Note 3 - Derivative Instruments (Notes)

9 Months Ended

Sep. 30, 2014

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Instruments

Derivative Instruments

We provide a significant portion of our credit protection within our financial guaranty segment in the form of CDS, which are accounted for as derivatives. Derivative instruments are recorded at fair value and changes in fair value are recorded as such in the condensed consolidated statement of operations. All of our derivative instruments are recognized in our condensed consolidated balance sheets as either derivative assets or derivative liabilities. In many of our CDS transactions, primarily our corporate CDOs, we 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 four years.

We record premiums and origination costs related to our CDS and certain other derivative contracts in change in fair value of derivative instruments and policy acquisition costs, respectively, on our condensed consolidated statements of operations. Our classification of these contracts is the same whether we are a direct insurer or we reinsure these contracts.

The following table sets forth our 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, 2014		December 31, 2013
Balance Sheets
Derivative assets:
Financial Guaranty credit derivative assets	$	6,102	$	6,323
Other derivative assets	18,111		10,319
Total derivative assets	24,213		16,642
Derivative liabilities:
Financial Guaranty credit derivative liabilities	138,605		238,728
Financial Guaranty VIE derivative liabilities	46,653		68,457
Total derivative liabilities	185,258		307,185
Total derivative liabilities, net	$	161,045	$	290,543

The notional value of our derivative contracts at September 30, 2014 and December 31, 2013 was $9.1 billion and $12.3 billion, respectively.

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

	Three Months Ended September 30,					Nine Months Ended September 30,
(In thousands)	2014		2013			2014			2013
Statements of Operations
Net premiums earned—derivatives	$	2,882	$	4,170		$	9,673		$	14,019
Financial Guaranty credit derivatives	8,979		9,198			97,521			(86,233		)
Financial Guaranty VIE derivatives	4,982		(4,026		)	20,123			513
Other derivatives	2,517		1,436			(394		)	1,344
Change in fair value of derivative instruments	$	19,360	$	10,778		$	126,923		$	(70,357	)

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) assets underlying 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 realized losses resulting from 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, the fair value amounts could vary significantly from period to period. See Note 4 for information on the fair value of our financial instruments.

The following table shows selected information about our derivative contracts:

($ in thousands)	September 30, 2014
	Number of Contracts	Par/ Notional Exposure		Total Net Asset (Liability)
Product
Corporate CDOs	14	$	6,060,500	$	(423	)
Non-Corporate CDOs and other derivative transactions:
TruPs	9	816,257		(18,378		)
CDO of CMBS	1	430,000		(39,341		)
Other:
Structured finance	3	436,865		(39,728		)
Public finance	19	1,071,409		(25,144		)
Total Non-Corporate CDOs and other derivative transactions	32	2,754,531		(122,591		)
Assumed financial guaranty credit derivatives:
Structured finance	21	128,112		(9,185		)
Public finance	4	95,015		(304		)
Total Assumed	25	223,127		(9,489		)
Financial Guaranty VIE derivative liabilities (1)	1	79,473		(46,653		)
Other (2)	3	—		18,111
Grand Total	75	$	9,117,631	$	(161,045	)

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(1) Represents the fair value of a CDS included in a VIE that we have consolidated.

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