Note 3 - Derivative Instruments (Notes)

9 Months Ended

Sep. 30, 2013

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Instruments and Hedging Activities Disclosure

Derivative Instruments

We provide a significant portion of our credit protection within our financial guaranty segment in the form of CDS. In many of our CDS transactions, primarily our corporate CDOs, we generally are required to make payments to our counterparty above a specified level of subordination, upon the occurrence of credit events related to the borrowings or bankruptcy of obligors contained within pools of corporate obligations or, in the case of pools of mortgage or other asset-backed obligations, upon the occurrence of credit events related to the specific obligations in the pool. When we provide a CDS as credit protection on a specific obligation, we generally guarantee the full and timely payment of principal and interest when due on such obligation. These derivatives have various maturity dates, but the majority of the net par outstanding of our remaining insured CDS transactions, including all of our corporate CDOs, mature within five years.

The following table sets forth our gross unrealized gains and gross unrealized losses on derivative assets and liabilities as of the dates indicated. Certain contracts are in an asset position because the net present value of the contractual premium we receive exceeds the net present value of our estimate of the expected future premiums that a financial guarantor of similar credit quality to us would charge to provide the same credit protection, assuming a transfer of our obligation to such financial guarantor as of the measurement date.

(In thousands)	September 30, 2013		December 31, 2012
Balance Sheets
Derivative assets:
Financial Guaranty credit derivative assets	$	7,311	$	12,024
NIMS related and other	13,533		1,585
Total derivative assets	20,844		13,609
Derivative liabilities:
Financial Guaranty credit derivative liabilities	276,830		196,406
Financial Guaranty VIE derivative liabilities	68,040		70,467
Total derivative liabilities	344,870		266,873
Total derivative liabilities, net	$	324,026	$	253,264

The notional value of our derivative contracts at September 30, 2013 and December 31, 2012 was $14.2 billion and $19.2 billion, respectively.

The components of the gains (losses) included in the change in fair value of derivative instruments are as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
(In thousands)	2013			2012			2013			2012
Statements of Operations
Net premiums earned—derivatives	$	4,170		$	7,169		$	14,019		$	23,041
Financial Guaranty credit derivatives	9,198			(51,839		)	(86,233		)	(171,219		)
Financial Guaranty VIE derivatives	(4,026		)	3,616			513			1,253
NIMS related and other	1,436			(2		)	1,344			(12		)
Change in fair value of derivative instruments	$	10,778		$	(41,056	)	$	(70,357	)	$	(146,937	)

The valuation of derivative instruments may result in significant volatility from period to period in gains and losses as reported on our condensed consolidated statements of operations. Generally, these gains and losses result, in part, from changes in corporate credit or asset-backed spreads and changes in the market’s perception of the creditworthiness of any: (i) underlying corporate entities; (ii) the credit performance of the assets underlying asset-backed securities (“ABS”); or (iii) primary obligors of obligations for which we provide second-to-pay credit protection. Additionally, when determining the fair value of our liabilities, we are required to incorporate into the fair value of those liabilities an adjustment that reflects our own non-performance risk, and consequently, changes in the market’s perception of our non-performance risk can also result in gains and losses on our derivative instruments. Any incurred gains or losses (which include any claim payments) on our financial guaranty contracts that are accounted for as derivatives are recognized as a change in fair value of derivative instruments. Because our fair value determinations for derivative and other financial instruments are based on assumptions and estimates that are inherently subject to risk and uncertainty, our fair value amounts could vary significantly from period to period. See Note 4 for more information on the fair value of our derivative instruments.

The following table shows selected information about our derivative contracts:

($ in thousands)	September 30, 2013
	Number of Contracts	Par/ Notional Exposure		Total Net Asset/ (Liability)
Product
NIMS related and other (1)	2	$	—	$	13,533
Corporate CDOs	23	9,103,298		2,286
Non-Corporate CDOs and other derivative transactions:
Trust Preferred Securities (“TruPs”)	13	1,032,996		(35,652		)
CDOs of commercial mortgage-backed securities (“CMBS”)	4	1,831,000		(99,255		)
Other:
Structured finance	5	552,466		(82,133		)
Public finance	22	1,312,117		(42,497		)
Total Non-Corporate CDOs and other derivative transactions	44	4,728,579		(259,537		)
Assumed financial guaranty credit derivatives:
Structured finance	26	159,774		(11,765		)
Public finance	5	93,638		(503		)
Total Assumed	31	253,412		(12,268		)
Financial Guaranty VIE derivative liabilities (2)	1	77,686		(68,040		)
Grand Total	101	$	14,162,975	$	(324,026	)

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(1) Represents NIMS derivative assets related to consolidated NIMS VIEs and other purchased derivatives for which we do not have loss exposure that exceeds our net asset amount.

(2) Represents the fair value of a CDS included in a VIE that we have consolidated. See Note 5 for more information on this transaction, the underlying reference securities and our maximum exposure to loss from this consolidated financial guaranty transaction. The assets in the VIE represent the only funds available to pay the CDS counterparty for amounts due under the contract; therefore, the notional exposure presented for the CDS is limited to the current trust assets.