MBIA INC quarterly report, Q2 FY2014

MBIA Inc. — Q2 2014 Form 10-Q

Business context and reporting period. MBIA provides financial-guarantee insurance and asset-management services through U.S. public finance insurer National, structured-finance and international insurer MBIA Corp., and advisory business Cutwater. This unaudited report covers the three and six months ended June 30, 2014; balance-sheet comparisons are with December 31, 2013. The conduit business was wound down and dissolved during the quarter. Amounts below are in millions of dollars unless noted.

Financial performance and position

Metric	Q2 2014	Q2 2013	Six months 2014	Six months 2013
Total revenue	$187	$112	$764	$331
Pre-tax income (loss)	$55	$(264)	$459	$(49)
Net income (loss)	$120	$(178)	$376	$(14)
Diluted earnings (loss) per share	$0.45	$(0.94)	$1.83	$(0.07)
Net cash from operating activities	Not provided by quarter	$(396)	$1,171

• GAAP results were highly affected by insured-derivative fair-value changes. Net derivative fair-value results were a $47 loss in Q2 and a $422 gain for the first half, versus losses of $182 and $243 in the comparable 2013 periods. Management attributed first-half gains mainly to reversals of unrealized losses following commutations.
• Management’s non-GAAP adjusted pre-tax result was $39 income for Q2 versus a $160 loss; for the first half, it was a $60 loss versus a $180 loss. The company cautions that this measure is not a substitute for GAAP results.
• Premiums earned were $89 in Q2 versus $124 and $177 for the first half versus $244. Lower scheduled and refunding premiums reflected portfolio runoff and lower refunding activity; no new public-finance or structured-finance insurance was written in the periods.
• Net investment income was $42 in Q2 versus $38 and $92 for the first half versus $76. Total expenses were $132 in Q2 versus $376 and $305 for the first half versus $380; Q2 loss and LAE expense was $12 versus $188 in 2013, while first-half expense was $62 versus a $6 benefit.
• At June 30, total assets were $16.0 billion, total liabilities $12.2 billion and total equity $3.8 billion, compared with $17.0 billion, $13.7 billion and $3.3 billion at year-end. MBIA Inc. shareholders’ equity was $3.787 billion; book value was $19.48 per share, versus $17.05. Adjusted book value, a non-GAAP measure, was $27.05 per share, down from $27.78.
• Cash and cash equivalents on the consolidated balance sheet were $534, with another $66 held by consolidated VIEs. Consolidated cash ended the half at $600, down from $1.258 billion at the start. Investing activities provided $324 and financing activities used $589 during the first half. Operating cash use reflected, among other items, much lower recovery and reinsurance receipts than in 2013.
• Reported debt and funding obligations included $1.755 billion of long-term debt, $1.286 billion of medium-term notes and $660 million of investment agreements. VIE notes were $4.937 billion and are associated with consolidated VIEs. MBIA Inc.’s net debt was approximately $1.0 billion. The filing does not present a single consolidated debt measure that excludes VIE obligations.
• MBIA Inc.’s liquidity position was $365, including $317 available for general corporate liquidity and $48 not directly pledged for asset/liability products. It received $202 under the tax-sharing arrangement during the half; management cautioned that future subsidiary distributions and escrow releases are not assured.

Material changes and business developments

• National’s statutory capital increased to $3.355 billion from $3.258 billion at year-end, and its claims-paying resources were $5.240 billion, approximately unchanged from $5.252 billion. S&P upgraded National to AA- and Moody’s to A3, both initially with stable outlooks; after quarter-end, Moody’s affirmed A3 but changed the outlook to negative. Kroll assigned AA+ with a stable outlook.
• National earned $154 pre-tax for the first half, compared with $156 in 2013; Q2 pre-tax income was $62 versus $14. Net premiums earned fell 36% for the half to $132. National did not write new business in the reporting periods, citing pricing and market conditions, but said it had begun pursuing selected municipal opportunities.
• MBIA Corp. commuted $3.9 billion of gross par exposure in the first half, primarily CMBS, CRE CDO and first-lien RMBS; it commuted a further $238 million after quarter-end. Structured-finance insured gross par outstanding was $69.0 billion, down from $80.4 billion at year-end. Management said further commutations depend on available liquidity.
• MBIA Corp.’s statutory capital declined to $758 from $825; it reported a $74 statutory net loss for the first half. Its claims-paying resources fell to $2.871 billion from $3.461 billion. It has significant negative earned surplus, cannot pay dividends, and the NYSDFS had not permitted interest payments on its surplus notes since 2012. Accrued unpaid interest was $232 as of July 15, 2014.
• MBIA Corp.’s net insured CDS derivative liability was $332 at June 30, versus $1.2 billion at year-end. These are Level 3 fair-value estimates sensitive to market spreads and MBIA Corp.’s own nonperformance risk; they are not equivalent to expected cash claims.
• The valuation allowance against deferred tax assets fell to $7 from $93 at year-end, primarily after sales of previously impaired assets. The net deferred tax asset was $950. The resulting tax effects contributed to earnings volatility; Q2 included a $65 tax benefit despite pre-tax income of $55.
• The company repurchased $9 of shares in the first half and $122 par value of GFL medium-term notes; it retired $129 par value of conduit notes and dissolved Meridian. After quarter-end it used the remaining $14 share-repurchase authorization. A new headquarters lease has $42 of minimum payments over its initial term through 2030.

Outlook, risks and contingencies

• Management stated it expects MBIA Inc. to meet debt and general corporate needs through subsidiary distributions and tax-sharing payments, but warned that these sources may not generate sufficient cash. It described MBIA Inc. as having ongoing liquidity risk and noted that much of its cash and securities are pledged or otherwise constrained.
• Management said MBIA Corp.’s forecasts showed adequate resources for expected claims, but warned that higher claims or lower and delayed recoveries could leave it unable to pay claims and potentially lead to NYSDFS rehabilitation or liquidation proceedings. A filing risk factor identifies ineligible RMBS loans, excess-spread and put-back recoveries, and CMBS/CRE exposures as significant uncertainties.
• Second-lien RMBS excess-spread recoveries were estimated at $577 on the balance sheet at June 30; estimates are sensitive to loan performance, interest-rate spreads and prepayments. The company also recorded $363 for Credit Suisse put-back claims in consolidated VIE assets. Litigation remains unresolved; management believes it will prevail, but recovery is uncertain. A six-month extension of peak second-lien loan performance assumptions would, the filing estimates, add about $60 to reserves.
• National’s municipal portfolio faces fiscal stress, notably Puerto Rico and Detroit. Puerto Rico exposure was $4.832 billion at June 30; PREPA drew about $41.6 from its reserve account to support the July 1 debt-service payment after missing a funding deposit. The filing says insured obligations shown were current at June 30, but Puerto Rico enacted a restructuring law that was challenged in court. Detroit UTGO settlement terms remained subject to bankruptcy-court approval, and National objected to Detroit’s proposed treatment of water and sewer bonds.
• Other material legal matters include Credit Suisse RMBS litigation and an appeal/possible amended complaint in the J.P. Morgan matter. The filing states that damages, if any, could not be estimated. It also reports that CQS litigation was dismissed with prejudice for an immaterial payment.
• Management cited low interest rates, narrow municipal spreads, competition, economic uncertainty and stressed public issuers as factors affecting new insurance demand and profitability. It provided no quantitative earnings or revenue guidance. Results may be volatile because of estimates for losses, recoveries, derivatives and deferred taxes.

Investor facts to verify

• Whether Credit Suisse litigation and RMBS excess-spread collections support the recorded recovery estimates, and how claim payments compare with recoveries.
• MBIA Corp.’s actual liquidity, statutory capital, claims-paying resources and regulatory status, including the surplus-note payment restrictions and contingency-reserve qualifying-asset deficit.
• Developments in Puerto Rico—especially PREPA—and Detroit bankruptcy proceedings, including any effect on claims, reserves and National’s capital.
• National’s ability to write new business at adequate risk-adjusted returns, and the implications of Moody’s negative outlook.
• How much of reported earnings reflects recurring insurance and investment performance versus Level 3 derivative marks, commutations and tax-valuation changes; also distinguish parent-company liquidity from consolidated and VIE cash.