MBIA INC - Quarter Report: 2018 September (Form 10-Q)

 

 

United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

 

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018

or

 

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                  to                 

Commission File Number 1-9583

 

 

MBIA INC.

(Exact name of registrant as specified in its charter)

 

 

 

Connecticut		06-1185706
(State of incorporation)		(I.R.S. Employer Identification No.)
1 Manhattanville Road, Suite 301, Purchase, New York		10577
(Address of principal executive offices)		(Zip Code)

(914) 273-4545

(Registrant’s telephone number, including area code)

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer		☒		Accelerated filer		☐
Non-accelerated filer		☐		Smaller reporting company		☐
Emerging growth company		☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ☐

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ☐    No  ☒

As of October 31, 2018, 90,690,129 shares of Common Stock, par value $1 per share, were outstanding.

      

 

				PAGE
PART I FINANCIAL INFORMATION
Item 1.		Financial Statements MBIA Inc. and Subsidiaries (Unaudited)
		Consolidated Balance Sheets as of September 30, 2018 and December 31, 2017 (Unaudited)			1
		Consolidated Statements of Operations for the three and nine months ended September 30, 2018 and 2017 (Unaudited)			2
		Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2018 and 2017 (Unaudited)			3
		Consolidated Statement of Changes in Shareholders’ Equity for the nine months ended September 30, 2018 (Unaudited)			4
		Consolidated Statements of Cash Flows for the nine months ended September 30, 2018 and 2017 (Unaudited)			5
		Notes to Consolidated Financial Statements (Unaudited)			6
		Note 1: Business Developments and Risks and Uncertainties			6
		Note 2: Significant Accounting Policies			8
		Note 3: Recent Accounting Pronouncements			9
		Note 4: Variable Interest Entities			11
		Note 5: Loss and Loss Adjustment Expense Reserves			13
		Note 6: Fair Value of Financial Instruments			19
		Note 7: Investments			36
		Note 8: Derivative Instruments			40
		Note 9: Income Taxes			43
		Note 10: Business Segments			44
		Note 11: Earnings Per Share			48
		Note 12: Accumulated Other Comprehensive Income			49
		Note 13: Commitments and Contingencies			50
		Note 14: Subsequent Events			53
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			54
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			85
Item 4.		Controls and Procedures			85
PART II OTHER INFORMATION
Item 1.		Legal Proceedings			86
Item 1A.		Risk Factors			86
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			87
Item 6.		Exhibits			88
SIGNATURES					89

FORWARD-LOOKING AND CAUTIONARY STATEMENTS

This quarterly report of MBIA Inc., together with its consolidated subsidiaries, (collectively, “MBIA”, the “Company”, “we”, “us” or “our”) includes statements that are not historical or current facts and are “forward-looking statements” made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The words “believe”, “anticipate”, “project”, “plan”, “expect”, “estimate”, “intend”, “will likely result”, “looking forward”, or “will continue” and similar expressions identify forward-looking statements. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. MBIA cautions readers not to place undue reliance on any such forward-looking statements, which speak only to their respective dates. We undertake no obligation to publicly correct or update any forward-looking statement if the Company later becomes aware that such result is not likely to be achieved.

The following are some of the general factors that could affect financial performance or could cause actual results to differ materially from estimates contained in or underlying the Company’s forward-looking statements:

 

•

increased credit losses or impairments on public finance obligations that National Public Finance Guarantee Corporation (“National”) insures issued by state, local and territorial governments and finance authorities and other providers of public services, located in the U.S. or abroad, that are experiencing fiscal stress;

 

•

the possibility that loss reserve estimates are not adequate to cover potential claims;

 

•

a disruption in the cash flow from our subsidiaries or an inability to access the capital markets and our exposure to significant fluctuations in liquidity and asset values in the global credit markets as a result of collateral posting requirements;

 

•

our ability to fully implement our strategic plan;

 

•

the possibility that MBIA Insurance Corporation will have inadequate liquidity or resources to timely pay claims as a result of higher than expected losses on certain insured transactions or as a result of a delay or failure in collecting expected recoveries, which could lead the New York State Department of Financial Services (“NYSDFS”) to put MBIA Insurance Corporation into a rehabilitation or liquidation proceeding under Article 74 of the New York Insurance Law and/or take such other actions as the NYSDFS may deem necessary to protect the interests of MBIA Insurance Corporation’s policyholders;

 

•

deterioration in the economic environment and financial markets in the United States or abroad, real estate market performance, credit spreads, interest rates and foreign currency levels; and

 

•

the effects of changes to governmental regulation, including insurance laws, securities laws, tax laws, legal precedents and accounting rules.

The above factors provide a summary of and are qualified in their entirety by the risk factors discussed under “Risk Factors” in Part II Other Information, Item 1A included in this Quarterly Report on Form 10-Q. In addition, refer to “Note 1: Business Developments and Risks and Uncertainties” in the Notes to Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for a discussion of certain risks and uncertainties related to our financial statements.

This quarterly report of MBIA Inc. also includes statements of the opinion and belief of MBIA management which may be forward-looking statements subject to the preceding cautionary disclosure. Unless otherwise indicated herein, the basis for each statement of opinion or belief of MBIA management in this report is the relevant industry or subject matter experience and views of certain members of MBIA’s management. Accordingly, MBIA cautions readers not to place undue reliance on any such statements, because like all statements of opinion or belief they are not statements of fact and may prove to be incorrect. We undertake no obligation to publicly correct or update any statement of opinion or belief if the Company later becomes aware that such statement of opinion or belief was not or is not then accurate. In addition, readers are cautioned that each statement of opinion or belief may be further qualified by disclosures set forth elsewhere in this report or in other disclosures by MBIA.

PART I FINANCIAL INFORMATION

Item 1. Financial Statements

MBIA INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (Unaudited)

(In millions except share and per share amounts)

 

		September 30, 2018				December 31, 2017
Assets
Investments:
Fixed-maturity securities held as available-for-sale, at fair value (amortized cost $3,562 and $3,728)		$	3,533			$	3,712
Investments carried at fair value			231				200
Investments pledged as collateral, at fair value (amortized cost $32 and $147)			30				148
Short-term investments, at fair value (amortized cost $411 and $589)			411				589
Other investments (includes investments at fair value of $- and $4)			1				6
Total investments			4,206				4,655
Cash and cash equivalents			167				122
Premiums receivable			306				369
Deferred acquisition costs			78				95
Insurance loss recoverable			1,542				511
Other assets			125				128
Assets of consolidated variable interest entities:
Cash			12				24
Investments held-to-maturity, at amortized cost (fair value $901 and $916)			890				890
Investments carried at fair value			163				182
Loans receivable at fair value			428				1,679
Loan repurchase commitments			415				407
Other assets			29				33
Total assets		$	8,361			$	9,095
Liabilities and Equity
Liabilities:
Unearned premium revenue		$	609			$	752
Loss and loss adjustment expense reserves			1,033				979
Long-term debt			2,218				2,121
Medium-term notes (includes financial instruments carried at fair value of $123 and $115)			738				765
Investment agreements			314				337
Derivative liabilities			173				262
Other liabilities			196				165
Liabilities of consolidated variable interest entities:
Variable interest entity notes (includes financial instruments carried at fair value of $709 and $1,069)			1,960				2,289
Total liabilities			7,241				7,670
Commitments and contingencies (Refer to Note 13: Commitments and Contingencies)
Equity:
Preferred stock, par value $1 per share; authorized shares--10,000,000; issued and outstanding—none			-				-
Common stock, par value $1 per share; authorized shares--400,000,000; issued shares--283,625,689 and 283,717,973			284				284
Additional paid-in capital			3,155				3,171
Retained earnings			973				1,095
Accumulated other comprehensive income (loss), net of tax of $7 and $16			(206)				(19)
Treasury stock, at cost--192,936,029 and 192,233,526 shares			(3,098)				(3,118)
Total shareholders’ equity of MBIA Inc.			1,108				1,413
Preferred stock of subsidiary			12				12
Total equity			1,120				1,425
Total liabilities and equity		$	8,361			$	9,095

The accompanying notes are an integral part of the consolidated financial statements.

 

1

MBIA INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

(In millions except share and per share amounts)

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2018				2017				2018				2017
Revenues:
Premiums earned:
Scheduled premiums earned		$	44			$	26			$	96			$	82
Refunding premiums earned			18				27				42				64
Premiums earned (net of ceded premiums of $1, $1, $4 and $4)			62				53				138				146
Net investment income			31				33				96				122
Fees and reimbursements			17				1				23				9
Change in fair value of insured derivatives:
Realized gains (losses) and other settlements on insured derivatives			(5)				(7)				(49)				(41)
Unrealized gains (losses) on insured derivatives			4				6				36				(10)
Net change in fair value of insured derivatives			(1)				(1)				(13)				(51)
Net gains (losses) on financial instruments at fair value and foreign exchange			5				(11)				18				(55)
Net investment losses related to other-than-temporary impairments:
Investment losses related to other-than-temporary impairments			-				(26)				-				(80)
Other-than-temporary impairments recognized in accumulated other comprehensive income (loss)			(1)				(45)				(3)				(4)
Net investment losses related to other-than-temporary impairments			(1)				(71)				(3)				(84)
Net gains (losses) on extinguishment of debt			3				1				3				9
Other net realized gains (losses)			1				(1)				-				36
Revenues of consolidated variable interest entities:
Net investment income			9				8				25				20
Net gains (losses) on financial instruments at fair value and foreign exchange			12				21				29				2
Other net realized gains (losses)			(33)				-				(126)				28
Total revenues			105				33				190				182
Expenses:
Losses and loss adjustment			46				205				177				469
Amortization of deferred acquisition costs			9				8				17				23
Operating			18				21				57				82
Interest			52				50				155				148
Expenses of consolidated variable interest entities:
Operating			3				3				8				8
Interest			22				19				63				55
Total expenses			150				306				477				785
Income (loss) before income taxes			(45)				(273)				(287)				(603)
Provision (benefit) for income taxes			-				(6)				2				965
Net income (loss)		$	(45)			$	(267)			$	(289)			$	(1,568)
Net income (loss) per common share:
Basic		$	(0.50)			$	(2.17)			$	(3.24)			$	(12.38)
Diluted		$	(0.50)			$	(2.17)			$	(3.24)			$	(12.38)
Weighted average number of common shares outstanding:
Basic			89,490,267				122,967,924				89,075,892				126,643,642
Diluted			89,490,267				122,967,924				89,075,892				126,643,642

The accompanying notes are an integral part of the consolidated financial statements.

 

2

MBIA INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)

(In millions)

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2018				2017				2018				2017
Net income (loss)		$	(45)			$	(267)			$	(289)			$	(1,568)
Other comprehensive income (loss):
Unrealized gains (losses) on available-for-sale securities:
Unrealized gains (losses) arising during the period			(4)				16				(61)				20
Provision (benefit) for income taxes			-				7				5				7
Total			(4)				9				(66)				13
Reclassification adjustments for (gains) losses included in net income (loss)			(2)				1				(3)				(4)
Provision (benefit) for income taxes			-				(1)				-				(1)
Total			(2)				2				(3)				(3)
Available-for-sale securities with other-than-temporary impairments:
Other-than-temporary impairments and unrealized gains (losses) arising during the period			25				40				48				6
Provision (benefit) for income taxes			-				2				-				2
Total			25				38				48				4
Reclassification adjustments for (gains) losses included in net income (loss)			2				4				3				6
Provision (benefit) for income taxes			-				1				-				2
Total			2				3				3				4
Foreign currency translation:
Foreign currency translation gains (losses)			-				1				2				145
Provision (benefit) for income taxes			-				(1)				-				20
Total			-				2				2				125
Instrument-specific credit risk of liabilities measured at fair value:
Unrealized gains (losses) arising during the period			28				-				(4)				-
Total			28				-				(4)				-
Total other comprehensive income (loss)			49				54				(20)				143
Comprehensive income (loss)		$	4			$	(213)			$	(309)			$	(1,425)

The accompanying notes are an integral part of the consolidated financial statements.

 

3

MBIA INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)

For The Nine Months Ended September 30, 2018

(In millions except share amounts)

 

		Common Stock								Additional Paid-in				Retained				Accumulated Other Comprehensive				Treasury Stock								Total Shareholders’ Equity				Preferred Stock of Subsidiary								Total
		Shares				Amount				Capital				Earnings				Income (Loss)				Shares				Amount				of MBIA Inc.				Shares				Amount				Equity
Balance, December 31, 2017			283,717,973			$	284			$	3,171			$	1,095			$	(19)				(192,233,526)			$	(3,118)			$	1,413				1,315			$	12			$	1,425
ASU 2016-01 transition adjustment			-				-				-				164				(164)				-				-				-				-				-				-
ASU 2018-02 transition adjustment			-				-				-				3				(3)				-				-				-				-				-				-
Net income (loss)			-				-				-				(289)				-				-				-				(289)				-				-				(289)
Other comprehensive income (loss)			-				-				-				-				(20)				-				-				(20)				-				-				(20)
Share-based compensation			(92,284)				-				5				-				-				(18,412)				-				5				-				-				5
Treasury shares issued for warrant exercises			-				-				(21	)			-				-				1,277,620				34				13				-				-				13
Treasury shares acquired under share repurchase program			-				-				-				-				-				(1,961,711)				(14)				(14)				-				-				(14)
Balance, September 30, 2018			283,625,689			$	284			$	3,155			$	973			$	(206)				(192,936,029)			$	(3,098)			$	1,108				1,315			$	12			$	1,120

The accompanying notes are an integral part of the consolidated financial statements.

 

4

MBIA INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(In millions)

 

		Nine Months Ended September 30,
		2018				2017
Cash flows from operating activities:
Premiums, fees and reimbursements received		$	73			$	41
Investment income received			162				193
Insured derivative commutations and losses paid			(49)				(41)
Financial guarantee losses and loss adjustment expenses paid			(367)				(744)
Proceeds from recoveries and reinsurance			46				100
Operating and employee related expenses paid			(68)				(103)
Interest paid, net of interest converted to principal			(119)				(139)
Income taxes (paid) received			(1)				-
Net cash provided (used) by operating activities			(323)				(693)
Cash flows from investing activities:
Purchases of available-for-sale investments			(1,684)				(1,146)
Sales of available-for-sale investments			1,647				1,300
Paydowns and maturities of available-for-sale investments			245				392
Purchases of investments at fair value			(142)				(199)
Sales, paydowns and maturities of investments at fair value			162				270
Sales, paydowns and maturities (purchases) of short-term investments, net			269				67
Paydowns and maturities of loans receivable			365				202
Consolidation of variable interest entities			-				18
Deconsolidation of variable interest entities			(7)				-
(Payments) proceeds for derivative settlements			(19)				(58)
Collateral (to) from counterparties			-				4
Capital expenditures			-				(1)
Other investing			-				(23)
Net cash provided (used) by investing activities			836				826
Cash flows from financing activities:
Proceeds from investment agreements			9				13
Principal paydowns of investment agreements			(30)				(57)
Principal paydowns of medium-term notes			(62)				(55)
Proceeds from the MBIA Corp. Financing Facility			-				328
Principal paydowns of variable interest entity notes			(382)				(311)
Purchases of treasury stock			(15)				(98)
Other financing			-				(4)
Net cash provided (used) by financing activities			(480)				(184)
Net increase (decrease) in cash and cash equivalents			33				(51)
Cash and cash equivalents—beginning of period			146				187
Cash and cash equivalents—end of period		$	179			$	136
Reconciliation of net income (loss) to net cash provided (used) by operating activities:
Net income (loss)		$	(289)			$	(1,568)
Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities:
Change in:
Premiums receivable			54				34
Deferred acquisition costs			18				22
Unearned premium revenue			(142)				(149)
Loss and loss adjustment expense reserves			50				615
Insurance loss recoverable			(192)				(781)
Accrued interest payable			113				81
Accrued expenses			(10)				(26)
Unrealized (gains) losses on insured derivatives			(36)				10
Net (gains) losses on financial instruments at fair value and foreign exchange			(47)				53
Other net realized (gains) losses			126				(64)
Deferred income tax provision (benefit)			1				961
Interest on variable interest entities, net			14				26
Other operating			17				93
Total adjustments to net income (loss)			(34)				875
Net cash provided (used) by operating activities		$	(323)			$	(693)
Supplementary Disclosure of Consolidated Cash Flow Information
Non-cash investing activities:
Non-cash consideration received from the sale of MBIA UK Insurance Limited		$	-			$	332

The accompanying notes are an integral part of the consolidated financial statements.

 

5

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 1: Business Developments and Risks and Uncertainties

Summary

MBIA Inc., together with its consolidated subsidiaries, (collectively, “MBIA” or the “Company”) operates within the financial guarantee insurance industry. MBIA manages three operating segments: 1) United States (“U.S.”) public finance insurance; 2) corporate; and 3) international and structured finance insurance. The Company’s U.S. public finance insurance business is primarily operated through National Public Finance Guarantee Corporation (“National”) and its international and structured finance insurance business is primarily operated through MBIA Insurance Corporation and its subsidiaries (“MBIA Corp.”).

Refer to “Note 10: Business Segments” for further information about the Company’s operating segments.

Business Developments

Financial Strength Ratings

In June of 2017, Standard & Poor’s Financial Services LLC (“S&P”) downgraded the financial strength rating of National which made it difficult for National to compete with higher-rated competitors. Therefore, at that time, National ceased its efforts to actively pursue writing new financial guarantee business. The Company then terminated its agreements with S&P, Kroll Bond Rating Agency (“Kroll”) and Moody’s Investors Services (“Moody’s”) to provide financial strength ratings to MBIA Inc. and certain of its subsidiaries. S&P and Kroll subsequently withdrew all of their ratings. On January 17, 2018, Moody’s downgraded the financial strength rating of National to Baa2 from A3 with a stable outlook, affirmed the financial strength rating of MBIA Corp. at Caa1 with a developing outlook, downgraded MBIA Inc.’s rating to Ba3 with a stable outlook from Ba1 with a negative outlook, and affirmed the financial strength rating of MBIA Mexico S.A. de C.V. (“MBIA Mexico”) at Caa1/B3.mx with a developing outlook. Moody’s, at its discretion and in the absence of a contract with the Company, continues to maintain ratings on MBIA Inc. and its subsidiaries.

Stock Warrants

In April and June of 2018, the holder of certain MBIA Inc. warrants exercised its right to purchase, in total, 11.85 million shares of MBIA Inc. common stock at an exercise price of $9.59 per share. As a result, the Company issued a total of 1.3 million shares of MBIA Inc. common stock to the holder in accordance with the cashless settlement provision of the warrants. As of September 30, 2018, there were no warrants outstanding.

Risks and Uncertainties

The Company’s financial statements include estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. The outcome of certain significant risks and uncertainties could cause the Company to revise its estimates and assumptions or could cause actual results to differ from the Company’s estimates. The discussion below highlights the significant risks and uncertainties that could have a material effect on the Company’s financial statements and business objectives in future periods.

U.S. Public Finance Market Conditions

National continues to surveil and remediate its existing insured portfolio and will seek opportunities to enhance shareholder value using its strong financial resources, while protecting the interests of all of its policyholders. Certain state and local governments and territory obligors that National insures remain under financial and budgetary 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 National’s insured transactions. National monitors and analyzes these situations and other stressed credits closely, and the overall extent and duration of this stress is uncertain.

In particular, the Commonwealth of Puerto Rico and certain of its instrumentalities (“Puerto Rico”) are experiencing significant fiscal stress and constrained liquidity due to, among other things, Puerto Rico’s structural budget imbalance, the lack of access to the capital markets, a stagnating local economy, net migration of people out of Puerto Rico and a high debt burden. Although Puerto Rico has tried to address its challenges through various fiscal policies, it continues to experience significant fiscal stress. On January 1, 2018 and July 1, 2018, Puerto Rico defaulted on scheduled debt service for National insured bonds and National paid gross claims in the aggregate of $276 million. Puerto Rico continues in its efforts to rebuild its infrastructure and to otherwise recover from the impact of Hurricane Maria in 2017, aided in part by the Federal Emergency Management Agency and other federal agencies. The extent and duration of such aid is inherently uncertain, and the necessary and greater involvement of the federal government, through its actions to deliver disaster relief and other support services, in addition to the evolving role of the Financial Oversight and Management Board for Puerto Rico (the “Oversight Board”) and the role of Puerto Rico in its own recovery, heightens political risk in connection with the restructuring of legacy debt. This risk could lead the Oversight Board, Puerto Rico or the federal government to seek to extract greater concessions from creditors based on the uncertainty of Puerto Rico’s long term recovery prospects. In this event, losses at National on select Puerto Rico exposures could increase materially.

 

6

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 1: Business Developments and Risks and Uncertainties (continued)

 

MBIA Corp. Insured Portfolio

MBIA Corp.’s primary objectives are to satisfy all claims by its policyholders and to maximize future recoveries, if any, for its senior lending and other surplus note holders, and then its preferred stock holders. MBIA Corp. is executing this strategy by, among other things, pursuing various actions focused on maximizing the collection of recoveries and by reducing potential losses on its insurance exposures. MBIA Corp.’s insured portfolio could deteriorate and result in additional significant loss reserves and claim payments. MBIA Corp.’s ability to meet its obligations is limited by available liquidity and its ability to secure additional liquidity through financing and other transactions. There can be no assurance that MBIA Corp. will be successful in generating sufficient cash to meet its obligations.

Zohar and RMBS Recoveries

Payment of claims totaling $919 million in November of 2015 and January of 2017, on MBIA Corp.’s policies insuring the class A-1 and A-2 notes issued by Zohar CDO 2003-1, Limited (“Zohar I”) and insuring certain notes issued by Zohar II 2005-1, Limited (“Zohar II”), entitles MBIA Corp. to reimbursement of such amounts plus interest and expenses and/or to exercise certain rights and remedies to seek recovery of such amounts. MBIA Corp. anticipates that the primary source of the recoveries will come from the monetization of the assets of Zohar I and Zohar II, which include, among other things, loans made to, and equity interests in, companies purportedly controlled by the sponsor and former collateral manager of Zohar I and Zohar II (the “Zohar Sponsor”) (all the assets of Zohar I and Zohar II, the “Zohar Assets”). On March 11, 2018, the then-director of Zohar I and Zohar II placed those funds into voluntary bankruptcy proceedings in federal bankruptcy court in the District of Delaware (the “Zohar Funds Bankruptcy Cases”). On May 21, 2018, the Court granted the Zohar funds’ motion to approve a settlement (the “Zohar Bankruptcy Settlement”) which established a process by which the debtor funds, through an independent director and a chief restructuring officer, will work with the original sponsor of the funds to monetize the Zohar Assets and repay creditors, including MBIA Corp. In addition, the Zohar Bankruptcy Settlement provides for a stay of all pending litigation between the parties for a minimum of fifteen months. Subsequent to the Zohar Bankruptcy Settlement, the Company deconsolidated Zohar I and Zohar II as variable interest entities (“VIEs” or “VIE”) and, as of September 30, 2018, salvage and subrogation recoveries related to Zohar I and Zohar II are reported within “Insurance loss recoverable” on the Company’s consolidated balance sheet. Refer to “Note 4: Variable Interest Entities” for additional information about the deconsolidation of the Zohar funds. Notwithstanding the Zohar Bankruptcy Settlement, there can be no assurance that the value of the Zohar Assets will be sufficient to permit MBIA Corp. to recover all or substantially all of the payments it made on Zohar I and Zohar II.

MBIA Corp. also projects to collect excess spread from insured residential mortgage-backed securities (“RMBS”), and to recover proceeds from Credit Suisse Securities (USA) LLC, DLJ Mortgage Capital, Inc. and Select Portfolio Servicing Inc. (collectively, “Credit Suisse”) arising from its failure to repurchase ineligible loans that were included in a Credit Suisse sponsored RMBS transaction. However, the amount and timing of these collections and recoveries are uncertain.

Failure to collect a substantial amount of its expected recoveries could impede MBIA Corp.’s ability to make payments when due on other policies. MBIA Corp. believes that if the New York State Department of Financial Services (“NYSDFS”) concludes at any time that MBIA Insurance Corporation will not be able to pay its policyholder claims, the NYSDFS would likely put MBIA Insurance Corporation into a rehabilitation or liquidation proceeding under Article 74 of the New York Insurance Law and/or take such other actions as the NYSDFS may deem necessary to protect the interests of MBIA Insurance Corporation’s policyholders. The determination to commence such a proceeding or take other such actions is within the exclusive control of the NYSDFS.

Given the separation of MBIA Inc. and MBIA Corp. as distinct legal entities, the absence of any cross defaults between the entities and the lack of reliance by MBIA Inc. on MBIA Corp. for the receipt of dividends, the Company does not believe that a rehabilitation or liquidation proceeding with respect to MBIA Insurance Corporation would have any significant liquidity impact on MBIA Inc. or result in a liquidation or similar proceeding of MBIA Mexico. Such a proceeding could have material adverse consequences for MBIA Corp., including the termination of insured credit default swaps (“CDS”) and other derivative contracts for which counterparties may assert market-based claims, the acceleration of debt obligations issued by affiliates and insured by MBIA Corp., the loss of control of MBIA Insurance Corporation to a rehabilitator or liquidator, and unplanned costs.

Refer to “Note 5: Loss and Loss Adjustment Expense Reserves” for additional information about MBIA Corp.’s recoveries.

 

7

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 1: Business Developments and Risks and Uncertainties (continued)

 

Corporate Liquidity

Subsequent to September 30, 2018, National declared and paid a dividend of $108 million to its ultimate parent, MBIA Inc. Also, subsequent to September 30, 2018, National purchased from MBIA Inc., certain MBIA Inc. 5.700% Senior Notes due 2034 and certain MBIA Inc. 7.000% Debentures due 2025 that were previously repurchased by MBIA Inc. and had not been retired, resulting in an increase to MBIA Inc.’s liquidity of $41 million. Based on the Company’s projections of National’s dividends, additional anticipated releases under its tax sharing agreement and related tax escrow account (“Tax Escrow Account”), and other cash inflows, the Company expects that MBIA Inc. will have sufficient cash to satisfy its debt service and general corporate needs. However, MBIA Inc. continues to have liquidity risk which could be triggered by deterioration in the performance of invested assets, interruption of or reduction in dividends or tax payments received from operating subsidiaries, impaired access to the capital markets, as well as other factors which are not anticipated at this time. Furthermore, failure by MBIA Inc. to settle liabilities that are also insured by MBIA Corp. could result in claims on MBIA Corp.

Note 2: Significant Accounting Policies

The Company has disclosed its significant accounting policies in “Note 2: Significant Accounting Policies” in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. The following significant accounting policies provide an update to those included in the Company’s Annual Report on Form 10-K.

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X and, accordingly, do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America (“GAAP”) for annual periods. These statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2017. The accompanying consolidated financial statements have not been audited by an independent registered public accounting firm in accordance with the standards of the Public Company Accounting Oversight Board (U.S.), but in the opinion of management such financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for the fair statement of the Company’s consolidated financial position and results of operations. All material intercompany balances and transactions have been eliminated.

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. As additional information becomes available or actual amounts become determinable, the recorded estimates are revised and reflected in operating results.

The results of operations for the three and nine months ended September 30, 2018 may not be indicative of the results that may be expected for the year ending December 31, 2018. The December 31, 2017 consolidated balance sheet was derived from audited financial statements, but does not include all disclosures required by GAAP for annual periods. Certain amounts have been reclassified in the prior year’s financial statements to conform to the current presentation. This includes a change in the classification of certain cash receipts and cash payments on the Company’s consolidated statement of cash flows as required under Accounting Standards Update (“ASU”) 2016-15, “Statement of Cash Flows (Topic 230)”. This classification change affected “Interest paid, net of interest converted to principal”, in operating cash flows, and “Principal paydowns of investment agreements” and “Principal paydowns of medium-term notes”, in financing cash flows, on the Company’s consolidated statement of cash flows for the prior period. Such reclassifications did not materially impact total revenues, expenses, assets, liabilities, shareholders’ equity, operating cash flows, investing cash flows, or financing cash flows for all periods presented.

During the third quarter of 2018, the Company corrected an error related to the second quarter of 2018 of $3 million and an error related to the first quarter of 2017 of $3 million, which, in aggregate, reduced the third quarter of 2018’s net loss by $6 million. The first quarter of 2017 error related to a gain on the extinguishment of debt and the second quarter of 2018 error related to a benefit on losses and loss adjustment expense. The Company evaluated the materiality of these errors in accordance with Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 99, Materiality, and SEC Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements, and concluded that these errors, individually and in the aggregate, were immaterial to the three months ended September 30, 2018 and the prior periods to which these errors relate.

 

8

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

 

Note 3: Recent Accounting Pronouncements

Recently Adopted Accounting Standards

Revenue from Contracts with Customers (Topic 606) (ASU 2014-09) and Deferral of the Effective Date (ASU 2015-14)

In May of 2014, the Financial Accounting Standards Board (“FASB”) issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606).” ASU 2014-09 amends the accounting guidance for recognizing revenue for the transfer of goods or services from contracts with customers unless those contracts are within the scope of other accounting standards. ASU 2014-09 does not apply to financial guarantee insurance contracts within the scope of Topic 944, “Financial Services — Insurance.” In August of 2015, the FASB issued ASU 2015-14, “Revenue from Contracts with Customers (Topic 606) — Deferral of the Effective Date.” ASU 2015-14 defers the effective date of ASU 2014-09 to interim and annual periods beginning January 1, 2018, and is applied on a retrospective or modified retrospective basis. The Company adopted ASU 2014-09 in the first quarter of 2018 and the adoption of ASU 2014-09 did not affect the Company’s consolidated financial statements.

Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (ASU 2016-01)

In January of 2016, the FASB issued ASU 2016-01, “Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” ASU 2016-01 requires certain equity investments other than those accounted for under the equity method of accounting or result in consolidation of the investee to be measured at fair value with changes in fair value recognized in net income, and permits an entity to measure equity investments that do not have readily determinable fair values at cost less any impairment plus or minus adjustments for certain changes in observable prices. An entity is also required to evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale (“AFS”) debt securities in combination with the entity’s other deferred tax assets. ASU 2016-01 requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability that results from a change in the instrument-specific credit risk for financial liabilities that the entity has elected to measure at fair value in accordance with the fair value option for financial instruments. ASU 2016-01 was effective for interim and annual periods beginning January 1, 2018. As such, the Company reclassed a loss of $162 million from retained earnings to accumulated other comprehensive income (“AOCI”) related to the instrument-specific credit risk portion of financial liabilities measured at fair value in accordance with the fair value option. In addition, the Company reclassed net unrealized gains of $2 million from AOCI to retained earnings related to equity investments. As of September 30, 2018 and December 31, 2017, the Company had a full valuation allowance against its deferred tax asset.

Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (ASU 2018-02)

In February of 2018, the FASB issued ASU 2018-02, “Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” ASU 2018-02 permits, but does not require, the reclassification of the income tax effects of the Tax Cuts and Jobs Act (the “Act”) from AOCI to retained earnings. ASU 2018-02 is effective for interim and annual periods beginning after December 15, 2018. Early adoption of ASU 2018-02 is permitted and is applied in the period of adoption or retroactively to each period in which the effect of the change in the U.S. federal corporate income tax rate in the Act is recognized. The Company adopted ASU 2018-02 in the first quarter of 2018. As such, the Company reclassed income taxes of $3 million from AOCI to retained earnings. The Company’s accounting policy related to releasing income tax effects that are lodged in AOCI is on a portfolio approach basis.

The Company has not adopted any other new accounting pronouncements that had a material impact on its consolidated financial statements.

 

9

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 3: Recent Accounting Pronouncements (continued)

 

Recent Accounting Developments

Leases (Topic 842) (ASU 2016-02)

In February of 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)”, that amends the accounting guidance for leasing transactions. ASU 2016-02 requires a lessee to classify lease contracts as finance or operating leases, and to recognize assets and liabilities for the rights and obligations created by leasing transactions with lease terms more than twelve months. ASU 2016-02 substantially retains the criteria for classifying leasing transactions as finance or operating leases. For finance leases, a lessee recognizes a right-of-use asset and a lease liability initially measured at the present value of the lease payments, and recognizes interest expense on the lease liability separately from the amortization of the right-of-use asset. For operating leases, a lessee recognizes a right-of-use asset and a lease liability initially measured at the present value of the lease payments, and recognizes lease expense on a straight-line basis. ASU 2016-02 is effective for interim and annual periods beginning January 1, 2019 with early adoption permitted, and is applied on a modified retrospective basis. The Company is currently evaluating its lease commitments and expects an increase in its total assets and total liabilities on its consolidated balance sheet reflecting the recognition of its right-of-use asset and lease liability, respectively. The gross up of the assets and liabilities is expected to have no impact on the Company’s statement of operations. Refer to “Note 13: Commitments and Contingencies” for information about the Company’s lease commitments.

Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (ASU 2016-13)

In June of 2016, the FASB issued ASU 2016-13, “Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 requires financing receivables and other financial assets measured at amortized cost to be presented at the net amount expected to be collected by recording an allowance for credit losses with changes in the allowance recorded as credit loss expense or reversal of credit loss expense based on management’s current estimate of expected credit losses each period. ASU 2016-13 does not apply to credit losses on financial guarantee insurance contracts within the scope of Topic 944, “Financial Services-Insurance.” ASU 2016-13 also requires impairment relating to credit losses on AFS debt securities to be presented through an allowance for credit losses with changes in the allowance recorded in the period of the change as credit loss expense or reversal of credit loss expense. Any impairment amount not recorded through an allowance for credit losses on AFS debt securities is recorded through other comprehensive income. ASU 2016-13 is effective for interim and annual periods beginning January 1, 2020 with early adoption permitted beginning January 1, 2019. ASU 2016-13 is applied on a modified retrospective basis except that prospective application is applied to AFS debt securities with other-than-temporary impairments (“OTTI”) recognized before the date of adoption. The Company is evaluating the impact of adopting ASU 2016-13.

Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement (ASU 2018-13)

In August of 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement.” ASU 2018-13 modifies the disclosure requirements on fair value measurements. ASU 2018-13 is effective for interim and annual periods beginning January 1, 2020 with early adoption permitted to remove or modify disclosures upon issuance of the standard and delay adoption of the additional disclosures until the effective date. Upon the effective date, certain amendments should be applied prospectively, while others are to be applied retrospectively to all periods presented. The Company is evaluating the impact of adopting ASU 2018-13. Since the amendments of ASU 2018-13 only impact disclosure requirements, the Company does not expect the adoption of ASU 2018-13 to have an impact on its consolidated financial statements.

 

10

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

 

Note 4: Variable Interest Entities

Through MBIA’s international and structured finance insurance segment, the Company provides credit protection to issuers of obligations that may involve issuer-sponsored special purpose entities (“SPEs”). An SPE may be considered a VIE to the extent the SPE’s total equity at risk is not sufficient to permit the SPE to finance its activities without additional subordinated financial support or its equity investors lack any one of the following characteristics: (i) the power to direct the activities of the SPE that most significantly impact the entity’s economic performance or (ii) the obligation to absorb the expected losses of the entity or the right to receive the expected residual returns of the entity. A holder of a variable interest or interests in a VIE is required to assess whether it has a controlling financial interest, and thus is required to consolidate the entity as primary beneficiary. An assessment of a controlling financial interest identifies the primary beneficiary as the variable interest holder that has both of the following characteristics: (i) the power to direct the activities of the VIE that most significantly impact the entity’s economic performance and (ii) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. The primary beneficiary is required to consolidate the VIE. An ongoing reassessment of controlling financial interest is required to be performed based on any substantive changes in facts and circumstances involving the VIE and its variable interests.

The Company evaluates issuer-sponsored SPEs initially to determine if an entity is a VIE, and is required to reconsider its initial determination if certain events occur. For all entities determined to be VIEs, MBIA performs an ongoing reassessment to determine whether its guarantee to provide credit protection on obligations issued by VIEs provides the Company with a controlling financial interest. Based on its ongoing reassessment of controlling financial interest, the Company determines whether a VIE is required to be consolidated or deconsolidated.

The Company makes its determination for consolidation based on a qualitative assessment of the purpose and design of a VIE, the terms and characteristics of variable interests of an entity, and the risks a VIE is designed to create and pass through to holders of variable interests. The Company generally provides credit protection on obligations issued by VIEs, and holds certain contractual rights according to the purpose and design of a VIE. The Company may have the ability to direct certain activities of a VIE depending on facts and circumstances, including the occurrence of certain contingent events, and these activities may be considered the activities of a VIE that most significantly impact the entity’s economic performance. The Company generally considers its guarantee of principal and interest payments of insured obligations, given nonperformance by a VIE, to be an obligation to absorb losses of the entity that could potentially be significant to the VIE. At the time the Company determines it has the ability to direct the activities of a VIE that most significantly impact the economic performance of the entity based on facts and circumstances, MBIA is deemed to have a controlling financial interest in the VIE and is required to consolidate the entity as primary beneficiary. The Company performs an ongoing reassessment of controlling financial interest that may result in consolidation or deconsolidation of any VIE.

Consolidated VIEs

The carrying amounts of assets and liabilities of consolidated VIEs were $1.9 billion and $2.0 billion, respectively, as of September 30, 2018, and $3.2 billion and $2.3 billion, respectively, as of December 31, 2017. The carrying amounts of assets and liabilities are presented separately in “Assets of consolidated variable interest entities” and “Liabilities of consolidated variable interest entities” on the Company’s consolidated balance sheets. VIEs are consolidated or deconsolidated based on an ongoing reassessment of controlling financial interest, when events occur or circumstances arise, and whether the ability to exercise rights that constitute power to direct activities of any VIEs are present according to the design and characteristics of these entities. In May of 2018, the Court overseeing the Zohar Funds Bankruptcy Cases approved the Zohar Bankruptcy Settlement, which concerns two entities that the Company had consolidated as VIEs. As a result, in the second quarter of 2018, the Company deconsolidated these two VIEs and recorded a $93 million loss within “Other net realized gains (losses)” under “Revenues of consolidated variable interest entities” on the Company’s consolidated statement of operations. The loss resulted from the difference between the fair value of the VIE assets that were deconsolidated and the Company’s current estimate of salvage and subrogation recoveries from those VIEs under insurance accounting. Refer to “Note 1: Business Developments and Risks and Uncertainties” for further information about the Zohar Bankruptcy Settlement. In the third quarter of 2018, three VIEs were deconsolidated. No additional VIEs were consolidated during the nine months ended September 30, 2018.

Holders of insured obligations of issuer-sponsored VIEs related to the Company’s international and structured finance insurance segment do not have recourse to the general assets of MBIA. In the event of nonpayment of an insured obligation issued by a consolidated VIE, the Company is obligated to pay principal and interest, when due, on the respective insured obligation only. The Company’s exposure to consolidated VIEs is limited to the credit protection provided on insured obligations and any additional variable interests held by MBIA.

 

11

MBIA Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 4: Variable Interest Entities (continued)

 

Nonconsolidated VIEs

The following tables present the total assets of nonconsolidated VIEs in which the Company holds a variable interest as of September 30, 2018 and December 31, 2017, through its insurance operations. The following tables also present the Company’s maximum exposure to loss for nonconsolidated VIEs and carrying values of the assets and liabilities for its interests in these VIEs as of September 30, 2018 and December 31, 2017. The maximum exposure to loss as a result of MBIA’s variable interests in VIEs is represented by insurance in force. Insurance in force is the maximum future payments of principal and interest which may be required under commitments to make payments on insured obligations issued by nonconsolidated VIEs. The Company has aggregated nonconsolidated VIEs based on the underlying credit exposure of the insured obligation. The nature of the Company’s variable interests in nonconsolidated VIEs is related to financial guarantees and any investments in obligations issued by nonconsolidated VIEs.

 

		September 30, 2018
										Carrying Value of Assets												Carrying Value of Liabilities
In millions		VIE Assets				Maximum Exposure to Loss				Investments(1)				Premiums Receivable(2)				Insurance  Loss Recoverable(3)				Unearned Premium Revenue(4)				Loss and Loss Adjustment Expense Reserves(5)
Insurance:
Global structured finance:
Mortgage-backed residential		$	5,879			$	3,251			$	18			$	20			$	143			$	18			$	356
Mortgage-backed commercial			131				59				-				-				-				-				-
Consumer asset-backed			4,514				586				-				2				1				1				10
Corporate asset-backed			3,854				1,377				-				9				839				11				10
Total global structured finance			14,378				5,273				18				31				983				30				376
Global public finance			15,058				2,296				-				9				-				12				-
Total insurance		$	29,436			$	7,569			$	18			$	40			$	983			$	42			$	376

 

(1) -

Reported within “Investments” on MBIA’s consolidated balance sheets.

 

(2) -

Reported within “Premiums receivable” on MBIA’s consolidated balance sheets.

 

(3) -

Reported within “Insurance loss recoverable” on MBIA’s consolidated balance sheets.

 

(4) -

Reported within “Unearned premium revenue” on MBIA’s consolidated balance sheets.

 

(5) -

Reported within “Loss and loss adjustment expense reserves” on MBIA’s consolidated balance sheets.

 

		December 31, 2017
										Carrying Value of Assets												Carrying Value of Liabilities
In millions		VIE Assets				Maximum Exposure to Loss				Investments(1)				Premiums Receivable(2)				Insurance  Loss Recoverable(3)				Unearned Premium Revenue(4)				Loss and Loss Adjustment Expense Reserves(5)
Insurance:
Global structured finance:
Mortgage-backed residential		$	7,295			$	3,741			$	19			$	22			$	172			$	20			$	396
Mortgage-backed commercial			216				94				-				-				-				-				-
Consumer asset-backed			5,010				981				-				4				1				3				10
Corporate asset-backed			2,418				1,645				-				13				-				14				-
Total global structured finance			14,939				6,461				19				39				173				37				406
Global public finance			15,568				2,524				-				10				-				14				-
Total insurance		$	30,507			$	8,985			$	19			$	49			$	173			$	51			$	406

 

(1) -

Reported within “Investments” on MBIA’s consolidated balance sheets.

 

(2) -

Reported within “Premiums receivable” on MBIA’s consolidated balance sheets.

 

(3) -

Reported within “Insurance loss recoverable” on MBIA’s consolidated balance sheets.

 

(4) -

Reported within “Unearned premium revenue” on MBIA’s consolidated balance sheets.

 

(5) -

Reported within “Loss and loss adjustment expense reserves” on MBIA’s consolidated balance sheets.

 

12