MBIA Inc. — Q2 2010 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2010. MBIA provides financial-guarantee insurance and asset-management services; its asset/liability and conduit businesses are in wind-down. Results are unaudited.
Financial results and position
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Total revenue | $2.078 billion | $992 million | $221 million | $2.922 billion |
| Net income (loss) | $1.295 billion | $898 million | $(185) million | $1.599 billion |
| Net income (loss) per diluted share | $6.32 | $4.30 | $(0.90) | $7.64 |
| Net cash used by operating activities | — | $(168) million | $(805) million |
- Q2 profit was dominated by a $1.538 billion unrealized gain on insured derivatives; the six-month period included a $673 million unrealized loss on those derivatives. Management says fair-value movements are highly volatile and may not reflect underlying economics.
- Net premiums earned were $156 million in Q2 and $313 million for the first half, down 12% and 23% year over year, respectively. Net investment income was $107 million in Q2 and $229 million year to date, also lower than the comparable periods.
- At June 30, total assets were $33.464 billion, liabilities $30.799 billion, and total equity $2.665 billion. The corresponding December 31, 2009 figures were $25.701 billion, $23.094 billion, and $2.607 billion. The balance-sheet expansion largely reflects changed consolidation of variable-interest entities (VIEs); consolidated VIEs reported $14.0 billion of assets and $12.6 billion of liabilities.
- Investments totaled $12.085 billion. Cash was $1.052 billion on the balance sheet, plus $444 million reported as cash of consolidated VIEs. The cash-flow statement reports $1.495 billion at period-end, consistent with those amounts combined; VIE cash supports VIE obligations and is not generally available for MBIA’s other obligations.
- Reported debt and funding obligations include $1.970 billion of medium-term notes, $82 million of short-term debt, $1.934 billion of long-term debt, and $11.046 billion of VIE notes. Wind-down liabilities and assets are expected to decline as obligations mature or are repaid.
- MBIA Inc. shareholders’ equity was $2.651 billion; GAAP book value was $13.16 per share, versus $12.66 at year-end. Management’s non-GAAP adjusted book value was $35.76 per share, down from $36.35, primarily due to increased insured-CDS impairments. Conventional operating margins are not a meaningful performance measure for this financial-guarantee business.
Changes, outlook, risks, and unusual items
- Year-to-date results reversed from $1.599 billion profit in 2009 to a $185 million loss in 2010, principally reflecting the swing in insured-derivative fair values. Q2 earnings increased year over year for the same fair-value reason.
- MBIA adopted revised VIE consolidation guidance in Q1 2010. It recorded a $322 million net decrease to opening retained earnings, offset in part by a $349 million reduction in accumulated other comprehensive loss; the adoption materially changed reported assets and liabilities.
- Management expects continued volatility and uncertainty through the remainder of 2010. It does not expect significant new financial-guarantee business before ratings upgrades and market acceptance; timing of any upgrade is uncertain. The company wrote no U.S. public-finance or structured-finance/international insurance in the first half.
- Management said it continued to meet payment obligations and believed liquidity was adequate, but warned that worsening insured losses, market conditions, asset-sale constraints, limited capital-market access, or accelerated settlements could create additional liquidity pressure. MBIA Corp. reported $2.6 billion of unencumbered cash and available-for-sale investments; corporate activities had $390 million of cash and highly liquid assets. Contingent liquidity sources were approximately $576 million.
- Mortgage repurchase recoveries are a major estimate and litigation risk. MBIA reported approximately $2.1 billion of estimated recoveries related to ineligible loans; approximately $1.4 billion net of reinsurance and tax was recognized, an amount exceeding half of parent-company equity excluding subsidiary preferred stock. Sellers/servicers dispute many claims, litigation may take years, and counterparties may be unable to pay.
- Since late 2007, MBIA Corp. had made $6.2 billion of cash payments, before reinsurance, related to second-lien RMBS, CDO-related claims, and settlements. It had paid $4.9 billion of claims on second-lien RMBS. The filing describes these exposures as material sources of payment volatility and liquidity risk.
- MBIA’s June 30 loss-reserve estimates included assumptions for future mortgage performance and recoveries. Management estimated that if modeled peak default levels persisted six months longer than its probability-weighted outcome, case reserves could increase by approximately $450 million.
- Subsequent events: MBIA Corp. agreed to pay $72 million to commute $4.4 billion of gross par exposure under three insured CDS transactions; the after-reinsurance impact was expected to be $34 million in Q3. It acquired the remaining 82.6% of Channel Re for $40 million and commuted reinsurance arrangements. Management expected a roughly $75 million pretax Q3 loss, primarily from settling a Channel Re reinsurance receivable carried at $754 million for less than book value. The transactions were expected to improve MBIA Corp.’s liquidity and statutory capital.
- Other notable exposures include $110.6 billion net par outstanding on insured derivatives, with fair value dependent substantially on Level 3 models and unobservable inputs. Level 3 assets were $6.0 billion and Level 3 liabilities $10.6 billion at June 30.
- Litigation includes challenges to MBIA’s corporate transformation, municipal bond-insurance and derivatives-related claims, and MBIA-initiated mortgage recovery actions. The filing warns adverse transformation-litigation rulings could materially affect strategy, results, and financial condition. The company also warned that the 2010 Dodd-Frank Act could, depending on implementation, create collateral requirements for insured derivatives despite contractual terms.
Most important facts for investors to verify
- How much of the $2.1 billion estimated mortgage recoveries is ultimately collected, and the effect of litigation outcomes, delays, and seller/servicer creditworthiness.
- Whether MBIA Corp.’s mortgage, CDO, and CMBS claims and cash needs exceed current reserves and liquidity assumptions.
- The impact of the Channel Re commutation and expected Q3 loss, including the recoverability and final settlement of the $754 million receivable.
- How changes in MBIA’s credit spreads, recovery assumptions, derivative valuations, and VIE consolidation affect earnings, equity, and liquidity.
- Progress on ratings upgrades, the transformation litigation, and any regulatory interpretation of collateral requirements for insured derivatives.