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MBI > SEC Filings for MBI > Form 10-K on 3-Mar-2014All Recent SEC Filings

Show all filings for MBIA INC

Form 10-K for MBIA INC


3-Mar-2014

Annual Report


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

INTRODUCTION

MBIA Inc. ("MBIA", the "Company", "we", "us", or "our") operates one of the largest financial guarantee insurance businesses in the industry and is a provider of asset management and advisory services. These activities are managed through three business segments: United States ("U.S.") public finance insurance; structured finance and international insurance; and advisory services. Our U.S. public finance insurance business is primarily operated through National Public Finance Guarantee Corporation (together with its subsidiaries, "National"), our structured finance and international insurance business is primarily operated through MBIA Insurance Corporation and its subsidiaries ("MBIA Corp."), and our asset management and advisory services business is primarily operated through Cutwater Holdings, LLC and its subsidiaries ("Cutwater"). We also manage certain business activities through our corporate, asset/liability products, and conduit segments. Our corporate segment includes revenues and expenses that arise from general corporate activities. Funding programs managed through our asset/liability products and conduit segments are in wind-down.

EXECUTIVE OVERVIEW

National

Our primary strategies are to provide ongoing surveillance to our existing insured portfolio and to write new U.S. public finance business through National. 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. During 2013, we achieved several strategic initiatives that support the objective of writing new business. In May of 2013, MBIA Inc., together with its subsidiaries MBIA Corp. and National, entered into a comprehensive settlement agreement and related agreements (the "BofA Settlement Agreement") with Bank of America Corporation and certain of its subsidiaries (collectively, "Bank of America") and entered into an agreement with Societe Generale. As a result of the BofA Settlement Agreement and the Societe Generale settlement, Standard & Poor's Financial Services LLC ("S&P") upgraded National's rating to A with a stable outlook. Also, Moody's Investors Service, Inc. ("Moody's") upgraded National's rating to Baa1 with a positive outlook. On February 14, 2014, Moody's reaffirmed National's Baa1 rating with a positive outlook. We believe National's financial strength and competitive position merit higher stable ratings. The absence of higher ratings from S&P and Moody's has adversely impacted our ability to write new insurance business. We are seeking higher stable ratings for National that would be necessary to support writing new business in accordance with our business plan, but there is no assurance that we will be able to achieve such ratings and the timing of such rating upgrades is uncertain. We continue to consider obtaining ratings from additional rating agencies.

As a result of the BofA Settlement Agreement and the repayment of MBIA Insurance Corporation's secured loan from National (the "National Secured Loan"), we believe National is better positioned to attract new business in the municipal market. National is the largest U.S. municipal-only bond insurer in the financial guarantee industry, it maintains underwriting criteria for most municipal risk types, and expects opportunities for new business across the spectrum of municipal sectors. We expect that the majority of its new business will be in the general obligation, tax-backed and revenue bond sectors. The Company also believes there are significant amounts of insurable bonds that have been issued on an unwrapped basis in recent years, which the Company believes meet its underwriting criteria and present attractive secondary market opportunities.

National seeks to generate shareholder value through appropriate risk adjusted pricing; however, current market conditions and the competitive landscape may limit National's new business opportunities and its ability to price and underwrite risk with attractive returns. An increase in interest rates and issuances of new municipal debt in 2014 would present new business opportunities for National in the U.S. public finance market.

In August of 2013, the novation agreement between Financial Guaranty Insurance Corporation ("FGIC") and National, whereby FGIC transferred, by novation, to National all the rights and liabilities under each of the policies covered under a reinsurance agreement with FGIC, became effective. This novation agreement included covered policies that previously benefited from the reinsurance agreement and second-to-pay policies entered into by MBIA Insurance Corporation in 2008 that were subsequently assigned to and reinsured by National in 2009. As a result of this novation, National is now the primary insurer under these policies.


Table of Contents

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

EXECUTIVE OVERVIEW (continued)

While our U.S. public finance insured portfolio in National continued to perform satisfactorily on the whole, we did experience increased stress in this portfolio, as a portion of the obligations that we insure were issued by some of the state and local governments and territories that remain under extreme financial and budgetary stress. In addition, some of these local governments have filed for protection under Chapter 9 of the United States Bankruptcy Code or have entered into state statutory proceedings established to assist municipalities in managing through periods of severe fiscal 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 our insured transactions. We continue to monitor and analyze these situations very closely, and the overall extent and duration of this stress is uncertain. For example, in the City of Detroit, Michigan's bankruptcy proceeding, the City of Detroit has filed a plan of adjustment proposing to treat unlimited tax general obligation bonds, including National insured bonds, as unsecured debt with no right to the specific voter-approved revenues that back the bonds. Bond insurers are litigating this treatment, arguing that bonds backed by property tax revenues issued for specific civic projects are secured by those revenues. National also has exposure to the Commonwealth of Puerto Rico and certain of its instrumentalities in the territory ("Puerto Rico"). Puerto Rico is experiencing fiscal stress, however it has taken pro-active actions to address its significant economic challenges. We are continuing to monitor the situation closely, and, at this time, we do not expect a default by Puerto Rico. Refer to the "U.S. Public Finance Insurance Selected Portfolio Exposures" section for additional information on our Puerto Rico exposures.

National's insurance policy protects policyholders from potential defaults and guarantees payment of scheduled principal and interest. We believe the increase in municipal stress will increase the demand for National's insurance product.

MBIA Inc. Liquidity

As of December 31, 2013 and 2012, the liquidity position of MBIA Inc., which consists of the liquidity positions of its corporate and asset/liability products activities, was $359 million and $239 million, respectively. MBIA Inc.'s liquidity position has substantially improved since 2012 due to the dividend of $214 million declared and paid by National and the release of $115 million from an escrow account under the MBIA group's tax sharing agreement (the "Tax Escrow Account"). Subsequent to December 31, 2013, an additional $160 million was released to MBIA Inc. from the Tax Escrow Account. In addition, during 2013, we received or repurchased $328 million of debt issued by MBIA Inc. or its subsidiary MBIA Global Funding, LLC ("GFL"), as our strategy is to bring our leverage down using cash generated from operations. The Company expects that MBIA Inc. will generate sufficient cash to satisfy its debt obligations and its general corporate needs over time from expected subsidiary dividends, additional anticipated releases from the Tax Escrow Account or by raising third-party capital. Refer to the "Liquidity-MBIA Inc. Liquidity" section for additional information on MBIA Inc.'s liquidity position.

Operating Cost Reductions

In order to better position the Company for future business opportunities, in the third quarter of 2013, we initiated cost reduction measures focused on our legal, consulting, staffing and head office occupancy costs. As a result, expenses for net compensation costs related to staff reductions totaled $18 million. These expenses are included in "Operating expenses" on our consolidated statement of operations for the year ended December 31, 2013. These staff reductions reduced our worldwide headcount by approximately 21% compared with our headcount as of June 30, 2013. We estimate that our staff reductions will result in annualized future savings of approximately $24 million, which may be offset by any future staff increases and increases in compensation. In addition, in connection with the anticipated sale of the office used in our operations, we recorded an impairment charge of $29 million on our Armonk, New York facility. This impairment charge is reflected in the results of our U.S. public finance insurance segment and is included in "Other net realized gains (losses)" on our consolidated statement of operations for the year ended December 31, 2013.

In addition to costs related to staffing and occupancy, during 2013, we incurred total expenses of approximately $97 million related to settlement, consulting and legal expenses associated with the resolution of litigation matters and settlements.


Table of Contents

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

EXECUTIVE OVERVIEW (continued)

MBIA Corp.

During 2013, the Company continued to execute its strategy to mitigate MBIA Corp.'s high risk insurance exposures, primarily through the commutation of insurance policies, and improve the liquidity position of MBIA Corp. During 2013, MBIA Corp. commuted $20.0 billion of gross par exposure, primarily comprising structured commercial mortgage-backed securities ("CMBS") pools, investment grade collateralized debt obligations ("CDOs"), asset-backed securities ("ABS") CDOs, first-lien residential mortgage-backed securities ("RMBS"), high yield corporate CDOs, commercial real estate ("CRE") CDOs and structured insurance securities, including $7.4 billion and $4.2 billion of gross insured exposure commuted with Bank of America and Societe Generale, respectively. Subsequent to December 31, 2013, MBIA Corp. commuted an additional $3.0 billion of gross insured exposure comprising structured CMBS pools in which the reference CMBS were originally rated single-A. The cost of the commutation in excess of the statutory loss reserves on the policies as of September 30, 2013 is reflected in MBIA Corp.'s statutory accounts as of December 31, 2013. The cost reflected in the statutory financial statements includes a fixed cash payment and the recognition of a contingent value that could be delivered in the future. Under accounting principles generally accepted in the United States of America ("GAAP"), the commuted policies are accounted for as derivatives and carried at their fair values as of December 31, 2013. The fair values of the Company's derivative liabilities for the commuted policies as of December 31, 2013 exceeded the cost of the commutation. The difference between the fair values of the Company's derivative liabilities for the commuted policies and the estimated/projected aggregate cost of the commutation will be reflected in earnings in the first quarter of 2014, the period in which the commutation occurred. In connection with this commutation, on February 14, 2014, Moody's placed the current rating of MBIA Insurance Corporation, B3 with a positive outlook, on review for upgrade. We continue to evaluate opportunities to commute additional high risk insurance exposures, although our ability to commute is limited by available liquidity.

Other significant actions, occurring during 2013, included the following:

In May of 2013, the Company executed the BofA Settlement Agreement which resulted in MBIA Corp. repaying the remaining balance and accrued interest on the National Secured Loan. Refer to "Note 1: Business Developments and Risks and Uncertainties" in the Notes to Consolidated Financial Statements for a discussion of the BofA Settlement Agreement.

In December of 2013, MBIA Insurance Corporation sold its claims and certain related rights (the "Claims"), as an unsecured creditor, against the bankruptcy estates of Residential Funding Company, LLC, GMAC Mortgage LLC and Residential Capital LLC and certain related entities (collectively, "ResCap") for an amount that modestly exceeded the recoveries recorded in respect of the Claims on MBIA Corp.'s balance sheet as of September 30, 2013. Refer to "Note 1: Business Developments and Risks and Uncertainties" in the Notes to Consolidated Financial Statements for a further discussion of ResCap.

In May of 2013, the Company entered into an agreement with Societe Generale pursuant to which MBIA commuted insured exposure comprising ABS CDOs, structured CMBS pools and CRE CDOs. As of result of the BofA Settlement Agreement and the Societe Generale settlement, all litigation brought originally by the group of eighteen domestic and international financial institutions, relating to the establishment of National, has been resolved.

During 2013, MBIA Corp's liquidity position has been substantially strengthened as a result of the BofA Settlement Agreement and the sale of the ResCap Claims. MBIA Corp. continues to manage liquidity risk and satisfy all contractual payment obligations. Our expected liquidity and capital forecasts for MBIA Corp. and projected collections of excess spread and the remaining put-back recoverable reflect more than adequate resources to pay expected claims. However, there are risks to these forecasts, as the amount and timing of potential claims from our remaining insured CMBS pools and RMBS exposures are potentially volatile, as are the projected collections of excess spread and the remaining put-back recoverable. If MBIA Corp. experiences higher than expected claim payments or is unable to commute the remaining insurance exposures that represent substantial risk to the Company, MBIA Corp. may ultimately have insufficient resources to continue to pay claims, which could cause the New York State Department of Financial Services ("NYSDFS") to put MBIA Insurance Corporation into a rehabilitation or liquidation proceeding. Refer to the "Liquidity-MBIA Corp. Liquidity" section for additional information on MBIA Corp.'s liquidity position.


Table of Contents

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

EXECUTIVE OVERVIEW (continued)

Economic and Financial Market Trends

The U.S. economy steadily improved during 2013 aided by stabilization in the housing and automobile sectors. In addition, the unemployment rate dropped in the fourth quarter of 2013 to its lowest level in five years. On the heels of these improving signs in the U.S. economy, in January of 2014 the Federal Reserve began tapering their quantitative easing programs and reaffirmed their intention to keep short-term interest rates low. Information concerning our interest rate sensitivity appears in Part II, Item 7A, "Quantitative and Qualitative Disclosures about Market Risk." The continued improvement in the labor market should help to increase personal incomes, and the passing of the federal budget and extension of the debt ceiling by Congress should reduce both the possibility of a government shutdown and any default of its debt until 2015. However, the ultimate outcome on the continued implementation of the Affordable Care Act will add uncertainty to the business and consumer segments of our economy. We believe confidence in the U.S. economy should continue to expand in 2014, however, sustained job growth and resolution of fiscal policies in Washington are paramount to a complete recovery. While Europe continues to display signs of recovering from its recession and enters 2014 with more positive sentiment than a year ago, such signs are still inconclusive and unemployment rates there are still high. Prolonged debt and budget issues and related austerity programs suggest that it may be some time before Europe shows sustained growth and a robust recovery. MBIA's business outlook should be viewed against this backdrop since these are some of the key economic conditions which, together with the volatility of gains and losses on our insured credit derivatives, significantly impact our financial results.

Financial Highlights

Our financial results, prepared in accordance with GAAP, have been extremely volatile since the fourth quarter of 2007 primarily as a result of unrealized gains and losses from fair valuing our insured credit derivatives, as well as a result of insured losses and recoveries on second-lien RMBS. While we do not believe that the volatility caused by the unrealized gains and losses on our insured derivatives reflects the underlying economics of our business, we expect that our reported financial results will remain volatile during 2014 as a result of actual and perceived future performance of our insured credit derivatives and the perception of MBIA's credit risk. Our economic performance may also be volatile depending on changes in our loss estimates based on changes in macroeconomic conditions in the U.S. and abroad and deviations in collateral performance from our expectations.

For the year ended December 31, 2013, we recorded consolidated net income of $250 million, or $1.29 per diluted share, compared with consolidated net income of $1.2 billion, or $6.33 per diluted share, for 2012 and a consolidated net loss of $1.3 billion, or $6.85 per diluted share, for 2011.

We also use adjusted pre-tax income (loss), a non-GAAP measure, to supplement our analysis of our periodic results. We consider adjusted pre-tax income (loss) a fundamental measure of periodic financial performance, which we believe is useful for an understanding of our results. Adjusted pre-tax income (loss) adjusts GAAP pre-tax income (loss) to remove the effects of consolidating insured variable interest entities ("VIEs") and gains and losses related to insured credit derivatives, which we believe will reverse over time, as well as to add in changes in the present value of insurance claims we expect to pay on insured credit derivatives based on our ongoing insurance loss monitoring. Adjusted pre-tax income (loss) is not a substitute for and should not be viewed in isolation of GAAP pre-tax income (loss), and our definition of adjusted pre-tax income (loss) may differ from that used by other companies. Refer to the following "Results of Operations" section for a reconciliation of adjusted pre-tax income (loss) to GAAP pre-tax income (loss).

For the year ended December 31, 2013, consolidated adjusted pre-tax loss was $452 million compared with adjusted pre-tax losses of $708 million and $497 million for 2012 and 2011, respectively.

Our consolidated shareholders' equity increased slightly to $3.3 billion as of December 31, 2013 compared with $3.2 billion as of December 31, 2012. Our consolidated book value per share as of December 31, 2013 was $17.05 compared with $16.22 as of December 31, 2012.


Table of Contents

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

EXECUTIVE OVERVIEW (continued)

In addition to book value per share, we also analyze adjusted book value ("ABV") per share, a non-GAAP measure. We consider ABV a measure of fundamental value of the Company and the change in ABV an important measure of financial performance. ABV adjusts GAAP book value to remove the impact of certain items which the Company believes will reverse from GAAP book value over time through the GAAP statements of operations and GAAP statements of comprehensive income, as well as to add in the impact of certain items which the Company believes will be realized in GAAP book value in future periods. The Company has limited such adjustments to those items that it deems to be important to fundamental value and performance and which the likelihood and amount can be reasonably estimated. ABV assumes no new business activity. We have presented ABV to allow investors and analysts to evaluate the Company using the same measure that MBIA's management regularly uses to measure financial performance and value. ABV is not a substitute for and should not be viewed in isolation of GAAP book value, and our definition of ABV may differ from that used by other companies. Refer to the following "Results of Operations" section for a further discussion of ABV and a reconciliation of GAAP book value per share to ABV per share.

As of December 31, 2013, ABV per share was $27.78, down from $30.68 as of December 31, 2012.

A detailed discussion of our financial results is presented within the "Results of Operations" section included herein. Refer to the "Capital Resources-Insurance Statutory Capital" section for a discussion of National's and MBIA Corp.'s capital positions under statutory accounting principles ("U.S. STAT").

CRITICAL ACCOUNTING ESTIMATES

We prepare our financial statements in accordance with GAAP, which requires the use of estimates and assumptions. The following accounting estimates are viewed by management to be critical because they require significant judgment on the part of management. Management has discussed and reviewed the development, selection, and disclosure of critical accounting estimates with the Company's Audit Committee. Financial results could be materially different if other methodologies were used or if management modified its assumptions.

Loss and Loss Adjustment Expense Reserves

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

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


Table of Contents

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

CRITICAL ACCOUNTING ESTIMATES (continued)

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

Since 2007, the majority of our case basis reserves and insurance loss recoveries were related to insured second-lien RMBS transactions. Refer to "Note 6: Loss and Loss Adjustment Expense Reserves" in the Notes to Consolidated Financial Statements for a comprehensive discussion of our RMBS loss reserves and recoveries, including critical accounting estimates used in the determination of these amounts.

Valuation of Financial Instruments

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

The fair value measurements of financial instruments held or issued by the Company are determined through the use of observable market data when available. Market data is obtained from a variety of third-party sources, including dealer quotes. If dealer quotes are not available for an instrument that is infrequently traded, we use alternate valuation methods, including either dealer quotes for similar contracts or modeling using market data inputs. The use of alternate valuation methods generally requires considerable judgment in the application of estimates and assumptions and changes to these variables may produce materially different values.

The fair value pricing of assets and liabilities is a function of many components which include interest rate risk, market risk, liquidity risk and credit risk. For financial instruments that are internally valued by the Company, as well as those for which the Company uses broker quotes or pricing . . .

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