10-Q 1 d459699d10q.htm FORM 10-Q Form 10-Q
Table of Contents

 

 

United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

 

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

For the quarterly period ended September 30, 2017

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

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

 

 

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 whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer     (Do not check if a smaller reporting company)    Smaller reporting company  
Emerging growth company       

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes      No  

As of November 3, 2017, 91,777,937 shares of Common Stock, par value $1 per share, were outstanding.

 


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         PAGE  

PART I FINANCIAL INFORMATION

  

Item 1.

  Financial Statements MBIA Inc. and Subsidiaries (Unaudited)   
  Consolidated Balance Sheets as of September 30, 2017 and December 31, 2016 (Unaudited)      1  
  Consolidated Statements of Operations for the three and nine months ended September 30, 2017 and 2016 (Unaudited)      2  
  Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2017 (Unaudited)      3  
  Consolidated Statement of Changes in Shareholders’ Equity for the nine months ended September 30, 2017 (Unaudited)      4  
  Consolidated Statements of Cash Flows for the nine months ended September 30, 2017 and 2016 (Unaudited)      5  
  Notes to Consolidated Financial Statements (Unaudited)      6  
  Note 1: Business Developments and Risks and Uncertainties      6  
  Note 2: Significant Accounting Policies      9  
  Note 3: Recent Accounting Pronouncements      9  
  Note 4: Variable Interest Entities      11  
  Note 5: Loss and Loss Adjustment Expense Reserves      13  
  Note 6: Fair Value of Financial Instruments      20  
  Note 7: Investments      37  
  Note 8: Derivative Instruments      41  
  Note 9: Debt      44  
  Note 10: Income Taxes      44  
  Note 11: Business Segments      46  
  Note 12: Earnings Per Share      49  
  Note 13: Accumulated Other Comprehensive Income      51  
  Note 14: Commitments and Contingencies      51  
  Note 15: Subsequent Events      53  

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      54  

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk      89  

Item 4.

  Controls and Procedures      89  

PART II OTHER INFORMATION

  

Item 1.

  Legal Proceedings      90  

Item 1A.

  Risk Factors      90  

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      91  

Item 6.

  Exhibits      93  

SIGNATURES

     94  


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FORWARD-LOOKING AND CAUTIONARY STATEMENTS

This quarterly 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;

 

   

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 II Other Information, Item 1A included in this Quarterly Report on Form 10-Q. In addition, refer to “Note 1: Business Developments and Risks and Uncertainties” in the Notes to Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for a discussion of certain risks and uncertainties related to our financial statements.

This quarterly 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.

 


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PART I FINANCIAL INFORMATION

Item 1. Financial Statements

MBIA INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (Unaudited)

(In millions except share and per share amounts)

 

                     
     September 30, 2017      December 31, 2016  

Assets

     

Investments:

     

Fixed-maturity securities held as available-for-sale, at fair value (amortized cost $4,203 and $4,713)

   $ 4,234       $ 4,694   

Investments carried at fair value

     164         146   

Investments pledged as collateral, at fair value (amortized cost $169 and $234)

     170         233   

Short-term investments held as available-for-sale, at fair value (amortized cost $452 and $552)

     452         552   

Other investments (includes investments at fair value of $4 and $5)

             
  

 

 

    

 

 

 

Total investments

     5,026         5,633   

Cash and cash equivalents

     116         163   

Premiums receivable

     382         409   

Deferred acquisition costs

     96         118   

Insurance loss recoverable

     611         504   

Assets held for sale

            555   

Deferred income taxes, net

            970   

Other assets

     146         113   

Assets of consolidated variable interest entities:

     

Cash

     20         24   

Investments held-to-maturity, at amortized cost (fair value $897 and $876)

     890         890   

Investments carried at fair value

     189         255   

Loans receivable at fair value

     1,632         1,066   

Loan repurchase commitments

     406         404   

Other assets

     30         33   
  

 

 

    

 

 

 

Total assets

   $ 9,544       $ 11,137   
  

 

 

    

 

 

 

Liabilities and Equity

     

Liabilities:

     

Unearned premium revenue

   $ 808       $ 958   

Loss and loss adjustment expense reserves

     818         541   

Long-term debt

     2,093         1,986   

Medium-term notes (includes financial instruments carried at fair value of $127 and $101)

     898         895   

Investment agreements

     350         399   

Derivative liabilities

     284         299   

Liabilities held for sale

            346   

Other liabilities

     221         233   

Liabilities of consolidated variable interest entities:

     

Variable interest entity notes (includes financial instruments carried at fair value of $1,140 and $1,351)

     2,352         2,241   
  

 

 

    

 

 

 

Total liabilities

     7,824         7,898   
  

 

 

    

 

 

 

Commitments and contingencies (Refer to Note 14)

     

Equity:

     

Preferred stock, par value $1 per share; authorized shares—10,000,000; issued and outstanding—none

             

Common stock, par value $1 per share; authorized shares—400,000,000; issued shares—283,967,973 and 283,989,999

     284         284   

Additional paid-in capital

     3,170         3,160   

Retained earnings

     1,132         2,700   

Accumulated other comprehensive income (loss), net of tax of $6 and $37

     15         (128)  

Treasury stock, at cost—160,858,509 and 148,789,168 shares

     (2,893)        (2,789)  
  

 

 

    

 

 

 

Total shareholders’ equity of MBIA Inc.

     1,708         3,227   

Preferred stock of subsidiary

     12         12   
  

 

 

    

 

 

 

Total equity

     1,720         3,239   
  

 

 

    

 

 

 

Total liabilities and equity

   $ 9,544       $ 11,137   
  

 

 

    

 

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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MBIA INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

(In millions except share and per share amounts)

 

                                           
     Three Months Ended September 30,      Nine Months Ended September 30,  
     2017      2016      2017      2016  

Revenues:

           

Premiums earned:

           

Scheduled premiums earned

   $ 26       $ 42       $ 82       $ 131   

Refunding premiums earned

     27         35         64         94   
  

 

 

    

 

 

    

 

 

    

 

 

 

Premiums earned (net of ceded premiums of $1, $2, $4 and $5)

     53         77         146         225   

Net investment income

     33         39         122         115   

Fees and reimbursements

            22                24   

Change in fair value of insured derivatives:

           

Realized gains (losses) and other settlements on insured derivatives

     (7)        (4)        (41)        (20)  

Unrealized gains (losses) on insured derivatives

            20         (10)         
  

 

 

    

 

 

    

 

 

    

 

 

 

Net change in fair value of insured derivatives

     (1)        16         (51)        (20)  

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

     (11)        38         (55)        (17)  

Net investment losses related to other-than-temporary impairments:

           

Investment losses related to other-than-temporary impairments

     (26)               (80)        (1)  

Other-than-temporary impairments recognized in accumulated other comprehensive income (loss)

     (45)               (4)         
  

 

 

    

 

 

    

 

 

    

 

 

 

Net investment losses related to other-than-temporary impairments

     (71)               (84)        (1)  

Net gains (losses) on extinguishment of debt

                           

Other net realized gains (losses)

     (1)        (2)        36         (3)  

Revenues of consolidated variable interest entities:

           

Net investment income

                   20         25   

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

     21                        

Other net realized gains (losses)

                   28          
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

     33         203         182         353   

Expenses:

           

Losses and loss adjustment

     205         50         469         149   

Amortization of deferred acquisition costs

            10         23         30   

Operating

     21         32         82         97   

Interest

     50         49         148         148   

Expenses of consolidated variable interest entities:

           

Operating

                          10   

Interest

     19                55         20   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total expenses

     306         148         785         454   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) before income taxes

     (273)        55         (603)        (101)  

Provision (benefit) for income taxes

     (6)        24         965         (28)  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss)

   $ (267)      $ 31       $ (1,568)      $ (73)  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss) per common share:

           

Basic

   $ (2.17)      $ 0.23       $ (12.38)      $ (0.55)  

Diluted

   $ (2.17)      $ 0.23       $ (12.38)      $ (0.55)  

Weighted average number of common shares outstanding:

           

Basic

     122,967,924         131,633,411         126,643,642         133,368,752   

Diluted

     122,967,924         132,042,067         126,643,642         133,368,752   
   

The accompanying notes are an integral part of the consolidated financial statements.

 

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MBIA INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)

(In millions)

 

                                           
     Three Months Ended September 30,      Nine Months Ended September 30,  
     2017      2016      2017      2016  

Net income (loss)

   $ (267)      $ 31       $ (1,568)      $ (73)  

Other comprehensive income (loss):

           

Unrealized gains (losses) on available-for-sale securities:

           

Unrealized gains (losses) arising during the period

     16         (20)        20         204   

Provision (benefit) for income taxes

            (7)               72   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

            (13)        13         132   

Reclassification adjustments for (gains) losses included in net income (loss)

            (1)        (4)         

Provision (benefit) for income taxes

     (1)        (1)        (1)         
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

                   (3)         

Available-for-sale securities with other-than-temporary impairments:

 

        

Other-than-temporary impairments and unrealized gains (losses) arising during the period

     40                        

Provision (benefit) for income taxes

                           
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     38                       5  

Reclassification adjustments for (gains) losses included in net income (loss)

                           

Provision (benefit) for income taxes

                           
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

                           

Foreign currency translation:

           

Foreign currency translation gains (losses)

            (15)        145         (70)  

Provision (benefit) for income taxes

     (1)        (5)        20         (24)  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

            (10)        125         (46)  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total other comprehensive income (loss)

     54         (23)        143         96   
  

 

 

    

 

 

    

 

 

    

 

 

 

Comprehensive income (loss)

   $ (213)      $      $ (1,425)      $ 23   
  

 

 

    

 

 

    

 

 

    

 

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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MBIA INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)

For The Nine Months Ended September 30, 2017

(In millions except share amounts)

 

                                                                                                                        
     Common Stock      Additional
Paid-in
     Retained     

Accumulated
Other
Comprehensive

     Treasury Stock      Total
Shareholders’
Equity
     Preferred Stock
of Subsidiary
     Total  
     Shares      Amount      Capital      Earnings      Income (Loss)      Shares      Amount      of MBIA Inc.      Shares      Amount      Equity  

Balance, December 31, 2016

     283,989,999       $ 284       $ 3,160       $ 2,700       $ (128)        (148,789,168)      $ (2,789)      $ 3,227         1,315       $ 12       $ 3,239   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss)

                          (1,568)                             (1,568)                      (1,568)  

Other comprehensive income (loss)

                                 143                       143                       143   

Share-based compensation

     (22,026)               10                       (359,335)        (4)                              

Treasury shares acquired under share repurchase program

                                        (11,710,006)        (100)        (100)                      (100)  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Balance, September 30, 2017

     283,967,973       $ 284       $ 3,170       $ 1,132       $ 15         (160,858,509)      $ (2,893)      $ 1,708         1,315       $ 12       $ 1,720   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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MBIA INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(In millions)

 

                     
     Nine Months Ended September 30,  
     2017      2016  

Cash flows from operating activities:

     

Premiums, fees and reimbursements received

   $ 41       $ 87   

Investment income received

     193         249   

Insured derivative commutations and losses paid

     (41)        (24)  

Financial guarantee losses and loss adjustment expenses paid

     (744)        (324)  

Proceeds from recoveries and reinsurance

     100         88   

Operating and employee related expenses paid

     (103)        (98)  

Interest paid, net of interest converted to principal

     (119)        (102)  

Income taxes (paid) received

            (4)  
  

 

 

    

 

 

 

Net cash provided (used) by operating activities

     (673)        (128)  
  

 

 

    

 

 

 

Cash flows from investing activities:

     

Purchases of available-for-sale investments

     (1,146)        (2,112)  

Sales of available-for-sale investments

     1,300         1,785   

Paydowns and maturities of available-for-sale investments

     392         410   

Purchases of investments at fair value

     (199)        (88)  

Sales, paydowns and maturities of investments at fair value

     270         197   

Sales, paydowns and maturities (purchases) of short-term investments, net

     67         90   

Sales, paydowns and maturities of held-to-maturity investments

            1,799   

Sales, paydowns and maturities of other investments

             

Paydowns and maturities of loans receivable

     202         188   

Consolidation/(deconsolidation) of variable interest entities, net

     18          

(Payments) proceeds for derivative settlements

     (58)        (36)  

Collateral (to) from counterparties

            10   

Capital expenditures

     (1)        (1)  

Other investing

     (23)        (8)  
  

 

 

    

 

 

 

Net cash provided (used) by investing activities

     826         2,236   
  

 

 

    

 

 

 

Cash flows from financing activities:

     

Proceeds from investment agreements

     13         17   

Principal paydowns of investment agreements

     (66)        (63)  

Principal paydowns of medium-term notes

     (67)        (122)  

Proceeds from the MBIA Corp. Financing Facility

     328          

Principal paydowns of variable interest entity notes

     (311)        (2,136)  

Purchases of treasury stock

     (98)        (109)  

Other financing

     (3)         
  

 

 

    

 

 

 

Net cash provided (used) by financing activities

     (204)        (2,413)  
  

 

 

    

 

 

 

Effect of exchange rate changes on cash and cash equivalents

            (1)  

Net increase (decrease) in cash and cash equivalents

     (51)        (306)  

Cash and cash equivalents—beginning of period

     187         522   
  

 

 

    

 

 

 

Cash and cash equivalents—end of period

   $ 136       $ 216   
  

 

 

    

 

 

 

Reconciliation of net income (loss) to net cash provided (used) by operating activities:

     

Net income (loss)

   $ (1,568)      $ (73)  

Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities:

     

Change in:

     

Premiums receivable

     34         61   

Deferred acquisition costs

     22         31   

Unearned premium revenue

     (149)        (197)  

Loss and loss adjustment expense reserves

     615         (1)  

Insurance loss recoverable

     (781)        (98)  

Accrued interest payable

     101         82   

Accrued expenses

     (26)         

Unrealized (gains) losses on insured derivatives

     10          

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

     53         17   

Other net realized (gains) losses

     (64)         

Deferred income tax provision (benefit)

     961         (33)  

Interest on variable interest entities, net

     26         45   

Other operating

     93         31   
  

 

 

    

 

 

 

Total adjustments to net income (loss)

     895         (55)  
  

 

 

    

 

 

 

Net cash provided (used) by operating activities

   $ (673)      $ (128)  
  

 

 

    

 

 

 

Supplementary Disclosure of Consolidated Cash Flow Information

     

Non-cash investing activities:

     

Non-cash consideration received from the sale of MBIA UK Insurance Limited

   $ 332       $  

The accompanying notes are an integral part of the consolidated financial statements.

 

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Table of Contents

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 1: Business Developments and Risks and Uncertainties

Summary

MBIA Inc., together with its consolidated subsidiaries, (collectively, “MBIA” or the “Company”) operates one of the largest financial guarantee insurance businesses in the industry. MBIA manages three operating segments: 1) United States (“U.S.”) public finance insurance; 2) corporate; and 3) international and structured finance insurance. The Company’s U.S. public finance insurance business is primarily operated through National Public Finance Guarantee Corporation (“National”) and its international and structured finance insurance business is primarily operated through MBIA Insurance Corporation and its subsidiaries (“MBIA Corp.”). Effective on January 10, 2017, MBIA Corp.’s wholly-owned subsidiary, MBIA UK (Holdings) Limited (“MBIA UK Holdings”), sold its operating subsidiary, MBIA UK Insurance Limited (“MBIA UK”), to Assured Guaranty Corp. (“Assured”), a subsidiary of Assured Guaranty Ltd. Refer below for a further discussion of the sale of MBIA UK. 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, 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.

Refer to “Note 11: Business Segments” for further information about the Company’s operating segments.

Business Developments

Financial Strength Ratings

On June 26, 2017, Standard & Poor’s Financial Services LLC (“S&P”) downgraded the financial strength rating of National from AA- with a stable outlook to A with a stable outlook. 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 major rating agencies. At the current S&P rating it is difficult for National to compete with higher-rated competitors, therefore, at this time, National has ceased its efforts to actively pursue writing new financial guarantee business. National continues to surveil and remediate its existing insured portfolio and will proactively seek opportunities to enhance shareholder value using its strong financial resources, while protecting the interests of all of its policyholders.

On September 28, 2017, MBIA Inc., on behalf of its subsidiaries, National and MBIA Corp., provided notice to Moody’s Investors Services (“Moody’s”) terminating the agreement by which Moody’s agreed to provide financial strength ratings to MBIA Inc., National and MBIA Corp. Also on September 28, 2017, National provided notice to Kroll Bond Rating Agency (“Kroll”) terminating the agreement by which Kroll agreed to provide a financial strength rating to National. These termination notices were effective in October of 2017.

Full Valuation Allowance on the Company’s Net Deferred Tax Asset

During the nine months ended September 30, 2017, the Company established a full valuation allowance on its net deferred tax asset, which resulted in a charge to earnings of $1.2 billion. This charge was included in “Provision (benefit) for income taxes” on the Company’s consolidated statement of operations. Refer to “Note 10: Income Taxes” for further information about this valuation allowance on the Company’s net deferred tax asset.

Sale of MBIA UK

On January 10, 2017, 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 notes owned by Assured that were issued by Zohar II 2005-1, Limited (“Zohar II”) with an aggregate outstanding principal amount of $347 million as of January 10, 2017 (the “Sale Transaction”). For the nine months ended September 30, 2017, the Company recorded a gain of $5 million to adjust the carrying value of MBIA UK to its fair value less costs to sell as of the sale date. This gain was reflected in the results of the Company’s international and structured finance insurance segment and included in “Other net realized gains (losses)” on the Company’s consolidated statement of operations.

 

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Table of Contents

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 1: Business Developments and Risks and Uncertainties (continued)

 

Held for Sale Classification

The assets and liabilities of MBIA UK were classified as held for sale as of December 31, 2016 and presented within “Assets held for sale” and “Liabilities held for sale” on the Company’s consolidated balance sheet. Income before income taxes for MBIA UK was $9 and $32 million, respectively, for the three and nine months ended September 30, 2016. The following table summarizes the components of assets and liabilities held for sale as of December 31, 2016:

 

          
     As of  

In millions

   December 31, 2016  

Assets

  

Investments

   $ 466   

Cash and cash equivalents

     73   

Premiums receivable

     267   

Other assets

     19   

Valuation allowance

     (270)   
  

 

 

 

Total assets held for sale

   $ 555   
  

 

 

 

Liabilities

  

Unearned premium revenue

   $ 304   

Other liabilities

     42   
  

 

 

 

Total liabilities held for sale

   $ 346   
  

 

 

 

MBIA Corp. Financing Facility

On January 10, 2017, 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 have provided $325 million of senior financing and MBIA Inc. has 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. MBIA Corp. issued financial guarantee insurance policies insuring MZ Funding’s obligations under the Facility. Refer to “Note 9: Debt” for further information about the Facility.

Risks and Uncertainties

The Company’s financial statements include estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. The outcome of certain significant risks and uncertainties could cause the Company to revise its estimates and assumptions or could cause actual results to differ from the Company’s estimates. The discussion below highlights the significant risks and uncertainties that could have a material effect on the Company’s financial statements and business objectives in future periods.

U.S. Public Finance Market Conditions

National’s insured portfolio continued to perform satisfactorily against a backdrop of strengthening domestic economic activity. While a stable or growing economy will generally benefit tax revenues and fees charged for essential municipal services which secure National’s insured bond portfolio, some state and local governments and territory obligors National insures remain under financial and budgetary stress. This could lead to an increase in defaults by such entities on the payment of their obligations and losses or impairments on a greater number of the Company’s insured transactions. The Company monitors and analyzes these situations and other stressed credits closely, and the overall extent and duration of this stress is uncertain.

 

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MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 1: Business Developments and Risks and Uncertainties (continued)

 

In particular, the Commonwealth of Puerto Rico and certain of its instrumentalities (“Puerto Rico”) are experiencing significant fiscal stress and constrained liquidity due to, among other things, Puerto Rico’s structural budget imbalance, limited access to the capital markets, a stagnating local economy, net migration of people out of Puerto Rico and a high debt burden. Although Puerto Rico has tried to address its challenges through various fiscal policies, it continues to experience significant fiscal stress. On January 1, 2017 and July 1, 2017, Puerto Rico also defaulted on a scheduled debt service for National insured bonds and National paid gross claims in the aggregate of $242 million as a result. On September 20, 2017, Hurricane Maria made landfall in Puerto Rico as a Category 4 hurricane resulting in catastrophic damage to much of the island’s basic infrastructure, including its electrical transmission and distribution grid, telecommunications network, housing, roads, bridges, water and sewer systems. On September 21, 2017, the President of the United States approved a Major Disaster Declaration for Puerto Rico and the Federal Emergency Management Agency (“FEMA”) made federal disaster assistance available to Puerto Rico to supplement its recovery efforts. Hurricane Maria’s impact on Puerto Rico will likely also impact its ability to both repay its legacy indebtedness and participate in ongoing debt restructuring negotiations. The physical damage and resultant lost economic activity may exceed the collective aid Puerto Rico receives from private insurance, relief from FEMA and other federal agencies and programs. Economic activity in Puerto Rico may not return to pre-hurricane levels and Puerto Rico’s recovery could be more shallow and protracted than that experienced by other similarly affected governments, given Puerto Rico’s prior constrained liquidity and economic activity. While the federal government has made aid available to Puerto Rico, there can be no assurance that such aid will continue in the amounts necessary to offset the adverse impacts from Hurricane Maria in their entirety. In addition, the necessary and greater involvement of the federal government, through its actions to deliver disaster relief and other support services, in addition to the evolving role of the Financial Oversight and Management Board for Puerto Rico (“Oversight Board”) and the role of Puerto Rico in its own recovery, heightens political risk in connection with the restructuring of legacy debt. This risk could lead the Oversight Board, Puerto Rico or the federal government to seek to extract greater concessions from creditors based on the uncertainty of Puerto Rico’s long term recovery prospects. In this event, losses at National on select Puerto Rico exposures could increase materially.

MBIA Corp. Insured Portfolio

MBIA Corp.’s primary objectives are to satisfy claims of its policyholders, and to maximize future recoveries, if any, for its Senior Lenders and surplus note holders and, thereafter, its preferred stock holders. MBIA Corp. is executing this strategy by pursuing various actions focused on maximizing the collection of recoveries and by reducing potential losses on its insurance exposures. MBIA Corp.’s insured portfolio could deteriorate and result in additional significant loss reserves and claim payments. MBIA Corp.’s ability to meet its obligations is limited by available liquidity and its ability to secure additional liquidity through financing and other transactions. There can be no assurance that MBIA Corp. will be successful in generating sufficient cash to meet its obligations.

On January 20, 2017, MBIA Corp. was presented with and fully satisfied a claim of $770 million (the “Zohar II Claim”) on an insurance policy it had written insuring the certain notes issued by Zohar II. MBIA Corp. was able to satisfy the Zohar II Claim as a result of having completed the Sale Transaction and by borrowing from the Facility, as described above, together with using approximately $60 million from its own resources. Refer to “Note 1: Business Developments and Risks and Uncertainties” in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 for additional information about these transactions.

RMBS Recoveries

The amount and timing of projected collections from excess spread from residential mortgage-backed securities (“RMBS”) and the put-back recoverable from Credit Suisse are uncertain.

Zohar Recoveries

Payment of a claim in November of 2015 on MBIA Corp.’s policy insuring the class A-1 and A-2 notes issued by Zohar CDO 2003-1, Limited (“Zohar I”) and satisfying the Zohar II Claim entitles MBIA Corp. to reimbursement of such amounts plus interest and expenses and/or to exercise certain rights and remedies to seek recovery of such amounts. There can be no assurance, however, that the value of the Zohar assets will be sufficient to permit MBIA Corp. to recover all or substantially all of the payments it made on Zohar I and Zohar II.

Refer to “Note 5: Loss and Loss Adjustment Expense Reserves” for information about MBIA Corp.’s recoveries.

 

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Table of Contents

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 1: Business Developments and Risks and Uncertainties (continued)

 

Corporate Liquidity

Subsequent to September 30, 2017, National declared and paid a dividend of $118 million to its ultimate parent, MBIA Inc. Also, subsequent to September 30, 2017, National purchased from MBIA Inc., certain MBIA Inc. 5.700% Senior Notes due 2034 that were previously repurchased by MBIA Inc. and had not been retired, resulting in an increase to MBIA Inc.’s liquidity of $130 million. Based on the Company’s projections of National’s dividends, additional anticipated releases under its tax sharing agreement and related tax escrow account (“Tax Escrow Account”), and other cash inflows, the Company expects that MBIA Inc. will have sufficient cash to satisfy its debt service and general corporate needs. However, MBIA Inc. continues to have liquidity risk which could be triggered by deterioration in the performance of invested assets, interruption of or reduction in dividends or tax payments received from operating subsidiaries, impaired access to the capital markets, as well as other factors which cannot be anticipated at this time. Furthermore, failure by MBIA Inc. to settle liabilities that are also insured by MBIA Corp. could result in claims on MBIA Corp.

Note 2: Significant Accounting Policies

The Company has disclosed its significant accounting policies in “Note 2: Significant Accounting Policies” in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. The following significant accounting policies provide an update to those included in the Company’s Annual Report on Form 10-K.

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X and, accordingly, do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America (“GAAP”) for annual periods. These statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2016. The accompanying consolidated financial statements have not been audited by an independent registered public accounting firm in accordance with the standards of the Public Company Accounting Oversight Board (U.S.), but in the opinion of management such financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for the fair statement of the Company’s consolidated financial position and results of operations. All material intercompany balances and transactions have been eliminated.

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. As additional information becomes available or actual amounts become determinable, the recorded estimates are revised and reflected in operating results.

The results of operations for the three and nine months ended September 30, 2017 may not be indicative of the results that may be expected for the year ending December 31, 2017. The December 31, 2016 consolidated balance sheet was derived from audited financial statements, but does not include all disclosures required by GAAP for annual periods. Certain amounts have been reclassified in the prior year’s financial statements to conform to the current presentation. This includes a change in the presentation of cash paid when withholding shares for tax-withholding purposes in “Purchases of treasury stock” on the Company’s consolidated statement of cash flows as required under Accounting Standards Update (“ASU”) 2016-09, “Compensation-Stock Compensation (Topic 718)”. The change in presentation effected “Operating and employee related expenses paid”, in operating cash flows and “Purchases of treasury stock”, in financing cash flows, on the Company’s consolidated statement of cash flows in prior periods. Such reclassifications did not materially impact total revenues, expenses, assets, liabilities, shareholders’ equity, operating cash flows, investing cash flows, or financing cash flows for all periods presented.

Note 3: Recent Accounting Pronouncements

Recently Adopted Accounting Standards

The Company has not adopted any new accounting pronouncements that had a material impact on its consolidated financial statements.

 

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Table of Contents

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 3: Recent Accounting Pronouncements (continued)

 

Recent Accounting Developments

Revenue from Contracts with Customers (Topic 606) (ASU 2014-09) and Deferral of the Effective Date (ASU 2015-14)

In May of 2014, the Financial Accounting Standards Board (“FASB”) issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606).” ASU 2014-09 amends the accounting guidance for recognizing revenue for the transfer of goods or services from contracts with customers unless those contracts are within the scope of other accounting standards. ASU 2014-09 does not apply to financial guarantee insurance contracts within the scope of Topic 944, “Financial Services — Insurance.” ASU 2014-09 applies to certain fees and reimbursements, and is not expected to materially impact revenue recognition of these fees and reimbursements. In August of 2015, the FASB issued ASU 2015-14, “Revenue from Contracts with Customers (Topic 606) — Deferral of the Effective Date.” ASU 2015-14 defers the effective date of ASU 2014-09 to interim and annual periods beginning January 1, 2018, and is applied on a retrospective or modified retrospective basis. The adoption of ASU 2014-09 is not expected to materially impact the Company’s consolidated financial statements.

Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (ASU 2016-01)

In January of 2016, the FASB issued ASU 2016-01, “Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” ASU 2016-01 requires certain equity investments other than those accounted for under the equity method of accounting or result in consolidation of the investee to be measured at fair value with changes in fair value recognized in net income, and permits an entity to measure equity investments that do not have readily determinable fair values at cost less any impairment plus or minus adjustments for certain changes in observable prices. An entity is also required to evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale (“AFS”) debt securities in combination with the entity’s other deferred tax assets. ASU 2016-01 requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability that results from a change in the instrument-specific credit risk for financial liabilities that the entity has elected to measure at fair value in accordance with the fair value option for financial instruments. ASU 2016-01 is effective for interim and annual periods beginning January 1, 2018, and is applied on a modified retrospective basis. Early adoption is not permitted with the exception of early application of the guidance that requires separate presentation in other comprehensive income of the change in the instrument-specific credit risk for financial liabilities measured at fair value in accordance with the fair value option.

Based on fair values as of September 30, 2017 of equity investments, the cumulative-effect adjustment, net of tax, related to net unrealized gains of such investments was approximately $1 million, which represents the amount that would have been reclassed from accumulated other comprehensive income (loss) (“AOCI”) to retained earnings had the Company adopted ASU 2016-01 on September 30, 2017. As of September 30, 2017, the Company had a full valuation allowance against its deferred tax asset. Refer to “Note 10: Income Taxes” for further information about this valuation allowance on the Company’s deferred tax asset. The Company is continuing to assess the impact of adopting ASU 2016-01 on its financial liabilities measured at fair value in accordance with the fair value option. The amount previously disclosed in its Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2017 may change materially based on its continued assessment, including as a result of the valuation allowance on its deferred tax assets recorded in the second quarter of 2017. The Company plans to adopt ASU 2016-01 in its entirety on January 1, 2018 and does not expect there to be a material impact to the Company’s consolidated financial statements.

Leases (Topic 842) (ASU 2016-02)

In February of 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)”, that amends the accounting guidance for leasing transactions. ASU 2016-02 requires a lessee to classify lease contracts as finance or operating leases, and to recognize assets and liabilities for the rights and obligations created by leasing transactions with lease terms more than twelve months. ASU 2016-02 substantially retains the criteria for classifying leasing transactions as finance or operating leases. For finance leases, a lessee recognizes a right-of-use asset and a lease liability initially measured at the present value of the lease payments, and recognizes interest expense on the lease liability separately from the amortization of the right-of-use asset. For operating leases, a lessee recognizes a right-of-use asset and a lease liability initially measured at the present value of the lease payments, and recognizes lease expense on a straight-line basis. ASU 2016-02 is effective for interim and annual periods beginning January 1, 2019 with early adoption permitted, and is applied on a modified retrospective basis. The adoption of ASU 2016-02 is not expected to materially impact the Company’s consolidated financial statements.

 

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Table of Contents

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 3: Recent Accounting Pronouncements (continued)

 

Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (ASU 2016-13)

In June of 2016, the FASB issued ASU 2016-13, “Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 requires financing receivables and other financial assets measured at amortized cost to be presented at the net amount expected to be collected by recording an allowance for credit losses with changes in the allowance recorded as credit loss expense or reversal of credit loss expense based on management’s current estimate of expected credit losses each period. ASU 2016-13 does not apply to credit losses on financial guarantee insurance contracts within the scope of Topic 944, “Financial Services-Insurance.” ASU 2016-13 also requires impairment relating to credit losses on AFS debt securities to be presented through an allowance for credit losses with changes in the allowance recorded in the period of the change as credit loss expense or reversal of credit loss expense. Any impairment amount not recorded through an allowance for credit losses on AFS debt securities is recorded through other comprehensive income. ASU 2016-13 is effective for interim and annual periods beginning January 1, 2020 with early adoption permitted beginning January 1, 2019. ASU 2016-13 is applied on a modified retrospective basis except that prospective application is applied to AFS debt securities with other-than-temporary impairments (“OTTI”) recognized before the date of adoption. The Company is evaluating the impact of adopting ASU 2016-13.

Note 4: Variable Interest Entities

Through MBIA’s international and structured finance insurance segment, the Company provides credit protection to issuers of obligations that may involve issuer-sponsored special purpose entities (“SPEs”). An SPE may be considered a variable interest entity (“VIE”) to the extent the SPE’s total equity at risk is not sufficient to permit the SPE to finance its activities without additional subordinated financial support or its equity investors lack any one of the following characteristics: (i) the power to direct the activities of the SPE that most significantly impact the entity’s economic performance or (ii) the obligation to absorb the expected losses of the entity or the right to receive the expected residual returns of the entity. A holder of a variable interest or interests in a VIE is required to assess whether it has a controlling financial interest, and thus is required to consolidate the entity as primary beneficiary. An assessment of a controlling financial interest identifies the primary beneficiary as the variable interest holder that has both of the following characteristics: (i) the power to direct the activities of the VIE that most significantly impact the entity’s economic performance and (ii) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. The primary beneficiary is required to consolidate the VIE. An ongoing reassessment of controlling financial interest is required to be performed based on any substantive changes in facts and circumstances involving the VIE and its variable interests.

The Company evaluates issuer-sponsored SPEs initially to determine if an entity is a VIE, and is required to reconsider its initial determination if certain events occur. For all entities determined to be VIEs, MBIA performs an ongoing reassessment to determine whether its guarantee to provide credit protection on obligations issued by VIEs provides the Company with a controlling financial interest. Based on its ongoing reassessment of controlling financial interest, the Company determines whether a VIE is required to be consolidated or deconsolidated.

The Company makes its determination for consolidation based on a qualitative assessment of the purpose and design of a VIE, the terms and characteristics of variable interests of an entity, and the risks a VIE is designed to create and pass through to holders of variable interests. The Company generally provides credit protection on obligations issued by VIEs, and holds certain contractual rights according to the purpose and design of a VIE. The Company may have the ability to direct certain activities of a VIE depending on facts and circumstances, including the occurrence of certain contingent events, and these activities may be considered the activities of a VIE that most significantly impact the entity’s economic performance. The Company generally considers its guarantee of principal and interest payments of insured obligations, given nonperformance by a VIE, to be an obligation to absorb losses of the entity that could potentially be significant to the VIE. At the time the Company determines it has the ability to direct the activities of a VIE that most significantly impact the economic performance of the entity based on facts and circumstances, MBIA is deemed to have a controlling financial interest in the VIE and is required to consolidate the entity as primary beneficiary. The Company performs an ongoing reassessment of controlling financial interest that may result in consolidation or deconsolidation of any VIE.

Nonconsolidated VIEs

The following tables present the total assets of nonconsolidated VIEs in which the Company holds a variable interest as of September 30, 2017 and December 31, 2016, through its insurance operations. The following tables also present the Company’s maximum exposure to loss for nonconsolidated VIEs and carrying values of the assets and liabilities for its interests in these VIEs as of September 30, 2017 and December 31, 2016. The Company has aggregated nonconsolidated VIEs based on the underlying credit exposure of the insured obligation. The nature of the Company’s variable interests in nonconsolidated VIEs is related to financial guarantees, insured credit default swap (“CDS”) contracts and any investments in obligations issued by nonconsolidated VIEs.

 

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Table of Contents

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 4: Variable Interest Entities (continued)

 

                                                                            
     September 30, 2017  
                   Carrying Value of Assets      Carrying Value of Liabilities  

In millions

   VIE
Assets
     Maximum
Exposure
to Loss
     Investments(1)      Premiums
Receivable(2)
     Insurance  Loss
Recoverable(3)
     Unearned
Premium
Revenue(4)
     Loss and Loss
Adjustment
Expense
Reserves(5)
 

Insurance:

                    

Global structured finance:

                    

Mortgage-backed residential

   $ 7,660      $ 3,955      $ 19      $ 24      $ 248      $ 22      $ 407  

Mortgage-backed commercial

     226        106        -        -        -        -        -  

Consumer asset-backed

     4,939        1,107        -        5        2        4        11  

Corporate asset-backed

     2,481        1,744        -        13        -        15        -  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total global structured finance

     15,306        6,912        19        42        250        41        418  

Global public finance

     19,850        3,104        -        10        -        15        -  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total insurance

   $ 35,156      $ 10,016      $ 19      $ 52      $ 250      $ 56      $ 418  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) - Reported within “Investments” on MBIA’s consolidated balance sheets.

 

(2) - Reported within “Premiums receivable” on MBIA’s consolidated balance sheets.

 

(3) - Reported within “Insurance loss recoverable” on MBIA’s consolidated balance sheets.

 

(4) - Reported within “Unearned premium revenue” on MBIA’s consolidated balance sheets.

 

(5) - Reported within “Loss and loss adjustment expense reserves” on MBIA’s consolidated balance sheets.

 

                                                                            
     December 31, 2016  
                   Carrying Value of Assets      Carrying Value of Liabilities  

In millions

   VIE
Assets
     Maximum
Exposure
to Loss
     Investments(1)      Premiums
Receivable(2)
     Insurance  Loss
Recoverable(3)
     Unearned
Premium
Revenue(4)
     Loss and Loss
Adjustment
Expense
Reserves(5)
 

Insurance:

                    

Global structured finance:

                    

Collateralized debt obligations

   $ 3,167      $ 1,914      $ 51      $ 2      $ -      $ -      $ 73  

Mortgage-backed residential

     9,146        4,796        20        28        304        27        325  

Mortgage-backed commercial

     257        145        -        -        -        -        -  

Consumer asset-backed

     4,893        1,331        -        7        2        5        8  

Corporate asset-backed

     2,625        2,205        5        18        -        20        -  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total global structured finance

     20,088        10,391        76        55        306        52        406  

Global public finance

     44,306        12,051        -        11        -        18        -  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total insurance

   $ 64,394      $ 22,442      $ 76      $ 66      $ 306      $ 70      $ 406  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) - Reported within “Investments” on MBIA’s consolidated balance sheets.

 

(2) - Reported within “Premiums receivable” on MBIA’s consolidated balance sheets. Excludes $125 million that is included within “Assets held for sale” on the Company’s consolidated balance sheets.

 

(3) - Reported within “Insurance loss recoverable” on MBIA’s consolidated balance sheets.

 

(4) - Reported within “Unearned premium revenue” on MBIA’s consolidated balance sheets. Excludes $134 million that is included within “Liabilities held for sale” on the Company’s consolidated balance sheets.

 

(5) - Reported within “Loss and loss adjustment expense reserves” on MBIA’s consolidated balance sheets.

The maximum exposure to loss as a result of MBIA’s variable interests in VIEs is represented by insurance in force. Insurance in force is the maximum future payments of principal and interest which may be required under commitments to make payments on insured obligations issued by nonconsolidated VIEs.

Consolidated VIEs

The carrying amounts of assets and liabilities of consolidated VIEs were $3.2 billion and $2.4 billion, respectively, as of September 30, 2017, and $2.7 billion and $2.2 billion, respectively, as of December 31, 2016. The carrying amounts of assets and liabilities are presented separately in “Assets of consolidated variable interest entities” and “Liabilities of consolidated variable interest entities” on the Company’s consolidated balance sheets. VIEs are consolidated or deconsolidated based on an ongoing reassessment of controlling financial interest, when events occur or circumstances arise, and whether the ability to exercise rights that constitute power to direct activities of any VIEs are present according to the design and characteristics of these entities. Two additional VIEs were consolidated during the nine months ended September 30, 2017 and one additional VIE was consolidated during the nine months ended September 30, 2016.

 

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Table of Contents

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 4: Variable Interest Entities (continued)

 

Holders of insured obligations of issuer-sponsored VIEs related to the Company’s international and structured finance insurance segment do not have recourse to the general assets of MBIA. In the event of nonpayment of an insured obligation issued by a consolidated VIE, the Company is obligated to pay principal and interest, when due, on the respective insured obligation only. The Company’s exposure to consolidated VIEs is limited to the credit protection provided on insured obligations and any additional variable interests held by MBIA.

Note 5: Loss and Loss Adjustment Expense Reserves

U.S. Public Finance Insurance

U.S. public finance insured transactions consist of 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. The Company estimates future losses by using probability-weighted cash flow scenarios that are customized to each insured transaction. Future loss estimates consider debt service due for each insured transaction, which includes par outstanding and interest due, as well as recoveries for such payments, if any. Gross par outstanding for capital appreciation bonds represents the par amount at the time of issuance of the insurance policy.

Certain local governments remain under financial and budgetary stress and a few have filed for protection under title 11, United States Code (the “Bankruptcy Code”), or have entered into state statutory proceedings established to assist municipalities in managing through periods of severe fiscal stress. In the case of Puerto Rico, certain credits that the Company insures have filed petitions for covered instrumentalities under Title III of the Puerto Rico Oversight, Management and Economic Stability Act (“PROMESA”), which incorporates by reference provisions from the Bankruptcy Code. This could lead to an increase in defaults by such entities on the payment of their obligations and losses or impairments in greater amounts on the Company’s insured transactions. The filing for protection under the Bankruptcy Code or entering state statutory proceedings does not necessarily result in a default or indicate that an ultimate loss will occur.

On September 20, 2017, Hurricane Maria made landfall in Puerto Rico as a Category 4 hurricane resulting in catastrophic damage to much of the island’s basic infrastructure, including its electrical transmission and distribution grid, telecommunications network, housing, roads, bridges, water and sewer systems. On September 21, 2017, the President of the United States approved a Major Disaster Declaration for Puerto Rico and the FEMA made federal disaster assistance available to Puerto Rico to supplement its recovery efforts. Hurricane Maria’s impact on Puerto Rico will likely also impact its ability to both repay its legacy indebtedness and participate in ongoing debt restructuring negotiations. The physical damage and resultant lost economic activity may exceed the collective aid Puerto Rico receives from private insurance, relief from FEMA and other federal agencies and programs. Economic activity in Puerto Rico may not return to pre-hurricane levels and Puerto Rico’s recovery could be more shallow and protracted than that experienced by other similarly affected governments, given Puerto Rico’s prior constrained liquidity and economic activity. While the federal government has made aid available to Puerto Rico, there can be no assurance that such aid will continue in the amounts necessary to offset the adverse impacts from Hurricane Maria in their entirety. In addition, the necessary and greater involvement of the federal government, through its actions to deliver disaster relief and other support services, in addition to the evolving role of the Oversight Board and the role of Puerto Rico in its own recovery, heightens political risk in connection with the restructuring of legacy debt. This risk could lead the Oversight Board, Puerto Rico or the federal government to seek to extract greater concessions from creditors based on the uncertainty of Puerto Rico’s long term recovery prospects. In this event, losses at National on select Puerto Rico exposures could increase materially. The Company monitors and analyzes these situations closely, however, the overall extent and duration of such events are uncertain.

International and Structured Finance Insurance

The international and structured finance insurance segment’s case basis reserves and insurance loss recoveries recorded in accordance with GAAP do not include estimates for policies insuring credit derivatives or on financial guarantee VIEs that are eliminated in consolidation. Policies insuring credit derivative contracts are accounted for as derivatives and are carried at fair value in the Company’s consolidated financial statements under GAAP. The fair values of insured credit derivative contracts are influenced by a variety of market and transaction-specific factors that may be unrelated to potential future claim payments under the Company’s insurance policies. In the absence of credit impairments on insured credit derivative contracts or the early termination of such contracts at a loss, the cumulative unrealized losses recorded from these contracts should reverse before or at the maturity of the contracts. As the Company’s insured credit derivatives have similar terms, conditions, risks, and economic profiles to its financial guarantee insurance policies, the Company evaluates them for impairment, under Statutory accounting, in the same way that it estimates loss and loss adjustment expense (“LAE”) for its financial guarantee policies. Refer to “Note 8: Derivative Instruments” for a further discussion of the Company’s use of derivatives and their impact on the Company’s consolidated financial statements.

 

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Table of Contents

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 5: Loss and Loss Adjustment Expense Reserves (continued)

 

RMBS Case Basis Reserves (Financial Guarantees)

The Company’s RMBS reserves and recoveries relate to financial guarantee insurance policies, excluding those on consolidated VIEs. The Company’s first-lien RMBS case basis reserves primarily relate to RMBS backed by alternative A-paper and subprime mortgage loans. The Company’s second-lien RMBS case basis reserves relate to RMBS backed by home equity lines of credit and closed-end second mortgages. The Company calculated RMBS case basis reserves as of September 30, 2017 for both first and second-lien RMBS transactions using a process called the “Roll Rate Methodology.” The Roll Rate Methodology is a multi-step process using databases of loan level information, proprietary internal cash flow models, and commercially available models to estimate potential losses and recoveries on insured bonds. Refer to “Note 6: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, for additional information on the Company’s Roll Rate Methodology for its RMBS case basis reserves.

The Company monitors portfolio performance on a monthly basis against projected performance, reviewing delinquencies, roll rates, and prepayment rates (including voluntary and involuntary). However, loan performance remains difficult to predict and losses may exceed expectations. In the event of a material deviation in actual performance from projected performance, the Company would increase or decrease the case basis reserves accordingly.

RMBS Recoveries

The Company primarily records two types of recoveries related to insured RMBS exposures: excess spread that is generated from the trust structures in the insured transactions; and second-lien “put-back” claims related to those mortgage loans whose inclusion in an insured securitization failed to comply with representations and warranties (“ineligible loans”).

Excess Spread

Excess spread within insured RMBS securitizations is the difference between interest inflows on mortgage loan collateral and interest outflows on the insured RMBS notes. The aggregate amount of excess spread depends on the future loss trends (which include future delinquency trends, average time to charge-off/liquidate delinquent loans, and the availability of pool mortgage insurance), the future spread between Prime and the London Interbank Offered Rate interest rates, and borrower refinancing behavior (which may be affected by changes in the interest rate environment) that results in voluntary prepayments. Minor deviations in loss trends and voluntary prepayments may substantially impact the amounts collected from excess spread. Excess spread may also include estimated recoverables from mortgage insurance contracts and subsequent recoveries on charged-off loans associated with the insured RMBS securitizations.

Second-lien Put-Back Claims Related to Ineligible Loans

The Company has settled the majority of the Company’s put-back claims. Only its claims against Credit Suisse remain outstanding. The Company’s settlement amounts have been consistent with the put-back recoveries that had been included in the Company’s financial statements at the times preceding the settlements.

The put-back contract claim remaining with Credit Suisse is related to the inclusion of ineligible loans in the 2007-2 Home Equity Mortgage Trust securitization. Credit Suisse has challenged the Company’s assessment of the ineligibility of individual mortgage loans and the dispute is the subject of litigation for which there is no assurance that the Company will prevail.

Based on the Company’s assessment of the strength of its contractual put-back rights against Credit Suisse, as well as on its prior settlements with other sellers/servicers and success of other monolines’ put-back settlements, the Company believes it will prevail in enforcing its contractual rights and that it is entitled to collect the full amount of its incurred losses, which totaled $435 million through September 30, 2017. The Company is also entitled to collect interest on amounts paid; it believes that in the context of its put-back litigation, the appropriate interest rate should be the New York State statutory rate. However, the Company currently calculates its put-back recoveries using the contractual interest rate, which is lower than the New York State statutory rate.

Notwithstanding the foregoing, uncertainty remains with respect to the ultimate outcome of the litigation with Credit Suisse, which is contemplated in the probability-weighted cash flow scenario based-modeling the Company uses. The Credit Suisse recovery scenarios are based on the amount of incurred losses measured against certain probabilities of ultimate resolution of the dispute with Credit Suisse. Most of the probability weight is assigned to partial recovery scenarios and are discounted using the current risk-free discount rates associated against the underlying transaction’s cash flows.

 

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Table of Contents

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 5: Loss and Loss Adjustment Expense Reserves (continued)

 

The Company continues to consider relevant facts and circumstances in developing its assumptions on expected cash inflows, probability of potential recoveries (including the outcome of litigation) and recovery period. The estimated amount and likelihood of potential recoveries are expected to be revised and supplemented to the extent there are developments in the pending litigation and/or changes to the financial condition of Credit Suisse. While the Company believes it will be successful in realizing its recoveries from its put-back contract claims against Credit Suisse, the ultimate amount recovered may be materially different from that recorded by the Company given the inherent uncertainty of the manner of resolving the claims (i.e., litigation and/or negotiated out-of-court settlement) and the assumptions used in the required estimation process for accounting purposes which are based, in part, on judgments and other information that are not easily corroborated by historical data or other relevant benchmarks. Refer to “Note 14: Commitments and Contingencies” for further information about the Company’s litigation with Credit Suisse.

CDO Reserves

The Company also has loss and LAE reserves on certain transactions within its collateralized debt obligation (“CDO”) portfolio, including its multi-sector CDO and high yield corporate CDO asset classes that were insured in the form of financial guarantee policies. MBIA’s insured multi-sector CDOs are transactions that include a variety of collateral ranging from corporate bonds to structured finance assets (which includes, but are not limited to, RMBS-related collateral, multi-sector and corporate CDOs). The Company’s high yield corporate CDO portfolio consists of middle-market/special-opportunity corporate loan transactions.

Zohar Recoveries

MBIA Corp. will seek to recover the payments it made (plus interest and expenses) with respect to Zohar I and the Zohar II Claim. MBIA Corp. anticipates that the primary source of the recovery of the Zohar II Claim will come from the monetization of the assets of 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 (the “Zohar Sponsor”) (all the assets of Zohar II, the “Zohar II Assets”).

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 in 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 the Zohar Sponsor (all the assets of Zohar I, the “Zohar I Assets”). Over time, MBIA Corp. expects to acquire the legal ownership of the Zohar I Assets and recover all or substantially all of the payment it made (plus interest and expenses) with regards to the Zohar I claim. As of September 30, 2017, the recoveries of Zohar I and Zohar II are included in “Loans receivable at fair value” which are presented in “Assets of consolidated variable interest entities” on the Company’s consolidated balance sheets.

There can be no assurance, however, that the value of the Zohar II Assets and the Zohar I Assets will be sufficient to permit MBIA Corp. to recover all or substantially all of the payments it made on the Zohar I and the Zohar II Claims. Failure to recover a substantial amount of such payments could impede its ability to make payments when due on other policies. MBIA Corp. believes that if the New York State Department of Financial Services (“NYSDFS”) concludes at any time that MBIA Insurance Corporation will not be able to pay its policyholder claims, the NYSDFS would likely 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. The determination to commence such a proceeding or take other such actions is within the exclusive control of the NYSDFS.

Refer to “Note 6: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, for additional information on the Company’s loss reserving process including risk-management activities.

 

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Table of Contents

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 5: Loss and Loss Adjustment Expense Reserves (continued)

 

Summary of Loss and LAE Reserves and Recoveries

The Company’s loss and LAE reserves and recoveries before consolidated VIE eliminations, along with amounts that were eliminated as a result of consolidated VIEs, which are included in the Company’s consolidated balance sheets as of September 30, 2017 and December 31, 2016 are presented in the following table:

 

                                                                 
     As of September 30, 2017      As of December 31, 2016  

In millions

   Balance Sheet Line Item      Balance Sheet Line Item  
     Insurance
loss
recoverable
     Loan
repurchase
commitments
     Loss
and LAE
reserves
     Insurance
loss
recoverable
     Loan
repurchase
commitments
     Loss and
LAE
reserves
 

U.S. Public Finance Insurance

   $ 356       $      $ 348       $ 174       $      $ 97   

International and Structured Finance Insurance:

 

              

Before VIE eliminations

     1,559         406         694         551         404         650   

VIE eliminations

     (1,304)               (224)        (221)               (206)  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total international and structured finance insurance

     255         406         470         330         404         444   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 611       $ 406       $ 818       $ 504       $ 404       $ 541   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Changes in Loss and LAE Reserves

The following table presents changes in the Company’s loss and LAE reserves for the nine months ended September 30, 2017. Changes in loss reserves attributable to the accretion of the claim liability discount, changes in discount rates, changes in amount and timing of estimated claim payments and recoveries, changes in assumptions and changes in LAE reserves are recorded in “Losses and loss adjustment” expenses in the Company’s consolidated statements of operations. As of September 30, 2017, the weighted average risk-free rate used to discount the Company’s loss reserves (claim liability) was 2.17%. LAE reserves are generally expected to be settled within a one-year period and are not discounted. As of September 30, 2017 and December 31, 2016, the Company’s gross loss and LAE reserves included $69 million and $60 million, respectively, related to LAE.

 

                                                                                       
In millions      Changes in Loss and LAE Reserves for the Nine Months Ended September 30, 2017         

Gross Loss
and LAE
Reserves as of
December 31,
2016

     Loss
Payments
for Cases
with
Reserves(1)
     Accretion
of
Claim
Liability
Discount
     Changes in
Discount
Rates
     Changes in
Assumptions
     Changes in
Unearned
Premium
Revenue
     Changes in
LAE
Reserves
     Other(2)      Gross Loss
and LAE
Reserves as of
September 30,
2017
 
$ 541      $ (1,057)      $ 7      $ 8      $ 498      $ (32)      $ 9      $ 844      $ 818  

 

(1) -  Includes payments made to satisfy the Zohar II Claim.

 

(2) -  Primarily changes in the amount to satisfy the Zohar II Claim.

The increase in the Company’s gross loss and LAE reserves reflected in the preceding table was primarily related to increases due to changes in assumptions on certain Puerto Rico exposures.

 

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MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 5: Loss and Loss Adjustment Expense Reserves (continued)

 

Changes in Insurance Loss Recoverable and Recoveries on Unpaid Losses    

Current period changes in the Company’s estimate of potential recoveries may be recorded as an insurance loss recoverable asset, netted against the gross loss and LAE reserve liability, or both. The following table presents changes in the Company’s insurance loss recoverable and changes in recoveries on unpaid losses reported within the Company’s claim liability for the nine months ended September 30, 2017. Changes in insurance loss recoverable attributable to the accretion of the discount on the recoverable, changes in discount rates, changes in amount and timing of estimated collections, changes in assumptions and changes in LAE recoveries are recorded in “Losses and loss adjustment” expenses in the Company’s consolidated statements of operations.

 

                                                                                       
            Changes in Insurance Loss Recoverable and Recoveries on Unpaid Losses
for the Nine Months Ended September 30, 2017
        

In millions

   Gross
Reserve as of
December 31,
2016
     Collections
for Cases
with
Recoveries
     Accretion
of
Recoveries
     Changes in
Discount
Rates
     Changes in
Assumptions
     Changes in
LAE
Recoveries
     Other(1)      Gross
Reserve
as of
September 30,
2017
 

Insurance loss recoverable

   $ 504      $ (56)      $ 7      $ 7      $ 133       $      $ 16      $ 611  

Recoveries on unpaid losses (2)

     79               1        1        (42)        (5)               34  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 583      $ (56)      $ 8      $ 8      $ 91       $ (5)      $ 16      $ 645  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) - Primarily changes in amount and timing of collections.

 

(2) - As of September 30, 2017 and December 31, 2016, excludes Puerto Rico recoveries, and as of December 31, 2016, the Zohar II recoveries, which have been netted against reserves.

The increase in the Company’s insurance loss recoverable reflected in the preceding table was primarily due to changes in assumptions on certain Puerto Rico credits offset by a decrease in insured RMBS transactions. The decrease in the Company’s recoveries on unpaid losses is primarily related to insured RMBS transactions.

Loss and LAE Activity

The Company’s financial guarantee insurance losses and LAE (excluding insured credit derivatives and consolidated VIEs), net of reinsurance for the three and nine months ended September 30, 2017 and 2016 are presented in the following table:

 

                                           
     Three Months Ended September 30,      Nine Months Ended September 30,  

In millions

   2017      2016      2017      2016  

U.S. Public Finance Insurance Segment

   $ 141       $ 28       $ 310       $ 46   

International and Structured Finance Insurance Segment:

           

Second-lien RMBS

     54         44         58         78   

First-lien RMBS

                   84         61   

CDOs

            (23)               (46)  

Other(1)

                          10   
  

 

 

    

 

 

    

 

 

    

 

 

 

Losses and loss adjustment expense

   $ 205       $ 50       $ 469       $ 149   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) - Includes non-U.S. public finance and other issues.

For the three months ended September 30, 2017, losses and LAE primarily related to increases in actual and expected payments on certain Puerto Rico exposures and decreases in projected collections from mortgage insurance included in the Company’s excess spread within its second-lien RMBS transactions from the settlement of litigation regarding insurance coverage involving Old Republic Insurance Corporation, Bank of America, N.A. and The Bank of New York Mellon.

For the three months ended September 30, 2016, losses and LAE primarily related to increases in actual and expected payments on certain Puerto Rico exposures and second-lien RMBS transactions. These were partially offset by increases in recoveries of expected payments on certain Puerto Rico exposures and decreases in expected payments on CDOs.

For the nine months ended September 30, 2017, losses and LAE primarily related to increases in actual and expected payments on certain Puerto Rico exposures, insured first-lien RMBS transactions and a decrease in actual and projected collections from mortgage insurance included in the Company’s excess spread within its second-lien RMBS transactions from the settlement of litigation regarding insurance coverage involving Old Republic Insurance Corporation, Bank of America, N.A. and The Bank of New York Mellon.

 

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Table of Contents

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 5: Loss and Loss Adjustment Expense Reserves (continued)

 

For the nine months ended September 30, 2016, losses and LAE primarily related to increases in actual and expected payments on certain Puerto Rico exposures and insured first and second-lien RMBS transactions and decreases in projected collections from excess spread within insured second-lien RMBS transactions. These were partially offset by increases in recoveries of expected payments on certain Puerto Rico exposures and decreases in expected payments on CDOs.

Costs associated with remediating insured obligations assigned to the Company’s surveillance categories are recorded as LAE and included in “Losses and loss adjustment” expenses on the Company’s consolidated statements of operations. For the three months ended September 30, 2017 and 2016, gross LAE related to remediating insured obligations were $6 million. For the nine months ended September 30, 2017 and 2016, gross LAE related to remediating insured obligations were $33 million and $34 million, respectively.

Surveillance Categories

The following table provides information about the financial guarantees and related claim liability included in each of MBIA’s surveillance categories as of September 30, 2017:

 

                                                      
     Surveillance Categories  

$ in millions

   Caution
List
Low
     Caution
List
Medium
     Caution
List
High
     Classified
List
     Total  

Number of policies

     93        5        1        284         383   

Number of issues(1)

     20        4        1        120         145   

Remaining weighted average contract period (in years)

     7.1        4.6        8.6        9.7         8.8   

Gross insured contractual payments outstanding:(2)

              

Principal

   $ 3,016      $ 13      $ 108      $ 6,218       $ 9,355   

Interest

     2,772        4        49        5,795         8,620   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 5,788      $ 17      $ 157      $ 12,013       $ 17,975   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross Claim Liability(3)

   $ -      $ -      $ -      $ 934       $ 934   

Less:

              

Gross Potential Recoveries(4)

     -        -        -        934         934   

Discount, net(5)

     -        -        -        (215)        (215)  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net claim liability (recoverable)

   $ -      $ -      $ -      $ 215       $ 215   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Unearned premium revenue

   $ 10      $ -      $ 4      $ 79       $ 93   

 

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

 

(2) - Represents contractual principal and interest payments due by the issuer of the obligations insured by MBIA.

 

(3) - The gross claim liability with respect to Puerto Rico exposures are net of expected recoveries for policies in a net payable position.

 

(4) - Gross potential recoveries with respect to certain Puerto Rico exposures are net of the claim liability for policies in a net recoverable position.

 

(5) - Represents discount related to Gross Claim Liability and Gross Potential Recoveries.

 

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Table of Contents

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 5: Loss and Loss Adjustment Expense Reserves (continued)

 

The following table provides information about the financial guarantees and related claim liability included in each of MBIA’s surveillance categories as of December 31, 2016:

 

                                                      
     Surveillance Categories  

$ in millions

   Caution
List
Low
     Caution
List
Medium
     Caution
List
High
     Classified
List
     Total  

Number of policies

     90        6        3        331         430   

Number of issues(1)

     17        4        2        126         149   

Remaining weighted average contract period (in years)

     7.5        3.4        7.2        7.0         7.1   

Gross insured contractual payments outstanding:(2)

              

Principal

   $ 2,917      $ 17      $ 320      $ 7,031       $ 10,285   

Interest

     2,795        4        107        2,777         5,683   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 5,712      $ 21      $ 427      $ 9,808       $ 15,968   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross Claim Liability(3)

   $ -      $ -      $ -      $ 718       $ 718   

Less:

              

Gross Potential Recoveries(4)

     -        -        -        770         770   

Discount, net(5)

     -        -        -        (75)        (75)  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net claim liability (recoverable)

   $ -      $ -      $ -      $ 23       $ 23   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Unearned premium revenue

   $ 9      $ -      $ 8      $ 68       $ 85   

 

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

 

(2) - Represents contractual principal and interest payments due by the issuer of the obligations insured by MBIA.

 

(3) - The gross claim liability with respect to Puerto Rico and Zohar II exposures are net of expected recoveries for policies in a net payable position.

 

(4) - Gross potential recoveries with respect to certain Puerto Rico exposures are net of the claim liability for policies in a net recoverable position.

 

(5) - Represents discount related to Gross Claim Liability and Gross Potential Recoveries.

As of September 30, 2017, the gross claim liability primarily related to insured first-lien RMBS transactions as well as certain Puerto Rico exposures. As of December 31, 2016, the gross claim liability primarily related to insured first-lien RMBS transactions. As of September 30, 2017 and December 31, 2016, the gross potential recoveries principally related to certain Puerto Rico exposures and insured second-lien RMBS transactions. As of September 30, 2017, these potential recoveries exclude the recoveries of Zohar I and Zohar II that are included in “Loans receivable at fair value” which are presented in “Assets of consolidated variable interest entities” on the Company’s consolidated balance sheets.

The Company’s recoveries have been, and remain based on either salvage rights, the rights conferred to MBIA through the transactional documents (inclusive of the insurance agreement), or subrogation rights embedded within financial guarantee insurance policies. Expected salvage and subrogation recoveries, as well as recoveries from other remediation efforts, reduce the Company’s claim liability. Once a claim payment has been made, the claim liability has been satisfied and MBIA’s right to recovery is no longer considered an offset to future expected claim payments, it is recorded as a salvage asset. The amount of recoveries recorded by the Company is limited to paid claims plus the present value of projected estimated future claim payments. As claim payments are made, the recorded amount of potential recoveries may exceed the remaining amount of the claim liability for a given policy. The gross claim liability and gross potential recoveries reflect the elimination of claim liabilities and potential recoveries related to VIEs consolidated by the Company. As of September 30, 2017 and December 31, 2016, reinsurance recoverable on paid and unpaid losses was $15 million and $6 million, respectively, and was included in “Other assets” on the Company’s consolidated balance sheets.

 

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MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

 

Note 6: Fair Value of Financial Instruments

Fair Value Measurement

Financial Assets

Financial assets held by the Company primarily consist of investments in debt securities. Substantially all of the Company’s investments are priced by independent third parties, including pricing services and brokers. Typically, the Company receives one pricing service value or broker quote for each instrument, which represents a non-binding indication of value. The Company, along with its third-party portfolio manager, reviews the assumptions, inputs and methodologies used by pricing services and brokers to obtain reasonable assurance that the prices used in its valuations reflect fair value. When the Company and its third-party portfolio manager believe a third-party quotation differs significantly from its internally developed expectation of fair value, whether higher or lower, the Company reviews its data or assumptions with the provider. This review includes comparing significant assumptions such as prepayment speeds, default ratios, forward yield curves, credit spreads and other significant quantitative inputs to internal assumptions, and working with the price provider to reconcile the differences. The price provider may subsequently provide an updated price. In the event that the price provider does not update its price, and the Company still does not agree with the price provided, its third-party portfolio manager will obtain a price from another third-party provider or use an internally developed price which it believes represents the fair value of the investment. The fair values of investments for which internal prices were used were not significant to the aggregate fair value of the Company’s investment portfolio as of September 30, 2017 or December 31, 2016. All challenges to third-party prices are reviewed by staff of the Company as well as its third-party portfolio manager with relevant expertise to ensure reasonableness of assumptions. A pricing analysis is reviewed and approved by the Company’s valuation committee.

Financial Liabilities (excluding derivative liabilities)

Financial liabilities, excluding derivative liabilities, issued by the Company primarily consist of debt issued for general corporate purposes within its corporate segment, medium-term notes (“MTNs”), investment agreements, debt issued by consolidated VIEs and warrants. The majority of the financial liabilities that the Company has elected to fair value or that require fair value reporting or disclosures are valued based on the estimated value of the underlying collateral, the Company’s or a third-party’s estimate of discounted cash flow model estimates, or quoted market values for similar products. These valuations include adjustments for expected nonperformance risk of the Company.

Derivative Liabilities

The Company’s derivative liabilities are primarily interest rate swaps and insured credit derivatives. The Company’s insured credit derivative contracts are non-traded structured credit derivative transactions. Since insured derivatives are highly customized and there is generally no observable market for these derivatives, the Company estimates their fair values in a hypothetical market based on internal models simulating what a similar company would charge to assume the Company’s position in the transaction at the measurement date. This pricing would be based on the expected loss of the exposure. The Company reviews its valuation model results on a quarterly basis to assess the appropriateness of the assumptions and results in light of current market activity and conditions. This review is performed by internal staff with relevant expertise. When market spreads or securities prices are observable for similar transactions, those spreads are an integral part of the analysis.

Internal Review Process

All significant financial assets and liabilities are reviewed by the valuation committee to ensure compliance with the Company’s policies and risk procedures in the development of fair values of financial assets and liabilities. The valuation committee reviews, among other things, key assumptions used for internally developed prices, significant changes in sources and uses of inputs, including changes in model approaches, and any adjustments from third-party inputs or prices to internally developed inputs or prices. The committee also reviews any significant impairment or improvements in fair values of the financial instruments from prior periods. The committee is comprised of senior finance team members with relevant experience in the financial instruments their committee is responsible for. The committee documents its agreement with the fair value measurements reported in the Company’s consolidated financial statements.

Valuation Techniques

Valuation techniques for financial instruments measured at fair value or disclosed at fair value are described below.

Fixed-Maturity Securities (including short-term investments) Held as Available-For-Sale, Investments Carried at Fair Value, Investments Pledged as Collateral, Investments Held-to-Maturity, and Other Investments

These investments include investments in U.S. Treasury and government agencies, state and municipal bonds, foreign governments, corporate obligations, mortgage-backed securities (“MBS”), asset-backed securities (“ABS”), money market securities, and perpetual debt and equity securities.

 

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MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 6: Fair Value of Financial Instruments (continued)

 

These investments are generally valued based on recently executed transaction prices or quoted market prices. When quoted market prices are not available, fair value is generally determined using quoted prices of similar investments or a valuation model based on observable and unobservable inputs. Inputs vary depending on the type of investment. Observable inputs include contractual cash flows, interest rate yield curves, CDS spreads, prepayment and volatility scores, diversity scores, cross-currency basis index spreads, and credit spreads for structures similar to the financial instrument in terms of issuer, maturity and seniority. Unobservable inputs include cash flow projections and the value of any credit enhancement.

The investment in the fixed-income fund was measured at fair value by applying the net asset value per share practical expedient. The investment in the fixed-income fund may be redeemed on a quarterly basis with prior redemption notification of ninety days subject to withdrawal limitations. The investment is required to be held for a minimum of twelve months, and any subsequent quarterly redemption is limited to 25% of the investment or a complete redemption over four consecutive quarters in the amounts of 25%, 33%, 50%, and 100% of the remaining investment balance as of the first, second, third and fourth consecutive quarters, respectively.

The fair value of the held-to-maturity (“HTM”) investments is determined using discounted cash flow models. Key inputs include unobservable cash flows projected over the expected term of the investment discounted using observable interest rate yield curves of similar securities.

Investments based on quoted market prices of identical investments in active markets are classified as Level 1 of the fair value hierarchy. Level 1 investments generally consist of U.S. Treasury and government agency, foreign government, money market securities and perpetual debt and equity securities. Quoted market prices of investments in less active markets, as well as investments which are valued based on other than quoted prices for which the inputs are observable, such as interest rate yield curves, are categorized in Level 2 of the fair value hierarchy. Investments that contain significant inputs that are not observable are categorized as Level 3.

Cash and Cash Equivalents, Receivable for Investments Sold, Payable for Investments Purchased, Accrued Investment Income and Interest Payable for Derivatives

The carrying amounts of cash and cash equivalents, receivable for investments sold, payable for investments purchased, accrued investment income and interest payable for derivatives approximate fair values due to the short-term nature and credit worthiness of these instruments. These items are categorized in Level 1 or Level 2 of the fair value hierarchy.

Loans Receivable at Fair Value

Loans receivable at fair value are comprised of loans held by consolidated VIEs consisting of residential mortgage and corporate loans. Fair values of residential mortgage loans are determined using quoted prices for MBS issued by the respective VIE and adjusted for the fair values of the financial guarantees provided by MBIA Corp. on the related MBS. Fair values of corporate loans are based on discounted cash flow methodologies. Loans receivable at fair value are determined using market prices adjusted for financial guarantees provided to VIE obligations and discounted cash flow techniques and are categorized in Level 3 of the fair value hierarchy.

Loan Repurchase Commitments

Loan repurchase commitments are obligations owed by the sellers/servicers of mortgage loans to MBIA as reimbursement of paid claims. Loan repurchase commitments are assets of the consolidated VIEs. This asset represents the rights of MBIA against the sellers/servicers for breaches of representations and warranties that the securitized residential mortgage loans sold to the trust to comply with stated underwriting guidelines and for the sellers/servicers to cure, replace, or repurchase mortgage loans. Fair value measurements of loan repurchase commitments represent the amounts owed by the sellers/servicers to MBIA as reimbursement of paid claims. Loan repurchase commitments are not securities and no quoted prices or comparable market transaction information are observable or available. Fair values of loan repurchase commitments are determined using discounted cash flow techniques and are categorized in Level 3 of the fair value hierarchy.

Other Assets

VIEs consolidated by the Company have entered into derivative instruments consisting of cross currency swaps. Cross currency swaps are entered into to manage the variability in cash flows resulting from fluctuations in foreign currency rates. The fair values of VIE derivatives is determined based on inputs from unobservable cash flows projection of the derivative, discounted using observable discount rates. As the significant inputs are unobservable, the derivative contract is categorized in Level 3 of the fair value hierarchy.

 

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MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 6: Fair Value of Financial Instruments (continued)

 

Other assets also include receivables representing the right to receive reimbursement payments on claim payments expected to be made on certain insured VIE liabilities due to risk mitigating transactions with third parties executed to effectively defease, or, in-substance commute the Company’s exposure on its financial guarantee policies. The right to receive reimbursement payments is based on the value of the Company’s financial guarantee determined using the cash flow model. The fair value of the financial guarantee primarily contains unobservable inputs and is categorized in Level 3 of the fair value hierarchy.

Long-term Debt

The fair value of long-term notes, debentures and surplus notes are estimated based on quoted prices for these or similar securities.

The fair value of the accrued interest expense on the surplus notes due in 2033 is determined based on the carrying amount of the accrued interest expense, adjusted for the credit risk of the Company. The carrying amounts of accrued interest expense on all other long-term debt approximate fair value due to the short-term nature of the interest payment. Long-term debt is categorized in Level 2 of the fair value hierarchy.

Medium-term Notes

The fair values of certain MTNs are based on quoted market prices provided by third-party sources, where available. When quoted market prices are not available, the Company applies a matrix pricing grid to determine fair value based on the quoted market prices received for similar instruments and considering the MTNs’ stated maturity and interest rate. Nonperformance risk is included in the quoted market prices and the matrix pricing grid. The Company has elected to measure certain MTNs at fair value on a recurring basis with changes in fair value reflected in earnings. MTNs are categorized in Level 3 of the fair value hierarchy.

Investment Agreements

The fair values of investment agreements are determined using discounted cash flow techniques based on contractual cash flows and observable interest rates currently being offered for similar agreements with comparable maturity dates. Investment agreements contain collateralization and termination agreements that substantially mitigate the nonperformance risk of the Company. As the terms of the notes are private, and the timing and amount of contractual cash flows are not observable, these investment agreements are categorized in Level 3 of the fair value hierarchy.

Variable Interest Entity Notes

The fair values of VIE notes are determined based on recently executed transaction prices or quoted prices where observable. When position-specific quoted prices are not observable, fair values are based on quoted prices of similar securities. Fair values based on quoted prices of similar securities may be adjusted for factors unique to the securities, including any credit enhancement. When observable quoted prices are not available, fair value is determined based on discounted cash flow techniques of the underlying collateral using observable and unobservable inputs. Observable inputs include interest rate yield curves and bond spreads of similar securities. Unobservable inputs include the value of any credit enhancement. VIE notes are categorized in Level 2 or Level 3 of the fair value hierarchy based on the lowest level input that is significant to the fair value measurement in its entirety.

Derivatives

The corporate segment has entered into derivative transactions primarily consisting of interest rate swaps. Fair values of over-the-counter derivatives are determined using valuation models based on observable inputs, nonperformance risk of the Company and nonperformance risk of the counterparties. Observable and market-based inputs include interest rate yields, credit spreads and volatilities. These derivatives are categorized in Level 2 or Level 3 of the fair value hierarchy based on the lowest level input that is significant to the fair value measurement in its entirety.

Derivatives—Insurance

The derivative contracts insured by the Company cannot be legally traded and generally do not have observable market prices. The Company determines the fair values of insured credit derivatives using valuation models based on observable inputs and considering nonperformance risk of the Company. Negotiated settlements are also considered to validate the valuation models and to reflect assumptions the Company believes market participants would use.

Valuation Model Overview

For the nine months ended September 30, 2017, the Company used an internally developed Direct Price Model to value insured CDS contracts that incorporate market prices or estimated prices of similar securities that are obtained for all collateral within a transaction, the present value of the market-implied potential losses, and nonperformance risk. The valuation of insured derivatives includes the impact of its credit standing. The insured credit derivatives are categorized in Level 3 of the fair value hierarchy based on unobservable inputs that are significant to the fair value measurement in its entirety.

 

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MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 6: Fair Value of Financial Instruments (continued)

 

Prior to 2017, the Company used the Binomial Expansion Technique (“BET”) Model and the Direct Price Model to value insured CDS contracts. The BET Model estimates what a bond insurer would charge to guarantee a transaction at the measurement date, based on the market-implied default risk of the underlying collateral and the remaining structural protection in a deductible or subordination. Inputs to the process of determining fair value for structured transactions using the BET Model include estimates of collateral loss, allocation of loss to separate tranches of the capital structure, credit spreads, recovery rates and nonperformance risk and weighted average life.

The Company has also entered into a derivative contract as a result of a commutation. The fair value of the derivative is determined using a discounted cash flow model. Key inputs include unobservable cash flows projected over the expected term of the derivative, discounted using observable discount rates and CDS spreads. As the significant inputs are unobservable, the derivative contract is categorized in Level 3 of the fair value hierarchy.

Other Liabilities

Stock warrants issued by the Company are valued using the Black-Scholes model and are recorded at fair value. Inputs into the warrant valuation include the Company’s stock price, the strike price of the warrant, time to expiration, a volatility parameter, interest rates, and dividend data. As all significant inputs are market-based and observable, warrants are categorized in Level 2 of the fair value hierarchy.

Other liabilities also include payables for certain contingent consideration. The fair value of the liability is based on the cash flow methodologies using observable and unobservable inputs. Unobservable inputs include invested asset balances and asset management fees that are significant to the fair value estimate and the liability is categorized in Level 3 of the fair value hierarchy.

Held For Sale

As of December 31, 2016, the Company estimated the fair value of the assets and liabilities of MBIA UK held for sale based on the fair value of the expected total consideration for the sale of MBIA UK. The fair value of the sale consideration is categorized in Level 2 of the fair value hierarchy. Refer to “Note 1: Business Developments and Risks and Uncertainties” for additional information about the sale of MBIA UK.

Financial Guarantees

Gross Financial Guarantees—The fair value of gross financial guarantees is determined using discounted cash flow techniques based on inputs that include (i) assumptions of expected losses on financial guarantee policies where loss reserves have not been recognized, (ii) amount of losses expected on financial guarantee policies where loss reserves have been established, net of expected recoveries, (iii) the cost of capital reserves required to support the financial guarantee liability, (iv) operating expenses, and (v) discount rates which reflect the expected nonperformance risk and recovery rates of the Company.

The carrying value of the Company’s gross financial guarantees consists of unearned premium revenue and loss and LAE reserves, net of the insurance loss recoverable as reported on the Company’s consolidated balance sheets.

Ceded Financial Guarantees—The fair value of ceded financial guarantees is determined by applying the percentage ceded to reinsurers to the related fair value of the gross financial guarantees. The carrying value of ceded financial guarantees consists of prepaid reinsurance premiums and reinsurance recoverable on paid and unpaid losses as reported within “Other assets”, net of gross salvage payable to reinsurers as reported within “Other liabilities” on the Company’s consolidated balance sheets.

 

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Table of Contents

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 6: Fair Value of Financial Instruments (continued)

 

Significant Unobservable Inputs

The following tables provide quantitative information regarding the significant unobservable inputs used by the Company for assets and liabilities measured at fair value on a recurring basis as of September 30, 2017 and December 31, 2016.

 

                                           

In millions

  Fair Value as of
September 30, 2017
   

Valuation Techniques

 

Unobservable Input

  Range
(Weighted Average)
 

Assets of consolidated VIEs:

       

Loans receivable at fair value

  $ 1,632     Market prices adjusted for financial guarantees provided to VIE obligations   Impact of financial guarantee     0% - 34% (6%)  
   

Discounted cash flow

 

Multiples(1)

 

Loan repurchase commitments

    406     Discounted cash flow   Recovery rates(2)  
      Breach rates(2)  

Liabilities of consolidated VIEs:

       

Variable interest entity notes

    430     Market prices of VIE assets adjusted for financial guarantees provided   Impact of financial guarantee     0% - 65% (39%)  

Credit derivative liabilities, net:

       

CMBS and multi-sector CDO

    74     Direct Price Model   Nonperformance risk     46% - 46% (46%)  

Other derivative liabilities

    4     Discounted cash flow   Cash flows     $0 - $49 ($25)(3)  

 

(1) - Unobservable inputs are primarily based on comparable companies’ EBITDA Multiples.
(2) - Recovery rates and breach rates include estimates about potential variations in the outcome of litigation with a counterparty.
(3) - Midpoint of cash flows are used for the weighted average.

 

In millions

  Fair Value as of
December 31, 2016
   

Valuation Techniques

 

Unobservable Input

  Range
(Weighted Average)
 

Assets of consolidated VIEs:

       

Loans receivable at fair value

  $ 916     Market prices adjusted for financial guarantees provided to VIE obligations   Impact of financial guarantee     0% - 28% (3%)  
   

Discounted cash flow

 

Multiples(1)

 

Loan repurchase commitments

    404     Discounted cash flow   Recovery rates(2)  
      Breach rates(2)  

Liabilities of consolidated VIEs:

       

Variable interest entity notes

    476     Market prices of VIE assets adjusted for financial guarantees provided   Impact of financial guarantee     0% - 54% (24%)  

Credit derivative liabilities, net:

       
      Recovery rates     25% - 40% (33%)  

CMBS

    62     BET Model   Nonperformance risk     10% - 32% (32%)  
      Weighted average life (in years)     1.1 - 1.5 (1.3)  
      CMBS spreads     25% - 35% (30%)  

Multi-sector CDO

    2     Direct Price Model   Nonperformance risk     58% - 58% (58%)  

Other derivative liabilities

    20    

Discounted cash flow

 

Cash flows

    $0 - $83 ($42)(3)  

 

(1) - Unobservable inputs are primarily based on comparable companies’ EBITDA Multiples.

 

(2) - Recovery rates and breach rates include estimates about potential variations in the outcome of litigation with a counterparty.

 

(3) - Midpoint of cash flows are used for the weighted average.

 

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Table of Contents

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 6: Fair Value of Financial Instruments (continued)

 

Sensitivity of Significant Unobservable Inputs

The significant unobservable inputs used in the fair value measurement of the Company’s loans receivable at fair value of consolidated VIEs are the impact of the financial guarantee and multiples. The fair value of loans receivable are calculated by subtracting the value of the financial guarantee from the market value of VIE liabilities and by discounted cash flow methodologies. The value of a financial guarantee is estimated by the Company as the present value of expected cash payments under the policy. As expected cash payments provided by the Company under the insurance policy increase, there is a lower expected cash flow on the underlying loans receivable of the VIE. This results in a lower fair value of the loans receivable in relation to the obligations of the VIE. Multiples are external factors that are considered when determining the fair values of certain loans. Any increase or decrease in multiples would result in an increase or decrease in the fair value, respectively.

The significant unobservable inputs used in the fair value measurement of the Company’s loan repurchase commitments of consolidated VIEs are the recovery rates and breach rates. Recovery rates reflect the estimates of future cash flows reduced for litigation delays and risks and/or potential financial distress of the sellers/servicers. The estimated recoveries of the loan repurchase commitments may differ from the actual recoveries that may be received in the future. Breach rates represent the rate at which mortgages fail to comply with stated representations and warranties of the sellers/servicers. Significant increases or decreases in the recovery rates and the breach rates would result in significantly higher or lower fair values of the loan repurchase commitments, respectively. Additionally, changes in the legal environment and the ability of the counterparties to pay would impact the recovery rate assumptions, which could significantly impact the fair value measurement. Any significant challenges by the counterparties to the Company’s determination of breaches of representations and warranties could have a material adverse impact on the fair value measurement. Recovery rates and breach rates are determined independently. Changes in one input will not necessarily have any impact on the other input.

The significant unobservable input used in the fair value measurement of the Company’s VIE notes of consolidated VIEs is the impact of the financial guarantee. The fair value of VIE notes is calculated by adding the value of the financial guarantee to the market value of VIE assets. The value of a financial guarantee is estimated by the Company as the present value of expected cash payments under the policy. As the value of the guarantee provided by the Company to the obligations issued by the VIE increases, the credit support adds value to the liabilities of the VIE. This results in an increase in the fair value of the liabilities of the VIE.

Effective in 2017, the Company used the Direct Price Model to value its commercial mortgage-backed securities (“CMBS”) and multi-sector CDO credit derivatives. The significant unobservable input used in the fair value measurement was nonperformance risk. The nonperformance risk is an assumption of MBIA Corp.’s own ability to pay and whether MBIA Corp. will have the necessary resources to pay the obligations as they come due. Any significant increase or decrease in MBIA Corp.’s nonperformance risk would result in a decrease or increase in the fair value of the derivative liabilities, respectively. Prior to 2017, the Company used the BET Model to value its CMBS credit derivatives. The significant unobservable inputs used in the fair value measurement of its CMBS credit derivatives were CMBS spreads, recovery rates, nonperformance risk and weighted average life. The CMBS spread is an indicator of credit risk of the collateral securities. The recovery rate represents the percentage of notional expected to be recovered after an asset defaults, indicating the severity of a potential loss. The nonperformance risk is an assumption of MBIA Corp.’s own ability to pay and whether MBIA Corp. will have the necessary resources to pay the obligations as they come due. Weighted average life is based on the Company’s estimate of when the principal of the underlying collateral of the CMBS structure will be repaid. A significant increase or decrease in CMBS spreads would result in an increase or decrease in the fair value of the derivative liability, respectively. A significant increase in weighted average life can result in an increase or decrease in the fair value of the derivative liability, depending on the discount rate and the timing of significant losses. Any significant increase or decrease in recovery rates, or MBIA Corp.’s nonperformance risk would result in a decrease or increase in the fair value of the derivative liabilities, respectively. CMBS spreads, recovery rates, nonperformance risk and weighted average lives are determined independently. Changes in one input will not necessarily have any impact on the other inputs.

The significant unobservable input used in the fair value measurement of MBIA Corp.’s other derivatives, which are valued using a discounted cash flow model, is the estimates of future cash flows discounted using market rates and CDS spreads. Any significant increase or decrease in future cash flows would result in an increase or decrease in the fair value of the derivative liability, respectively.

 

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Table of Contents

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 6: Fair Value of Financial Instruments (continued)

 

Fair Value Measurements

The following tables present the fair value of the Company’s assets (including short-term investments) and liabilities measured and reported at fair value on a recurring basis as of September 30, 2017 and December 31, 2016:

 

                                                      
     Fair Value Measurements at Reporting Date Using         

In millions

   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable Inputs
(Level 3)
    Counterparty
and Cash
Collateral
Netting
     Balance as of
September 30,
2017
 

Assets:

             

Fixed-maturity investments:

             

U.S. Treasury and government agency

   $ 724      $ 93      $     $      $ 817  

State and municipal bonds

            1,113                     1,113  

Foreign governments

            8                     8  

Corporate obligations

            1,511                     1,511  

Mortgage-backed securities:

             

Residential mortgage-backed agency

            699                     699  

Residential mortgage-backed non-agency

            36                     36  

Commercial mortgage-backed

            51                     51  

Asset-backed securities:

             

Collateralized debt obligations

            72                     72  

Other asset-backed

            315        5 (1)             320  
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total fixed-maturity investments

     724        3,898        5              4,627  

Money market securities

     269                            269  

Perpetual debt and equity securities

     26        21                     47  

Fixed-income fund

                                81 (2) 

Cash and cash equivalents

     116                            116  

Derivative assets:

             

Non-insured derivative assets:

             

Interest rate derivatives

            3                     3  

 

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Table of Contents

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 6: Fair Value of Financial Instruments (continued)

 

                                                      
    Fair Value Measurements at Reporting Date Using        

In millions

  Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
    Significant
Other
Observable
Inputs
(Level 2)
    Significant
Unobservable
Inputs

(Level 3)
    Counterparty
and Cash
Collateral
Netting
    Balance as of
September 30,
2017
 

Assets of consolidated VIEs:

         

Corporate obligations

          20                   20  

Mortgage-backed securities:

         

Residential mortgage-backed non-agency

          111                   111  

Commercial mortgage-backed

          39                   39  

Asset-backed securities:

         

Collateralized debt obligations

          8       1 (1)            9  

Other asset-backed

          10                   10  

Cash

    20                         20  

Loans receivable at fair value:

         

Residential loans receivable

                759             759  

Corporate loans receivable

                873             873  

Loan repurchase commitments

                406             406  

Other assets:

         

Currency derivatives

                13 (1)            13  

Other

                17 (1)            17  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

  $ 1,155     $ 4,110     $ 2,074     $     $ 7,420  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities:

         

Medium-term notes

  $     $     $ 127 (1)    $     $ 127  

Derivative liabilities:

         

Insured derivatives:

         

Credit derivatives

          2       74             76  

Non-insured derivatives:

         

Interest rate derivatives

          204                   204  

Other

                4             4  

Other liabilities:

         

Warrants

          12                   12  

Other payable

                7 (1)            7  

Liabilities of consolidated VIEs:

         

Variable interest entity notes

          710       430             1,140  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

  $     $ 928     $ 642     $     $ 1,570  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) - Unobservable inputs are either not developed by the Company or do not significantly impact the overall fair values of the aggregate financial assets and liabilities.

 

(2) - Investment that was measured at fair value by applying the net asset value per share practical expedient, and was required not to be classified in the fair value hierarchy.

 

27


Table of Contents

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 6: Fair Value of Financial Instruments (continued)

 

                                                      
     Fair Value Measurements at Reporting Date Using         

In millions

   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
    Counterparty
and Cash
Collateral
Netting
     Balance as of
December 31,
2016
 

Assets:

             

Fixed-maturity investments:

             

U.S. Treasury and government agency

   $ 825      $ 112      $ -     $      $ 937  

State and municipal bonds

     -        1,440        -              1,440  

Foreign governments

     -        9        -              9  

Corporate obligations

     -        1,332        2 (1)             1,334  

Mortgage-backed securities:

             

Residential mortgage-backed agency

     -        868        -              868  

Residential mortgage-backed non-agency

     -        45        -              45  

Commercial mortgage-backed

     -        43        -              43  

Asset-backed securities:

             

Collateralized debt obligations

     -        7        15 (1)             22  

Other asset-backed

     -        257        44 (1)             301  
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total fixed-maturity investments

     825        4,113        61              4,999  

Money market securities

     521        -        -              521  

Perpetual debt and equity securities

     26        9        -              35  

Fixed-income fund

     -        -        -              75 (2) 

Cash and cash equivalents

     163        -        -              163  

Derivative assets:

             

Non-insured derivative assets:

             

Interest rate derivatives

     -        3        -              3  

 

28


Table of Contents

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 6: Fair Value of Financial Instruments (continued)

 

                                                      
     Fair Value Measurements at Reporting Date Using         

In millions

   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
    Counterparty
and Cash
Collateral
Netting
     Balance as of
December 31,
2016
 

Assets of consolidated VIEs:

             

Corporate obligations

     -        27        -       -        27  

Mortgage-backed securities:

             

Residential mortgage-backed non-agency

     -        149        -       -        149  

Commercial mortgage-backed

     -        52        -       -        52  

Asset-backed securities:

             

Collateralized debt obligations

     -        7        1 (1)      -        8  

Other asset-backed

     -        18        1 (1)      -        19  

Cash

     24        -        -       -        24  

Loans receivable at fair value:

             

Residential loans receivable

     -        -        916       -        916  

Corporate loans receivable

     -        -        150 (1)      -        150  

Loan repurchase commitments

     -        -        404       -        404  

Derivative assets:

             

Currency derivatives

     -        -        19 (1)      -        19  
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total assets

   $ 1,559      $ 4,378      $ 1,552     $ -      $ 7,564  
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Liabilities:

             

Medium-term notes

   $ -      $ -      $ 101 (1)    $ -      $ 101  

Derivative liabilities:

             

Insured derivatives:

             

Credit derivatives

     -        2        64       -        66  

Non-insured derivatives:

             

Interest rate derivatives

     -        213        -       -        213  

Other

     -        -        20       -        20  

Other liabilities:

             

Warrants

     -        33        -       -        33  

Liabilities of consolidated VIEs:

             

Variable interest entity notes

     -        875        476       -        1,351  
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total liabilities

   $ -      $ 1,123      $ 661     $ -      $ 1,784  
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) - Unobservable inputs are either not developed by the Company or do not significantly impact the overall fair values of the aggregate financial assets and liabilities.

 

(2) - Investment that was measured at fair value by applying the net asset value per share practical expedient, and was required not to be classified in the fair value hierarchy.

Level 3 assets at fair value as of September 30, 2017 and December 31, 2016 represented approximately 28% and 21%, respectively, of total assets measured at fair value. Level 3 liabilities at fair value as of September 30, 2017 and December 31, 2016 represented approximately 41% and 37%, respectively, of total liabilities measured at fair value.

 

29


Table of Contents

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 6: Fair Value of Financial Instruments (continued)

 

The following tables present the fair values and carrying values of the Company’s assets and liabilities that are disclosed at fair value but not reported at fair value on the Company’s consolidated balance sheets as of September 30, 2017 and December 31, 2016:

 

                                                      
     Fair Value Measurements at Reporting Date Using              

In millions

   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
    Significant Other
Observable Inputs
(Level 2)
    Significant
Unobservable Inputs
(Level 3)
    Fair Value
Balance as of
September 30,
2017
    Carry Value
Balance as of
September 30,
2017
 

Assets:

          

Other investments

   $ -     $ 2     $ -     $ 2     $ 2  

Accrued investment income(1)

     -       28       -       28       28  

Receivable for investments sold(1)

     -       49       -       49       49  

Assets of consolidated VIEs:

          

Investments held-to-maturity

     -       -       897       897       890  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

   $ -     $ 79     $ 897     $ 976     $ 969  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities:

          

Long-term debt

   $ -     $ 1,054     $ -     $ 1,054     $ 2,093  

Medium-term notes

     -       -       497       497       771  

Investment agreements

     -       -       453       453       350  

Payable for investments purchased(2)

     -       74       -       74       74  

Interest payable for derivatives(2)

     -       15       -       15       15  

Liabilities of consolidated VIEs:

          

Variable interest entity notes

     -       353       897       1,250       1,212  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

   $ -     $ 1,496     $ 1,847     $ 3,343     $ 4,515  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Financial Guarantees:

          

Gross

   $ -     $ -     $ 2,116     $ 2,116     $ 1,015  

Ceded

     -       -       71       71       36  

 

(1) - Reported within “Other assets” on MBIA’s consolidated balance sheets.

(2) - Reported within “Other liabilities” on MBIA’s consolidated balance sheets.

 

                                                      
     Fair Value Measurements at Reporting Date Using              

In millions

   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
    Significant Other
Observable Inputs
(Level 2)
    Significant
Unobservable Inputs
(Level 3)
    Fair Value
Balance as of
December 31,
2016
    Carry Value
Balance as of
December 31,
2016
 

Assets:

          

Other investments

   $ -     $ 2     $ -     $ 2     $ 3  

Accrued investment income(1)

     -       40       -       40       40  

Assets held for sale

     -       306       -       306       306  

Assets of consolidated VIEs:

          

Investments held-to-maturity

     -       -       876       876       890  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

   $ -     $ 348     $ 876     $ 1,224     $ 1,239  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities:

          

Long-term debt

   $ -     $ 1,030     $ -     $ 1,030     $ 1,986  

Medium-term notes

     -       -       478       478       794  

Investment agreements

     -       -       508       508       399  

Payable for investments purchased(2)

     -       32       -       32       32  

Liabilities of consolidated VIEs:

          

Variable interest entity notes

     -       -       882       882       890  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

   $ -     $ 1,062     $ 1,868     $ 2,930     $ 4,101  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Financial Guarantees:

          

Gross

   $ -     $ -     $ 2,638     $ 2,638     $ 995  

Ceded

     -       -       18       18       43  

 

(1) - Reported within “Other assets” on MBIA’s consolidated balance sheets.

 

(2) - Reported within “Other liabilities” on MBIA’s consolidated balance sheets.

 

30


Table of Contents

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 6: Fair Value of Financial Instruments (continued)

 

The following tables present information about changes in Level 3 assets (including short-term investments) and liabilities measured at fair value on a recurring basis for the three months ended September 30, 2017 and 2016:

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Three Months Ended September 30, 2017

 

                                                                                                                                              

In millions

  Balance,
Beginning
of Period
    Realized
Gains /
(Losses)
    Unrealized
Gains /
(Losses)
Included
in
Earnings
    Unrealized
Gains /
(Losses)
Included
in OCI
    Foreign
Exchange
Recognized
in OCI or
Earnings
    Purchases     Issuances     Settlements     Sales     Transfers
into
Level  3(1)
    Transfers
out of
Level 3(1)
    Ending
Balance
    Change in
Unrealized
Gains
(Losses)

for
the Period
Included in
Earnings
for Assets

still held
as of
September 30,
2017
 

Assets:

                         

Commercial mortgage-backed

  $ 7     $ -     $     $ -     $ -     $ -     $ -     $     $     $ -     $ (7)     $ -     $  

Other asset-backed

    5       -             -       -       -       -                   -             5        

Assets of consolidated VIEs:

                         

Commercial mortgage-backed

    3       -             -       -       -       -             (3)       -             -        

Collateralized debt obligations

    1       -             -       -       -       -                   -             1        

Loans receivable- residential

    815       -             -       -       -       -       (58)             -             759        

Loans receivable- corporate

    875       -             -       -       -       -       (6)             -             873        

Loan repurchase commitments

    407       -       (1)       -       -       -       -                   -             406       (1)  

Currency derivatives, net

    9       -             -       1       -       -                   -             13        

Other

    -       -             -       -       17       -                   -             17        
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

  $ 2,122     $ -     $     $ -     $ 1     $ 17     $ -     $ (64)     $ (3)     $ -     $ (7)     $ 2,074     $  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

                                                                                                                                              

In millions

  Balance,
Beginning
of Period
    Realized
(Gains) /
Losses
    Unrealized
(Gains) /
Losses
Included
in
Earnings
    Unrealized
(Gains) /
Losses
Included
in OCI
    Foreign
Exchange
Recognized
in OCI or
Earnings
    Purchases     Issuances     Settlements     Sales     Transfers
into
Level  3(1)
    Transfers
out of
Level 3(1)
    Ending
Balance
    Change in
Unrealized
(Gains)
Losses for
the Period
Included in
Earnings

for
Liabilities
still held
as of
September 30,
2017
 

Liabilities:

                         

Medium-term notes

  $ 123     $ -     $ (1)     $ -     $ 5     $ -     $ -     $     $     $ -     $ -     $ 127     $  

Credit derivatives, net

    80       7       (6)       -       -       -       -       (7)             -       -       74       (6)  

Other derivatives

    4       -             -       -       -       -                   -       -       4        

Other payable

    -       -             -       -       6       -                   -       -       7        

Liabilities of consolidated VIEs:

                         

VIE notes

    491       -             -       -       -       -       (14)       (51)       -       -       430        
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

  $ 698     $ 7     $ (2)     $ -     $ 5     $ 6     $ -     $ (21)     $ (51)     $ -     $ -     $ 642     $  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) - Transferred in and out at the end of the period.

 

31


Table of Contents

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 6: Fair Value of Financial Instruments (continued)

 

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Three Months Ended September 30, 2016

 

                                                                                                                                              

In millions

  Balance,
Beginning
of Period
    Realized
Gains /
(Losses)
    Unrealized
Gains /
(Losses)
Included
in
Earnings
    Unrealized
Gains /
(Losses)
Included
in OCI
    Foreign
Exchange
Recognized
in OCI or
Earnings
    Purchases     Issuances     Settlements     Sales     Transfers
into
Level  3(1)
    Transfers
out of
Level 3(1)
    Ending
Balance
    Change in
Unrealized
Gains
(Losses)

for
the Period
Included in
Earnings

for Assets
still held

as of
September 30,
2016
 

Assets:

                         

Foreign governments

  $ 7     $ -     $     $ -     $ -     $ 5     $ -     $ (6)     $ -     $ -     $     $ 6     $  

Corporate obligations

    2       -             -       -       -       -       (1)       -       -             1        

Commercial mortgage-backed

    -       -             -       -       -       -             -       1             1        

Collateralized debt obligations

    20       -             -       -       -