MBIA Inc. — Q3 2010 Form 10-Q
Reporting period: Three and nine months ended September 30, 2010. Unaudited consolidated financial statements; comparisons are with the same periods of 2009 unless otherwise stated.
Business context
MBIA provides financial guarantee insurance and asset-management advisory services. Its principal businesses are U.S. public finance insurance through National, structured finance and international insurance through MBIA Corp., and advisory services through Cutwater. Asset/liability products and conduit operations are winding down. Following rating downgrades in 2008, the company has written no meaningful volume of new insurance and does not expect significant new financial-guarantee business before ratings improve.
Financial performance and position
| Metric | Q3 2010 | Nine months 2010 | Prior comparable period |
|---|---|---|---|
| Total revenues | $(191) million | $30 million | $(620) million and $2.301 billion, respectively |
| Pre-tax income (loss) | $(357) million | $(648) million | $(1.066) billion and $1.422 billion, respectively |
| Net income (loss) available to common shareholders | $(213) million; $(1.06) per share | $(398) million; $(1.96) per share | $(728) million; $(3.50) per share, and $864 million; $4.15 per share |
| Net premiums earned | $137 million | $450 million | $181 million and $588 million, respectively |
| Net investment income | $113 million | $342 million | $137 million and $445 million, respectively |
| Net change in fair value of insured derivatives | $(492) million | $(1.263) billion | $(840) million and $1.256 billion, respectively |
| Loss and loss-adjustment expense | $(20) million, a benefit | $122 million | $239 million and $203 million, respectively |
| Operating cash flow | Not presented quarterly | $(422) million | $(1.468) billion |
Reported results are highly affected by fair-value movements in insured derivatives and therefore do not provide a stable operating margin measure. Q3’s smaller loss than in 2009 reflected reduced derivative losses and lower loss expenses. For the nine-month comparison, results swung from 2009 profit to a 2010 loss, principally because insured derivatives produced a $1.263 billion net loss in 2010 versus a $1.256 billion gain in 2009. Management says these unrealized derivative movements can be volatile and may not reflect underlying economics.
- Balance sheet at September 30: Total assets were $33.27 billion, liabilities $30.75 billion and total equity $2.52 billion. At December 31, 2009, these were $25.70 billion, $23.09 billion and $2.61 billion, respectively. The increase in assets and liabilities substantially reflects VIE consolidation under newly adopted accounting guidance, not simply business growth.
- Cash and liquidity: Balance-sheet cash and equivalents were $902.6 million, plus $513.7 million reported within consolidated VIE assets. Cash-flow-statement ending cash, which includes VIE cash, was $1.416 billion. Investing activities provided $3.589 billion and financing activities used $2.553 billion in the first nine months.
- Debt and obligations: Balance-sheet amounts included $1.852 billion of long-term debt, $72 million of short-term debt, $1.852 billion of medium-term notes, and $2.280 billion of investment agreements. Consolidated VIEs carried $10.403 billion of VIE notes and $428 million of long-term debt. These obligations have different recourse and liquidity characteristics; VIE obligations should not be treated as ordinary parent-company debt.
- Equity and book value: Parent-company shareholders’ equity was $2.510 billion; GAAP book value was $12.56 per share versus $12.66 at year-end 2009. Management’s non-GAAP adjusted book value was $36.11 per share versus $36.35, with the decline primarily attributed to increased CDS impairments.
- Statutory capital: National reported $2.3 billion and MBIA Corp. $3.067 billion at September 30. MBIA Corp.’s statutory capital declined from $3.333 billion at year-end; National’s increased from $1.995 billion. These insurance statutory measures are distinct from GAAP equity.
- Derivative exposure: Insured derivatives had a reported net liability of approximately $5.5 billion at fair value. Much of the valuation relies on Level 3 inputs and models; the filing says inclusion of MBIA’s own nonperformance risk reduced the estimated liability by $15.9 billion versus a valuation without that adjustment.
Material changes and unusual items
- Scheduled and refunding premiums continued to decline with portfolio runoff and minimal new business. Nine-month U.S. public finance premiums were down 22%; structured finance and international premiums were down 29%.
- MBIA adopted new VIE consolidation guidance in Q1 2010. Adoption produced a $322 million net reduction to beginning retained earnings, partly offset in accumulated other comprehensive income, and materially changed reported assets, liabilities and earnings presentation.
- In Q3, MBIA Corp. acquired the remaining interests in Channel Re, commuted reinsurance arrangements and liquidated the company. The transactions produced a reported $61 million net loss, while management said they increased MBIA Corp.’s statutory capital by $132 million and liquidity by $595 million. The commutation also brought previously ceded insured exposure back to MBIA entities.
- MBIA reported $2.2 billion of estimated recoveries related to ineligible mortgages in insured RMBS transactions. The estimate includes amounts recorded across insurance loss recoverables, loan repurchase commitments, reserves and expense offsets; it relies substantially on disputed contractual put-back claims and modeled extrapolations.
- Investment unrealized losses improved: gross unrealized losses on available-for-sale investments were $722 million at September 30 versus $1.6 billion at year-end 2009. Held-to-maturity consolidated VIE investments had $4.236 billion amortized cost and $3.821 billion fair value.
- Consolidated fixed-maturity investments were largely rated investment grade, but the structured finance and international insured portfolio weakened: below-investment-grade gross par rose to 19.7% from 11.6% a year earlier. Commercial mortgage delinquencies and expected losses remain uncertain.
Outlook, liquidity, risks and contingencies
Management expects reported results and economic performance to remain volatile and uncertain through the remainder of 2010. It does not expect significant new financial-guarantee writing before an insurance-rating upgrade; timing and eligibility are uncertain and depend in part on litigation challenging National’s establishment. No quantitative earnings guidance is provided.
- Management said the company continued to meet payment obligations and believed resources were adequate for ongoing short- and long-term needs. However, it warned that higher claims, worsening markets, inability to sell assets or access capital, or accelerated liabilities could create additional liquidity pressure. Structured-finance and international operations had approximately $250 million of contingent liquidity estimated to be accessible within one to three months, subject to approvals and other conditions.
- Since Q4 2007, MBIA Corp. had made $6.6 billion of cash payments, before reinsurance and collections, on second-lien RMBS and certain CDO-related exposures; $5.2 billion related to second-lien RMBS claims. Continued elevated payments could materially stress liquidity.
- RMBS put-back recoveries are a major estimate and litigation risk. Sellers/servicers dispute many claims, recoveries of this scale have not yet been realized by another financial-guarantee insurer, and counterparties may lack resources to pay. Management estimated that the recorded recovery could be about $300 million lower absent a revised extrapolation assumption. The company expects many recoveries by mid-2012, but timing and amount are uncertain.
- MBIA Corp.’s statutory capital depends materially on mortgage recoveries, CMBS losses and the statutory discount rate. Its $1.3 billion statutory recovery estimate for ineligible loans represented 43% of its statutory capital. Failure or delay in collection could adversely affect capital and regulatory position.
- Transformation litigation challenges the restructuring that established National and seeks, among other relief, to unwind transactions or impose liability on National and MBIA Inc. Certain motions to dismiss were denied; adverse outcomes could materially harm the company’s strategy, results and financial condition. Separate securities, municipal antitrust, derivative and other lawsuits, as well as regulatory inquiries, also remain outstanding.
- The Dodd-Frank Act could, depending on regulatory interpretation and implementation, impose retroactive collateral or capital requirements on insured credit derivatives despite contractual terms that generally do not require MBIA to post collateral.
- Disclosure controls and procedures were concluded by management to be effective at period-end; no material change in internal control over financial reporting was reported during the quarter.
Most important facts for investors to verify
- Whether the $2.2 billion of estimated RMBS recoveries is collectible, on what schedule, and how much depends on extrapolation versus reviewed loan files.
- Actual future RMBS and CMBS claim payments versus reserve assumptions, including the impact of delinquency trends and commercial-property liquidations.
- MBIA Corp.’s liquidity and statutory capital after Channel Re, subsequent claims and any changes in recovery estimates; distinguish resources by legal entity.
- Fair-value sensitivity of the $5.5 billion derivative liability, including the effect of Level 3 assumptions and MBIA’s own nonperformance-risk adjustment.
- Progress and possible outcomes of transformation and recovery litigation, and any resulting effect on National’s ratings, dividend capacity or ability to write business.
- Liquidity obligations and maturities across parent, insurance subsidiaries, asset/liability operations and consolidated VIEs; VIE cash and assets are not necessarily available to satisfy parent obligations.