured by MBIA Insurance Corporation, would accelerate. To the extent GFL failed to pay the accelerated amounts under the GFL MTNs, the MTN holders would have policy claims against MBIA Insurance Corporation for scheduled payments of interest and principal;

 

    An MBIA Insurance Corporation proceeding may accelerate certain investment agreements issued by MBIA Inc., including, in some cases, with make-whole payments. While the investment agreements are fully collateralized with high quality collateral, the settlements of these amounts could reduce MBIA Inc.’s liquidity resources, and to the extent MBIA Inc. fails to pay the accelerated amounts under these investment agreements or the collateral securing these investment agreements is deemed insufficient to pay the accelerated amounts due, the holders of the investment agreements would have policy claims against MBIA Insurance Corporation;

 

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Item 1A. Risk Factors (continued)

 

    The payment of installment premiums due to National from MBIA Insurance Corporation under the reinsurance agreement between National and MBIA Insurance Corporation (Refer to Item 1, “Our Insurance Operations”, “Reinsurance” for a description of the agreement) could be disrupted, delayed or subordinated to the claims of policyholders of MBIA Insurance Corporation;

 

    CDS and other derivative counterparties may seek to terminate derivative contracts insured by MBIA Insurance Corporation and make market-based damage claims (irrespective of whether actual credit-related losses are expected under the underlying exposure);

 

    The rehabilitator or liquidator would replace the Board of Directors of MBIA Insurance Corporation and take control of the operations and assets of MBIA Insurance Corporation, which would result in the Company losing control of MBIA Insurance Corporation and possible changes to MBIA Insurance Corporation’s strategies and management; and

 

    Unplanned costs on MBIA Inc., as well as significant additional expenses for MBIA Insurance Corporation arising from the appointment of a rehabilitator or liquidator, as receiver, and payment of the fees and expenses of the advisors to such rehabilitator or liquidator.

Revenues and liquidity would be adversely impacted by 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 early termination of insurance contracts, accelerated prepayments of underlying obligations, commutation of existing financial guarantee insurance policies or non-payment. Such a reduction would result in lower revenues and reduced liquidity.

Item 1B. Unresolved Staff Comments

The Company from time to time receives written comments from the staff of the SEC regarding its periodic or current reports under the Securities Exchange Act of 1934, as amended. There are no comments that remain unresolved that the Company received more than 180 days before the end of the year to which this report relates.

Item 2. Properties

The Company maintains office space located in Purchase, New York, in which the Company, National, MBIA Corp., and MBIA Services Corporation have their headquarters. The Company also leases office space in New York, New York; San Francisco, California; Mexico City, Mexico; and London, England. The Company generally believes that these facilities are adequate and suitable for its current needs.

Item 3. Legal Proceedings

For a discussion of the Company’s litigation and related matters, refer to “Note 20: Commitments and Contingencies” in the Notes to Consolidated Financial Statements in Part II, Item 8. In the normal course of operating its businesses, MBIA Inc. may be involved in various legal proceedings. As a courtesy, the Company posts on its website under the section “Legal Proceedings,” selected information and documents in reference to selected legal proceedings in which the Company is the plaintiff or the defendant. The Company will not necessarily post all documents for each proceeding and undertakes no obligation to revise or update them to reflect changes in events or expectations. The complete official court docket can be publicly accessed by contacting the clerk’s office of the respective court where each litigation is pending.

Item 4. Mine Safety Disclosures

Not applicable.

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The Company’s common stock is listed on the New York Stock Exchange under the symbol “MBI.” As of February 23, 2017, there were 420 shareholders of record of the Company’s common stock. The Company did not pay cash dividends on its common stock during 2016 or 2015. For information on the ability for certain subsidiaries of the Company to transfer funds to the Company in the form of cash dividends or otherwise, refer to “Item 1. Business—Insurance Regulation” in this annual report.

The high and low sales stock prices with respect to the Company’s common stock for the last two years are presented below:

 

     2016      2015  
     Stock Price      Stock Price  

Quarter Ended

           High                      Low                      High                      Low          

March 31

   $ 9.49      $ 5.51      $ 9.73      $ 7.92  

June 30

     8.95        6.34        9.98        4.94  

September 30

     8.70        6.61        7.75        5.29  

December 31

     11.46        7.15        8.37        5.26  

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 support our liquidity and maintain the claims-paying ratings of MBIA Corp. and National as well as other business needs.

On October 28, 2015, the Company’s Board of Directors authorized the repurchase by the Company or its subsidiaries of up to $100 million of its outstanding shares under a new share repurchase authorization. As of December 31, 2016, there was no remaining authorized capacity under the October 28, 2015 repurchase program.

On February 23, 2016, the Company’s Board of Directors authorized the repurchase by the Company or its subsidiaries of up to $100 million of its outstanding shares under a new share repurchase authorization. As of December 31, 2016, $88 million remained available under the February 23, 2016 repurchase program.

The table below presents repurchases made by the Company in each month during the fourth quarter of 2016. Refer to “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” in Part III for a further discussion of securities authorized for issuance under long-term incentive plans.

 

Month

   Total Number
of Shares
Purchased(1)
     Average Price
Paid Per Share
     Total Number of
Shares

Purchased as
Part of Publicly
Announced Plan
     Maximum Amount That
May Be Purchased Under the
Plan (in millions)
 
           
           
           
           

October

     83,124      $ 7.97             $ 88  

November

     233,188        9.92               88  

December

     680,343        10.81               88  

 

(1)—Includes 1,874 shares purchased in open market transactions as investments in the Company’s non-qualified deferred compensation plan and 947,781 shares were repurchased by the Company in open market transactions for settling awards under the Company’s long-term incentive plans.

As of December 31, 2016, 283,989,999 shares of Common Stock of the Company, par value $1 per share, were issued and 135,200,831 shares were outstanding.

 

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Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities (continued)

 

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 Index (“S&P 500 Index”) and the S&P 500 Financials Sector Index (“S&P Financials Index”) for the last five fiscal years. The graph assumes a $100 investment at the closing price on December 31, 2011 and reinvestment of dividends in the security/index on the respective dividend payment dates without commissions. This graph does not forecast future performance of our common stock.

 

LOGO

 

          2011                2012                2013                2014                2015                2016       

MBIA Inc. Common Stock

     100.00        67.73        103.02        82.31        55.91        92.32  

S&P 500 Index

     100.00        115.99        153.54        174.54        176.94        198.09  

S&P Financials Index

     100.00        128.74        174.56        201.05        197.91        242.93  

Source: Bloomberg Finance L.P.

 

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Item 6. Selected Financial Data

 

In millions except per share amounts

   2016      2015      2014      2013      2012  

Summary Statement of Operations Data:

              

Premiums earned

   $ 300      $ 372      $ 397      $ 457      $ 605  

Net investment income

     152        152        179        166        214  

Net change in fair value of insured derivatives

     (19)        129        459        232        1,464  

Net gains (losses) on financial instruments at fair value and foreign exchange

     84        63        78        69        55  

Net investment losses related to other-than- temporary impairments

     (5)        (13)        (15)        —          (105)  

Other net realized gains (losses)

     (282)        17        28        (29)        7  

Revenues of consolidated variable interest entities

     31        128        101        233        134  

Total revenues

     294        853        1,270        1,209        2,435  

Losses and loss adjustment

     220        123        133        117        50  

Operating

     137        140        195        338        381  

Interest

     197        199        210        236        284  

Expenses of consolidated variable interest entities

     39        52        47        56        72  

Total expenses

     633        564        629        793        837  

Income (loss) before income taxes

     (339)        289        641        416        1,598  

Net income (loss)

     (338)        180        569        250        1,234  

Net income (loss) per common share:

 

        

Basic

   $ (2.54)      $ 1.06      $ 2.94      $ 1.30      $ 6.36  

Diluted

   $ (2.54)      $ 1.06      $ 2.76      $ 1.29      $ 6.33  

Summary Balance Sheet Data:

              

Investments and cash and cash equivalents

     5,796        6,814        7,559        7,996        6,676  

Total assets of consolidated variable interest entities

     2,672        5,378        5,041        5,592        8,334  

Total assets

     11,137        14,836        16,263        16,931        21,698  

Unearned premium revenue

     958        1,591        1,986        2,441        2,938  

Loss and loss adjustment expense reserves

     541        516        506        641        853  

Long-term debt

     1,986        1,889        1,789        1,680        1,706  

Medium-term notes

     895        1,016        1,201        1,427        1,598  

Investment agreements

     399        462        547        700        944  

Derivative liabilities

     299        314        437        1,152        2,934  

Total liabilities of consolidated variable interest entities

     2,241        5,096        4,804        5,297        7,286  

Total equity

     3,239        3,741        3,950        3,299        3,194  

Book value per share

   $ 23.87      $ 24.61      $ 20.47      $ 17.05      $ 16.22  

Insurance Statistical Data:

              

Debt service outstanding

   $ 235,899      $ 326,612      $ 437,778      $ 554,296      $ 679,074  

Gross par amount outstanding

     141,225        202,661        277,481        357,246        449,487  

 

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Item 6. Selected Financial Data (continued)

 

Quarterly Financial Information (unaudited):

 

     2016  

In millions except per share amounts

   First      Second      Third      Fourth      Full Year(1)  

Premiums earned

   $ 75      $ 73      $ 77      $ 75      $ 300  

Net investment income

     39        37        39        37        152  

Net change in fair value of insured derivatives

     (28)        (8)        16        1        (19)  

Net gains (losses) on financial instruments at fair value and foreign exchange

     (69)        14        38        101        84  

Net investment losses related to other-than-temporary impairments

     (1)                      (4)        (5)  

Other net realized gains (losses)

     (1)               (2)        (279)        (282)  

Revenues of consolidated variable interest entities

     14        (2)        13        6        31  

Total revenues

     32        118        203        (59)        294  

Losses and loss adjustment

     22        77        50        71        220  

Operating

     35        30        32        40        137  

Interest

     50        49        49        49        197  

Expenses of consolidated variable interest entities

     16        7        7        9        39  

Total expenses

     133        173        148        179        633  

Income (loss) before income taxes

     (101)        (55)        55        (238)        (339)  

Net income (loss)

     (78)        (27)        31        (265)        (338)  

Net income (loss) per common share:

              

Basic

   $ (0.58)      $ (0.20)      $ 0.23      $ (2.01)      $ (2.54)  

Diluted

   $ (0.58)      $ (0.20)      $ 0.23      $ (2.01)      $ (2.54)  

 

(1)—May not cross-foot due to rounding.

 

     2015  

In millions except per share amounts

   First      Second      Third      Fourth      Full Year(1)  

Premiums earned

   $ 101      $ 91      $ 84      $ 96      $ 372  

Net investment income

     37        37        38        40        152  

Net change in fair value of insured derivatives

     28        60        3        38        129  

Net gains (losses) on financial instruments at fair value and foreign exchange

     30        45        (55)        43        63  

Net investment losses related to other-than-temporary impairments

            (7)        (3)        (3)        (13)  

Other net realized gains (losses)

     20        (1)        (1)        (1)        17  

Revenues of consolidated variable interest entities

     2        19        25        82        128  

Total revenues

     219        245        92        297        853  

Losses and loss adjustment

     (6)        46        39        44        123  

Operating

     35        32        35        38        140  

Interest

     50        50        49        50        199  

Expenses of consolidated variable interest entities

     14        12        13        13        52  

Total expenses

     106        153        147        158        564  

Income (loss) before income taxes

     113        92        (55)        139        289  

Net income (loss)

     69        64        (35)        82        180  

Net income (loss) per common share:

              

Basic

   $ 0.37      $ 0.36      $ (0.23)      $ 0.54      $ 1.06  

Diluted

   $ 0.37      $ 0.36      $ (0.23)      $ 0.54      $ 1.06  

 

(1)—May not cross-foot due to rounding.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of financial condition and results of operations of MBIA Inc. should be read in conjunction with the consolidated financial statements and notes thereto included in this Form 10-K. In addition, this discussion and analysis of financial condition and results of operations includes statements of the opinion of MBIA Inc.’s management which may be forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. 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. Refer to “Forward-Looking Statements” and “Risk Factors” in Part I, Item 1A of this Form 10-K for a further discussion of risks and uncertainties.

INTRODUCTION

MBIA Inc., together with its consolidated subsidiaries, (collectively, “MBIA”, the “Company”, “we”, “us”, or “our”) operates one of the largest financial guarantee insurance businesses in the industry. MBIA manages its business within three operating segments: 1) United States (“U.S.”) public finance insurance; 2) corporate; and 3) international and structured finance insurance. Our U.S. public finance insurance business is primarily operated through National Public Finance Guarantee Corporation (“National”), our corporate segment is operated through MBIA Inc. and several of its subsidiaries, including our service company, MBIA Services Corporation (“MBIA Services”) and our international and structured finance insurance business is primarily operated through MBIA Insurance Corporation and its subsidiaries (“MBIA Corp.”). References to MBIA Inc. generally refer to activities within our corporate segment and, unless otherwise indicated or the context otherwise requires, references to “MBIA Corp.” are (i) for any references relating to the period ended January 10, 2017, to MBIA Insurance Corporation, together with its subsidiaries, MBIA UK Insurance Limited (“MBIA UK”), and MBIA Mexico S.A. de C.V. (“MBIA Mexico”) and (ii) for any references relating to the period after January 10, 2017, to MBIA Insurance Corporation together with MBIA Mexico.

National’s primary business is insuring new issue and secondary market municipal bonds, consistent with our portfolio management and return requirements, and to maximize the economics of our existing insured portfolio through effective surveillance and remediation. Our corporate segment consists of general corporate activities, including providing general support services to MBIA’s other operating businesses and asset and capital management. MBIA Corp.’s primary objectives are to satisfy claims of its policyholders, and to maximize future recoveries, if any, for its senior lending and other surplus note holders and, thereafter, its preferred stock holders. MBIA Corp. is executing this strategy by reducing and mitigating potential losses on its insurance exposures and pursuing various actions focused on maximizing the collection of recoveries. We do not expect to write new business in our international and structured finance insurance segment.

Effective on January 10, 2017, MBIA Corp.’s wholly-owned subsidiary, MBIA UK (Holdings) Limited (“MBIA UK Holdings”), sold its operating subsidiary, MBIA UK, to Assured Guaranty Corp. (“Assured”), a subsidiary of Assured Guaranty Ltd. Prior to 2015, MBIA managed two other operating segments, advisory services and conduit. Our advisory services segment was primarily operated through Cutwater Holdings, LLC and its subsidiaries (“Cutwater”). Effective on January 1, 2015, we exited our advisory business through the sale of Cutwater to a subsidiary of The Bank of New York Mellon Corporation. In the second quarter of 2014, we exited our conduit business through the liquidation of Meridian Funding Company, LLC (“Meridian”). Refer to the following “Executive Overview” section for a further discussion on the sale of MBIA UK.

EXECUTIVE OVERVIEW

2016 Key Activities

The following is a summary of our notable 2016 activities:

 

    Increased new business writings at National to $1.6 billion of gross par exposure and 158 insurance policies issued in 2016 from $597 million of gross par exposure and 59 insurance policies issued in 2015.

 

    Entered into an agreement to sell MBIA UK and secured a $325 million financing, each described further below, to enable MBIA Corp. to satisfy, on January 20, 2017, a claim of $770 million on an insurance policy insuring certain notes issued by Zohar II 2005-1, Limited (“Zohar II”).

 

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EXECUTIVE OVERVIEW (continued)

 

    Puerto Rico debt service outstanding decreased $401 million during 2016, which included gross claim payments by National in the aggregate of $173 million. National also provided $139 million of liquidity to Puerto Rico through the purchase of notes. Subsequent to December 31, 2016, we paid additional gross claims on our Puerto Rico exposure in the aggregate of $24 million.

While National succeeded in more than doubling its new business generation, it continued to experience several challenges to its business. A low interest rate environment and the competitive landscape continued to suppress demand for its municipal bond insurance. In addition, continued financial stress of some municipal bond issuers, including Puerto Rico, inhibited National from seeking to redeploy its excess capital. MBIA Corp. continued to satisfy its obligations when due and continues to reduce and mitigate potential losses on its insurance exposures, while turning its focus to pursuing various legal actions to maximize the collection of recoveries. Refer to the following “Results of Operations” section for a further discussion of our 2016 key activities and challenges.

Financial Highlights

The following tables present our financial highlights. A detailed discussion of our financial results is presented within the “Results of Operations” section included herein. Refer to the “Capital Resources—Insurance Statutory Capital” section for a discussion of National’s and MBIA Insurance Corporation’s capital positions under statutory accounting principles (“U.S. STAT”).

 

     Years Ended December 31,  

In millions except for per share amounts and policies

   2016      2015      2014  

Net income (loss)

   $ (338)      $ 180      $ 569  

Net income (loss) per diluted share

     (2.54)        1.06        2.76  

Combined operating income (loss)(1)

     30        87        185  

Combined operating income (loss) per diluted share(1)

     0.23        0.52        0.97  

Gross par exposure insured

     1,577        597        343  

Number of policies written

     158        59        8  

 

(1)—Combined operating income (loss) and combined operating income (loss) per diluted share are non-GAAP measures. Refer to the following “Results of Operations” section for a discussion of operating income (loss) and operating income (loss) per diluted share and a reconciliation of GAAP net income to operating income (loss) and GAAP net income per diluted share to operating income (loss) per diluted share.

 

     As of December 31,  

In millions except per share amounts

   2016      2015  

Shareholders’ equity of MBIA Inc.

   $ 3,227      $ 3,729  

Book value per share

     23.87        24.61  

Adjusted book value per share(1)

     31.88        28.98  

 

(1)—Adjusted book value per share is a non-GAAP measure. Refer to the following “Results of Operations” section for a discussion of adjusted book value and a reconciliation of GAAP book value per share to adjusted book value per share.

National

National is the largest U.S. public finance-only bond insurer in the financial guarantee industry as measured by total insured gross par outstanding of $110.4 billion as of December 31, 2016. National’s ability to write new business and to compete with other financial guarantors is largely dependent on the financial strength ratings assigned to National by Kroll Bond Rating Agency (“Kroll”), Standard & Poor’s Financial Services LLC (“S&P”) and Moody’s Investors Service, Inc. (“Moody’s”). As of December 31, 2016, National had the following ratings: AA+ with a stable outlook by Kroll; AA- with a stable outlook by S&P; and A3 with a negative outlook by Moody’s.

National pursues opportunities for new business in most municipal sectors. Based on our underwriting and pricing criteria, the majority of our new business is in the general obligation, tax-backed and revenue bond sectors. In addition to the new issue market, we are pursuing opportunities in the secondary market with respect to bonds issued previously that were not insured and that meet our underwriting criteria.

 

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EXECUTIVE OVERVIEW (continued)

 

National seeks to generate shareholder value at appropriate risk-adjusted pricing; however, current market conditions and the competitive landscape may limit National’s new business opportunities and our ability to price and underwrite risk with attractive returns.

For the issuer, the value of financial guarantee insurance is largely determined by the spread between the interest rate on insured versus uninsured debt. For the investor, the decision to purchase insured bonds is influenced by the overall yield environment. In the current environment of low interest rates, investors may choose to purchase uninsured bonds to increase their returns. An environment of higher interest rates and/or wider spreads would likely enhance the new business opportunities for National. We also believe the current stress in certain sectors of the municipal bond market reinforces the value of National’s guarantee of timely payment of interest and principal. Refer to the “U.S. Public Finance Insurance” section for additional information on National’s new business.

Overall our U.S. public finance insured portfolio continues to perform satisfactorily against a backdrop of relatively stable domestic economic activity. While a stable or growing economy will generally benefit the tax revenues and fees charged for essential municipal services which secure the credits in our insured bond portfolio, some state, local governments and territory obligors we insure remain under financial and budgetary stress. This could lead to defaults by such entities on the payment of their obligations and insurance losses or claim payments on a greater number of our insured transactions. We continue to monitor and analyze these situations and other stressed credits closely, and the overall extent and duration of this stress is uncertain.

Exposure to Puerto Rico

As of December 31, 2016, National had $3.6 billion of gross insured par outstanding ($4.1 billion of gross insured par outstanding when including accreted interest on insured capital appreciation bonds (“CABs”)) related to the Commonwealth of Puerto Rico and certain of its instrumentalities (“Puerto Rico”). Puerto Rico continues to experience significant fiscal stress and constrained liquidity. As of December 31, 2016, National owned, in aggregate, $144 million of bonds issued by the Puerto Rico Electric Power Authority (“PREPA”) in connection with the Restructuring Support Agreement (“RSA”) entered into on December 23, 2015. On July 1, 2016 Puerto Rico defaulted on scheduled debt service for certain National insured bonds and National paid gross claims in the aggregate of $173 million as a result. Subsequent to December 31, 2016, National paid additional gross claims in the aggregate of $24 million. Refer to the “U.S. Public Finance Insurance Puerto Rico Exposures” section for additional information on our Puerto Rico exposures.

MBIA Inc.

Our near-term strategy at the holding company is to reduce our leverage to a level consistent with a mid-investment grade capital structure. In addition to scheduled debt maturities, from time to time, we reduce unsecured debt through calls or repurchases. We may also repurchase outstanding MBIA Inc. common shares when we deem it beneficial to our shareholders. The following table presents our activity relating to the repurchase of MBIA Inc. common shares and reductions of medium-term notes (“MTNs”) and MBIA Inc. Senior Notes for the years ended December 31, 2016, 2015 and 2014:

 

In millions

   2016      2015      2014  

Shares repurchased

   $ 105      $ 303      $ 35  

MTNs repurchased, redeemed or matured

     129        118        300  

MBIA Inc. Senior Notes repurchased or received

            10         

In addition to the unsecured debt referenced in the preceding table, MBIA Inc. and MBIA Investment Management Corp. (“IMC”) issued investment agreements to which we have pledged high-quality securities as collateral. All of our MTNs, MBIA Inc. Senior Notes and investment agreements are collectively managed and serviced by available liquidity. Based on MBIA Inc.’s debt service requirements and expected operating expenses, we expect that MBIA Inc. will have sufficient cash to satisfy its debt obligations and its general corporate needs over time from expected subsidiary dividends, additional anticipated releases under our tax sharing agreement (the “Tax Sharing Agreement”) and related tax escrow account (“Tax Escrow Account”), investment income and potential securities issuance; however, there can be no assurance that such sources will be adequate or that we will have access to the capital markets when needed. Refer to the “Liquidity – MBIA Inc. Liquidity” section for information on MBIA Inc.’s liquidity and refer to the “Capital Resources” section for further information on our share and debt repurchases.

 

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EXECUTIVE OVERVIEW (continued)

 

MBIA Corp.

MBIA Insurance Corporation has significant negative statutory earned surplus and therefore no current capacity to pay dividends. In addition, since July 15, 2012, the New York State Department of Financial Services (“NYSDFS”) has not approved any payments on MBIA Insurance Corporation’s outstanding surplus notes. MBIA Corp. has contributed to the Company’s net operating loss carryforward (“NOL”), which is used in the calculation of our consolidated income taxes. If MBIA Corp. becomes profitable, it is not expected to make any tax payments under our Tax Sharing Agreement. Based on MBIA Corp.’s current projected earnings and our expectation that it will not write new business, we believe it is unlikely that MBIA Corp. will generate significant income in the near future. As a result, we believe MBIA Corp. does not provide significant economic or shareholder value to MBIA Inc. Refer to the “Capital Resources – MBIA Insurance Corporation” section for additional information on MBIA Insurance Corporation’s surplus notes and statutory capital.

Zohar Policies

During 2016, MBIA Corp. was particularly focused on ensuring its ability to cover any payment that might come due on an insurance policy it had written insuring certain notes (the “Zohar II Notes”) issued by Zohar II, which matured on January 20, 2017 (the “Zohar II Maturity Date”), and on exercising its rights and remedies to seek reimbursement of the $149 million claim it paid in November of 2015 (the “Zohar I Claim”) on its policy insuring the class A-1 and A-2 notes issued by Zohar CDO 2003-1, Limited (“Zohar I”).

MBIA Corp. was presented with a claim of $770 million (the “Zohar II Claim”) under the policy it had issued on the Zohar II Notes (the “Zohar II Policy”). MBIA Corp. fully satisfied its obligations under the Zohar II Policy. In order to do so, MBIA Corp. used approximately $60 million from its own resources and executed the following two related transactions on January 10, 2017: 1) MBIA UK Holdings sold its operating subsidiary, MBIA UK, and made a cash payment of $23 million, to Assured, in exchange for the receipt by MBIA UK Holdings of certain Zohar II Notes owned by Assured, which had an aggregate outstanding principal amount of $347 million as of December 31, 2016,which notes were distributed as a dividend to MBIA Corp. upon consummation of the sale of MBIA UK (the “Sale Transaction”); and 2) MBIA Corp. consummated a financing facility (the “Facility”) with affiliates of certain holders of 14% Fixed-to-Floating Rate Surplus Notes of MBIA Corp. (collectively, the “Senior Lenders”), and with MBIA Inc., pursuant to which the Senior Lenders provided $325 million of senior financing and MBIA Inc. provided $38 million of subordinated financing to MZ Funding LLC (“MZ Funding”), a newly formed wholly-owned subsidiary of the Company, which in turn lent the proceeds of such financing to MBIA Corp. Refer to (i) “Results of Operations – Summary of Consolidated Results” for a summary of the net financial impact from the Sale Transaction; (ii) “Capital Resources – MBIA Insurance Corporation” for information on the impact from the Sale Transaction on MBIA Insurance Corporation’s statutory capital; (iii) “Note 1: Business Developments and Risks and Uncertainties” in the Notes to Consolidated Financial Statements for a further discussion on the Sale Transaction and assets and liabilities classified as held for sale; and (iv) “Liquidity” for additional information on the Facility.

Zohar I and Zohar II Recoveries

Payment of the Zohar I Claim and the Zohar II Claim entitles MBIA Corp. to reimbursement of such payments plus interest and expenses and/or to exercise certain rights and remedies to seek recovery of such payments. In connection with the exercise of its rights and remedies, MBIA Corp. directed the trustee for Zohar I to commence an auction (the “Auction”) of all of the assets of Zohar I, which occurred on December 21, 2016. MBIA Corp. was the winning bidder in the Auction, and in connection therewith, acquired the beneficial ownership of the Zohar I assets, which include loans made to, and equity interests in, companies purportedly controlled by sponsor and former collateral manager of Zohar I and Zohar II. Refer to “Note 1: Business Developments and Risks and Uncertainties” in the Notes to Consolidated Financial Statements for a further discussion on the Zohar I and Zohar II recoveries.

Failure to recover a substantial amount of the payments made on the Zohar I Claim and the Zohar II Claim, and/or certain RMBS recoveries, could impede MBIA Corp.’s ability to meet its future obligations. Refer to “Risk Factors-MBIA Corp. Risk Factors-Continuing elevated loss payments and delay or failure in realizing expected recoveries on insured transactions may materially and adversely affect MBIA Insurance Corporation’s statutory capital and its ability to meet liquidity needs and could cause the NYSDFS to put MBIA Insurance Corporation into a rehabilitation or liquidation proceeding if the NYSDFS concludes that MBIA Insurance Corporation will not be able to pay expected claims.” in Part I, Item 1A of this Form 10-K for a further discussion.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

EXECUTIVE OVERVIEW (continued)

 

Economic and Financial Market Trends

The U.S. economy ended 2016 with solid momentum from strong consumer spending, rising housing prices and increased business investment. In addition, job growth remained strong and the unemployment rate held steady throughout 2016. As a result of these positive signs, the Federal Open Market Committee (“FOMC”) raised the federal funds rate in December of 2016. The FOMC has announced that they expect multiple rate hikes in 2017. Also, for 2017, we expect Congress to focus on tax reform, a reduction in regulation and an increase in infrastructure spending.

During 2016, the U.K. held a referendum in which it voted to leave the European Union, referred to as “Brexit”. This decision caused financial markets volatility and concerns over a potential recession in the U.K. and the rest of Europe with an unusually high level of uncertainty that could undermine European confidence and growth. In January of 2017, we sold our operating subsidiary, MBIA UK.

Economic and financial market trends could impact MBIA’s business outlook and its financial results. Many states and municipalities have experienced growing tax collections that resulted from increased economic activity and higher assessed property valuations. The economic improvement at the state and local level strengthens the credit quality of the issuers of our insured municipal bonds, improves the performance of our insured U.S. public finance portfolio and could reduce the amount of National’s incurred losses. A decrease in oil prices could have a positive impact on certain sales taxes to the extent consumer spending increases as a result. However, some states and municipalities will experience a decrease in revenues where their economies are reliant on the oil and gas industries. With higher projected interest rates and the urgent need for renewed investment in our nation’s infrastructure, the value proposition of bond insurance is becoming more compelling and thus we expect that will lead to increased demand for our product.

CRITICAL ACCOUNTING ESTIMATES

We prepare our 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 critical accounting estimates with the Company’s Audit Committee. Financial results could be materially different if other methodologies were used or if management modified its assumptions.

Loss and Loss Adjustment Expense Reserves

Loss and loss adjustment expense (“LAE”) reserves are established by loss reserve committees in each of our major operating insurance companies (National, MBIA Insurance Corporation and MBIA UK) and reviewed by our executive Loss Reserve Committee, which consists of members of senior management. Loss and LAE reserves include case basis reserves and accruals for LAE incurred with respect to non-derivative financial guarantees. Case basis reserves represent our estimate of expected losses to be paid under insurance contracts, net of expected recoveries, on insured obligations that have defaulted or are expected to default. These reserves require the use of judgment and estimates with respect to the occurrence, timing and amount of paid losses and recoveries on insured obligations. Given that the reserves are based on such estimates and assumptions, there can be no assurance that the actual ultimate losses will not be greater than or less than such estimates resulting in the Company recognizing additional or reversing excess loss and LAE reserves through earnings.

We take into account a number of variables 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 issuers of the insured obligations, expected recovery rates on unsecured obligations, the projected cash flow or market value of any assets pledged as collateral on secured obligations, and the expected rates of recovery, cash flow or market values on such obligations or assets. Factors that may affect the actual ultimate realized losses for any policy include economic conditions and trends, political developments, the extent to which sellers/servicers comply with the representations or warranties made in connection therewith, levels of interest rates, rates of inflation, borrower behavior, the default rate and salvage values of specific collateral, and our ability to enforce contractual rights through litigation and otherwise. Our remediation strategy for an insured obligation that has defaulted or is expected to default may also have an impact on our loss reserves.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

CRITICAL ACCOUNTING ESTIMATES (continued)

 

In establishing case basis loss reserves, we calculate the present value of probability-weighted estimated loss payments, net of estimated recoveries, using a discount rate equal to the risk-free rate applicable to the currency and the weighted average remaining life of the insurance contract. Yields on U.S. Treasury offerings are used to discount loss reserves denominated in U.S. dollars, which represent the majority of our loss reserves. Similarly, yields on foreign government offerings are used to discount loss reserves denominated in currencies other than the U.S. dollar.

Refer to “Note 6: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements for a comprehensive discussion of our loss reserves and recoveries, including critical accounting estimates used in the determination of these amounts.

Valuation of Financial Instruments

We have categorized our financial instruments measured at fair value into the three-level hierarchy according to accounting guidance for fair value measurements and disclosures based on the significance of pricing inputs to the measurement in its entirety. Fair value measurements of financial instruments that use quoted prices in active markets for identical assets or liabilities are generally categorized as Level 1, fair value measurements of financial instruments that use quoted prices in markets that are not active where significant inputs are observable are generally categorized as Level 2, and fair value measurements of financial instruments where significant inputs are not observable are generally categorized as Level 3. We categorize our financial instruments based on the lowest level category at which we can generate reliable fair values. The determination of reliability requires management to exercise judgment. The degree of judgment used to determine the fair values of financial instruments generally correlates to the degree that pricing is not observable.

The fair value measurements 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. The use of alternate valuation methods generally requires considerable judgment in the application of estimates and assumptions 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 include 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. Substantially all of the Company’s investments carried and reported at fair value are priced by independent third parties, including pricing services and brokers.

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. Level 3 assets represented approximately 21% and 19% of total assets measured at fair value on a recurring basis as of December 31, 2016 and 2015, respectively. Level 3 liabilities represented approximately 37% and 52% of total liabilities measured at fair value on a recurring basis as of December 31, 2016 and 2015, respectively.

Refer to “Note 7: 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, including valuation techniques and significant inputs.

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 our consolidated 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. Our temporary differences relate principally to net operating losses, premium revenue recognition, accrued interest on outstanding surplus notes, insured loss reserves, unrealized gains or losses on investments and insured derivatives and deferred acquisition costs.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

CRITICAL ACCOUNTING ESTIMATES (continued)

 

Valuation allowances are established to reduce deferred tax assets to an amount that more likely than not will be realized. Changes in the amount of a valuation allowance are reflected within our provision for income taxes in our consolidated statements 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.

In evaluating our ability to recover our net deferred tax asset, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, and results of recent operations. In projecting future taxable income, we begin with historical results and incorporate assumptions about the amount of future federal pre-tax income. The assumptions about future taxable income require significant judgment and are consistent with the plans and estimates we are using to manage our underlying businesses. Actual future taxable income or loss could be significantly different from our projections. In evaluating the objective evidence that recent results provide, we consider three years of cumulative pre-tax comprehensive income (loss). We consider a trend of comprehensive income to be positive evidence of our ability to recover our net deferred tax asset and a trend of comprehensive losses to be negative evidence.

We believe that it is more likely than not that the Company’s net deferred tax asset will be realized due to the reliance on the Company’s future projections of income and evidence of a three-year cumulative comprehensive gain as of December 31, 2016. If our assumptions and projections change and/or additional significant evidence becomes available in the future, we may determine we will not be able to realize all of our deferred tax asset. If such determination is made in the future, the tax charge relating to the establishment of a valuation allowance reserve against our net deferred tax asset could be in the full amount of our net deferred tax asset at such time and materially impact our earnings.

Refer to “Note 11: Income Taxes” in the Notes to Consolidated Financial Statements for additional information about the Company’s deferred income taxes.

RECENT ACCOUNTING PRONOUNCEMENTS

Refer to “Note 3: Recent Accounting Pronouncements” in the Notes to Consolidated Financial Statements for a discussion of accounting guidance recently adopted by the Company.

RESULTS OF OPERATIONS

Summary of Consolidated Results

The following table presents a summary of our consolidated financial results for the years ended December 31, 2016, 2015 and 2014:

 

     Years Ended December 31,  

In millions except for per share amounts

   2016      2015      2014  

Total revenues

   $ 294      $ 853      $ 1,270  

Total expenses

     633        564        629  
  

 

 

    

 

 

    

 

 

 

Income (loss) before income taxes

     (339)        289        641  

Provision (benefit) for income taxes

     (1)        109        72  
  

 

 

    

 

 

    

 

 

 

Net income (loss)

   $ (338)      $ 180      $ 569  
  

 

 

    

 

 

    

 

 

 

Net income (loss) per common share:

        

Basic

   $ (2.54)      $ 1.06      $ 2.94  

Diluted

   $ (2.54)      $ 1.06      $ 2.76  

Weighted average number of common shares outstanding:

        

Basic

     133,001,088        163,936,318        188,171,503  

Diluted

     133,001,088        164,869,788        190,898,627  

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

RESULTS OF OPERATIONS (continued)

 

2016 compared with 2015

The decrease in consolidated total revenues was primarily due to the loss from the sale of MBIA UK (refer to “Sale of MBIA UK” below for further information), a decrease in net gains on insured derivatives and lower net premiums earned due to higher refunding activity in 2015. Net losses on insured derivatives in 2016 were primarily the result of claim payments on commercial mortgage-backed securities (“CMBS”) transactions. Net gains on insured derivatives in 2015 were principally the result of changes in transaction-specific factors, such as credit ratings, partially offset by claim payments.

Consolidated total expenses for the years ended December 31, 2016 and 2015 included $220 million and $123 million, respectively, of net insurance loss and LAE. This increase was principally due to loss incurred on certain Puerto Rico exposures and insured second-lien residential mortgage-backed securities (“RMBS”) transactions, partially offset by decreases in insured collateralized debt obligation (“CDO”) losses.

Sale of MBIA UK

The following table presents the net expected impact to our consolidated financial statements related to the sale of MBIA UK for the year ended December 31, 2016 and the expected 2017 impact. Refer to “Note 1: Business Developments and Risks and Uncertainties” in the Notes to Consolidated Financial Statements for a further discussion on the Sale Transaction and assets and liabilities classified as held for sale.

 

In millions

   For the Year Ended
December 31, 2016
    Expected
2017 Impact
    Net Expected
Impact of Sale of
MBIA UK
 

Consolidated Statements of Operations Impact

      

Income (loss) recorded on adjustment of carrying value to fair value less costs to sell

   $ (278) (1)    $ 18 (2)    $ (260)  

Provision for income taxes (3)

     (14)       (7)       (21)  
  

 

 

   

 

 

   

 

 

 

Net after-tax income (loss) impact to the consolidated statements of operations

   $ (292)     $ 11     $ (281)  
  

 

 

   

 

 

   

 

 

 
     As of
December 31, 2016
    Expected
2017 Impact
    Net Expected
Impact of Sale of
MBIA UK
 

Shareholders’ Equity Impact

      

Equity impact from loss recorded

   $ (292)     $ 11     $ (281)  

Reversal of accumulated other comprehensive loss (4)

           97       97  

Deferred income taxes(5)

     (32)             (32)  
  

 

 

   

 

 

   

 

 

 

Net impact to total shareholders’ equity

   $ (324)     $ 108     $ (216)  
  

 

 

   

 

 

   

 

 

 

 

(1)—Reporting within “Other net realized gains (losses)” on our consolidated statement of operations and reflected in the results of our international and structured finance insurance segment.

(2)—Relates to the appreciation to the outstanding par value of the Zohar II Notes acquired from the sale of MBIA UK.

(3)—Primarily relates to an increase in deferred tax liabilities from a basis difference of MBIA UK, which is due to a change in assertion of MBIA UK paying future dividends over time to calculating deferred taxes on the basis of the sale of MBIA UK and a valuation allowance against certain foreign tax credits. These are included in “Provision (benefit) for income taxes” on our consolidated statement of operations.

(4)—These amounts were included in the 2016 loss recorded to the statement of operations and are reversed out of accumulated other comprehensive income in the first quarter of 2017 when the sale was consummated.

(5)—Relates to an increase in deferred tax liabilities due to foreign currency exchange that was recorded in “Accumulated other comprehensive income” on our consolidated balance sheets.

2015 compared with 2014

The decrease in consolidated total revenues was due to decreases in net gains on insured derivatives and certain fees and reimbursements. Net gains on insured derivatives in 2015 were principally the result of changes in transaction-specific factors, such as credit ratings, partially offset by claim payments. Net gains on insured derivatives in 2014 were principally the result of commuting derivative liabilities at prices below their fair values, partially offset by settlement and claim payments.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

RESULTS OF OPERATIONS (continued)

 

Consolidated total expenses for the years ended December 31, 2015 and 2014 included $123 million and $133 million, respectively, of net insurance loss and LAE. This decrease was principally due to decreases in certain first-lien RMBS exposures, partially offset by an increase in losses on certain U.S. public finance exposures.

Non-GAAP Operating Income (Loss)

In addition to our results prepared in accordance with GAAP, we also analyze the operating performance of the Company using operating income (loss) and operating income (loss) per diluted common share, both non-GAAP measures. Since operating income (loss) is used by management to assess performance and make business decisions, we consider operating income (loss) and operating income (loss) per diluted common share fundamental measures of periodic financial performance which are useful in understanding our results. Operating income (loss) and operating income (loss) per diluted common share are not substitutes for net income (loss) and net income (loss) per diluted common share determined in accordance with GAAP, and our definitions of operating income (loss) and operating income (loss) per diluted common share may differ from those used by other companies.

Operating income (loss) and operating income (loss) per diluted common share include the combined after-tax results of our U.S. public finance insurance and corporate segments and remove the after-tax results of activities that are not part of our ongoing business strategy. This includes the activities of our international and structured finance insurance segment, advisory services and conduit segments (collectively, “Non-Core Segments”). We do not expect to write new business in our international and structured finance insurance segment. We exited our advisory services segment through the sale of Cutwater effective January 1, 2015 and in the second quarter of 2014, we liquidated our conduit segment.

In addition to removing our Non-Core Segments, operating income (loss) is adjusted for the following:

 

    Elimination of the impact of mark-to-market gains (losses) on financial instruments that primarily include interest rate swaps and hybrid financial instruments. Also eliminated are the mark-to market gains (losses) on warrants issued by the Company. All of these amounts fluctuate based on market interest rates, credit spreads, MBIA Inc.’s common stock price and other market factors.

 

    Elimination of foreign exchange gains (losses) on the remeasurement of certain assets and liabilities and transactions in non-functional currencies. Given the possibility of volatility in foreign exchange markets, we exclude the impact of foreign exchange gains (losses) to provide a measurement of comparability of operating income (loss).

 

    Elimination of gains (losses) on the sale of investments, net investment losses related to other-than-temporary impairments (“OTTI”) and net gains (losses) on extinguishment of debt since the timing of these transactions are subject to management’s assessment of market opportunities and capital liquidity positions.

 

    Elimination of the results from the sale of Cutwater.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

RESULTS OF OPERATIONS (continued)

 

The following table presents our combined operating income (loss) and operating income (loss) per diluted common share and provides reconciliations of GAAP net income (loss) to operating income (loss) and GAAP net income (loss) per diluted common share to operating income (loss) per diluted common share for the years ended December 31, 2016, 2015 and 2014:

 

     Years Ended December 31,  

In millions, except share and per share amounts

   2016     2015     2014  

Net income (loss)

   $ (338)     $ 180     $ 569  

Less: operating income adjustments:

      

Income (loss) before income taxes of our Non-Core Segments and eliminations

     (475)       12       359  

Adjustments to income before income taxes of our U.S. public finance insurance and corporate segments:

      

Mark-to-market gains (losses) on financial instruments(1)

     12       39       (39)  

Foreign exchange gains (losses)(1)

     11       60       95  

Net gains (losses) on sales of investments(1)

     60       20       43  

Net investment losses related to OTTI

     (5)       (13)       (15)  

Net gains (losses) on extinguishment of debt

     5       (1)       3  

Other net realized gains (losses)(2)

     (5)       21        

Operating income adjustment to the (provision) benefit for income tax(3)

     29       (45)       (62)  
  

 

 

   

 

 

   

 

 

 

Operating income (loss)

   $ 30     $ 87     $ 185  
  

 

 

   

 

 

   

 

 

 

Operating income (loss) per diluted common share

   $ 0.23 (4)    $ 0.52 (5)    $ 0.97 (5) 

 

(1)—Reported within “Net gains (losses) on financial instruments at fair value and foreign exchange” on the Company’s consolidated statements of operations.

(2)—Primarily relates to the results from the sale of Cutwater.

(3)—Reported within “Provision (benefit) for income taxes” on the Company’s consolidated statements of operations.

(4)—Operating income (loss) per diluted common share is calculated by taking operating income (loss) divided by the weighted average number of diluted common shares outstanding, which includes the GAAP diluted weighted average number of common shares of 133,001,088 and the dilutive effect of common stock equivalents of 444,557 shares.

(5)—Operating income (loss) per diluted common share is calculated by taking operating income (loss) divided by GAAP weighted average number of diluted common shares outstanding.

Adjusted Book Value

In addition to book value per share, we also analyze adjusted book value (“ABV”) per share, a non-GAAP measure. We consider ABV a measure of fundamental value of the Company and the change in ABV an important measure of financial performance. We have refined our calculation of ABV as of December 31, 2016 and have conformed the prior year’s calculation to the current presentation. ABV now adjusts GAAP book value to remove the legal entity book value of MBIA Corp., but continues to include all deferred taxes available to the Company. Previously, ABV adjusted GAAP book value to remove the book value of our international and structured finance insurance segment and included all deferred taxes available to the Company. In addition, ABV adjusts for certain items which the Company believes will reverse from GAAP book value through GAAP earnings and other comprehensive income, as well as to add in the impact of certain items which the Company believes will be realized in GAAP book value in future periods. The Company has limited such adjustments to those items that it deems to be important to fundamental value and performance and for which the likelihood and amount can be reasonably estimated. We have presented ABV to allow investors and analysts to evaluate the Company using the same measure that MBIA’s management regularly uses to measure financial performance and value. ABV is not a substitute for and should not be viewed in isolation of GAAP book value, and our definition of ABV may differ from that used by other companies.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

RESULTS OF OPERATIONS (continued)

 

As of December 31, 2016, ABV per share was $31.88, an increase from $28.98 as of December 31, 2015, and an increase from $24.21 as of December 31, 2014. The increases in ABV per share were primarily driven by decreases in common shares outstanding from the share repurchases made by the Company during the years ended December 31, 2016 and 2015. The following table provides a reconciliation of consolidated book value per share to consolidated ABV per share:

 

     As of December 31,  

In millions except share and per share amounts

   2016      2015      2014  

Total shareholders’ equity of MBIA Inc.

   $ 3,227      $ 3,729      $ 3,929  

Common shares outstanding

     135,200,831        151,530,377        191,942,895  

Book value per share

   $ 23.87      $ 24.61      $ 20.47  

Reverse book value of the MBIA Corp. legal entity(1)

     5.07        0.86        0.44  
  

 

 

    

 

 

    

 

 

 

Book value after MBIA Corp. legal entity adjustment

     28.94        25.47        20.91  

Other book value adjustments:

        

Reverse net unrealized (gains) losses included in other comprehensive income (loss)

     0.24        0.40        (0.11)  

Add net unearned premium revenue(2)

     4.31        5.02        5.22  

Add tax effect on unrealized (gains) losses and unearned premium revenue

     (1.61)        (1.91)        (1.81)  
  

 

 

    

 

 

    

 

 

 

Total other book value adjustments per share

     2.94        3.51        3.30  
  

 

 

    

 

 

    

 

 

 

Adjusted book value per share

   $ 31.88      $ 28.98      $ 24.21  
  

 

 

    

 

 

    

 

 

 

 

(1)—The book value of the MBIA Corp. legal entity does not provide significant economic or shareholder value to MBIA Inc. The amount being reversed excludes deferred taxes available to MBIA Inc. As of December 31, 2014, this amount also includes the reversal of the book value of Cutwater which was sold effective January 1, 2015.

(2)—Consists of financial guarantee premiums, net of deferred acquisition costs. The discount rate on financial guarantee installment premiums was the risk-free rate as defined by the accounting principles for financial guarantee insurance contracts.

U.S. Public Finance Insurance

Our U.S. public finance insurance business is primarily conducted through National. The financial guarantees issued by National provide unconditional and irrevocable guarantees of the payment of the principal of, and interest or other amounts owing on, insured obligations when due or, in the event National has exercised, at its discretion, the right to accelerate insured obligations upon default or otherwise. National’s guarantees insure municipal bonds, including tax-exempt and taxable indebtedness of U.S. political subdivisions, as well as utilities, 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, user fees or tariffs related to the use of these projects, lease payments or other similar types of revenue streams.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

RESULTS OF OPERATIONS (continued)

 

The following table presents our U.S. public finance insurance segment results for the years ended December 31, 2016, 2015 and 2014:

 

     Years Ended December 31,      Percent Change  

In millions

      2016            2015            2014         2016 vs. 2015      2015 vs. 2014  

Net premiums earned

   $ 236      $ 304      $ 289        -22%        5%  

Net investment income

     119        116        119        3%        -3%  

Fees and reimbursements

     2        3        9        -33%        -67%  

Realized gains (losses) and other settlements on insured derivatives

                   1        —%        -100%  

Net gains (losses) on financial instruments at fair value and foreign exchange

     72        14        26        n/m        -46%  

Net investment losses related to other-than-temporary impairments

     (4)        (10)        (15)        -60%        -33%  

Other net realized gains (losses)

     2        (4)        14        -150%        -129%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

     427        423        443        1%        -5%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Losses and loss adjustment

     74        5        (10)        n/m        -150%  

Amortization of deferred acquisition costs

     49        65        61        -25%        7%  

Operating

     60        62        55        -3%        13%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total expenses

     183        132        106        39%        25%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) before income taxes

     244        291        337        -16%        -14%  

Provision (benefit) for income taxes

     68        100        115        -32%        -13%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss)

   $ 176      $ 191      $ 222        -8%        -14%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

n/m—Percent change not meaningful.

National supports the credit enhancement needs of municipal debt issuers across the U.S. National maintains underwriting criteria for most municipal risk types and pursues opportunities for new business across the spectrum of municipal sectors. During the year ended December 31, 2016, National insured $1.6 billion of gross par exposure in the primary and secondary markets. The majority of its new business is in the general obligation, tax-backed and revenue bond sectors. Low interest rates and competitive pricing levels continue to limit new business opportunities.

NET PREMIUMS EARNED Net premiums earned on financial guarantees represent gross premiums earned net of premiums ceded to reinsurers, and include scheduled premium earnings and premium earnings from refunded issues. The decrease in net premiums earned for 2016 compared with 2015 resulted from decreases in refunded premiums earned of $42 million and scheduled premiums earned of $26 million. The increase in net premiums earned for 2015 compared with 2014 resulted from an increase in refunded premiums earned of $50 million, partially offset by a decrease in scheduled premiums earned of $35 million. Scheduled premium earnings declined due to the refunding and maturity of insured issues in prior periods. Refunding activity over the past several years has accelerated premium earnings in prior periods and reduced the amount of scheduled premiums that would have been earned in the current period.

NET GAINS (LOSSES) ON FINANCIAL INSTRUMENTS AT FAIR VALUE AND FOREIGN EXCHANGE The favorable change in net gains (losses) on financial instruments at fair value and foreign exchange for 2016 compared with 2015 was principally due to increases in net realized gains from the sales of securities in order to generate liquidity for anticipated claim payments on certain Puerto Rico exposures and from favorable market conditions. The unfavorable change in net gains (losses) on financial instruments at fair value and foreign exchange for 2015 compared with 2014 was principally due to decreases in net realized gains from the sales of securities from the ongoing management of our U.S. public finance insurance investment portfolio and unfavorable market fluctuations on financial instruments.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

RESULTS OF OPERATIONS (continued)

 

NET INVESTMENT LOSSES RELATED TO OTHER-THAN-TEMPORARY IMPAIRMENTS Net investment losses related to OTTI for 2016, 2015 and 2014 were primarily related to one impaired security for which a loss was recognized as the difference between its amortized cost and the net present value of its projected cash flows. This OTTI resulted from liquidity concerns and other adverse financial conditions of the issuer. Refer to the “Liquidity” section included herein for additional information about impaired investments.

OTHER NET REALIZED GAINS (LOSSES) Other net realized losses for 2015 related to an impairment charge on our Armonk, New York facility to adjust the carrying amount to its sales price less costs to sell. Other net realized losses for 2014 related to an insurance recovery on an errors and omissions liability policy of $18 million, partially offset by an additional impairment charge on our Armonk, New York facility of $3 million.

LOSS AND LOSS ADJUSTMENT EXPENSES National’s portfolio surveillance group is responsible for monitoring our U.S. public finance segment’s insured obligations. The level and frequency of monitoring of any insured obligation depends on the type, size, rating and performance of the insured issue.

Refer to “Note 6: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements for a description of the Company’s loss reserving policy and additional information related to its loss reserves.

The following table presents information about our U.S. public finance insurance loss and LAE expenses for the years ended December 31, 2016, 2015 and 2014:

 

    Years Ended December 31,     Percent Change  

In millions

      2016             2015             2014         2016 vs. 2015     2015 vs. 2014  

Loss and LAE related to actual and expected payments (1)

  $ 250     $ 8     $ (30)       n/m       -127%  

Recoveries of actual and expected payments

    (175)       (3)       20       n/m       -115%  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross losses incurred

    75       5       (10)       n/m       -150%  

Reinsurance

    (1)                   n/m       —%  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Losses and loss adjustment expenses

  $ 74     $ 5     $ (10)       n/m       -150%  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)—Loss and LAE with respect to Puerto Rico exposures reflect the expected loss and LAE payments net of expected recoveries on such payments.

n/m—Percent change not meaningful.

For the year ended December 31, 2016, losses and LAE primarily related to increases in actual and expected payments on certain Puerto Rico exposures, partially offset by increases in recoveries of actual and expected payments on certain Puerto Rico exposures. For the year ended December 31, 2015, losses and LAE primarily related to increases in reserves for certain Puerto Rico exposures, partially offset by decreases in reserves for certain municipal utilities. The benefit in losses and LAE for the year ended December 31, 2014 primarily related to decreases in reserves for certain general obligation bonds, partially offset by increases in reserves for certain Puerto Rico exposures.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

RESULTS OF OPERATIONS (continued)

 

The following table presents information about our U.S. public finance insurance loss and LAE reserves and recoverables as of December 31, 2016 and 2015:

 

In millions

   December 31, 2016      December 31, 2015      Percent Change  

Assets:

        

Insurance loss recoverable

   $ 174      $ 4        n/m  

Reinsurance recoverable on paid and unpaid losses (1)

     1        1        —%  

Liabilities:

        

Gross loss and LAE reserves (2)

     118        66        79%  

Expected recoveries on unpaid losses

     (21)        (21)        —%  
  

 

 

    

 

 

    

 

 

 

Loss and LAE reserves

   $ 97      $ 45        116%  
  

 

 

    

 

 

    

 

 

 

Insurance loss recoverable—ceded (3)

   $ 12      $        n/m  

 

(1)—Reported within “Other assets” on our consolidated balance sheets.

(2)—Gross loss and LAE reserves with respect to Puerto Rico exposures reflect the expected loss and LAE payments net of expected recoveries on such reserves.

(3)—Reported within “Other liabilities” on our consolidated balance sheets.

n/m—Percent change not meaningful.

Insurance loss recoverable as of December 31, 2016 increased compared with December 31, 2015 primarily as a result of increases in expected recoveries on certain Puerto Rico exposures. Loss and LAE Reserves as of December 31, 2016 increased compared with December 31, 2015 primarily as a result of increases in expected payments on certain Puerto Rico exposures.

Included in our U.S. public finance loss and LAE reserves are both reserves for insured obligations for estimated future claims payments, which includes insured credits where a payment default has occurred and National has already paid a claim and insured credits where a payment default has not yet occurred. The following table includes LAE reserves, but excludes par outstanding, as of December 31, 2016 for one issue that had no expected future claim payments or par outstanding, but for which National was obligated to pay LAE incurred in prior periods. As of December 31, 2016 and 2015, loss and LAE reserves comprised the following:

 

     Number of Issues (1)      Loss and LAE Reserve      Par Outstanding  
     December 31,      December 31,      December 31,      December 31,      December 31,      December 31,  

$ in millions

   2016      2015      2016      2015      2016      2015  

Gross of reinsurance:

                 

Issues with defaults

     5        3      $ 75      $ 13      $ 1,519      $ 52  

Issues without defaults

     6        5        22        32        1,446        1,430  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total gross of reinsurance

     11        8      $ 97      $ 45      $ 2,965      $ 1,482  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)—An “issue” represents the aggregate of financial guarantee policies that share the same revenue source for purposes of making debt service payments.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

RESULTS OF OPERATIONS (continued)

 

POLICY ACQUISITION COSTS AND OPERATING EXPENSES U.S. public finance insurance segment expenses for the years ended December 31, 2016, 2015 and 2014 are presented in the following table:

 

     Years Ended December 31,      Percent Change  

In millions

     2016          2015          2014        2016 vs. 2015      2015 vs. 2014  

Gross expenses

   $ 62      $ 63      $ 56        -2%        13%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Amortization of deferred acquisition costs

   $ 49      $ 65      $ 61        -25%        7%  

Operating

     60        62        55        -3%        13%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total insurance operating expenses

   $ 109      $ 127      $ 116        -14%        9%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross expenses represent total insurance expenses before the deferral of any policy acquisition costs. Amortization of deferred acquisition costs decreased for 2016 compared with 2015 due to higher refunding activity in 2015. Amortization of deferred acquisition costs increased for 2015 compared with 2014 due to higher refunding activity in 2015. When an insured obligation refunds, we accelerate any remaining deferred acquisition costs associated with the policy covering the refunded insured obligation. We did not defer a material amount of policy acquisition costs during 2016, 2015 or 2014.

NON-GAAP OPERATING INCOME (LOSS) In addition to the above results, we also analyze the operating performance of our U.S. public finance insurance segment using operating income (loss), a non-GAAP measure. We believe operating income (loss), as used by management, is useful for an understanding of the results of operations of the Company. Operating income (loss) is not a substitute for net income (loss) determined in accordance with GAAP, and our definition of operating income (loss) may differ from that used by other companies.

The following table presents a reconciliation of GAAP net income (loss) to operating income (loss) for the years ended December 31, 2016, 2015 and 2014:

 

     Years Ended December 31,  

In millions

       2016              2015              2014      

Net income (loss)

   $ 176      $ 191      $ 222  

Less: operating income adjustments:

        

Net gains (losses) on sales of investments(1)

     68        14        17  

Net investment losses related to OTTI

     (4)        (10)        (15)  

Operating income adjustments to the (provision) benefit for income tax(2)

     (8)        (1)        (1)  
  

 

 

    

 

 

    

 

 

 

Operating income (loss)

   $ 120      $ 188      $ 221  
  

 

 

    

 

 

    

 

 

 

 

(1)—Gross amounts are reported within “Net gains (losses) on financial instruments at fair value and foreign exchange” on the Company’s consolidated statements of operations.

(2)—Reported within “Provision (benefit) for income taxes” on the Company’s consolidated statements of operations.

INSURED PORTFOLIO EXPOSURE Financial guarantee insurance companies use a variety of approaches to assess the underlying credit risk profile of their insured portfolios. National uses both an internally developed credit rating system as well as third-party rating sources in the analysis of credit quality measures of its insured portfolio. In evaluating credit risk, we obtain, when available, the underlying rating of the insured obligation before the benefit of its insurance policy from nationally recognized rating agencies, Moody’s and S&P. Other companies within the financial guarantee industry may report credit quality information based upon internal ratings that would not be comparable to our presentation. We maintain internal ratings on our entire portfolio, and our ratings may be higher or lower than the ratings assigned by Moody’s or S&P.

The following table presents the credit quality distribution of National’s U.S. public finance outstanding gross par insured as of December 31, 2016 and 2015. CABs are reported at the par amount at the time of issuance of the insurance policy. 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 internal equivalent rating is used.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

RESULTS OF OPERATIONS (continued)

 

     Gross Par Outstanding  
In millions    December 31, 2016      December 31, 2015  

Rating

   Amount      %      Amount      %  

AAA

   $ 5,167        4.7%      $ 6,721        4.2%  

AA

     49,466        44.8%        77,081        47.9%  

A

     34,544        31.3%        56,890        35.3%  

BBB

     15,120        13.7%        13,947        8.6%  

Below investment grade

     6,070        5.5%        6,378        4.0%  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 110,367        100.0%      $ 161,017        100.0%  
  

 

 

    

 

 

    

 

 

    

 

 

 

U.S. Public Finance Insurance Puerto Rico Exposures

The following is a summary of exposures within the insured portfolio of our U.S. public finance insurance segment related to Puerto Rico as of December 31, 2016.

 

In millions

   Gross Par
Outstanding
     Gross Par
Outstanding
Plus CAB
Accreted
Interest
     Debt Service
Outstanding
    National
Internal
Rating
 

Puerto Rico Electric Power Authority (PREPA)(1)

   $ 1,250      $ 1,270      $ 1,820       d  

Puerto Rico Commonwealth GO(1)

     665        690        919       d  

Puerto Rico Public Buildings Authority(2)

     190        190        284       d  

Puerto Rico Highway and Transportation Authority Transportation Revenue (PRHTA)(1)

     586        586        1,068       d  

Puerto Rico Highway and Transportation Authority—Subordinated Transportation Revenue

     33        33        45       d  

Puerto Rico Sales Tax Financing Corporation (COFINA)(1)

     684        1,091        4,170       bbb3  

Puerto Rico Highway and Transportation Authority Highway Revenue (PRHTA)(1)

     87        89        123       d  

University of Puerto Rico System Revenue

     86        86        126       d  

Inter American University of Puerto Rico Inc.

     25        25        33       a3  
  

 

 

    

 

 

    

 

 

   

Total

   $ 3,606      $ 4,060      $ 8,588 (3)   
  

 

 

    

 

 

    

 

 

   

 

(1)—Includes CABs that reflect the gross par amount at the time of issuance of the insurance policy.

(2)—Additionally secured by the guarantee of the Commonwealth of Puerto Rico.

(3)—As a result of debt service payments made as of January 1, 2017, National’s total Puerto Rico debt service outstanding declined by $75 million.

For many years Puerto Rico’s economy has suffered from stagnation, net migration of people out of Puerto Rico and weak government fiscal management that has led to recurring budget deficits and increased borrowing to finance such deficits. As a result of mounting debt, deteriorating credit ratings and lack of market confidence, Puerto Rico does not have access to the capital markets at reasonable rates.

Developments concerning Puerto Rico’s fiscal condition have occurred, and are occurring, with more frequency. Set forth below are the developments that are significant to National and its exposures to Puerto Rico.

On June 30, 2016, the Puerto Rico Oversight, Management and Economic Stability Act (“PROMESA”), was signed into law by the President of the United States. PROMESA provides both for the creation of an independent oversight board with powers relating to the development and implementation of a fiscal plan for Puerto Rico as well as a court-supervised process (independent of the Bankruptcy Code) that allows Puerto Rico to restructure its debt if voluntary agreement cannot be reached with creditors through a collective action process.

 

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RESULTS OF OPERATIONS (continued)

 

On August 31, 2016, the President of the United States announced the appointment of the seven members who will comprise the Oversight Board. The Oversight Board elected its Chairman, adopted its bylaws and established a sub-committee to search for and hire a permanent Executive Director and General Counsel. Additionally, it retained legal and financial advisors. Among other matters, the Oversight Board and its advisors will evaluate Puerto Rico’s fiscal plan and potential restructuring options, and consider how to address such proposals under the guidelines provided by PROMESA. The Oversight Board originally set a target of certifying a Fiscal and Economic Growth Plan (“FEGP”) no later than January 31, 2017. However, after a request of additional time by the new Governor of Puerto Rico, the Oversight Board moved the date to certify the FEGP until March 15, 2017. Furthermore, the Oversight Board extended the stay provided under PROMESA from February 28, 2017 until May 1, 2017.

Consistent with Section 409 of PROMESA, an Economic Task Force was established in July of 2016. Under the law, this Economic Task Force is charged with identifying impediments to Puerto Rico’s growth and recommending changes to promote long-term economic growth and stability, spur new job creation, reduce child poverty, and attract investment in the territory. Its report was released on December 20, 2016 and contained numerous recommendations for Congress to address Puerto Rico’s Medicaid and Medicare programs, expand the federal child tax credit, and consider other tax reforms. It also recommended that Congress analyze and vote on Puerto Rico becoming the 51st state.

On April 6, 2016, Governor of Puerto Rico signed into law The Puerto Rico Emergency Moratorium and Financial Rehabilitation Act (Act 21-2016 or the “Moratorium Act”). The legislation authorized the Governor of Puerto Rico to order a moratorium on the payment of certain obligations of Puerto Rico through January 31, 2017. On June 30, 2016, the Governor of Puerto Rico, relying on that authorization, signed certain executive orders suspending payment of general obligation debt (“GO”) as well as declaring “states of emergency” for Puerto Rico, among other municipal entities including the Retirement System of Public Employees, Puerto Rico Industrial Corporation and the University of Puerto Rico. As such, on July 1, 2016, when payments were due and payable, Puerto Rico failed to pay debt service of approximately $779 million on GO bonds as well as a portion of $178 million of Puerto Rico guaranteed debt of the Puerto Rico Public Buildings Authority (“PBA”). National paid claims of approximately $169 million on the GO bonds. Subsequent to December 31, 2016, National paid additional claims in the aggregate amount of $24 million against GO bonds and PBA bonds, relating to debt service due on January 1, 2017. The Moratorium Act was repealed and replaced by the Financial Emergency and Fiscal Responsibility Act (Act 5-2017) on January 29, 2017. Act 5-2017 provides for an emergency period ending on May 1, 2017—which can be extended by the Governor until August 1, 2017—during which the Governor is authorized to prioritize payment for essential services over debt service. Act 5-2017 further provides that the executive orders issued under the Moratorium Act continue in effect until amended, rescinded, or superseded.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

RESULTS OF OPERATIONS (continued)

 

Pursuant to the Moratorium Act, the Puerto Rico Fiscal Agency and Financial Advisory Authority (“AAFAF”) was established as Puerto Rico’s financial adviser replacing the Government Development Bank (“GDB”). On January 20, 2017, the Governor of Puerto Rico signed into law the Puerto Rico Fiscal Agency and Financial Advisory Authority Act (Act 2-2017) which defines the responsibilities of AAFAF including acting as fiscal agent, financial adviser and informative agent of all governmental entities and to assist in confronting Puerto Rico’s fiscal crisis and economic emergency. AAFAF is in charge of collaboration, communication and cooperation between the Government of Puerto Rico and the Oversight Board. Further, AAFAF is responsible for the supervision, execution and administration of the FEGP. Also under color of the authority provided by the Moratorium Act, on May 17, 2016, the then Governor of Puerto Rico signed an executive order to suspend through June 30, 2016 PRHTA’s obligations to transfer to the fiscal agent certain toll revenues and any other revenues allocated to or received by PRHTA and authorize PRHTA’s use of such revenues for the ongoing provision of services essential to protect the health, safety, and welfare of the residents of Puerto Rico. On June 30, 2016, the then Governor of Puerto Rico signed two executive orders that, collectively, extended the May 17, 2016 suspension of revenue transfers to the fiscal agent and suspended the payment of PRHTA’s debt obligations under the 1968 and 1998 Resolutions coming due during the term of the Moratorium Act (but not the transfer of revenues pledged for the payment of outstanding loans owed to the GDB, which were modified solely to the extent necessary to provide PRHTA with the revenues it requires to fund operating expenses or essential services). In addition, one of the executive orders issued on June 30, 2016 also suspended the University of Puerto Rico’s (“UPR”) obligation to (a) transfer certain pledged revenues to the trustee for revenue bonds issued by UPR, and (b) make payments pursuant to the Lease Agreement between UPR and Desarrollos Universitarios Inc., which payments support the debt service payments on certain educational facilities revenue bonds issued by the Puerto Rico Industrial, Tourist, Educational, Medical and Environmental Control Facilities Financing Authority (“AFICA”). The UPR revenue bonds and AFICA educational facilities revenue bonds insured by National were paid from pledged revenues on June 1, 2016 and July 1, 2016, respectively. As a result of suspending UPR’s obligation to transfer funds to the trustee for debt service, National downgraded the internal rating of UPR to “d” during the third quarter of 2016. Holders of debt insured by National and issued by UPR, Puerto Rico Industrial Development Company, PBA, and most of PRHTA, were paid through reserves or funded by monthly deposits held by the respective trustee or fiscal agent. National paid an additional $4 million of claims on PRHTA debt in July of 2016 when the GDB refused to release debt service reserve funds held by it. Similarly, subsequent to December 31, 2016, National paid additional claims of $0.8 million against PRHTA bonds, relating to debt service due on January 1, 2017.

COFINA

In October of 2016, a group of GO bondholders, which had previously initiated litigation against Puerto Rico in July of 2016, moved to amend its complaint to add a challenge to Puerto Rico’s purported diversion of funds to the Puerto Rico Sales Tax Financing Corporation (“COFINA”). The plaintiff group contends that the funds being used to pay bonds issued by COFINA constitute “available resources” within the meaning of article VI, section 8 of the Puerto Rico Constitution, and therefore must be devoted to payment of principal and interest on Puerto Rico’s public debt before they may be used for other purposes. By failing to redirect such funds to pay GO bondholders, the plaintiff group claims that Puerto Rico is improperly diverting funds to COFINA bondholders. After being granted leave to amend, the plaintiffs filed their Second Amended Complaint in November of 2016. In February of 2017, the Court held that the COFINA-related claims were not stayed under PROMESA, and further allowed the Oversight Board and several COFINA creditors to intervene in the litigation. Currently, National has exposure to COFINA debt of over $1.0 billion, including CAB accreted interest. As legal opinions from Puerto Rico justice secretaries and bond counsel have confirmed, National believes that the legal structure of COFINA is sound and that it maintains a valid statutory lien on the sales tax revenue stream backing the bonds. Although the Court previously ruled that the automatic stay provision of PROMESA did not apply to some of the plaintiffs’ claims in the original complaint, some claims in the second amended complaint, including the COFINA-related claims, may be subject to the litigation stay. Notwithstanding the foregoing, until all legal challenges are resolved, there can be no assurance that the COFINA structure will be upheld and the sales tax revenue lien will be recognized.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

RESULTS OF OPERATIONS (continued)

 

PREPA

National’s largest exposure to Puerto Rico, by gross par outstanding, is to PREPA. On December 23, 2015, National, Assured Guaranty, and the ad hoc group of bondholders (representing approximately $3.0 billion, or 37.0% of the power revenue bonds, (collectively the “Supporting Creditors”)) entered into an RSA with the support of approximately 65% of $8.1 billion of outstanding PREPA bonds, including approximately $1.4 billion of PREPA bonds insured by National. The RSA calls for a newly formed bankruptcy remote special purpose entity (“SPE”) to issue securitized bonds including bonds that are equal in principal amount to the outstanding principal of the PREPA bonds insured by National and by other monoline insurers (“Mirror Bonds”). The Mirror Bonds will bear interest at the same rate and will amortize at the same schedule as the existing insured legacy bonds which they back. The payments on the Mirror Bonds will be used to make payment on the insured legacy bonds.

Additionally, and subject to certain market rate and rating agency conditions, the SPE may issue additional securitization bonds to refinance outstanding currently callable and non-callable insured legacy bonds (approximately $320 million of National exposure). National will issue a Surety Bond in an amount up to $344 million as partial funding of a Debt Service Reserve Fund (“DSRF”) for the securitization bonds which would be used after a $65 million cash funded DSRF. The Surety Bond will be amortized using cash from the SPE over seven years starting in the seventh year, but can amortize after the second year over nine years if PREPA does not refinance the currently callable and non-callable debt referenced above.

Finally, as a condition to the RSA, the Supporting Creditors agreed to purchase certain bonds of PREPA in the aggregate amount of $111 million (the “2016A and 2016B bonds”) of which National’s portion is approximately $35 million. The Supporting Creditors closed on the 2016A and 2016B bonds in May and June of 2016, respectively. The bonds will earn 10% interest, will mature on July 1, 2019 and will be supported by Mirror Bonds when the SPE issues its securitization bonds. In February of 2016, the PREPA Revitalization Act (the “Revitalization Act”) was approved by Puerto Rico’s House of Representatives and Senate and signed into law by the then Governor of Puerto Rico. Enactment of the Revitalization Act was required by the RSA and is an integral component of the PREPA restructuring. Validation of the Revitalization Act is required by the RSA and certain lawsuits have been filed challenging it. There is no concrete timetable for resolution of these lawsuits. PREPA made its July 1, 2016 debt service payment of approximately $417 million. In order to provide liquidity to PREPA, the Supporting Creditors purchased approximately $264 million of bonds (Series 2016C, 2016D and 2016E) and National purchased $105 million of 2016C bonds. The 2016C bonds will earn 5.4% interest, will amortize over the next four years, and will be supported by Mirror Bonds when the SPE issues its securitization bonds.

On December 15, 2016, the Supporting Creditors and PREPA reached an agreement to extend the RSA until March 31, 2017. As part of the extension, PREPA made the full interest payment of $192 million on January 1, 2017. The extension agreement also contained a milestone date of January 31, 2017 for the parties to reach an agreement on the RSA’s implementation under PROMESA, or another mutually agreed upon mechanism. On January 27, 2017, however, AAFAF announced that it will lead future negotiations on behalf of PREPA, and requested and received an extension of the January 31, 2017 milestone until March 31, 2017.

The Puerto Rico Energy Commission (“PREC”) has heard two separate but parallel rate cases. In June of 2016, PREC approved a volumetric transition charge for both residential and non-residential customers. The transition charge will be used to pay the debt issued by the SPE. Also in June of 2016, the PREC issued an order approving a requested provisional rate of approximately $0.013/kWh requested by PREPA. On January 11, 2017, the PREC approved an average permanent rate increase of 1.025 cents/kWh. The increase is smaller than the previously approved temporary rate, so PREPA will have to reimburse the $45 million annualized difference to customers. Among the adjustments made, PREC found that PREPA mistakenly double-counted $37 million of subsidy expenses. PREC also disallowed $41 million of capital expenditures for Aguirre Offshore Gas Port, capping spending on that project to $15 million. The rate increase will go into effect on March 13, 2017.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

RESULTS OF OPERATIONS (continued)

 

PRHTA

As set forth above, National has significant exposure to PRHTA. In December of 2015, the Governor of Puerto Rico signed an executive order to redirect certain revenues previously allocated to select public corporation and certain other government agencies (“clawback”), including PRHTA. On January 1, 2016, Puerto Rico made all of its debt service payments due except for bond payments totaling $37 million relating to the Puerto Rico Infrastructure Authority (“PRIFA”) and Public Finance Corporation. Following the missed payment by PRIFA, certain bond insurers (not including National) filed a lawsuit against Puerto Rico claiming that the clawback of the revenues violated the U.S. constitution and the laws of Puerto Rico. Puerto Rico has made a motion to dismiss that case but it is subject to the stay under PROMESA. The outcome of that legal challenge is uncertain, and further, while adoption of the clawback measure was intended to provide short-term relief, Puerto Rico’s lack of a comprehensive plan or clear evidence of steps to conserve resources necessary to meet its near term debt service obligations raises questions as to whether the intercept will continue to be a short-term measure.

Other

Other than Inter American University of Puerto Rico Inc., S&P, Fitch Ratings and/or Moody’s have downgraded the ratings of all Puerto Rico issuers to below investment grade with a negative outlook due to narrowing liquidity, sluggish economic growth and persistent structural deficits. Additionally, subsequent to the declaration of a state of emergency and suspension of debt service payments by the then Governor of Puerto Rico, S&P revised its rating for Puerto Rico, its GO, PREPA and PRHTA’s subordinated transportation revenue bonds, series 1998, state infrastructure bank, to “D” (default).

The following tables presents our scheduled gross debt service due on our Puerto Rico insured exposures as of December 31, 2016, for each of the subsequent five years ending December 31 and thereafter:

 

In millions

   2017      2018      2019      2020      2021      Thereafter      Total  

Puerto Rico Electric Power Authority (PREPA)

   $ 184      $ 120      $ 177      $ 115      $ 140      $ 1,084      $ 1,820  

Puerto Rico Commonwealth GO

     66        96        154        223        82        298        919  

Puerto Rico Public Buildings Authority

     15        21        27        11        11        199        284  

Puerto Rico Highway and Transportation Authority Transportation Revenue (PRHTA)

     31        35        29        30        30        913        1,068  

Puerto Rico Highway and Transportation Authority—Subordinated Transportation Revenue

     5        5        3        3        3        26        45  

Puerto Rico Sales Tax Financing Corporation (COFINA)

                                        4,170        4,170  

Puerto Rico Highway and Transportation Authority Highway Revenue (PRHTA)

     22        6        16        17        4        58        123  

University of Puerto Rico System Revenue

     8        7        7        7        7        90        126  

Inter American University of Puerto Rico Inc.

     3        3        3        3        3        18        33  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 334      $ 293      $ 416      $ 409      $ 280      $ 6,856      $ 8,588  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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RESULTS OF OPERATIONS (continued)

 

Corporate

Our corporate segment consists of general corporate activities, including providing general support services to MBIA Inc.’s subsidiaries and asset and capital management. General support services are provided by our service company, MBIA Services, including, among others, management, legal, accounting, treasury, information technology, and insurance portfolio surveillance, on a fee-for-service basis. Capital management includes activities related to servicing obligations issued by MBIA Inc. and its subsidiaries, MBIA Global Funding, LLC (“GFL”) and IMC. MBIA Inc. issued debt to finance the operations of the MBIA group. GFL raised funds through the issuance of MTNs with varying maturities, which were in turn guaranteed by MBIA Corp. GFL lent the proceeds of these MTN issuances to MBIA Inc. IMC, along with MBIA Inc., provided customized investment agreements, guaranteed by MBIA Corp., for bond proceeds and other public funds for such purposes as construction, loan origination, escrow and debt service or other reserve fund requirements. The Company has ceased issuing these MTNs and investment agreements and the outstanding liability balances and corresponding asset balances have declined over time as liabilities mature, terminate or are called or repurchased. All of the debt within the corporate segment is managed collectively and is serviced by available liquidity.

The following table summarizes the consolidated results of our corporate segment for the years ended December 31, 2016, 2015 and 2014:

 

     Years Ended December 31,      Percent Change  

In millions

   2016      2015      2014      2016 vs. 2015      2015 vs. 2014  

Net investment income

   $ 33      $ 36      $ 38        -8%        -5%  

Fees

     49        52        58        -6%        -10%  

Net gains (losses) on financial instruments at fair value and foreign exchange

     (14)        64        53        -122%        21%  

Net investment losses related to other-than-temporary impairments

     (1)        (3)               -67%        n/m  

Net gains (losses) on extinguishment of debt

     5        (1)        3        n/m        -133%  

Other net realized gains (losses)

     (5)        21        1        -124%        n/m  

Revenues of consolidated VIEs:

              

Other net realized gains (losses)

                   (5)        —%        -100%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

     67        169        148        -60%        14%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Operating

     83        82        94        1%        -13%  

Interest

     92        101        109        -9%        -7%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total expenses

     175        183        203        -4%        -10%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) before income taxes

     (108)        (14)        (55)        n/m        -75%  

Provision (benefit) for income taxes

     (15)        7        (173)        n/m        -104%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss)

   $ (93)      $  (21)      $ 118        n/m        -118%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

n/m—Percent change not meaningful.

NET INVESTMENT INCOME The decrease in net investment income for 2016 compared with 2015 was primarily due to lower average asset balances.

 

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RESULTS OF OPERATIONS (continued)

 

NET GAINS (LOSSES) ON FINANCIAL INSTRUMENTS AT FAIR VALUE AND FOREIGN EXCHANGE The unfavorable change in net gains (losses) on financial instruments at fair value and foreign exchange for 2016 compared with 2015 was primarily due to a decrease in foreign exchange gains on Euro denominated liabilities from a decline in the strengthening of the U.S. dollar and unfavorable changes in the fair value of the outstanding warrants issued on MBIA Inc. common stock. The changes in the fair value of outstanding warrants were primarily attributable to an increase in MBIA Inc.’s common stock, partially offset by changes in volatility, which are used in the valuation of the warrants. The favorable change in net gains (losses) on financial instruments at fair value and foreign exchange for 2015 compared with 2014 was primarily due to gains from the termination of derivatives, partially offset by a decrease in foreign exchange gains on Euro denominated liabilities, an increase in losses from mark-to-market changes of our interest rate swaps and a decrease in gains from the changes in the fair value of the outstanding warrants issued on MBIA Inc. common stock. The changes in the fair value of outstanding warrants were primarily attributable to a decrease in MBIA Inc.’s common stock, partially offset by an increase in volatility, which are used in the valuation of the warrants.

OTHER NET REALIZED GAINS (LOSSES) The decrease in other net realized gains (losses) for 2016 compared with 2015 was primarily due to the results from the sale of Cutwater. The increase in other net realized gains (losses) for 2015 compared with 2014 was primarily due to the gain from the sale of Cutwater.

OPERATING EXPENSES Operating expenses decreased for 2015 compared with 2014 primarily due to decreases in office related expenses as a result of the relocation of our headquarters to a leased facility in the fourth quarter of 2014, as well as a decrease in legal costs.

INTEREST EXPENSE Interest expense decreased for 2016 compared with 2015 and 2014 primarily due to the continued maturities and repurchases of debt obligations issued by the Company.

PROVISION (BENEFIT) FOR INCOME TAXES The 2016 benefit for income taxes was impacted by foreign tax credit adjustments, the fluctuation of the value of nontaxable warrants issued by the Company and nondeductible equity-based compensation expense. The 2015 provision for income taxes was impacted by nondeductible equity-based compensation expense. The 2014 benefit for income taxes includes a favorable adjustment of $87 million for the release of the full valuation allowance against the portion of our deferred tax asset which resulted from the sales of previously impaired investments. In addition for 2014, there was a $61 million reversal in our reserve for uncertain tax positions.

NON-GAAP OPERATING INCOME (LOSS) In addition to the above results, we also analyze the operating performance of our corporate segment using operating income (loss), a non-GAAP measure. We believe operating income (loss), as used by management, is useful for an understanding of the results of operations of the Company. Operating income (loss) is not a substitute for net income (loss) determined in accordance with GAAP, and our definition of operating income (loss) may differ from that used by other companies.

 

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RESULTS OF OPERATIONS (continued)

 

The following table presents a reconciliation of GAAP net income (loss) to operating income (loss) for the years ended December 31, 2016, 2015 and 2014:

 

     Years Ended December 31,  

In millions

   2016      2015      2014  

Net income (loss)

   $ (93)      $ (21)      $ 118  

Less: operating income adjustments:

        

Mark-to-market gains (losses) on financial instruments(1)

     12        39        (39)  

Foreign exchange gains (losses)(1)

     11        60        95  

Net gains (losses) on sales of investments(1)

     (8)        6        26  

Net investment losses related to OTTI

     (1)        (3)         

Net gains (losses) on extinguishment of debt

     5        (1)        3  

Other net realized gains (losses)(2)

     (5)        21         

Operating income adjustment to the (provision) benefit for income tax(3)

     (17)        (42)        68  
  

 

 

    

 

 

    

 

 

 

Operating income (loss)

   $ (90)      $ (101)      $ (35)  
  

 

 

    

 

 

    

 

 

 

 

(1)—Gross amounts are reported within “Net gains (losses) on financial instruments at fair value and foreign exchange” on the Company’s consolidated statements of operations.

(2)—Relates to the results from the sale of Cutwater.

(3)—Reported within “Provision (benefit) for income taxes” on the Company’s consolidated statements of operations.

International and Structured Finance Insurance

Our international and structured finance insurance business is principally operated through MBIA Corp. We believe that MBIA Corp. does not provide significant economic value to MBIA Inc. and its shareholders. The financial guarantees issued by MBIA Corp. generally provide unconditional and irrevocable guarantees of the payment of the principal of, and interest or other amounts owing on, non-U.S. public finance and global structured finance insured obligations when due or, in the event MBIA Corp. has the right, at its discretion, to accelerate insured obligations upon default or otherwise. MBIA Insurance Corporation insures the investment contracts written by MBIA Inc., and if MBIA Inc. or such subsidiaries were to have insufficient assets to pay amounts due upon maturity or termination, MBIA Insurance Corporation would make such payments under its insurance policies. MBIA Insurance Corporation also insured debt obligations of other affiliates, including GFL and IMC. MBIA Corp. has also written insurance policies guaranteeing the obligations under credit default swap (“CDS”) contracts of an affiliate, LaCrosse Financial Products, LLC and certain other derivative contracts. Certain policies cover payments potentially due under CDS, including termination payments that may become due in certain circumstances, including the occurrence of certain insolvency or payment defaults under the CDS or derivatives contracts by the insured counterparty or by the guarantor. MBIA Insurance Corporation provides reinsurance to MBIA Mexico. Effective on January 10, 2017, MBIA Corp.’s wholly-owned subsidiary, MBIA UK Holdings, sold MBIA UK to Assured.

MBIA Corp. insures non-U.S. public finance and global structured finance, including asset-backed obligations. MBIA Corp. has insured sovereign-related and sub-sovereign bonds, privately issued bonds used for the financing of utilities, toll roads, bridges, airports, public transportation facilities, and other types of infrastructure projects serving a substantial public purpose. Global structured finance and asset-backed obligations typically are securities repayable from 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, and leases for equipment, aircraft and real estate property. We no longer insure new credit derivative contracts except for transactions related to the restructuring or reduction of existing derivative exposure.

 

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RESULTS OF OPERATIONS (continued)

 

The following table presents our international and structured finance insurance segment results for the years ended December 31, 2016, 2015 and 2014:

 

     Years Ended December 31,      Percent Change  

In millions

     2016          2015          2014        2016 vs. 2015      2015 vs. 2014  

Net premiums earned

   $ 84      $ 99      $ 144        -15%        -31%  

Net investment income

     12        11        16        9%        -31%  

Fees and reimbursements

     72        67        87        7%        -23%  

Change in fair value of insured derivatives:

              

Realized gains (losses) and other settlements on insured derivatives

     (40)        (28)        (445)        43%        -94%  

Unrealized gains (losses) on insured derivatives

     21        157        903        -87%        -83%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net change in fair value of insured derivatives

     (19)        129        458        -115%        -72%  

Net gains (losses) on financial instruments at fair value and foreign exchange

     30        (9)               n/m        n/m  

Other net realized gains (losses)

     (279)               12        n/m        -100%  

Revenues of consolidated VIEs:

              

Net investment income

     31        86        50        -64%        72%  

Net gains (losses) on financial instruments at fair value and foreign exchange

            42        52        -100%        -19%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

     (69)        425        819        -116%        -48%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Losses and loss adjustment

     146        118        143        24%        -17%  

Amortization of deferred acquisition costs

     56        78        78        -28%        -%  

Operating

     44        50        56        -12%        -11%  

Interest

     115        111        110        4%        1%  

Expenses of consolidated VIEs:

              

Operating

     14        13        9        8%        44%  

Interest

     25        39        39        -36%        —%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total expenses

     400        409        435        -2%        -6%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) before income taxes

     (469)        16        384        n/m        -96%  

Provision (benefit) for income taxes

     (52)        3        134        n/m        -98%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss)

   $ (417)      $ 13      $ 250        n/m        -95%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

n/m—Percent change not meaningful.

As of December 31, 2016, MBIA Corp.’s total insured gross par outstanding was $30.9 billion. Included in this amount was $12.0 billion of gross par outstanding related to MBIA UK which was sold to Assured on January 10, 2017. Since December 31, 2007, MBIA Corp.’s total insured gross par outstanding has decreased approximately 91% from $331.2 billion.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

RESULTS OF OPERATIONS (continued)

 

NET PREMIUMS EARNED Our international and structured finance insurance segment generates net premiums from insurance policies accounted for as financial guarantee contracts. Certain premiums may be eliminated in our consolidated financial statements as a result of the Company consolidating VIEs. In addition, we generate net premiums from insured credit derivatives that are included in “Realized gains (losses) and other settlements on insured derivatives” on our consolidated statements of operations. The following table provides net premiums earned from our financial guarantee contracts for the years ended December 31, 2016, 2015 and 2014:

 

     Years Ended December 31,      Percent Change  

In millions

     2016          2015          2014        2016 vs. 2015      2015 vs. 2014  

Net premiums earned:

              

Non-U.S.

   $ 69      $ 73      $ 110        -5%        -34%  

U.S.

     15        26        34        -42%        -24%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total net premiums earned

   $ 84      $ 99      $ 144        -15%        -31%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

VIEs (eliminated in consolidation)

   $ 7      $ 56      $ 14        -88%        n/m  

 

n/m—Percent change not meaningful.

Net premiums earned represent gross premiums earned net of premiums ceded to reinsurers, and include scheduled premium earnings and premium earnings from refunded issues. Net premiums earned decreased for 2016 compared with 2015 and 2014 primarily due to decreases in scheduled premiums earned from the maturity and early settlements of insured transactions with no writings of new insurance policies.

FEES AND REIMBURSEMENTS The increase in fees and reimbursements for 2016 compared with 2015 was primarily due to an increase in termination and waiver and consent fees related to the ongoing management of our international and structured finance insurance business, partially offset by a decrease in ceding commission income as a result of lower refunding activity. The decrease in fees and reimbursements for 2015 compared with 2014 was primarily due to a decrease in termination and waiver and consent fees, partially offset by an increase in ceding commission income due to higher refunding activity. Due to the transaction-specific nature inherent in fees and reimbursements, these revenues can vary significantly from period to period.

NET CHANGE IN FAIR VALUE OF INSURED DERIVATIVES The Company no longer insures new credit derivative contracts. Realized losses on insured derivatives include payments made net of premiums and fees earned and salvage received. For 2016 and 2015, realized losses on insured derivatives resulted from claim payments on a pool of CMBS. For 2014, realized losses on insured derivatives resulted primarily from settlements and claim payments on a pool of CMBS. For 2016, 2015 and 2014, premiums and fees earned on insured derivatives were $3 million, $12 million and $18 million, respectively. Premiums earned related to insured credit derivatives will decrease over time as a result of settlements prior to maturity and scheduled amortizations.

For the year ended December 31, 2016, unrealized gains on insured derivatives were principally the result of a decline in the weighted average life on transactions, favorable changes in spreads/prices on the underlying collateral and a reversal of unrealized losses due to commutations partially offset by the effects of MBIA’s nonperformance risk on its derivative liabilities. For the year ended December 31, 2015, unrealized gains on insured derivatives were principally the result of refining the credit rating of underlying collateral. For the year ended December 31, 2014, unrealized gains on insured derivatives were principally associated with the reversal of unrealized losses from commutations.

As of December 31, 2016, the cost of a five-year CDS referencing MBIA Corp. was 11.84% upfront plus 5% per annum compared with 42.95% upfront plus 5% per annum and 16.71% upfront plus 5% per annum as of December 31, 2015 and 2014, respectively. As of December 31, 2016 and 2015, the fair value of MBIA Corp.’s insured CDS liability was $63 million and $85 million, respectively. Our mark-to-market on insured credit derivatives uses the most appropriate of the one to ten-year CDS cost for each transaction, and those costs ranged from 4.25% upfront plus 5% per annum to 12.59% upfront plus 5% per annum as of December 31, 2016. As of December 31, 2015, those costs ranged from 26.24% upfront plus 5% per annum to 44.55% upfront plus 5% per annum. As of December 31, 2014, those costs ranged from 3.68% upfront plus 5% per annum to 18.98% upfront plus 5% per annum.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

RESULTS OF OPERATIONS (continued)

 

As of December 31, 2016, MBIA Corp. had $588 million of gross par outstanding on insured credit derivatives compared with $3.2 billion as of December 31, 2015. During the year ended December 31, 2016, $1.8 billion of gross par outstanding on insured credit derivatives were terminated or matured. As of December 31, 2016, four insured credit derivatives remained outstanding.

NET GAINS (LOSSES) ON FINANCIAL INSTRUMENTS AT FAIR VALUE AND FOREIGN EXCHANGE The net gains on financial instruments and foreign exchange for 2016 were primarily related to gains from foreign currency revaluation of Chilean Unidad de Fomento and Euro denominated premium receivables and realized foreign exchange gains from the liquidation of an investment portfolio in the U.K. The net losses on financial instruments at fair value and foreign exchange for 2015 were primarily due to losses from foreign currency revaluation of Chilean Unidad de Fomento denominated premium receivables and foreign exchange currency losses on the sale of Euro denominated investments.

OTHER NET REALIZED GAINS (LOSSES) Other net realized gains (losses) for 2016 related to the loss recorded to adjust the carrying value of MBIA UK to its fair value less costs to sell. On January 10, 2017, MBIA UK was sold to Assured. The other net realized gains (losses) for 2014 was primarily related to an insurance recovery received on an errors and omissions liability policy. Refer to the previous “Results of Operations – Summary of Consolidated Results” section for additional information about the loss recorded to adjust the carrying value of MBIA UK to its fair value less costs to sell.

REVENUES OF CONSOLIDATED VIEs For 2016, total revenues of consolidated VIEs were $31 million compared with total revenues of $128 million for 2015 and $102 million for 2014. The decrease in revenues of consolidated VIEs for 2016 compared with 2015 was primarily due to a decrease in net investment income from the deconsolidation of VIEs and lower mark-to-market gains on assets of consolidated VIEs. The increase in revenues of consolidated VIEs for 2015 compared with 2014 was primarily due to an increase in net investment income of certain consolidated VIEs, primarily due to events that occurred resulting in increased cash flows related to these VIEs, partially offset by lower mark-to-market gains on assets of consolidated VIEs, primarily due to the absence of lower expected payments in 2015. We elected to record at fair value certain instruments that are consolidated under accounting guidance for consolidation of VIEs, and as such, changes in fair value are reflected in earnings.

LOSS AND LOSS ADJUSTMENT EXPENSES MBIA’s insured portfolio management group within our international and structured finance insurance business is responsible for monitoring international and structured finance insured obligations. The level and frequency of monitoring of any insured obligation depends on the type, size, rating and our assessed performance of the insured issue.

Refer to “Note 6: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements for a description of the Company’s loss reserving policy and additional information related to its loss reserves.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

RESULTS OF OPERATIONS (continued)

 

Summary of Financial Guarantee Insurance Losses and LAE

The following table presents information about our financial guarantee insurance losses and LAE recorded in accordance with GAAP for the years ended December 31, 2016, 2015 and 2014:

 

     Years Ended
December 31,
     Percent Change  

In millions

   2016      2015      2014      2016 vs. 2015      2015 vs. 2014  

Losses and LAE related to actual and expected payments(1)

   $ 110      $ 196      $ 72        -44%        n/m  

Recoveries of actual and expected payments

     35        (78)        71        -145%        n/m  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross losses incurred

     145        118        143        23%        -17%  

Reinsurance

     1                      n/m        n/m  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Losses and loss adjustment expenses(2)

   $ 146      $ 118      $ 143        24%        -17%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)—Loss and LAE with respect to Zohar II exposure reflect the expected loss and LAE payments net of expected recoveries on such payments.

(2)—As a result of consolidation of VIEs, these amounts include the elimination of loss and LAE of $29 million, $3 million and $20 million for 2016, 2015 and 2014, respectively.

n/m—Percent change not meaningful

For 2016, losses and LAE primarily related to increases in expected payments on insured first and second-lien RMBS transactions and decreases in projected collections from excess spread within insured second-lien RMBS securitizations, partially offset by decreases in expected payments related to CDOs.

For 2015, losses and LAE primarily related to increases in expected payments on CDOs and insured first-lien RMBS transactions and decreases in projected collections from excess spread within insured second-lien RMBS securitizations. These were partially offset by increases in recoveries of expected payments related to CDOs and increases in projected collections from excess spread within insured second-lien RMBS securitizations due to an anticipated sale of loans within certain securitizations that had previously been charged off by the servicer.

For 2014, losses and LAE primarily related to increases in expected payments on insured first-lien RMBS transactions and CDOs, decreases in projected collections from excess spread within insured second-lien RMBS securitizations and expected recoveries on an international road transaction. These were partially offset by decreases in expected payments on an international road transaction and increases in recoveries of expected payments related to insured first-lien RMBS transactions.

Refer to “Note 6: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements for further information about our insurance loss recoverable and loss and LAE reserves. The following table presents information about our insurance loss recoverable and reserves as of December 31, 2016 and 2015.

 

     December 31,      December 31,      Percent  

In millions

   2016      2015      Change  

Assets:

        

Insurance loss recoverable

   $ 330      $ 573        -42% (1) 

Reinsurance recoverable on paid and unpaid losses(2)

     5        5        —  %  

Liabilities:

        

Gross loss and LAE reserves(3)

     503        550        -9%  

Expected recoveries on unpaid losses

     (59)        (79)        -25%  
  

 

 

    

 

 

    

 

 

 

Loss and LAE reserves

   $ 444      $ 471        -6%  
  

 

 

    

 

 

    

 

 

 

 

(1)—The decrease was primarily due to a decrease in expected future recoveries on CDOs as a result of the consolidation and elimination of a VIE and a decrease in projected collections of excess spread within insured second-lien RMBS.

(2)—Reported within “Other assets” on our consolidated balance sheets.

(3)—Gross loss and LAE reserves with respect to Zohar II exposure reflect the expected loss and LAE payments net of expected recoveries on such reserves.

 

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RESULTS OF OPERATIONS (continued)

 

Included in MBIA Corp.’s loss and LAE reserves are estimated future claims payments for insured obligations for which a payment default has occurred and MBIA Corp. has already paid a claim and for insured obligations where a payment default has not yet occurred. The following table includes LAE reserves, but excludes par outstanding, as of December 31, 2016 and 2015 for one and two issues, respectively, that had no expected future claim payments or par outstanding, but for which MBIA Corp. was obligated to pay LAE incurred in prior periods. As of December 31, 2016 and 2015, loss and LAE reserves comprised the following:

 

     Number of Issues(1)      Loss and LAE Reserve      Par Outstanding  
     December 31,      December 31,      December 31,      December 31,      December 31,      December 31,  

$ in millions

   2016      2015      2016      2015      2016      2015  

Gross of reinsurance:

                 

Issues with defaults

     113        105      $ 366      $ 336      $ 3,228      $ 3,925  

Issues without defaults

     4        6        78        135        838        1,019  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total gross of reinsurance

     117        111      $ 444      $ 471      $ 4,066      $ 4,944  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)—An “issue” represents the aggregate of financial guarantee policies that share the same revenue source for purposes of making debt service payments.

POLICY ACQUISITION COSTS AND OPERATING EXPENSES International and structured finance insurance segment expenses for the years ended December 31, 2016, 2015 and 2014 are presented in the following table:

 

     Years Ended
December 31,
     Percent Change  

In millions

   2016      2015      2014      2016 vs. 2015      2015 vs. 2014  

Gross expenses

   $ 45      $ 51      $ 58        -12%        -12%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Amortization of deferred acquisition costs

   $ 56      $ 78      $ 78        -28%        —%  

Operating

     44        50        56        -12%        -11%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total insurance operating expenses

   $ 100      $ 128      $ 134        -22%        -4%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross expenses represent total insurance expenses before the deferral of any policy acquisition costs. Gross expenses decreased for 2016 compared with 2015 primarily due to decreases in premium taxes and assessments, compensation expense and building related expense. Gross expenses decreased for 2015 compared with 2014 primarily due to decreases in compensation expense, legal and consulting fees. Operating expenses decreased for 2016 compared with 2015 and 2014 due to decreases in gross expenses.

The decrease in the amortization of deferred acquisition costs for 2016 compared with 2015 was due to higher refunding activity in 2015. We did not defer a material amount of policy acquisition costs during 2016, 2015 or 2014. Policy acquisition costs in these periods were primarily related to commissions and premium taxes on installment policies written in prior periods.

INSURED PORTFOLIO EXPOSURE The credit quality of our international and structured finance insured portfolio is assessed in the same manner as our U.S. public finance insured portfolio. As of December 31, 2016 and 2015, 25% and 22%, respectively, of our international and structured finance insured portfolio, was rated below investment grade, before giving effect to MBIA’s guarantees, based on MBIA’s internal ratings, which are generally more current than the underlying ratings provided by S&P and Moody’s for this subset of our insured portfolio.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

RESULTS OF OPERATIONS (continued)

 

International and Structured Finance Insurance Selected Portfolio Exposures

The following is a summary of selected significant exposures within the insured portfolio of our international and structured finance insurance segment. Many of these sectors are and have been considered volatile over the past several years. We may experience considerable incurred losses and future expected payments in certain of these sectors. There can be no assurance that the loss reserves described below will be sufficient or that we will not experience losses on transactions on which we currently have no loss reserves, in particular if the economy deteriorates. We may seek to purchase, directly or indirectly, obligations guaranteed by MBIA or seek to commute policies. The amount of insurance exposure reduced, if any, and the nature of any such actions will depend on market conditions, pricing levels from time to time, and other considerations. In some cases, these activities may result in a reduction of loss reserves, but in all cases they are intended to limit our ultimate losses and reduce the future volatility in loss development on the related policies. Our ability to purchase guaranteed obligations and to commute policies will depend on management’s assessment of available liquidity.

European Sovereign Debt Exposure

Outside the U.S., financial guarantee insurance has been used on structured finance securities and by issuers of sovereign-related and sub-sovereign bonds, utilities and providers of public purpose projects, among others. MBIA does not insure any direct European sovereign debt. However, we do insure both structured finance and public finance obligations in select international markets. MBIA’s indirect European sovereign insured debt exposure totaled $5.2 billion as of December 31, 2016 and included obligations of sovereign-related and sub-sovereign issuers, such as regions, departments, and sovereign-owned and private entities that are supported by a sovereign state, region or department. Sovereign-related includes Private Finance Initiative transactions that involve private entities that receive contractual payments for providing services to public sector entities. Of the $5.2 billion of insured gross par outstanding, $432 million and $185 million were related to Spain and Ireland, respectively. The remaining $4.6 billion was related to the U.K. We do not insure any sovereign or sub-sovereign debt from Greece. Effective January 10, 2017, MBIA UK was sold with the related sovereign debt exposure. The Company has an immaterial amount of European sovereign debt holdings.

Residential Mortgage Exposure

MBIA Corp. insures mortgage-backed securities (“MBS”) backed by residential mortgage loans, including second-lien RMBS transactions (revolving home equity lines of credit (“HELOC”) loans and closed-end second (“CES”) mortgages). MBIA Corp. also insures MBS backed by first-lien alternative A-paper (“Alt-A”) and subprime mortgage loans directly through RMBS securitizations. There was considerable stress and deterioration in the mortgage market since 2008 reflected by heightened delinquencies and losses, particularly related to mortgage loans originated during 2005, 2006 and 2007.

The following table presents the gross par outstanding of MBIA Corp.’s total direct RMBS insured exposure as of December 31, 2016 and 2015. Amounts include the gross par outstanding related to transactions that the Company consolidates under accounting guidance for VIEs.

 

In millions    Gross Par Outstanding as of         
     December 31,      December 31,      Percent  

Collateral Type

   2016      2015      Change  

HELOC Second-lien

   $ 1,368      $ 1,861        -26%  

CES Second-lien

     1,373        1,768        -22%  

Alt-A First-lien(1)

     1,318        1,578        -16%  

Subprime First-lien

     606        724        -16%  

Prime First-lien

     56        99        -43%  
  

 

 

    

 

 

    

 

 

 

Total

   $ 4,721      $ 6,030        -22%  
  

 

 

    

 

 

    

 

 

 

 

(1)—Includes international exposure of $349 million and $449 million as of December 31, 2016 and 2015, respectively.

 

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RESULTS OF OPERATIONS (continued)

 

Collateralized Debt Obligations and Related Instruments

As part of our international and structured finance insurance activities, MBIA Corp. typically provided guarantees on senior and, in a limited number of cases, mezzanine tranches of CDOs, as well as protection on structured CMBS pools and corporate securities, and CDS referencing such securities. The following discussion, including reported amounts and percentages, includes insured CDO transactions consolidated by the Company as VIEs.

As of December 31, 2016 and 2015, MBIA Corp.’s CDO portfolio represented 8% and 14%, respectively, of its total insured gross par outstanding. In addition to the below table, MBIA Corp. insures approximately $345 million in commercial real estate (“CRE”) loan pools, comprising both European and domestic assets. The distribution of our insured CDO and related instruments portfolio by collateral type is presented in the following table:

 

In millions    Gross Par Outstanding as of         
     December 31,     December 31,      Percent  

Collateral Type

   2016     2015      Change  

Multi-sector CDOs

   $ 401 (1)    $ 688        -42%  

Investment grade corporate CDOs

           1,200        -100%  

High yield corporate CDOs

     1,635       2,420        -32%  

Structured CMBS pools

     188       1,002        -81%  

CRE CDOs

     326       698        -53%  
  

 

 

   

 

 

    

 

 

 

Total

   $ 2,550     $ 6,008        -58%  
  

 

 

   

 

 

    

 

 

 

 

(1)—Excludes $44 million of gross par outstanding where MBIA’s insured exposure has been fully offset by way of loss remediation transactions.

U.S. Public Finance and International and Structured Finance Reinsurance

Reinsurance enables the Company to cede exposure for purposes of syndicating risk. When a reinsurer is downgraded by one or more of the rating agencies, less capital credit is given to MBIA under rating agency models and the overall value of the reinsurance to MBIA is reduced. The Company generally retains the right to reassume the business ceded to reinsurers under certain circumstances, including a reinsurer’s rating downgrade below specified thresholds. Currently, we do not intend to use reinsurance on new policies to decrease our insured exposure. Refer to “Note 13: Insurance in Force” in the Notes to Consolidated Financial Statements for a further discussion about our reinsurance agreements.

Advisory Services

Our asset management advisory business was conducted through Cutwater. Cutwater offered advisory services, including cash management, discretionary asset management and structured products on a fee-for-service basis. Cutwater offered these services to public, not-for-profit, corporate and financial services clients, including MBIA Inc. and its other subsidiaries. In October of 2014, the Company entered into an agreement to sell Cutwater to a subsidiary of The Bank of New York Mellon Corporation. Effective with the January 1, 2015 sale of Cutwater, MBIA has no business activities within its advisory services segment.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

RESULTS OF OPERATIONS (continued)

 

The following table summarizes the results and assets under management of our advisory services segment for the year ended December 31, 2014. These results include revenues and expenses from transactions with the Company’s insurance, corporate, and conduit segments.

 

     Year Ended  
     December 31,  

In millions

   2014  

Fees

   $ 34  

Net gains (losses) on financial instruments at fair value and foreign exchange

     (3)  

Revenues of consolidated VIEs

     (8)  
  

 

 

 

Total revenues

     23  

Operating expenses

     48  
  

 

 

 

Income (loss) before income taxes

     (25)  

Provision (benefit) for income taxes

     (6)  
  

 

 

 

Net income (loss)

   $ (19)  
  

 

 

 

Ending assets under management:

  

Third-party

   $ 11,251  

Insurance

     5,930  

Corporate and conduit

     4,159  
  

 

 

 

Total ending assets under management

   $ 21,340  
  

 

 

 

Conduit

In 2014, the Company’s conduit segment was operated through Meridian and administered through MBIA Asset Finance, LLC. Assets held by Meridian were funded by MTNs. In the second quarter of 2014, we retired the remaining $129 million of outstanding MTNs issued by Meridian and dissolved the conduit segment. Certain of MBIA’s consolidated subsidiaries had received fees for services provided to Meridian. The following table presents the results of our conduit segment for the year ended December 31, 2014. These results include revenues and expenses from transactions with the Company’s other segments.

 

     Year Ended  
     December 31,  

In millions

   2014  

Revenues of consolidated VIEs:

  

Net investment income

   $ (1)  

Net gains (losses) on extinguishment of debt

     4  
  

 

 

 

Total revenues

     3  
  

 

 

 

Expenses of consolidated VIEs:

  

Operating

     9  
  

 

 

 

Income (loss) before income taxes

     (6)  

Provision (benefit) for income taxes

      
  

 

 

 

Net income (loss)

   $ (6)  
  

 

 

 

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

RESULTS OF OPERATIONS (continued)

 

Taxes

Provision for Income Taxes

The Company’s income taxes and the related effective tax rates for the years ended December 31, 2016, 2015 and 2014 are presented in the following table:

 

     Years Ended December 31,  

In millions

   2016      2015      2014  

Income (loss) before income taxes

   $ (339)      $ 289      $ 641  

Provision (benefit) for income taxes

   $ (1)      $ 109      $ 72  

Effective tax rate

     0.3%        37.7%        11.2%  

Income taxes paid

   $ 5      $ 9      $ 17  

For 2016, our effective tax rate applied to our loss before income taxes was lower than the U.S. statutory tax rate of 35% primarily due to the provision for deferred taxes on the basis differences of our foreign subsidiary, MBIA UK, which resulted from the change in assertion of MBIA UK paying future dividends over time to calculating deferred taxes on the basis of the sale of MBIA UK and a valuation allowance against certain foreign tax credits.

For 2015, our effective tax rate applied to our income before income taxes was higher than the U.S. statutory rate of 35% primarily due to nondeductible equity-based compensation expense.

For 2014, our effective tax rate applied to our income before income taxes was lower than the U.S. statutory rate of 35% primarily due to a decrease in our valuation allowance against our deferred tax asset from asset sales of previously impaired assets and a decrease in our reserve for uncertain tax positions.

The Company is a party to the Tax Sharing Agreement which has been in effect since January 1, 1987 and subsequently amended and restated effective September 8, 2011.

Refer to “Note 11: Income Taxes” in the Notes to Consolidated Financial Statements for a further discussion of income taxes, including any valuation allowance against the Company’s deferred tax assets and its accounting for tax uncertainties.

CAPITAL RESOURCES

The Company manages its capital resources to minimize its cost of capital while maintaining appropriate claims-paying resources (“CPR”) for National and MBIA Corp. The Company’s capital resources consist of total shareholders’ equity, total debt issued by MBIA Inc. for general corporate purposes, and surplus notes issued by MBIA Corp. Total capital resources were $4.7 billion and $5.2 billion as of December 31, 2016 and 2015, respectively. MBIA Inc. uses its capital resources to support the business activities of its subsidiaries. As of December 31, 2016, MBIA Inc.’s investments in subsidiaries totaled $3.7 billion.

In addition, MBIA Inc. also supports the MTN and investment agreement obligations issued by the Company. We seek to maintain sufficient liquidity and capital resources to meet the Company’s general corporate needs and debt service. Based on MBIA Inc.’s debt service requirements and expected operating expenses, we expect that MBIA Inc. will have sufficient cash to satisfy its debt obligations and its general corporate needs over time from distributions from its operating subsidiaries; however, there can be no assurance that MBIA Inc. will have sufficient cash in the event of unanticipated payments. In addition, the Company may also consider raising third-party capital. For further information, refer to “Strategic Plan Related and Other Risk Factors” in Part I, Item 1A of this Form 10-K and “Liquidity—MBIA Inc. Liquidity” section for additional information about MBIA Inc.’s liquidity.

Securities Repurchases

Repurchases of debt and 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 may also choose to redeem debt obligations where permitted by the relevant agreements. MBIA Inc. or its subsidiaries may repurchase or redeem outstanding common shares of MBIA Inc. and outstanding debt obligations at prices that we deem to be economically advantageous.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

CAPITAL RESOURCES (continued)

 

Equity securities

The Company and its subsidiaries’ share repurchases that were authorized under share repurchase programs, for the years ended December 31, 2016, 2015 and 2014 are presented in the following table:

 

     Years ended December 31,  

In millions except per share amounts

   2016      2015      2014  

Number of shares repurchased

     16.6        39.9        3.3  

Average price paid per share

   $ 6.37      $ 7.60      $ 10.45  

Remaining authorization as of December 31

   $ 88      $ 94      $ 188  

During 2016, we exhausted the capacity remaining under the October 28, 2015 repurchase program of $94 million by repurchasing 14.9 million common shares of MBIA Inc. at an average share price of $6.30.

On February 23, 2016, the Company’s Board of Directors authorized the repurchase by the Company and its subsidiaries of up to $100 million of its outstanding shares under a new share repurchase authorization. During 2016, we repurchased 1.7 million common shares of MBIA Inc. at an average share price of $7.02 under this new share repurchase authorization.

Debt securities

During 2016, we repurchased $6 million par value outstanding of GFL MTNs issued by our corporate segment at a weighted average cost of approximately 97% of par value.

Insurance Statutory Capital

National and MBIA Insurance Corporation are incorporated and licensed in, and are subject to primary insurance regulation and supervision by the State of New York. MBIA UK is authorized by the Prudential Regulation Authority (“PRA”) and regulated by the Financial Conduct Authority (“FCA”) and the PRA in the U.K. MBIA Mexico is regulated by the Comisión Nacional de Seguros y Fianzas in Mexico. National and MBIA Insurance Corporation each are required to file detailed annual financial statements, as well as interim financial statements, with the NYSDFS and similar supervisory agencies in each of the other jurisdictions in which it is licensed. These financial statements are prepared in accordance with New York State and the National Association of Insurance Commissioners’ statements of U.S. STAT and assist our regulators in evaluating minimum standards of solvency, including minimum capital requirements, and business conduct. MBIA UK is required to file quarterly and annual regulatory returns with the PRA and the FCA.

National

Capital and Surplus

National reported total statutory capital of $3.5 billion as of December 31, 2016, compared with $3.4 billion as of December 31, 2015. As of December 31, 2016, statutory capital comprised $2.7 billion of policyholders’ surplus and $745 million of contingency reserves. National had statutory net income of $192 million for the year ended December 31, 2016. As of December 31, 2016, National’s unassigned surplus was $2.1 billion.

In order to maintain its New York State financial guarantee insurance license, National is required to maintain a minimum of $65 million of policyholders’ surplus. National is also required to maintain contingency reserves to provide protection to policyholders in the event of extreme losses in adverse economic events. Refer to the following “MBIA Corp.—Capital and Surplus” section for additional information about contingency reserves under New York Insurance Law (“NYIL”).

 

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CAPITAL RESOURCES (continued)

 

NYIL regulates the payment of dividends by financial guarantee insurance companies and provides that such companies may not declare or distribute dividends except out of statutory earned surplus. Under NYIL, 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 reported in the latest statutory financial statements 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 Superintendent of the NYSDFS approves a greater dividend distribution based upon a finding that the insurer will retain sufficient surplus to support its obligations.

National had positive earned surplus as of December 31, 2016, which provides National with dividend capacity. During 2016, National declared and paid a dividend of $118 million to its ultimate parent, MBIA Inc. For the foreseeable future, we expect the as-of-right declared and paid dividend amounts from National to be limited to prior year net investment income and similar in amount to the 2016 dividend payment.

Claims-Paying Resources (Statutory Basis)

CPR is a key measure of the resources available to National to pay claims under its insurance policies. CPR consists of total financial resources and reserves calculated on a statutory basis. CPR has been a common measure used by financial guarantee insurance companies to report and compare resources and continues to be used by MBIA’s management to evaluate changes in such resources. We have provided CPR to allow investors and analysts to evaluate National using the same measure that MBIA’s management uses to evaluate National’s resources to pay claims under its insurance policies. There is no directly comparable GAAP measure. Our calculation of CPR may differ from the calculation of CPR reported by other companies.

National’s CPR and components thereto, as of December 31, 2016 and 2015 are presented in the following table:

 

     As of
December 31,
     As of
December 31,
 

In millions

   2016      2015  

Policyholders’ surplus

   $ 2,731      $ 2,478  

Contingency reserves

     745        910  
  

 

 

    

 

 

 

Statutory capital

     3,476        3,388  

Unearned premium reserve

     786        1,042  

Present value of installment premiums (1)

     187        197  
  

 

 

    

 

 

 

Premium resources (2)

     973        1,239  

Net loss and LAE reserves (1)

     (98)        (30)  

Salvage reserves

     256        102  
  

 

 

    

 

 

 

Gross loss and LAE reserves

     158        72  
  

 

 

    

 

 

 

Total claims-paying resources

   $ 4,607      $ 4,699  
  

 

 

    

 

 

 

 

  (1)—Calculated using a discount rate of 3.18% and 3.04% as of December 31, 2016 and 2015, respectively.
  (2)—Includes financial guarantee and insured credit derivative related premiums.

 

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CAPITAL RESOURCES (continued)

 

MBIA Insurance Corporation

Capital and Surplus

MBIA Insurance Corporation reported total statutory capital of $492 million as of December 31, 2016 compared with $885 million as of December 31, 2015. As of December 31, 2016, statutory capital comprised $238 million of policyholders’ surplus and $254 million of contingency reserves. As of December 31, 2015, statutory capital comprised $609 million of policyholders’ surplus and $276 million of contingency reserves. For the year ended December 31, 2016, MBIA Insurance Corporation had a statutory net loss of $323 million. Included in the net loss for 2016 was a loss of $114 million to adjust the carrying value of MBIA UK to its estimated fair value less costs to sell. In addition, MBIA Insurance Corporation’s policyholders’ surplus was negatively impacted as of December 31, 2016 and 2015 by $112 million and $75 million, respectively, as it was not permitted to treat the portion of its investment in subsidiaries in excess of 60% of net admitted assets less the par value of common and preferred stock and liabilities as an admitted asset, as required under NYIL. MBIA Insurance Corporation’s policyholders’ surplus as of December 31, 2016 and 2015 included negative unassigned surplus of $1.8 billion and $1.4 billion, respectively. MBIA Insurance Corporation’s policyholders’ surplus may be further negatively impacted if future additional insured losses are incurred and the percentage of its assets invested in subsidiaries continues to increase.

The $112 million reduction to policyholders’ surplus as of December 31, 2016 will be reversed in the first quarter of 2017 to reflect the sale of MBIA UK. In addition, in the first quarter of 2017, MBIA Insurance Corporation will release contingency reserves of approximately $20 million related to the maturity of the Zohar II Notes, as well as, record a gain of $18 million related to the appreciation to the par value of the Zohar II Notes received as consideration. Therefore, in the first quarter of 2017, MBIA Insurance Corporation’s policyholders’ surplus will increase approximately $150 million as a result of these transactions.

As of December 31, 2016, MBIA Insurance Corporation recognized estimated recoveries of $404 million, net of reinsurance on a statutory basis related to put-backs of ineligible mortgage loans in its insured transactions and $395 million related to excess spread recoveries on RMBS, net of reinsurance. These excess spread recoveries represented 80% of MBIA Insurance Corporation’s statutory capital as of December 31, 2016. There can be no assurance that we will be successful or that we will not be delayed in realizing these recoveries. Refer to “Note 6: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements for additional information about these recoveries.

Under NYIL, MBIA Insurance Corporation is also required to establish a contingency reserve to provide protection to policyholders in the event of extreme losses in adverse economic events. The amount of the reserve is based on the percentage of principal insured or premiums earned, depending on the type of obligation (net of collateral, reinsurance, refunding, refinancings and certain insured securities). Reductions in the contingency reserve may be recognized based on excessive reserves and under certain stipulated conditions, subject to the approval of the Superintendent of the NYSDFS. As a result of regulatory approved reductions, MBIA Insurance Corporation’s contingency reserves of $254 million as of December 31, 2016 represented reserves on 33 of the 278 outstanding credits insured by MBIA Insurance Corporation.

In order to maintain its New York State financial guarantee insurance license, MBIA Insurance Corporation is required to maintain a minimum of $65 million of policyholders’ surplus. Under NYIL, MBIA Insurance Corporation is required to invest its minimum surplus and contingency reserves and 50% of its loss reserves and unearned premium reserves in certain qualifying assets. As of December 31, 2016, MBIA Insurance Corporation maintained its minimum requirement of policyholders’ surplus but did not have enough qualifying assets to support its contingency reserves and 50% of its loss reserves and unearned premium reserves. As of December 31, 2016 and 2015, MBIA Insurance Corporation was in compliance with its aggregate risk limits under the NYIL, but was not in compliance with certain of its single risk limits. If new overages occur with respect to its single risk limits, MBIA Insurance Corporation will report them to the NYSDFS. If MBIA Insurance Corporation is not in compliance with its aggregate risk and its single risk limits, the NYSDFS may prevent MBIA Insurance Corporation from transacting any new financial guarantee insurance business until it no longer exceeds the limitations.

 

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CAPITAL RESOURCES (continued)

 

In connection with MBIA Insurance Corporation obtaining approval from the NYSDFS to release excessive contingency reserves in previous periods, MBIA Insurance Corporation agreed that it would not pay any dividends without prior approval from the NYSDFS. Due to its significant negative earned surplus, MBIA Insurance Corporation has not had the statutory capacity to pay dividends since December 31, 2009. Based on estimated future income, MBIA Insurance Corporation is not expected to have any statutory capacity to pay any dividends.

As of December 31, 2016, the par amount outstanding of MBIA Insurance Corporation’s 14% Fixed-to-Floating Rate Surplus Notes due January 15, 2033 (the “Surplus Notes”) was $953 million. Section 1307 of the NYIL and the Fiscal Agency Agreement governing the surplus notes (the “Fiscal Agency Agreement”), which was approved as it relates to Section 1307 by the NYSDFS in connection with the issuance of the Surplus Notes, each impose restrictions on the payments of principal and interest (or the redemption price or any make-whole premium) on the Surplus Notes (“Surplus Note Payments”). Section 1307 of the NYIL provides that any payments on surplus notes issued by an insurer “shall be repaid only out of free and divisible surplus of such insurer with the approval of the Superintendent whenever, in his/her judgment, the financial condition of such insurer warrants.” The Superintendent of Financial Services (the “Superintendent”) has broad discretion in determining whether to allow us to make Surplus Note Payments. We are not aware of any guidelines or interpretations that govern the exercise of the Superintendent’s discretion under Section 1307 in determining whether the financial condition of an insurer warrants the making of such payments. The Fiscal Agency Agreement provides that (a) Surplus Note Payments may be made only with the prior approval of the Superintendent, whenever, in his/her judgment, the financial condition of MBIA Insurance Corporation warrants, and (b) any such Surplus Note Payments may only be made to the extent MBIA Insurance Corporation has sufficient “Eligible Surplus” to make such payments. The Fiscal Agency Agreement defines “Eligible Surplus” as MBIA Insurance Corporation “surplus as regards policyholders,” less the sum of its “common capital stock” and “preferred capital stock”, as shown on its annual and quarterly statements filed with state insurance regulatory authorities. While the NYIL does not explicitly set forth the calculation of “free and divisible surplus”, MBIA believes that the calculation of Eligible Surplus, as set forth in the Fiscal Agency Agreement and as accepted by the NYSDFS, is the appropriate calculation of “free and divisible surplus.” MBIA Insurance Corporation had negative “free and divisible surplus,” determined as set forth above, of $53 million as of December 31, 2016 representing a decrease of $371 million from December 31, 2015. The decrease in MBIA Insurance Corporation’s “free and divisible surplus” during 2016 primarily resulted from a statutory net loss of $323 million during 2016. MBIA Insurance Corporation is required to seek the Superintendent’s approval to make payments of interest and principal when scheduled on the Surplus Notes. There is no assurance the Superintendent will approve Surplus Note Payments. Notwithstanding the sufficiency of MBIA Insurance Corporation’s Eligible Surplus available for the payment of Surplus Note Payments, the NYSDFS may deny approval of any Surplus Note Payments if the Superintendent concludes that MBIA Insurance Corporation’s financial condition does not warrant such approval.

The NYSDFS has not approved MBIA Insurance Corporation’s requests to make interest payments on the Surplus Notes since, and including, the January 15, 2013 interest payment. The NYSDFS has cited both MBIA Insurance Corporation’s liquidity and financial condition as well as the availability of “free and divisible surplus” as the basis for such non-approvals. As of January 15, 2017, the most recent scheduled interest payment date, there was $510 million of unpaid interest on the par amount outstanding of $953 million of the Surplus Notes. The unpaid interest on the Surplus Notes will become due on the first business day on or after which MBIA Insurance Corporation obtains approval to pay some or all of such unpaid interest. No interest has been accrued or will accrue on the deferred interest.

Claims-Paying Resources (Statutory Basis)

CPR is a key measure of the resources available to MBIA Corp. to pay claims under its insurance policies. CPR consists of total financial resources and reserves calculated on a statutory basis. CPR has been a common measure used by financial guarantee insurance companies to report and compare resources, and continues to be used by MBIA’s management to evaluate changes in such resources. We have provided CPR to allow investors and analysts to evaluate MBIA Corp., using the same measure that MBIA’s management uses to evaluate MBIA Corp.’s resources to pay claims under its insurance policies. There is no directly comparable GAAP measure. Our calculation of CPR may differ from the calculation of CPR reported by other companies.

 

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CAPITAL RESOURCES (continued)

 

MBIA Corp.’s CPR and components thereto, as of December 31, 2016 and 2015 are presented in the following table:

 

     As of
December 31,
     As of
December 31,
 

In millions

   2016      2015  

Policyholders’ surplus

   $ 238      $ 609  

Contingency reserves

     254        276  
  

 

 

    

 

 

 

Statutory capital

     492        885  

Unearned premium reserve

     319        356  

Present value of installment premiums(1) (4)

     424        520  
  

 

 

    

 

 

 

Premium resources(2)

     743        876  

Net loss and LAE reserves(1)

     (207)        (332)  

Salvage reserves(3)

     917        994  
  

 

 

    

 

 

 

Gross loss and LAE reserves

     710        662  
  

 

 

    

 

 

 

Total claims-paying resources

   $ 1,945      $ 2,423  
  

 

 

    

 

 

 

 

(1)—Calculated using a discount rate of 5.15% and 5.18% as of December 31, 2016 and 2015, respectively.

(2)—Includes financial guarantee and insured credit derivative related premiums.

(3)—This amount primarily consists of expected recoveries related to the Company’s excess spread and put-backs.

(4)—Based on the Company’s estimate of the remaining life for its insured exposures.

LIQUIDITY

We use a liquidity risk management framework, the primary objective of which is to match liquidity resources to needs. We monitor our cash and liquid asset resources using daily cash forecasting and stress-scenario testing. Members of MBIA’s senior management meet regularly to review liquidity metrics, discuss contingency plans and establish target liquidity levels. We evaluate and manage liquidity on a legal-entity basis to take into account the legal, regulatory and other limitations on available liquidity resources within the enterprise. The following is a discussion of our liquidity resources and requirements for our holding company and our insurance subsidiaries.

National Liquidity

The primary sources of cash within National are:

 

    principal and interest receipts on assets held in its investment portfolio; and

 

    premiums.

The primary uses of cash by National are:

 

    payments of operating expenses and taxes;

 

    loss payments on insured transactions; and

 

    payments of dividends.

As of December 31, 2016 and 2015, National held cash and investments of $4.2 billion and $4.5 billion, respectively, of which $366 million and $336 million, respectively, were highly liquid and comprised highly rated commercial paper, money market funds and municipal, U.S. agency and corporate bonds.

 

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LIQUIDITY (continued)

 

The insurance policies issued or reinsured by National provide unconditional and irrevocable guarantees of payments of the principal of, and interest or other amounts owing on, insured obligations when due. In the event of a default in payment of principal, interest or other insured amounts by an issuer, National generally promises to make funds available in the insured amount within one to three business days following notification. In some cases, the amount due can be substantial, particularly if the default occurs on a transaction to which National has a large notional exposure or on a transaction structured with large, bullet-type principal maturities. The fact that the U.S. public finance insurance segment’s financial guarantee contracts generally cannot be accelerated by a party other than the insurer helps to mitigate liquidity risk in this segment.

National maintains a simultaneous repurchase and reverse repurchase facility (“Asset Swap”) with MBIA Inc. which provides MBIA Inc. with eligible assets to pledge under investment agreements and derivative contracts. As of December 31, 2016, the notional amount used under each of these agreements was $129 million and the fair value of collateral pledged by National and MBIA Inc. under these agreements was $131 million and $137 million, respectively. The net average interest rate on these transactions was 0.41%, 0.26% and 0.23% for the years ended December 31, 2016, 2015 and 2014 respectively.

Corporate Liquidity

The primary sources of cash available to MBIA Inc. to meet its liquidity needs are:

 

    dividends from subsidiaries;

 

    releases from the tax sharing agreement, which are primarily funded by subsidiaries;

 

    available cash and liquid assets not subject to collateral posting requirements;

 

    principal and interest receipts on assets held in its investment portfolio; and

 

    access to capital markets.

The primary uses of cash by MBIA Inc. are:

 

    servicing outstanding corporate debt obligations and MTNs;

 

    collateral requirements under investment agreements, the Asset Swap and derivative arrangements;

 

    payments related to interest rate swaps;

 

    payments of operating expenses; and

 

    debt buybacks and share repurchases.

As of December 31, 2016 and 2015, the liquidity positions of MBIA Inc. comprising cash and liquid assets for general corporate purposes, excluding the amounts held in escrow under its tax sharing agreement, were $403 million and $416 million, respectively.

 

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LIQUIDITY (continued)

 

Based on our projections of National’s and MBIA Corp.’s future earnings and losses, we expect that for the foreseeable future National will be the primary source of dividends and tax sharing agreement payments to MBIA Inc. During 2016, National declared and paid a dividend of $118 million to its ultimate parent, MBIA Inc. There can be no assurance as to the amount and timing of any such future dividends. Also, for the foreseeable future, absent a special dividend subject to the approval of the NYSDFS, we expect the declared and paid dividend amounts from National to be limited to prior year net investment income and similar in amount to the 2016 dividend payment. Refer to the “Capital Resources – Insurance Statutory Capital” section for additional information on payments of dividends. We do not expect MBIA Inc. to receive distributions from MBIA Corp. During the year ended December 31, 2016, $105 million was released to MBIA Inc. under the MBIA group tax sharing agreement and related escrow agreement. This amount represented National’s liability under the tax sharing agreement for the 2013 tax year, which was released from escrow pursuant to the terms under the tax sharing agreement following the expiration of National’s two-year net operating loss carry-back period under U.S. tax rules. During 2016, National paid to the Tax Escrow Account estimated 2016 taxes of $103 million. As of December 31, 2016, $329 million was held in escrow for the 2014 through 2016 tax years. In the first quarter of 2017, $94 million was released to MBIA Inc. from the Tax Escrow Account related to the 2014 year. We expect to release up to $130 million from the Tax Escrow Account related to the 2015 tax year in January of 2018, subject to the terms and provisions of the Company’s tax sharing agreement. There can be no assurance that payments under the Tax Escrow Account from subsidiaries will be released to MBIA Inc. due to deductible or creditable tax attributes of National and/or the market value performance of the assets supporting the Tax Escrow Account.

Currently, the majority of the cash and securities of MBIA Inc. is pledged against investment agreement liabilities, the Asset Swap and derivatives, which limits its ability to raise liquidity through asset sales. If the market value or rating eligibility of the assets which are pledged against MBIA Inc.’s obligations were to decline, we would be required to pledge additional eligible assets in order to meet minimum required collateral amounts against these liabilities. To mitigate these risks, we seek to maintain cash and liquidity resources that we believe will be sufficient to make all payments due on our obligations and to meet other financial requirements, such as posting collateral. Contingent liquidity resources include: (1) sales of invested assets exposed to credit spread stress risk, which may occur at losses; (2) termination and settlement of interest rate swap agreements; and (3) accessing the capital markets. These actions, if taken, are expected to result in either additional liquidity or reduced exposure to adverse credit spread movements. There can be no assurance that these actions will be sufficient to fully mitigate this risk. Information concerning our credit spread sensitivity appears in Part II, Item 7A, “Quantitative and Qualitative Disclosures about Market Risk.”

MBIA Corp. Liquidity

The primary sources of cash within MBIA Corp. are:

 

    installment premiums;

 

    recoveries associated with loss payments; and

 

    principal and interest receipts on assets held in its investment portfolio.

The primary uses of cash by MBIA Corp. are:

 

    loss or commutation payments on insured transactions;

 

    repayment of the MZ Funding Loan;

 

    payments of operating expenses; and

 

    payment of principal and interest related to its surplus notes, if and to the extent approved by the NYSDFS. Refer to “Capital Resources—Insurance Statutory Capital” for a discussion on the non-approval of requests to the NYSDFS to pay interest on its surplus notes.

As of December 31, 2016 and 2015, MBIA Corp. held cash and investments of $328 million and $997 million, respectively, of which $201 million and $264 million, respectively, comprised cash and highly liquid assets that were immediately available to MBIA Insurance Corporation. As of December 31, 2016, $539 million of cash and investments was excluded in the balance for MBIA Corp. due to the sale of MBIA UK in January of 2017.

 

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LIQUIDITY (continued)

 

Insured transactions that require payment in full of the principal insured at maturity could present liquidity risk for MBIA Corp. as any salvage recoveries from such payments could be recovered over an extended period of time after the payment of the principal amount. MBIA Corp. is generally required to satisfy claims within one to three business days, and as a result seeks to identify potential claims in advance through our monitoring process. While our financial guarantee policies generally cannot be accelerated, thereby helping to mitigate liquidity risk, insurance of CDS and certain other derivative contracts may, in certain circumstances, including the occurrence of certain insolvency or payment defaults, be subject to termination by the counterparty, triggering a claim for the fair value of the contract. In order to monitor liquidity risk and maintain appropriate liquidity resources, we use the same methodology as we use to monitor credit quality and losses within our insured portfolio, including stress scenarios. Refer to “Note 6: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements for a discussion of our loss process.

MBIA Corp. has recorded expected excess spread recoveries of $439 million as of December 31, 2016 associated with insured RMBS issues, including recoveries related to consolidated VIEs. MBIA Corp. has also recorded expected recoveries related to its claims against Credit Suisse for ineligible mortgage loans included in an MBIA Corp. insured RMBS transaction. There can be no assurance that it will be successful or not be delayed in realizing these recoveries. During the year ended December 31, 2016, MBIA Corp. collected $92 million of excess spread recoveries related to insured RMBS issues.

The liquidity position of MBIA Corp. has been stressed by payments related to: RMBS exposures, both first and second-lien; CMBS exposures; commutations of insured transactions that reduced both exposure and potential loss volatility; and the Zohar I and Zohar II Claim payments. Refer to “Executive Overview” for a further discussion on the payment of the Zohar I and Zohar II Claims.

MBIA Corp. Financing Facility

In January of 2017, MBIA Corp. entered into a Facility, with the Senior Lenders, and with MBIA Inc., pursuant to which the Senior Lenders provided $325 million of senior financing and MBIA Inc. provided $38 million of subordinated financing to MZ Funding, which in turn lent the proceeds of such financing to MBIA Corp. MBIA Inc. also committed to provide an additional $50 million subordinated financing to MZ Funding, which MZ Funding would then lend to MBIA Corp. if needed by MBIA Insurance Corporation for liquidity purposes.

In connection with the Facility, MZ Funding was organized as a wholly-owned subsidiary of the Company to act as the direct borrower from the Senior Lenders and from the Company. Pursuant to the Senior Note Indenture, dated as of January 10, 2017 (the “Senior Note Indenture”), MZ Funding issued its 14% Insured Senior Notes due January 20, 2020, having an initial aggregate principal amount of $325 million (the “Insured Senior Notes”). Pursuant to the Subordinated Note Indenture, dated as of January 10, 2017 (the “Subordinated Note Indenture”), MZ Funding (i) issued its 14% Insured Subordinated Notes due January 20, 2020, having an initial aggregate principal amount of $38 million (the “Initial Insured Subordinated Notes”) and (ii) may from time to time on or after the closing date on January 10, 2017 issue additional 14% Insured Subordinated Notes due January 20, 2020, with an aggregate principal amount of up to $50 million (the “Additional Insured Subordinated Notes” and, together with the Initial Insured Subordinated Notes, the “Insured Subordinated Notes” and, together with the Insured Senior Notes, the “Notes”). The interest on the Notes is payable quarterly in arrears and payable in cash, but may be payable in kind at the option of MBIA Corp. to the extent that recoveries on the Collateral and the Cash Sweep (referred to below) is less than the accrued but unpaid interest on the Notes. The Insured Senior Notes and Insured Subordinated Notes are guaranteed pursuant to financial guarantee insurance policies issued by MBIA Corp.

As component parts of the Facility, MZ Funding entered into a Credit Agreement with MBIA Corp. (the “Credit Agreement”; and the loans thereunder, the “MBIA Loans”) pursuant to which it immediately lent the proceeds of the Notes to MBIA Corp.

 

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LIQUIDITY (continued)

 

MBIA Corp. is required to promptly submit a written request to MZ Funding to make an additional loan (“Additional Loans”), and MZ Funding is required to issue to the Company (and the Company is obligated to purchase) Additional Insured Subordinated Notes, in the aggregate amount of up to $50 million minus the outstanding principal amount of any outstanding Additional Loans (the “Undrawn Amount”) (i) immediately upon the earlier of: (x) such time as MBIA Corp. consents to the filing of a petition for an Insolvency Proceeding, or (y) such time as the NYSDFS informs MBIA Corp. that a filing of a petition for an Insolvency Proceeding in respect of MBIA Corp. is imminent, (ii) if the Senior Insured Notes have not been paid in full as of July 10, 2019, (iii) if as of the last day of any fiscal quarter of MBIA Corp. the Statutory Surplus of MBIA Corp. is less than $65 million(iv) the Available Liquidity less the Undrawn Delayed Draw Amount of MBIA Corp. is less than $20 million or (v) MBIA Corp. determines that it requires the Undrawn Amount for liquidity purposes; provided, however, in the event MBIA Corp. submits a request for a Delayed Draw Loan on account of subsection (iv) above, MBIA Corp. shall only be required to draw Delayed Draw Loans in increments of $12.5 million until such time that subsection (iv) above is no longer applicable.

If at the end of any fiscal quarter, MBIA’s “Available Liquidity” (as defined in the Credit Agreement) exceeds $150 million and MBIA Corp.’s “Statutory Surplus” (as defined in the Credit Agreement) exceeds $250 million, MBIA Corp. will make a payment on the MBIA Loans in the amount by which the Available Liquidity exceeds $150 million, except that during the first 18 months after the closing of MBIA Loans, the payment may be limited to the amount of the accrued but unpaid interest with the amount of any recovery in excess of accrued interest placed in an interest bearing account subject to the liens in favor of the Senior Lenders in lieu of the payment of principal on the MBIA Loans. This payment, which is referred to as the “Cash Sweep,” will be subject to approval, or non-disapproval, of the NYSDFS. In the event the NYSDFS objects to or otherwise prevents any portion of the payments described above, MBIA Corp. shall, subject to NYSDFS approval to make such payment, pay all approved portions of the Cash Sweep Amount, as provided for herein, and, if such deposit is approved by the NYSDFS, deposit any unapproved portion of the Cash Sweep Amount into the Mandatory Prepayment Account (as defined in the Credit Agreement).

Also, MBIA Corp. will be required to apply any recoveries in respect of the Collateral to the repayment of the MBIA Loans, except that during the first 18 months after closing of the MBIA Loans, MBIA Corp. may elect to place the amount of any recovery in excess of accrued interest in an interest bearing account subject to the liens in favor of the Senior Lenders in lieu of the payment of principal on the MBIA Loans. Any repayment of principal on the MBIA Loans during the first 18 months will be subject to a declining make-whole payment as set forth in the Credit Agreement, calculated as a percentage of the principal amount being repaid.

The Facility is secured by a first priority security interest in all of MBIA Corp.’s right, title and interest in the Zohar I Collateral and the Zohar II Collateral, as such terms are defined in the Security Agreement (collectively, including any proceeds thereof, the “Collateral”). In addition, the Insured Senior Notes are secured by a pledge of the Company’s interest in MZ Funding pursuant to the Pledge Agreement. Any payments or recoveries made on the Zohar II Collateral will be allocated on a pro-rata basis to repayment of the Insured Senior Notes and the MBIA Corp. Payment.

The Insured Senior Notes are secured by a first lien on the Collateral, and the Insured Subordinated Notes are secured by a second lien on the Collateral. The Company, MZ Funding and the trustees under the Senior Note Indenture and the Subordinated Note Indenture have entered into an Intercreditor Agreement (the “Intercreditor Agreement”), pursuant to which any amounts due the Company in respect of the Insured Subordinated Notes or from the MBIA Corp. policies insuring the Insured Subordinated Notes are subordinated to payment in full of the Insured Senior Notes until the amounts owed to the Senior Lenders in respect of the Insured Senior Notes have been paid in full. Therefore, at any time that the MBIA Loans are repaid, MZ Funding is required to apply the repayment first to the payment of interest and principal on the Insured Senior Notes and, after the Insured Senior Notes are paid in full, to the payment of the Insured Subordinated Notes, subject to certain reimbursements payable to MBIA Corp. The Company’s ability to collect the principal and interest on the Insured Subordinated Notes will be based primarily on the amount recovered by MBIA Corp. with respect to the Collateral, after payment in full of the Insured Senior Notes and other related payment obligations that are senior to the Insured Subordinated Notes pursuant to the Intercreditor Agreement.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

LIQUIDITY (continued)

 

Based on the estimated value of the Collateral in relation to the amount of the Senior Insured Notes and the Subordinated Insured Notes, the Company expects that the recoveries from the Collateral will be sufficient to enable the payment in full of the Senior Insured Notes and the Subordinated Insured Notes. There is uncertainty, however, with respect to the realizable value of the Collateral and there can be no assurance that recoveries on the Collateral will be sufficient to pay the Senior Insured Notes and the Subordinated Insured Notes in full or that, in the event that recoveries on the Collateral are not sufficient to pay the Senior Insured Notes and the Subordinated Insured Notes in full, that MBIA Corp. will be able to pay any shortfall necessary to pay the Senior Insured Notes and the Subordinated Insured Notes in full under the policy insuring the Subordinated Insured Notes.

Advances Agreement

MBIA Inc., National, MBIA Insurance Corporation and certain other affiliates are party to an intercompany advances agreement (the “MBIA Advances Agreement”). The MBIA Advances Agreement permits National to make advances to MBIA Inc. and other MBIA group companies that are party to the agreement at a rate per annum equal to LIBOR plus 0.25%. The agreement also permits other affiliates to make advances to National or MBIA Insurance Corporation at a rate per annum equal to LIBOR minus 0.10%. Advances by National cannot exceed 3% of its admitted assets as of the last quarter end. As of December 31, 2016 and 2015, there were no amounts drawn under the agreement.

Consolidated Cash Flows

Information about our consolidated cash flows by category is presented on our consolidated statements of cash flows. The following table summarizes our consolidated cash flows for the years ended December 31, 2016, 2015 and 2014:

 

     Years Ended December 31,      Percent Change  

In millions

   2016      2015      2014      2016 vs. 2015      2015 vs. 2014  

Statement of cash flow data:

              

Net cash provided (used) by:

              

Operating activities

   $ (142)      $ (55)      $ (333)        n/m        -83%  

Investing activities

     2,424        817        812        n/m        1%  

Financing activities

     (2,542)        (1,014)        (892)        n/m        14%  

Effect of exchange rate changes on cash and cash equivalents

     (2)        (8)        (8)        -75%        —%  

Cash and cash equivalents—beginning of year

     522        782        1,258        -33%        -38%  

Reclassification to assets held for sale

     (73)               (55)        n/m        -100%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Cash and cash equivalents—end of year

   $ 187      $ 522      $ 782        -64%        -33%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

n/m—Percent change not meaningful.

Operating activities

Net cash used by operating activities increased for the year ended December 31, 2016 compared with 2015 primarily due to an increase in losses and LAE paid of $113 million and a decrease in investment income received of $35 million, partially offset by a decrease in interest paid of $30 million and an increase in premiums, fees and reimbursements received of $20 million. Net cash used by operating activities decreased for the year ended December 31, 2015 compared with 2014 primarily due to decreases in insured derivative commutations and loss payments of $390 million and operating and employee related expenses of $108 million, partially offset by decreases in premiums, fees and reimbursements and investment income received of $164 million.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

LIQUIDITY (continued)

 

Investing activities

Net cash provided by investing activities increased for the year ended December 31, 2016 compared with 2015 primarily due to an increase in net proceeds from sales, paydowns and maturities of held-to-maturity investments of consolidated VIEs of $1.7 billion related to the deconsolidation of VIEs in 2016. Net cash provided by investing activities increased slightly for the year ended December 31, 2015 compared with 2014 primarily due to increases in net proceeds from purchases, sales, paydowns and maturities of investments and loans of $316 million and increases in the proceeds from derivative settlements, the sale of Cutwater and the sale of our Armonk, New York facility of $86 million. These increases were partially offset by a decrease in cash acquired from consolidated VIEs of $214 million and an increase in collateral posting of $175 million.

Financing activities

Net cash used by financing activities increased for the year ended December 31, 2016 compared with 2015 primarily due to an increase in the principal paydowns of consolidated VIE notes of $1.7 billion related to the deconsolidation of VIEs in 2016, partially offset by a decrease in the purchases of treasury stock of $195 million. Net cash used by financing activities increased for the year ended December 31, 2015 compared with 2014 primarily due to an increase in the purchases of treasury stock of $271 million, partially offset by decreases in the principal paydowns of VIE notes and investment agreements of $195 million.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

LIQUIDITY (continued)

 

Investments

The following discussion of investments, including references to consolidated investments, excludes investments reported under “Assets of consolidated variable interest entities” on our consolidated balance sheets. Investments of VIEs support the repayment of VIE obligations and are not available to settle obligations of MBIA. Our available-for-sale (“AFS”) investments comprise high-quality fixed-income securities and short-term investments. The following table presents our investment portfolio as of December 31, 2016 and 2015. As of December 31, 2016, AFS with a fair value of $466 million reported under “Assets held for sale” within our international and structured finance segment are excluded due to the sale of MBIA UK in January of 2017.

 

     As of December 31,         

In millions

        2016                2015           Percent Change  

Available-for-sale investments:

        

U.S. public finance insurance

        

Amortized cost

   $ 3,975      $ 4,227        -6%  

Unrealized net gain (loss)

     (63)        (70)        -10%  
  

 

 

    

 

 

    

 

 

 

Fair value

     3,912        4,157        -6%  
  

 

 

    

 

 

    

 

 

 

International and structured finance insurance

        

Amortized cost

     257        627        -59%  

Unrealized net gain (loss)

     5        7        -29%  
  

 

 

    

 

 

    

 

 

 

Fair value

     262        634        -59%  
  

 

 

    

 

 

    

 

 

 

Corporate

        

Amortized cost

     1,218        1,306        -7%  

Unrealized net gain (loss)

     39        23        70%  
  

 

 

    

 

 

    

 

 

 

Fair value

     1,257        1,329        -5%  
  

 

 

    

 

 

    

 

 

 

Total available-for-sale investments:

        

Amortized cost

     5,450        6,160        -12%  

Unrealized net gain (loss)

     (19)        (40)        -53%  
  

 

 

    

 

 

    

 

 

 

Total available-for-sale investments at fair value

     5,431        6,120        -11%  
  

 

 

    

 

 

    

 

 

 

Investments carried at fair value:

        

U.S. public finance insurance

        

Amortized cost

     120        112        7%  

Unrealized net gain (loss)

            21        -100%  
  

 

 

    

 

 

    

 

 

 

Fair value

     120        133        -10%  
  

 

 

    

 

 

    

 

 

 

International and structured finance insurance

        

Amortized cost

            1        -100%  

Unrealized net gain (loss)

                   —%  
  

 

 

    

 

 

    

 

 

 

Fair value

            1        -100%  
  

 

 

    

 

 

    

 

 

 

Corporate

        

Amortized cost

     75        95        -21%  

Unrealized net gain (loss)

     4        (2)        n/m  
  

 

 

    

 

 

    

 

 

 

Fair value

     79        93        -15%  
  

 

 

    

 

 

    

 

 

 

Total investments carried at fair value:

        

Amortized cost

     195        208        -6%  

Unrealized net gain (loss)

     4        19        -79%  
  

 

 

    

 

 

    

 

 

 

Total investments carried at fair value

     199        227        -12%  
  

 

 

    

 

 

    

 

 

 

Other investments at amortized cost:

        

U.S. public finance insurance

     3        3        —%  
  

 

 

    

 

 

    

 

 

 

Consolidated investments at carrying value

   $ 5,633      $ 6,350        -11%  
  

 

 

    

 

 

    

 

 

 

 

n/m—Percent change not meaningful.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

LIQUIDITY (continued)

 

The fair value of the Company’s investments is based on prices which include quoted prices in active markets and prices based on market-based inputs that are either directly or indirectly observable, as well as prices from dealers in relevant markets. Differences between fair value and amortized cost arise primarily as a result of changes in interest rates and general market credit spreads occurring after a fixed-income security is purchased, although other factors may also influence fair value, including specific credit-related changes, supply and demand forces and other market factors. When the Company holds an AFS investment to maturity, any unrealized gain or loss currently recorded in accumulated other comprehensive income (loss) in the shareholders’ equity section of the balance sheet is reversed. As a result, the Company would realize a value substantially equal to amortized cost. However, when investments are sold prior to maturity, the Company will realize any difference between amortized cost and the sale price of an investment as a realized gain or loss within its consolidated statements of operations.

Credit Quality

The credit quality distribution of the Company’s AFS fixed-maturity investment portfolios, excluding short-term investments, based on ratings from Moody’s as of December 31, 2016 is presented in the following table. Alternate ratings sources, such as S&P or the best estimate of the ratings assigned by the Company, have been used for a small percentage of securities that are not rated by Moody’s.

 

     U.S. Public Finance
Insurance
     Corporate      International and
Structured Finance
Insurance
     Total  

In millions

   Fair
Value
     % of
Fixed-Income
Investments
     Fair
Value
     % of
Fixed-Income
Investments
     Fair
Value
     % of
Fixed-Income
Investments
     Fair
Value
     % of
Fixed-Income
Investments
 

Available-for-sale:

                       

Aaa

   $ 1,706        45%      $ 559        61%      $ 19        19%      $ 2,284        47%  

Aa

     934        25%        46        5%        55        54%        1,035        21%  

A

     845        22%        184        20%        15        15%        1,044        22%  

Baa

     136        4%        56        6%               0%        192        4%  

Below investment grade

     9        0%        47        5%        12        12%        68        2%  

Not rated

     175        4%        21        3%               —%        196        4%  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,805        100%      $ 913        100%      $ 101        100%      $ 4,819        100%  

Short-term investments

     104           342           161           607     

Investments carried at fair value

     120           79                     199     

Other investments

     6           2                     8     
  

 

 

       

 

 

       

 

 

       

 

 

    

Consolidated investments at carrying value

   $ 4,035         $ 1,336         $ 262         $ 5,633     
  

 

 

       

 

 

       

 

 

       

 

 

    

As of December 31, 2016, the weighted average credit quality of the Company’s AFS investment portfolios, excluding short-term and other investments, as presented in the preceding table are as follows:

 

     U.S. Public
Finance
Insurance
     International
and Structured
Finance
Insurance
     Corporate  

Weighted average credit quality ratings

     Aa        Aa        Aa  

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

LIQUIDITY (continued)

 

Insured Investments

MBIA’s consolidated investment portfolio includes investments that are insured by various financial guarantee insurers (“Insured Investments”), including investments insured by National and MBIA Corp. (“Company-Insured Investments”). As of December 31, 2016, Insured Investments at fair value represented $489 million or 9% of consolidated investments, of which $334 million or 6% of consolidated investments were Company-Insured Investments. As of December 31, 2016, based on the actual or estimated underlying ratings of our consolidated investment portfolio, without giving effect to financial guarantees, the weighted average rating of only the Insured Investments in the investment portfolio would be in the Baa range.

In purchasing Insured Investments, the Company’s third-party portfolio manager independently assesses the underlying credit quality, structure and liquidity of each investment, in addition to the creditworthiness of the insurer. Insured Investments are diverse by sector, issuer and size of holding. The third-party portfolio manager assigns underlying ratings to Insured Investments without giving effect to financial guarantees based on underlying ratings assigned by Moody’s or S&P, when a rating is not published by Moody’s. When a Moody’s or S&P underlying rating is not available, the underlying rating is based on the portfolio manager’s best estimate of the rating of such investment. A downgrade of a financial guarantee insurer has historically had an adverse effect on the fair value of investments insured by the downgraded financial guarantee insurer. If the Company determines that declines in the fair values of Insured Investments are other-than-temporary, the Company will record a realized loss through earnings.

The underlying ratings of the Company-Insured Investments as of December 31, 2016 are reflected in the following table. Amounts represent the fair value of such investments including the benefit of the MBIA guarantee. The ratings in the following table are based on ratings from Moody’s. Alternate ratings sources, such as S&P, have been used for a small percentage of securities that are not rated by Moody’s.

 

In millions

 

 

Underlying Ratings Scale

   U.S. Public
Finance
Insurance
     Corporate      International
and Structured
Finance
Insurance
     Total  

National:

           

Aa

   $      $ 26      $      $ 26  

A

     164        68               232  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total National

   $ 164      $ 94      $      $ 258  
  

 

 

    

 

 

    

 

 

    

 

 

 

MBIA Corp.:

           

Aa

   $      $ 14      $      $ 14  

Baa

            5               5  

Below investment grade

            46        11        57  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total MBIA Corp.

   $      $ 65      $ 11      $ 76  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Company-Insured Investments

   $ 164      $ 159      $ 11      $ 334  
  

 

 

    

 

 

    

 

 

    

 

 

 

Without giving effect to the National and MBIA Corp. guarantees of the Company-Insured Investments in the consolidated investment portfolio, as of December 31, 2016, based on actual or estimated underlying ratings, the weighted average rating of the consolidated investment portfolio was in the Aa range. The weighted average rating of only the Company-Insured Investments was in the Below investment grade range, and investments rated below investment grade in the Company-Insured Investments were 4% of the total consolidated investment portfolio.

Impaired Investments

As of December 31, 2016 and 2015, we held impaired AFS investments (investments for which fair value was less than amortized cost) with a fair value of $2.2 billion and $2.8 billion, respectively.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

LIQUIDITY (continued)

 

We analyze impaired investments within our investment portfolio for OTTI on a quarterly basis. Key factors considered when assessing OTTI include but are not limited to: (a) structural and economic factors among security types that represent our largest exposure to credit impairment losses; (b) the duration and severity of the unrealized losses (i.e., a decline in the market value of a security by 20% or more at the time of the review, or 5% impaired at the time of review with a fair value below amortized cost for a consecutive 12-month period); and (c) the results of various cash flow modeling techniques. Our cash flow analysis considers all sources of cash, including credit enhancement, that support the payment of amounts owed by an issuer of a security. This includes the consideration of cash to be provided by financial guarantors, including National and MBIA Corp., resulting from an actual or potential insurance policy claim.

Refer to “Note 8: Investments” in the Notes to Consolidated Financial Statements for a detailed discussion about impaired investments.

Contractual Obligations

The following table summarizes the Company’s future estimated cash payments relating to contractual obligations as of December 31, 2016. Estimating these payments requires management to make estimates and assumptions regarding these obligations. The estimates and assumptions used by management are described below. Since these estimates and assumptions are subjective, actual payments in future periods may vary from those reported in the following table. Refer to “Note 13: Insurance in Force” in the Notes to Consolidated Financial Statements for information about the Company’s exposure under insurance contracts.

 

     As of December 31, 2016  

In millions

   2017      2018      2019      2020      2021      Thereafter      Total  

U.S. public finance insurance segment:

                    

Gross insurance claim obligations(1)