0000814585 us-gaap:VariableInterestEntityPrimaryBeneficiaryMember mbi:ResidentialMortgageLoansMember us-gaap:LoansReceivableMember 2020-03-31
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 National 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; |
| | • | the impact on our insured portfolios or business operations caused by the global spread of the novel coronavirus COVID-19; |
| | • | 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 Risk 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.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of financial condition and results of operations of MBIA Inc. should be read in conjunction with our Annual Report on Form
10-K
for the year ended December 31, 2019 and the consolidated financial statements and notes thereto included in this Form
10-Q.
In addition, this discussion and analysis of financial condition and results of operations includes statements of the opinion of MBIA Inc.’s management which may be forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. 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. Refer to “Risk Factors” in Part II, Item 1A and “Forward-Looking Statements” and “Risk Factors” in Part I, Item 1A of MBIA Inc.’s Annual Report on Form
10-K
for the year ended December 31, 2019 for a further discussion of risks and uncertainties.
MBIA Inc., together with its consolidated subsidiaries, (collectively, “MBIA”, the “Company”, “we”, “us”, or “our”) operates within the financial guarantee insurance industry. MBIA manages its business within three operating segments: 1) United States (“U.S.”) public finance insurance; 2) corporate; and 3) international and structured finance insurance. Our U.S. public finance insurance portfolio is managed through National Public Finance Guarantee Corporation (“National”), our corporate segment is managed through MBIA Inc. and several of its subsidiaries, including our service company, MBIA Services Corporation (“MBIA Services”) and our international and structured finance insurance business is primarily managed through MBIA Insurance Corporation and its subsidiaries (“MBIA Corp.”).
National’s primary objectives are to maximize the performance of its existing insured portfolio through effective surveillance and remediation activity and effectively manage its investment portfolio. Our corporate segment consists of general corporate activities, including providing support services to MBIA’s operating subsidiaries and asset and capital management. 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 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 reducing and mitigating potential losses on its insurance exposures. We do not expect National or MBIA Corp. to write significant new business.
The outbreak of the novel coronavirus
COVID-19
(“COVID-19”),
a respiratory disease caused by a new strain of coronavirus, was declared a pandemic by the World Health Organization in March of 2020 and has spread globally. The pandemic has affected a wide range of economic activities, domestic and global business and financial markets. The outbreak and its attendant governmental policy and social responses are evolving rapidly. Many states and municipalities have enacted various quarantining and
“shelter-in-place”
regulations which severely limit economic activity and travel. The Company’s employees have been working remotely since early March as the Company successfully implemented its business continuity plans. We continue to perform all of our traditional operations, including surveilling and, as necessary, remediating, the credits in our insured portfolios.
At this time it is not possible to comprehensively quantify the financial impact of the pandemic on our operating insurance companies’ overall insured portfolios, or to account for the impact of the outbreak on most of the specific credits within those portfolios, due to, in part, challenges in determining whether and to what extent the underlying credits will be able or willing to continue to meet their debt service obligations or avoid long term impairment in this environment. Adverse impacts on macroeconomic factors resulting from the spread of
COVID-19,
including without limitation reduced economic activity and certainty, increased unemployment, increased loan defaults or delinquencies, and increased stress on municipal budgets, including due to reduced tax revenues and the ability to raise taxes or limit spending, could materially and adversely affect the performance of our insured portfolios. The impact of the pandemic on National’s financial guarantee credits is likely to vary based on the nature of the taxes, fees and revenues pledged to debt repayment and their sensitivity to the related slowdown in economic activity. Several of the credits within National’s insured portfolio have made public pronouncements that the pandemic has had an impact on their economic status, without yet providing any specific quantification of the impact. The duration of the pandemic, the availability of federal aid to state and local governments, and the breadth and speed of economic recovery may all contribute to the ultimate degree and length of the economic stress incurred by the credits in National’s and MBIA Corp.’s insured portfolios. Further, any national recession that may result from the pandemic and its aftermath could, present additional but yet unknown credit risks to National’s and MBIA Corp.’s insured portfolios.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
EXECUTIVE OVERVIEW (continued)
Federal legislation passed to combat the economic impact of the pandemic, principally the $2.2 trillion Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, and an additional nearly $500 billion approved by Congress and the President in late April of 2020, included significant aid to public sector issuers including states, territories, healthcare, higher education and transportation issuers. In addition, the Federal Reserve has announced several actions in furtherance of its mandate from Congress to promote the stability of the financial system that are directly supportive of the municipal market. It is premature to assess whether these or any subsequent federal responses will prevent or reduce financial distress in the municipal sector. If the issuers of the obligations in National’s insured portfolio, including the Commonwealth of Puerto Rico and its instrumentalities (“Puerto Rico”), are unable to raise taxes, reduce spending, or receive federal assistance, we may experience new or additional losses or impairments on those obligations, which could materially and adversely affect our business, financial condition and financial results.
Certain of MBIA Corp.’s structured finance policies, including those in which the underlying principal obligations are comprised of residential or commercial mortgages and mortgage-backed securities, could be negatively impacted by delays or failures of borrowers to make payments of principal and interest when due, or delays or moratoriums on foreclosures or enforcement actions with respect to delinquent or defaulted mortgages imposed by governmental authorities. MBIA Corp. has recorded significant loss reserves on its residential mortgage-backed securities (“RMBS”) and collateralized debt obligations (“CDO”) exposures, and there can be no assurance that these reserves will be sufficient if the pandemic causes further deterioration to the economy. These transactions are also subject to servicer risks, which relate to problems with the transaction’s servicer that could adversely impact performance of the underlying assets. Additionally, several of our credits, particularly within our international public finance sector, feature large, near term debt-service payments, and there can be no assurance that the liquidity position of MBIA Corp. will enable it to satisfy any claims that arise if the issuers of such credits are unable or unwilling to refinance or repay their obligations. MBIA Corp. has recorded substantial expected recoveries on certain RMBS transactions, and the forbearance options available under the CARES Act for mortgage borrowers who are facing financial difficulties, may delay or impair collections on these recoveries.
The Company continues to monitor its cash and liquid asset resources using cash forecasting and stress-scenario testing. Members of the Company’s senior management meet regularly to review liquidity metrics, discuss contingency plans and establish target liquidity levels. It remains premature to predict the full impact the pandemic may have on our future liquidity position and needs. Declines in the market value or rating eligibility of assets pledged against the Company’s obligations as a result of credit market deterioration caused by
COVID-19
require additional eligible assets to be pledged in order to meet minimum required collateral amounts against these obligations. This could require the Company to sell assets, potentially with substantial losses or use free cash or other assets to meet the collateral requirements, thus negatively impacting the Company’s liquidity position. Associated declines in the yields in our insurance companies’ fixed-income portfolios could materially impact investment income.
The following table presents our financial highlights. In the fourth quarter of 2019, the Company adopted Accounting Standards Update (“ASU”)
2019-12,
“Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes” as of January 1, 2019. As a result of adopting ASU
2019-12,
the Company revised its previously reported amounts for the three months ended March 31, 2019. Refer to “Note 3: Recent Accounting Pronouncements” in the Notes to Consolidated Financial Statements for more information about the impact of ASU
2019-12.
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 Insurance Corporation’s capital position under statutory accounting principles (“U.S. STAT”).
| | | | | | | | |
| | Three Months Ended March 31, |
In millions except per share amounts | | | | | |
| | $ | | | | $ | | |
Net income (loss) per diluted share | | $ | | | | $ | | |
Adjusted net income (loss) (1) | | $ | | | | $ | | |
Adjusted net income (loss) per diluted share (1) | | $ | | | | $ | | |
Cost of shares purchased or repurchased | | $ | | | | $ | | |
| | (1) - | Adjusted net income (loss) and adjusted net income (loss) per diluted share are non-GAAP measures. Refer to the following “Results of Operations” section for a discussion of adjusted net income (loss) and adjusted net income (loss) per diluted share and a reconciliation of GAAP net income to adjusted net income (loss) and GAAP net income per diluted share to adjusted net income (loss) per diluted share. |
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
EXECUTIVE OVERVIEW (continued)
Economic and Financial Market Trends
The U.S. economy faced unprecedented challenges during the first quarter of 2020 due to the
COVID-19
pandemic which has rapidly spread across the world. Prior to the pandemic, the U.S. economy was relatively healthy as evidenced by a strong labor market and low inflation. The Federal Reserve has vowed to use all of its resources and tools to support the economy by assisting households, employers, and state and local governments during the coronavirus pandemic.
The Federal Open Market Committee lowered its target range for the federal funds rate to 0 to
1
/
4
percent at its March 2020 meeting. The Federal Reserve has committed to keeping interest rates at or near zero in order to lower borrowing costs until they are confident that the economy has stabilized and the health crisis has subsided. The Federal Reserve stated it will use its full range of authorities to ensure that the eventual recovery will be as robust as possible.
Economic and financial market trends could impact the Company’s financial results. As a result of the pandemic, many states and municipalities will experience financial distress through delayed tax collections, inability to reduce spending and not receiving timely financial assistance. Economic deterioration at the state and local level weakens the credit quality of the issuers of our insured municipal bonds, reduces the performance of our insured U.S. public finance portfolio and could increase the amount of National’s potential incurred losses. In addition, lower interest rates could result in decreased returns on our Company’s investment portfolios. Refer to the
“COVID-19”
section above for further information about the pandemic.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”), which requires the use of estimates and assumptions. Management has discussed and reviewed the development, selection, and disclosure of critical accounting estimates with the Company’s Audit Committee. Our most critical accounting estimates include loss and loss adjustment expense (“LAE”) reserves and valuation of financial instruments, since these estimates require significant judgment. Any modifications in these estimates could materially impact our financial results.
For a discussion of the Company’s critical accounting estimates, refer to “Critical Accounting Estimates” in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in the Company’s Annual Report on Form
10-K
for the year ended December 31, 2019. In addition, refer to “Note 5: Loss and Loss Adjustment Expense Reserves” and “Note 6: Fair Value of Financial Instruments” in the Notes to Consolidated Financial Statements for a current description of estimates used in our insurance loss reserving process and information about our financial assets and liabilities that are accounted for at fair value, including valuation techniques and significant inputs.
RECENT ACCOUNTING PRONOUNCEMENTS
Refer to “Note 3: Recent Accounting Pronouncements” in the Notes to Consolidated Financial Statements for a discussion of accounting guidance recently adopted by the Company.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Summary of Consolidated Results
The following table presents a summary of our consolidated financial results for the three months ended March 31, 2020 and 2019:
| | | | | | | | |
| | Three Months Ended March 31, |
In millions except per share amounts | | | | | |
| | $ | | ) | | $ | | |
| | | | | | | | |
| | | | | | | | | |
Income (loss) before income taxes | | | | ) | | | | ) |
Provision (benefit) for income taxes | | | | | | | | |
| | | | | | | | | |
| | $ | | ) | | $ | | ) |
| | | | | | | | | |
Net income (loss) per common share: | | | | | | | | |
| | $ | | ) | | $ | | ) |
| | $ | | ) | | $ | | ) |
Weighted average number of common shares outstanding: | | | | | | | | |
| | | | | | | | |
| | | | | | | | |
Consolidated total revenues decreased for the three months ended March 31, 2020 compared with the same period of 2019 principally due to fair value losses on securities from a widening of credit spreads during the first quarter of 2020 and higher losses on our interest rate swaps for which we receive floating rates as a result of lower interest rates during the first quarter of 2020. These unfavorable changes were partially offset by the absence of the following items that occurred in the three months ended March 31, 2019: (i) net realized losses due to the consolidation of the Puerto Rico Tax Financing (“COFINA”) consolidated variable interest entities (“VIEs”) following the confirmation of the COFINA Plan of Adjustment; and (ii) net investment losses related to other-than-temporary investments (“OTTI”) on an impaired security for which a loss was recognized as the difference between the amortized cost and net present value of projected cash flows. This impaired security was sold during the first quarter of 2020.
Consolidated total expenses for the three months ended March 31, 2020 included an expense of $243 million of losses and LAE compared with a benefit of $38 million of losses and LAE for the same period of 2019. This increase in losses and LAE was primarily due to increases in losses incurred on certain Puerto Rico credits, CDOs and first-lien RMBS. Refer to the following “Loss and Loss Adjustment Expenses” sections of National and MBIA Corp. for additional information on our losses and LAE.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS (continued)
Non-GAAP
Adjusted Net Income (Loss)
In addition to our results prepared in accordance with GAAP, we also analyze the operating performance of the Company using adjusted net income (loss) and adjusted net income (loss) per diluted common share, both
non-GAAP
measures. Since adjusted net income (loss) is used by management to assess performance and make business decisions, we consider adjusted net income (loss) and adjusted net income (loss) per diluted common share fundamental measures of periodic financial performance which are useful in understanding our results. Adjusted net income (loss) and adjusted net income (loss) per diluted common share are not substitutes for net income (loss) and net income (loss) per diluted common share determined in accordance with GAAP, and our definitions of adjusted net income (loss) and adjusted net income (loss) per diluted common share may differ from those used by other companies.
Adjusted net income (loss) and adjusted net income (loss) per diluted common share include the
after-tax
results of the Company and remove the
after-tax
results of our international and structured finance insurance segment, comprising the results of MBIA Corp. which given its capital structure and business prospects, we do not expect its financial performance to have a material economic impact on MBIA Inc., as well as the following:
| | • | Mark-to-market gains (losses) on financial instruments mark-to-market gains (losses) on financial instruments that primarily include interest rate swaps and hybrid financial instruments. These amounts fluctuate based on market interest rates, credit spreads and other market factors. |
| | • | Foreign exchange gains (losses) non-functional currencies. Given the possibility of volatility in foreign exchange markets, we exclude the impact of foreign exchange gains (losses) to provide a measurement of comparability of adjusted net income (loss). |
| | • | Net gains (losses) on sales of investments and impaired securities |
| | • | – The Company applies a zero effective tax rate for federal income tax purposes to its pre-tax adjustments, if applicable. |
Management further adjusts
non-GAAP
adjusted net income (loss) and adjusted net income (loss) per diluted common share by removing the impact of our U.S. public finance insurance segment VIE consolidations. GAAP requires the Company to consolidate certain VIEs that have issued debt obligations insured by the Company. However, since the Company does not own such VIEs, management uses certain measures adjusted to remove the impact of VIE consolidations for our U.S. public finance insurance segment in order to reflect financial exposure limited to its financial guarantee contracts. Wherever appropriate, the Company has separately disclosed the effect of our U.S. public finance insurance segment VIE consolidations.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS (continued)
The following table presents our adjusted net income (loss) and adjusted net income (loss) per diluted common share and provides a reconciliation of GAAP net income (loss) to adjusted net income (loss) for the three months ended March 31, 2020 and 2019:
| | | | | | | | |
| | Three Months Ended March 31, |
In millions except share and per share amounts | | | | | |
| | $ | | ) | | $ | | ) |
Less: adjusted net income (loss) adjustments: | | | | | | | | |
Income (loss) before income taxes of our international and structured finance insurance segment and eliminations | | | | ) | | | | ) |
Adjustments to income before income taxes of our U.S. public finance insurance and corporate segments: | | | | | | | | |
Mark-to-market gains (losses) on financial instruments (1) | | | | ) | | | | ) |
Foreign exchange gains (losses) (1) | | | | | | | | |
Net gains (losses) on sales of investments (1) | | | | | | | | |
Net investment losses related to impairments of securities | | | | | | | | ) |
Other net realized gains (losses) | | | | | | | | ) |
Adjusted net income adjustment to the (provision) benefit for income tax (2) | | | | | | | | |
| | | | | | | | | |
Adjusted net income (loss) | | $ | | ) | | $ | | |
| | | | | | | | | |
Adjusted net income (loss) per diluted common share (3) | | | | ) | | | | |
Gain (loss) related to our U.S. public finance insurance segment VIE consolidations included in adjusted net income (loss) | | | | | | | | ) |
Gain (loss) related to our U.S. public finance insurance segment VIE consolidations per diluted common share included in adjusted net income (loss) per diluted common share | | | | | | | | ) |
| (1) - | Reported within “Net gains (losses) on financial instruments at fair value and foreign exchange” on the Company’s consolidated statements of operations. |
| (2) - | Reported within “Provision (benefit) for income taxes” on the Company’s consolidated statements of operations. |
| (3) - | Adjusted net income (loss) per diluted common share is calculated by taking adjusted net income (loss) divided by the GAAP weighted average number of diluted common shares outstanding. |
Book Value Adjustments Per Share
In addition to GAAP book value per share, for internal purposes management also analyzes adjusted book value (“ABV”) per share, changes to which we view as an important indicator of financial performance. ABV is also used by management in certain components of management’s compensation. Since many of the Company’s investors and analysts continue to use ABV to evaluate MBIA’s share price and as the basis for their investment decisions, we present GAAP book value per share as well as the individual adjustments used by management to calculate its internal ABV metric.
Management adjusts GAAP book value to remove the book value of MBIA Corp. and for certain items which the Company believes will reverse from GAAP book value through GAAP earnings and comprehensive income, as well as 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 for which the likelihood and amount can be reasonably estimated. The following provides a description of management’s adjustments to GAAP book value:
| | • | Negative Book value of MBIA Corp. |
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS (continued)
| | • | Net unrealized (gains) losses on available-for-sale (“AFS”) securities excluding MBIA Corp. |
| | • | Net unearned premium revenue in excess of expected losses of National |
Since the Company has a full valuation allowance against its net deferred tax asset, the book value per share adjustments were adjusted by applying a zero effective tax rate.
The following table provides the Company’s GAAP book value per share and management’s adjustments to book value per share used in our internal analysis:
| | | | | | | | |
In millions except share and per share amounts | | | | | |
Total shareholders’ equity of MBIA Inc. | | $ | | | | $ | | |
Common shares outstanding | | | | | | | | |
GAAP book value per share | | $ | | | | $ | | |
Management’s adjustments described above: | | | | | | | | |
Remove negative book value per share of MBIA Corp. | | | | ) | | | | ) |
Remove net unrealized gains (losses) on available-for-sale securities included in other comprehensive income (loss) | | | | | | | | |
Include net unearned premium revenue in excess of expected losses | | | | | | | | |
U.S. Public Finance Insurance
Our U.S. public finance insurance portfolio is managed through National. The financial guarantees issued by National provide unconditional and irrevocable guarantees of the payment of the principal of, and interest or other amounts owing on, insured obligations when due or, in the event National has exercised, at its discretion, the right to accelerate the payment under its policies upon the acceleration of the underlying insured obligations due to default or otherwise. National’s guarantees insure municipal bonds, including
tax-exempt
and taxable indebtedness of U.S. political subdivisions, as well as utility districts, airports, healthcare institutions, higher educational facilities, student loan issuers, housing authorities and other similar agencies and obligations issued by private entities that finance projects that serve a substantial public purpose. Municipal bonds and privately issued bonds used for the financing of public purpose projects are generally supported by taxes, assessments, user fees or tariffs related to the use of these projects, lease payments or other similar types of revenue streams. As of March 31, 2020, National had total insured gross par outstanding of $47.4 billion.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS (continued)
National continues to monitor and remediate its existing insured portfolio and may also pursue strategic alternatives that could enhance shareholder value. Some state and local governments and territory obligors that National insures are experiencing financial and budgetary stress which may be exacerbated by
COVID-19.
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 the Company’s insured transactions. In particular, Puerto Rico had been experiencing significant fiscal stress and constrained liquidity, and in response, Congress passed the Puerto Rico Oversight, Management and Economic Stability Act (“PROMESA”), which established an independent Financial Oversight and Management Board for Puerto Rico (“Oversight Board”) vested with the sole power to certify fiscal plans for Puerto Rico. On January 1, 2020, Puerto Rico defaulted on scheduled debt service for National insured bonds and National paid gross claims in the aggregate of $59 million. As of March 31, 2020, National had $3.3 billion of debt service outstanding related to Puerto Rico. Refer to the “U.S. Public Finance Insurance Puerto Rico Exposures” section for additional information on PROMESA and our Puerto Rico exposures. We continue to monitor and analyze these situations and other stressed credits closely, and the overall extent and duration of stress affecting our insured credits remains uncertain.
The following table presents our U.S. public finance insurance segment results for the three months ended March 31, 2020 and 2019:
| | | | | | | | | | | | |
| | Three Months Ended
March 31, | | | |
| | | | | | | |
| | $ | | | | $ | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
Net gains (losses) on financial instruments at fair value and foreign exchange | | | | ) | | | | | | | | |
Net investment losses related to other-than-temporary impairments | | | | | | | | ) | | | | |
Other net realized gains (losses) | | | | | | | | | | | | |
Revenues of consolidated VIEs: | | | | | | | | | | | | |
Net gains (losses) on financial instruments at fair value and foreign exchange | | | | | | | | | | | | |
Other net realized gains (losses) | | | | | | | | ) | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | |
Losses and loss adjustment | | | | | | | | ) | | | | |
Amortization of deferred acquisition costs | | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | ) | | | | |
| | | | | | | | | | | | | |
Income (loss) before income taxes | | $ | | ) | | $ | | | | | | |
| | | | | | | | | | | | | |
n/m - Percent change not meaningful.
NET PREMIUMS EARNED Net premiums earned on financial guarantees represent gross premiums earned net of premiums ceded to reinsurers, and include scheduled premium earnings and premium earnings from refunded issues. The decrease in net premiums earned for the three months ended March 31, 2020 compared with the same period of 2019 resulted from a $2 million decrease in scheduled premiums earned and a $1 million decrease in refunded premiums earned. Refunding activity over the past several years has accelerated premium earnings in prior years and reduced the amount of scheduled premiums that would have been earned in the current year. In addition, in the first quarter of 2019, $1 million of premiums earned were eliminated in our consolidated financial statements as a result of the Company consolidating VIEs related to the COFINA transaction.
NET GAINS (LOSSES) ON FINANCIAL INSTRUMENTS AT FAIR VALUE AND FOREIGN EXCHANGE For the three months ended March 31, 2020, net gains (losses) on financial instruments at fair value and foreign exchange included fair value losses on securities due to a widening of credit spreads during the first quarter of 2020. For the three months ended March 31, 2019, net gains (losses) on financial instruments at fair value and foreign exchange included realized gains on the COFINA bonds owned by National as a result of the COFINA bond exchange and fair value gains on securities due to a decrease in interest rates during the first quarter of 2019.
NET INVESTMENT LOSSES RELATED TO OTHER-THAN-TEMPORARY IMPAIRMENTS Net investment losses related to OTTI for the three months ended March 31, 2019 were primarily related to an impaired security for which a credit loss was recognized in earnings. This OTTI resulted from adverse financial conditions of the issuer. This impaired security was sold during the first quarter of 2020.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS (continued)
REVENUES OF CONSOLIDATED VIEs VIEs within our U.S. public finance insurance segment included the Trusts established in connection with the COFINA Plan of Adjustment. For the three months ended March 31, 2019, total revenues of consolidated VIEs were losses of $15 million. This was primarily due to the loss on the initial consolidation of the COFINA VIEs in February of 2019, partially offset by net gains due to an increase in the fair value of collateral since consolidating the VIEs. We elected to record at fair value certain instruments that are consolidated under accounting guidance for consolidation of VIEs and, as such, changes in fair values of these instruments, which included investments held and debt issued, are reflected in earnings. During 2019, all remaining investment assets of the Trusts were sold and National elected to make a voluntary additional payment with the effect of simultaneously reducing the Trust’s debt obligations to zero and satisfying in full the obligations under its original insurance policies.
LOSS AND LOSS ADJUSTMENT EXPENSES Our U.S. public finance insured portfolio management group is responsible for monitoring our U.S. public finance segment’s insured obligations. The level and frequency of monitoring of any insured obligation depends on the type, size, rating and our assessed performance of the insured issue. Refer to “Note 5: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements for additional information related to the Company’s loss reserves.
For the three months ended March 31, 2020, losses and LAE primarily related to certain Puerto Rico exposures as well as an investor owned utility exposure.
For the three months ended March 31, 2019, the loss and LAE benefit primarily related to Puerto Rico exposures.
The following table presents information about our U.S. public finance insurance loss recoverable asset and loss and LAE reserves liabilities as of March 31, 2020 and December 31, 2019:
| | | | | | | | | | | | |
| | | | | | | |
| | | | | | | | | | | | |
Insurance loss recoverable | | $ | | | | $ | | | | | | |
Reinsurance recoverable on paid and unpaid losses (1) | | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
Insurance loss recoverable - ceded (2) | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | $ | | ) | | $ | | ) | | | | |
| | | | | | | | | | | | | |
| (1) - | Reported within “Other assets” on our consolidated balance sheets. |
| (2) - | Reported within “Other liabilities” on our consolidated balance sheets. |
The insurance loss recoverable as of March 31, 2020 increased compared with December 31, 2019 primarily as a result of expected recoveries related to claims paid on certain Puerto Rico exposures and changes in discount rates. Loss and LAE reserves as of March 31, 2020 increased compared with December 31, 2019 primarily due to a change in expected payments and the impact of changes in discount rates on our Puerto Rico reserves and, to a lesser extent, reserves related to an investor-owned utility exposure. This was partially offset by payments made related to certain Puerto Rico exposures.
POLICY ACQUISITION COSTS AND OPERATING EXPENSES U.S. public finance insurance segment expenses for the three months ended March 31, 2020 and 2019 are presented in the following table:
| | | | | | | | | | | | |
| | Three Months Ended March 31, | | | |
| | | | | |
| | $ | | | | $ | | | | | | |
| | | | | | | | | | | | | |
Amortization of deferred acquisition costs | | $ | | | | $ | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | |
Total insurance operating expenses | | $ | | | | $ | | | | | | |
| | | | | | | | | | | | | |
Gross expenses represent total insurance expenses before the deferral of any policy acquisition costs.
The decrease in the amortization of deferred acquisition costs were due to higher refunding activity in prior years. When an insured obligation refunds, we accelerate any remaining deferred acquisition costs associated with the policy covering the refunded insured obligation. We did not defer a material amount of policy acquisition costs during the first quarters of 2020 or 2019.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS (continued)
INSURED PORTFOLIO EXPOSURE Financial guarantee insurance companies use a variety of approaches to assess the underlying credit risk profile of their insured portfolios. National uses both an internally developed credit rating system as well as third-party rating sources in the analysis of credit quality measures of its insured portfolio. In evaluating credit risk, we obtain, when available, the underlying rating(s) of the insured obligation before the benefit of National’s insurance policy from nationally recognized rating agencies, Moody’s Investor Services (“Moody’s”) and Standard & Poor’s Financial Services LLC (“S&P”). Other companies within the financial guarantee industry may report credit quality information based upon internal ratings that would not be comparable to our presentation. We maintain internal ratings on our entire portfolio, and our ratings may be higher or lower than the underlying ratings assigned by Moody’s or S&P.
The following table presents the credit quality distribution of National’s U.S. public finance outstanding gross par insured as of March 31, 2020 and December 31, 2019. Capital appreciation bonds (“CABs”) are reported at the par amount at the time of issuance of the insurance policy. All ratings are as of the period presented and represent S&P underlying ratings, where available. If transactions are not rated by S&P, a Moody’s equivalent rating is used. If transactions are not rated by either S&P or Moody’s, an internal equivalent rating is used.
U.S. Public Finance Insurance Puerto Rico Exposures
The following is a summary of exposures within the insured portfolio of our U.S. public finance insurance segment related to Puerto Rico as of March 31, 2020.
| | | | | | | | | | | | |
| | | | | | | |
Puerto Rico Electric Power Authority (PREPA) | | $ | | | | $ | | | | | | |
Puerto Rico Commonwealth GO | | | | | | | | | | | | |
Puerto Rico Public Buildings Authority (PBA) (1) | | | | | | | | | | | | |
Puerto Rico Highway and Transportation Authority Transportation Revenue (PRHTA) | | | | | | | | | | | | |
Puerto Rico Highway and Transportation Authority - Subordinated Transportation Revenue (PRHTA) | | | | | | | | | | | | |
Puerto Rico Highway and Transportation Authority Highway Revenue (PRHTA) | | | | (2) | | | | | | | | |
University of Puerto Rico System Revenue | | | | | | | | | | | | |
Inter American University of Puerto Rico Inc. | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | $ | | | | $ | | | | | | |
| | | | | | | | | | | | | |
| (1) - | Additionally secured by the guarantee of the Commonwealth of Puerto Rico. |
| (2) - | Includes CABs that reflect the gross par amount at the time of issuance of the insurance policy. As of March 31, 2020, gross par outstanding plus CABs accreted interest was $56 million. |
On June 30, 2016, PROMESA was signed into law by the President of the United States. PROMESA provides for the creation of the Oversight Board with powers relating to the development and implementation of a fiscal plan for the Commonwealth and each of its instrumentalities as well as a court-supervised Title III process that allows Puerto Rico to restructure its debt if voluntary agreements cannot be reached with creditors through a collective action process.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS (continued)
On May 3, 2017, the Oversight Board certified and filed a petition under Title III of PROMESA for Puerto Rico with the District Court of Puerto Rico thereby commencing a bankruptcy-like case for the Commonwealth. Under separate petitions, the Oversight Board subsequently commenced Title III proceedings for COFINA, PRHTA, PREPA and PBA on May 5, 2017, May 21, 2017, July 2, 2017 and September 27, 2019, respectively. One of the proceedings was resolved on February 4, 2019, when the District of Puerto Rico entered the order confirming the Third Amended Title III Plan of Adjustment for COFINA. The plan became effective on February 12, 2019, and as of December 31, 2019, we no longer have exposure to COFINA. There can be no assurance that the other Title III proceedings will be resolved with similar outcomes.
As a result of prior defaults, various stays and the Title III cases, Puerto Rico failed to make certain scheduled debt service payments for National insured bonds. As a consequence, National has paid gross claims in the aggregate amount of $1.1 billion relating to general obligation (“GO”) bonds, PBA bonds, PREPA bonds and PRHTA bonds through March 31, 2020. Inclusive of the commutation payment and the additional payment in the amount of $66 million on December 17, 2019 related to COFINA, National has paid total gross claims in the aggregate amount of approximately $1.2 billion related to Puerto Rico.
On February 15, 2019, the United States Court of Appeals for the First Circuit held that the process PROMESA provides for the appointment of Oversight Board members is unconstitutional under the U.S. Constitution’s Appointments Clause. On June 20, 2019, the United States Supreme Court granted certification petitions. On July 2, 2019, the First Circuit granted the Oversight Board’s motion to stay the mandate pending the Supreme Court’s final disposition. The Supreme Court heard oral arguments on October 15, 2019 and a decision is not expected until later in 2020.
On May 2, 2019, the Oversight Board and the Official Committee of Unsecured Creditors of all Title III Debtors (other than COFINA) (the “Committee”) filed lien avoidance adversary complaints against several hundred defendants, including National, challenging the existence, extent, and enforceability of GO bondholders’ liens. After an approximately five-month stay of litigation entered by the Court on July 24, 2019, these adversary proceedings resumed pursuant to an interim schedule entered by the Court in December 2019. On February 5, 2020, National and Assured Guaranty Municipal Corp. filed a motion to dismiss the adversary proceeding. The adversary proceeding hearing was stayed indefinitely by further order of the Court.
On June 17, 2019, the Oversight Board announced it had reached a plan support agreement (“PSA”) with certain Commonwealth GO bondholders and guaranteed PBA bondholders on a framework for a plan of adjustment to resolve $35.0 billion worth of debt and unsecured claims against the Commonwealth. On February 9, 2020, the Oversight Board posted an amended PSA, which provides for faster debt maturities and increased creditor support than the originally filed PSA. The Oversight Board asserts that the amended PSA has the support of approximately $10.7 billion (or approximately 58%) in GO bonds and PBA bonds, and settles disputes regarding the validity of the 2011, 2012 and 2014 GO bonds without the need of a litigation trust as previously contemplated under the initial PSA. Under the amended PSA,
pre-2011
GO bond recoveries are 74.9% and
pre-2011
PBA recoveries are 77.6%. Bondholder recoveries will be in the form of both cash and new debt, and the new debt will be issued in the form of 50% GO debt and 50% COFINA junior debt. National is not a party to the amended PSA. The Commonwealth also does not support the revised PSA. The Oversight Board subsequently filed an amended Disclosure Statement and Plan of Adjustment on February 28, 2020. The motion to approve the Disclosure Statement was scheduled to be heard in
mid-June
of 2020. However, the Court adjourned the hearing until further notice due to the
COVID-19
crisis.
On July 24, 2019, Judge Swain entered an order staying certain adversary proceedings and contested matters until December 31, 2019, and imposing mandatory mediation under Judge Houser. Among the matters stayed in which National is either a party in interest or intervenor are the (i) PBA adversary proceeding seeking to recharacterize the PBA bonds as financings and (ii) GO adversary and HTA adversary proceedings, both challenging bondholder liens. Pursuant to interim schedules entered by the Court in December 2019, the PBA adversary proceeding and the HTA adversary proceeding were to remain stayed until March 11, 2020, but the Court subsequently stayed all such adversary proceedings indefinitely subject to the progress of the GO confirmation process.
On December 21, 2018, the Oversight Board filed an adversary complaint seeking to disallow the PBA’s administrative rent claims against the Commonwealth. The PBA bonds are payable from the rent the Commonwealth pays under its lease agreements with the PBA. The Oversight Board alleges that the Commonwealth has no obligation to make rent payments under section 365(d)(3) of the Bankruptcy Code and that the PBA is not entitled to a priority administrative expense claim under the leases. On April 16, 2019, Judge Swain entered an order setting a discovery schedule. The proceeding is currently stayed.
On September 27, 2019, the Oversight Board filed a Title III petition for the PBA.
National’s largest exposure to Puerto Rico, by gross par outstanding, is to PREPA.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS (continued)
On October 3, 2018, National, together with Assured Guaranty Corp., Assured Guaranty Municipal Corp., and Syncora Guarantee Inc. (collectively, “Movants”) filed a motion in the Title III case for PREPA for relief from the automatic stay to allow Movants to exercise their statutory right to have a receiver appointed at PREPA (the “Receiver Motion”). This motion is stayed pending a resolution of the 9019 Order, discussed below.
On May 3, 2019, PREPA, the Oversight Board, the Puerto Rico Fiscal Agency and Financial Advisory Authority (“AAFAF”), the Ad Hoc Group of PREPA bondholders (the “Ad Hoc Group”), and Assured Guaranty Corp. and Assured Guaranty Municipal Corp. (“Assured”) entered into the RSA which was amended on September 9, 2019 to include National and Syncora Guarantee, Inc. (“Syncora”) as supporting parties. Approximately 90% of PREPA’s bondholders have joined the RSA.
Among other things, the RSA contemplates a transaction pursuant to which, upon the effective date of a plan of adjustment, PREPA’s legacy bonds will be exchanged for new securitization bonds to be issued in two tranches. In addition, beginning on the last day of the month in which the order approving the RSA is entered, holders of bonds that are subject to the RSA will receive monthly settlement payments funded by a settlement charge to be included on customer bills (the “Settlement Payments”) until the effective date of a plan of adjustment for PREPA. The Settlement Payments are subject to increase if a plan of adjustment is not confirmed before March 31, 2021. The RSA provides that supporting parties will receive an administrative claim equal to interest accrued on certain of the securitization bonds, less the amount of any Settlement Payments made on account of such bonds, which administrative claim shall survive termination of the RSA. Additionally, pursuant to the RSA, supporting creditors will also receive certain fees and expense reimbursements. The RSA initially contemplated the filing of a plan of adjustment for PREPA by March 31, 2020; the timing of that action is now uncertain.
Pursuant to the RSA, the Oversight Board filed a Rule 9019 motion with the Title III court in May 2019 seeking approval of the RSA (the “Settlement Motion”) and a Motion to Dismiss the Receiver Motion. The RSA requires, upon entry of the order approving the Settlement Motion (the “9019 Order”), that Movants will withdraw the Receiver Motion, and the Ad Hoc Group will support such withdrawal. The Receiver Motion and the Motion to Dismiss the Receiver Motion have been delayed several times, and most recently were adjourned due to the outbreak of
COVID-19
until further notice. The Oversight Board and the Commonwealth have been ordered to submit a status report to the Title III court on May 15, 2020. The debt restructuring contemplated by the RSA will not be effective until (i) confirmation of a plan of adjustment under the Puerto Rico Oversight, Management and Economic Stability Act (“PROMESA”), (ii) negotiation and consummation of definitive documentation and legal opinions, (iii) enactment and implementation of supportive Puerto Rico legislation and (iv) receipt of Puerto Rico regulatory approval, each of which outcome is uncertain and subject to varying degrees of risk.
As contemplated by the RSA, on July 1, 2019 the Oversight Board and AAFAF also filed an adversary complaint against the Trustee for the PREPA Bonds, challenging the validity of the liens arising under the Trust Agreement that secure insured obligations of National. The adversary proceeding is stayed until the earlier of (a) 60 days after the Court denies the 9019 Motion, (b) consummation of a Plan, (c) 60 days after the filing by the Oversight Board and AAFAF of a Litigation Notice, or (d) further order of the Court.
Certain objectors to the RSA have filed adversary proceedings challenging the payment priority arising under the PREPA Trust Agreement, alleging that they are entitled to be paid in full before National and other bondholders have any lien on or recourse to PREPA’s assets, including pursuant to the RSA. All litigation on this matter has been stayed until the Court places the 9019 Motion back on the calendar for hearing.
On September 26, 2019, National sold its entire holding of uninsured PREPA bonds purchased in 2016 with a par value of $139 million.
On May 20, 2019, the Oversight Board and the Committee filed a lien avoidance adversary complaint against fiscal agents, holders, and insurers of certain PRHTA bonds, including National. The complaint challenges the extent and enforceability of certain security interests in PRHTA’s revenues. Pursuant to an interim schedule entered by the Court in December 2019, the Court has stayed the proceedings, with the understanding that the issues raised in these proceedings would be addressed in new adversary proceedings filed by the Oversight Board on January 16, 2020. Subsequent to those filings, these proceedings were stayed by order of the Court.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS
(continued)
On August 23, 2019, National and Assured (the “HTA Movants”) filed a motion in the Title III case for PRHTA for adequate protection or, in the alternative, relief from the automatic stay. The motion argues that the revenues securing the bonds insured by HTA Movants are being improperly diverted away from PRHTA, despite such revenues being the exclusive property of PRHTA and its bondholders. Pursuant to an interim schedule entered by the Court in December 2019, the HTA Movants, along with Ambac Assurance Corporation and FGIC, amended the motion on January 16, 2020. A preliminary hearing on the motion has been scheduled, at which time the Court will hear argument on issues of standing and HTA Movants’ property interest in the revenues that secure the bonds.
Status of Puerto Rico’s Fiscal Plans
On May 9, 2019, after requesting approval to amend its fiscal plans and the submission of several
non-compliant
versions by the Puerto Rico government, the Oversight Board certified its own revised fiscal plan for the Commonwealth. The revised fiscal plan reflects a cumulative surplus of $13.7 billion over the
six-year
projection period (after measures and structural reforms, but before contractual debt service). The new surplus is about $3.5 billion lower than the previous plan, which reflected a surplus of almost $17.0 billion. For the remaining component units, the Oversight Board certified fiscal plans for both PRHTA and the University of Puerto Rico (the “University”) on June 5, 2019, while certifying a revised Fiscal Plan for PREPA on June 27, 2019. The Oversight Board also certified the fiscal year 2020 budgets for Commonwealth, PREPA, the University and PRHTA. In January 2020, the Oversight Board requested that the Puerto Rico government submit a proposed updated Fiscal Plan for the Commonwealth in light of recent and recurring earthquakes and considering the Island’s current state of emergency. The Commonwealth submitted a revised fiscal plan on May 3, 2020. The Oversight Board has not established a date to certify the updated Fiscal Plan given the uncertainty of the
COVID-19
crisis.
University of Puerto Rico
The University is not a debtor in Title III and continues to be current on its debt service payment. However, the University is subject to a standstill agreement with its senior bondholders. The standstill agreement, which requires monthly transfers to the trustee in the amount of approximately $3.7 million, is scheduled to expire on May 25, 2020, unless otherwise extended. More recently, the University gave notice that it would not make its monthly transfers for March 2020 and April 2020, due to the
COVID-19
crisis. The parties agreed to amend the standstill agreement to delay the monthly transfer until May 2020. National is not a party to the Standstill Agreement.
Other than the Inter American University of Puerto Rico Inc., S&P, Fitch Ratings and/or Moody’s have downgraded the ratings of all Puerto Rico issuers to below investment grade with a negative outlook due to ongoing economic pressures, which will weigh on Puerto Rico’s ability to meet debt and other funding obligations, potentially driving bondholder recovery rates lower as restructuring the island’s debt burden unfolds.
In late December of 2019 into January of 2020, Puerto Rico experienced a series of earthquakes. An overall damage assessment of homes, public schools and other structures is ongoing. In response to the
COVID-19
pandemic, the Oversight Board approved in late March of 2020 an emergency measures support package amounting to $787 million. The Oversight Board funding source consists of $500 million from the fiscal year 2020 surplus, $157 million that will be
re-appropriated
from within the current fiscal year 2020 General Fund budget and the remaining $130 million will be covered by federal funds. The $787 million supplements any additional federal funding that Puerto Rico expects to receive under the CARES Act.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS
(continued)
The following table presents our scheduled gross debt service due on our Puerto Rico insured exposures for the nine months ending December 31, 2020, for each of the subsequent four years ending December 31 and thereafter:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
Puerto Rico Electric Power Authority (PREPA) | | $ | | | | $ | | | | $ | | | | $ | | | | $ | | | | $ | | | | $ | | |
Puerto Rico Commonwealth GO | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Puerto Rico Public Buildings Authority (PBA) | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Puerto Rico Highway and Transportation Authority Transportation Revenue (PRHTA) | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Puerto Rico Highway and Transportation Authority - Subordinated Transportation Revenue (PRHTA) | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Puerto Rico Highway and Transportation Authority Highway Revenue (PRHTA) | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
University of Puerto Rico System Revenue | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Inter American University of Puerto Rico Inc. | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | $ | | | | $ | | | | $ | | | | $ | | | | $ | | | | $ | | | | $ | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Our corporate segment consists of general corporate activities, including providing support services to MBIA Inc.’s subsidiaries and asset and capital management. Support services are provided by our service company, MBIA Services, and include, among others, management, legal, accounting, treasury, information technology, and insurance portfolio surveillance, on a
fee-for-service
basis. Capital management includes activities related to servicing obligations issued by MBIA Inc. and its subsidiaries, MBIA Global Funding, LLC (“GFL”) and MBIA Investment Management Corp. (“IMC”). MBIA Inc. issued debt to finance the operations of the MBIA group. GFL raised funds through the issuance of medium-term notes (“MTNs”) with varying maturities, which were in turn guaranteed by MBIA Corp. GFL lent the proceeds of these MTN issuances to MBIA Inc. IMC, along with MBIA Inc., provided customized investment agreements, guaranteed by MBIA Corp., for bond proceeds and other public funds for such purposes as construction, loan origination, escrow and debt service or other reserve fund requirements. The Company has ceased issuing new MTNs and investment agreements and the outstanding liability balances and corresponding asset balances have declined over time as liabilities matured, terminated or were called or repurchased. All of the debt within the corporate segment is managed collectively and is serviced by available liquidity.
The following table summarizes the consolidated results of our corporate segment for the three months ended March 31, 2020 and 2019:
| | | | | | | | | | | |
| | Three Months Ended March 31, | | | |
| | | | | | | | |
| | $ | | | | $ | | | | |
| | | | | | | | | | |
Net gains (losses) on financial instruments at fair value and foreign exchange | | | | ) | | | | ) | | |
Other net realized gains (losses) | | | | | | | | ) | | |
| | | | | | | | | | | |
| | | | ) | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | | |
Income (loss) before income taxes | | | | ) | | | | ) | | |
| | | | | | | | | | | |
n/m - Percent change not meaningful.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS
(continued)
NET GAINS (LOSSES) ON FINANCIAL INSTRUMENTS AT FAIR VALUE AND FOREIGN EXCHANGE The unfavorable change in net gains (losses) on financial instruments at fair value and foreign exchange for the three months ended March 31, 2020 compared with the same period of 2019 was primarily due to the impact of decreases in interest rates during 2020 on the fair values of interest rate swaps for which we receive floating rates. During 2019, we terminated a portion of these interest rate swaps. The termination amount paid in cash reflected the fair values of the swaps at termination date and all collateral held by the counterparty to the interest rate swaps was returned to the Company. The termination of these swaps was executed to reduce future exposure to interest rate movements.
OPERATING EXPENSES Operating expenses decreased for the three months ended March 31, 2020 compared with the same period of 2019 primarily due to a decrease in compensation expense.
International and Structured Finance Insurance
Our international and structured finance insurance portfolio is managed through MBIA Corp. The financial guarantees issued by MBIA Corp. generally provide unconditional and irrevocable guarantees of the payment of the principal of, and interest or other amounts owing on,
non-U.S.
public finance and global structured finance insured obligations when due or, in the event MBIA Corp. has the right, at its discretion, to accelerate insured obligations upon default or otherwise.
MBIA Corp. has insured sovereign-related and
sub-sovereign
bonds, privately issued bonds used for the financing of utilities, toll roads, bridges, airports, public transportation facilities, and other types of infrastructure projects serving a substantial public purpose. Global structured finance and asset-backed obligations typically are securities repayable from cash flows generated by a specified pool of assets, such as residential and commercial mortgages, insurance policies, consumer loans, corporate loans and bonds, trade and export receivables, and leases for equipment, aircraft and real estate property. MBIA Insurance Corporation insures the investment agreements written by MBIA Inc., and if MBIA Inc. were to have insufficient assets to pay amounts due upon maturity or termination, MBIA Insurance Corporation would be required to make such payments under its insurance policies. MBIA Insurance Corporation also insured debt obligations of other affiliates, including GFL, IMC and MZ Funding LLC (“MZ Funding”). MBIA Corp. has also written insurance policies guaranteeing the obligations under credit default swap (“CDS”) contracts of an affiliate, LaCrosse Financial Products, LLC and certain other derivative contracts. Certain policies cover payments potentially due under CDS, including termination payments that may become due in certain circumstances, including the occurrence of certain insolvency or payment defaults under the CDS or derivative contracts by the insured counterparty or by the guarantor. We no longer insure new CDS contracts except for transactions related to the restructuring of existing exposures. MBIA Insurance Corporation provides 100% reinsurance to MBIA Mexico S.A. de C.V. (“MBIA Mexico”).
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS
(continued)
MBIA Corp. has contributed to the Company’s net operating loss (“NOL”) carryforward, which is used in the calculation of our consolidated income taxes. If MBIA Corp. becomes profitable, it is not expected to make any tax payments under our tax sharing agreement. Based on MBIA Corp.’s current projected earnings and our expectation that it will not write significant new business, we believe it is unlikely that MBIA Corp. will generate significant income in the near future. As a result of MBIA Corp.’s capital structure and business prospects, we do not expect its financial performance to have a material economic impact on MBIA Inc.
The following table presents our international and structured finance insurance segment results for the three months ended March 31, 2020 and 2019:
| | | | | | | | | | | | |
| | Three Months Ended March 31, | | | |
| | | | | | | |
| | $ | | | | $ | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
Unrealized gains (losses) on insured derivatives | | | | | | | | | | | | |
Net gains (losses) on financial instruments at fair value and foreign exchange | | | | | | | | | | | | |
Other net realized gains (losses) | | | | | | | | | | | | |
Revenues of consolidated VIEs: | | | | | | | | | | | | |
| | | | | | | | | | | | |
Net gains (losses) on financial instruments at fair value and foreign exchange | | | | | | | | ) | | | | |
Other net realized gains (losses) | | | | ) | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | |
Losses and loss adjustment | | | | | | | | | | | | |
Amortization of deferred acquisition costs | | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
Expenses of consolidated VIEs: | | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | |
Income (loss) before income taxes | | | | ) | | | | ) | | | | |
| | | | | | | | | | | | | |
n/m - Percent change not meaningful.
As of March 31, 2020, MBIA Corp.’s total insured gross par outstanding was $9.1 billion.
NET PREMIUMS EARNED Our international and structured finance insurance segment generates net premiums from insurance policies accounted for as financial guarantee contracts. Certain premiums may be eliminated in our consolidated financial statements as a result of the Company consolidating VIEs. In addition, we generate net premiums from insured credit derivatives that are included in “Realized gains (losses) and other settlements on insured derivatives” on our consolidated statements of operations. The following table provides net premiums earned from our financial guarantee contracts for the three months ended March 31, 2020 and 2019:
| | | | | | | | | | | | |
| | Three Months Ended March 31, | | | | |
| | | | | | |
| | | | | | | | | | | | |
| | $ | | | | $ | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | |
Total net premiums earned | | $ | | | | $ | | | | | | |
| | | | | | | | | | | | | |
VIEs (eliminated in consolidation) | | $ | | | | $ | | | | | | |
| | | | | | | | | | | | | |
n/m—Percent change not meaningful.
Net premiums earned represent gross premiums earned net of premiums ceded to reinsurers, and include scheduled premium earnings and premium earnings from refunded issues. Net premiums earned decreased for the three months ended March 31, 2020 compared with the same period of 2019 primarily due to the runoff of the portfolio with no new business written. The negative $4 million of VIE net premiums earned eliminated in consolidation for the three months ended March 31, 2020 was primarily due to the termination of a policy, resulting in the reversal of previously eliminated net premiums in excess of cash received.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS
(continued)
UNREALIZED GAINS (LOSSES) ON INSURED DERIVATIVES For the three months ended March 31, 2019, unrealized gains on insured derivatives were principally due to the reversal of unrealized losses resulting from gross par amortization of insured transactions, partially offset by unfavorable changes in the estimated value of the remaining underlying collateral. Refer to “Note 8: Derivatives” in the Notes to Consolidated Financial Statements for additional information regarding our insured CDS credit.
NET GAINS (LOSSES) ON FINANCIAL INSTRUMENTS AT FAIR VALUE AND FOREIGN EXCHANGE The net gains on financial instruments at fair value and foreign exchange for the three months ended March 31, 2020 were primarily related to gains from foreign currency revaluations on Mexican peso denominated loss reserves as a result of the strengthening of the U. S. dollar, partially offset by losses from foreign currency revaluations on Chilean unidad de fomento denominated premium receivables as a result of the strengthening of the U.S. dollar.
REVENUES OF CONSOLIDATED VIEs The increase in revenues of consolidated VIEs for the three months ended March 31, 2020 compared with the same period of 2019 was primarily due to higher gains from putback claims on ineligible mortgage loans within a second-lien RMBS VIE, partially offset by credit losses on HTM investments held in a consolidated VIE.
LOSSES AND LOSS ADJUSTMENT EXPENSES Our international and structured finance insured portfolio management group is responsible for monitoring international and structured finance insured obligations. The level and frequency of monitoring of any insured obligation depends on the type, size, rating and our assessed performance of the insured issue. Refer to “Note 5: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements for a description of the Company’s loss reserving policy and additional information related to its loss reserves.
For the three months ended March 31, 2020, losses and LAE primarily related to a decrease in expected salvage collections related to CDOs. In addition, declines in the risk-free rates during the first quarter of 2020 increased the present value of loss reserves, primarily on our insured first-lien RMBS transactions. For the three months ended March 31, 2019, losses and LAE primarily related to increases in expected losses on insured first-lien RMBS transactions partially offset by an increase in projected collections from excess spread within insured second-lien RMBS securitizations. As a result of the consolidations of VIEs, losses and LAE includes the elimination of a losses and LAE benefit of $22 million for the three months ended March 31, 2020 and the elimination of losses and LAE expense of $14 million for the three months ended March 31, 2019.
The following table presents information about our insurance loss recoverable and reserves as of March 31, 2020 and December 31, 2019.
| | | | | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | | | | |
Insurance loss recoverable | | $ | | | | $ | | | | | | |
Reinsurance recoverable on paid and unpaid losses (1) | | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | $ | | | | $ | | | | | | |
| | | | | | | | | | | | | |
(1) - Reported within “Other assets” on our consolidated balance sheets.
Insurance loss recoverable primarily relates to reimbursement rights arising from the payment of claims on MBIA Corp.’s policies insuring certain CDOs. Such payments also entitle MBIA Corp. to exercise certain rights and remedies to seek recovery of its reimbursement entitlements. Refer to “Note 1: Business Developments and Risks and Uncertainties” in the Notes to Consolidated Financial Statements for additional information regarding our estimates of recoveries.
Refer to “Note 5: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements for additional information about our loss reserving policy, loss reserves and recoverables.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS
(continued)
POLICY ACQUISITION COSTS AND OPERATING EXPENSES International and structured finance insurance segment expenses for the three months ended March 31, 2020 and 2019 are presented in the following table:
| | | | | | | | | | | | |
| | Three Months Ended March 31, | | | |
| | | | | | | |
| | $ | | | | $ | | | | | | |
| | | | | | | | | | | | | |
Amortization of deferred acquisition costs | | $ | | | | $ | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | |
Total insurance operating expenses | | $ | | | | $ | | | | | | |
| | | | | | | | | | | | | |
Gross expenses represent total insurance expenses before the deferral of any policy acquisition costs.
The decrease in the amortization of deferred acquisition costs for the three months ended March 31, 2020 compared with the same period of 2019 was due to higher refunding activity in prior years. We did not defer a material amount of policy acquisition costs during the first quarters of 2020 or 2019. Policy acquisition costs in these periods were primarily related to ceding commissions and premium taxes on installment policies written in prior periods.
International and Structured Finance Insurance Portfolio Exposures
The credit quality of our international and structured finance insured portfolio is assessed in the same manner as our U.S. public finance insured portfolio. As of March 31, 2020 and December 31, 2019, 29% and 27%, respectively, of our international and structured finance insured portfolio was rated below investment grade, before giving effect to MBIA’s guarantees, based on MBIA’s internal ratings, which are generally more current than the underlying ratings provided by S&P and Moody’s for this subset of our insured portfolio.
Selected Portfolio Exposures
The following is a summary of selected significant exposures within our residential mortgage insured portfolio of our international and structured finance insurance segment. In addition, as of March 31, 2020, MBIA Corp. insured $304 million of CDOs and related instruments. We may experience considerable incurred losses in certain of these sectors. There can be no assurance that the loss reserves recorded in our financial statements will be sufficient or that we will not experience losses on transactions on which we currently have no loss reserves, in particular if the economy deteriorates. We may seek to purchase, directly or indirectly, obligations guaranteed by MBIA Corp. or seek to commute policies. The amount of insurance exposure reduced, if any, and the nature of any such actions will depend on market conditions, pricing levels from time to time, and other considerations. In some cases, these activities may result in a reduction of loss reserves, but in all cases they are intended to limit our ultimate losses and reduce the future volatility in loss development on the related policies. Our ability to purchase guaranteed obligations and to commute policies will depend on management’s assessment of available liquidity.
Residential Mortgage Exposure
MBIA Corp. insures RMBS backed by residential mortgage loans, including second-lien RMBS transactions (revolving home equity lines of credit (“HELOC”) loans and
closed-end
second (“CES”) mortgages). MBIA Corp. also insures MBS backed by first-lien alternative
A-paper
(“Alt-A”)
and subprime mortgage loans directly through RMBS securitizations. The following table presents the gross par outstanding of MBIA Corp.’s total direct RMBS insured exposure as of March 31, 2020 and December 31, 2019. Amounts include the gross par outstanding related to transactions that the Company consolidates under accounting guidance for VIEs.
| | | | | | | | | | | | |
| | Gross Par Outstanding as of | | | | |
| | | | | | |
| | | | | | | | | |
| | $ | | | | $ | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
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| | | | | | | | | | | | | |
| | $ | | | | $ | | | | | | |
| | | | | | | | | | | | | |
| | (1) | - Includes international exposure of $210 million and $248 million as of March 31, 2020 and December 31, 2019, respectively. |
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS
(continued)
U.S. Public Finance and International and Structured Finance Reinsurance
Reinsurance enables the Company to cede exposure for purposes of syndicating risk. The Company generally retains the right to reassume the business ceded to reinsurers under certain circumstances, including a reinsurer’s rating downgrade below specified thresholds. Currently, we do not intend to use reinsurance to decrease the insured exposure in our portfolio.
As of March 31, 2020, the aggregate amount of insured par outstanding ceded by MBIA to reinsurers under reinsurance agreements was $1.6 billion compared with $1.8 billion as of December 31, 2019. Under National’s reinsurance agreement with MBIA Corp., if a reinsurer of MBIA Corp. is unable to pay claims ceded by MBIA Corp. on U.S. public finance exposure, National will assume liability for such ceded claim payments. For a further discussion of the Company’s reinsurance, refer to “Note 13: Insurance in Force” in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form
10-K
for the year ended December 31, 2019.
Provision for Income Taxes
The Company’s income taxes and the related effective tax rates for the three months ended March 31, 2020 and 2019 are presented in the following table:
| | | | | | | | |
| | Three Months Ended March 31, |
| | | | | |
Income (loss) before income taxes | | $ | | ) | | $ | | ) |
Provision (benefit) for income taxes | | $ | | | | $ | | |
| | | | | | | | |
For the three months ended March 31, 2020 and 2019, our effective tax rate applied to our loss before income taxes was lower than the U.S. statutory tax rate of 21% due to the full valuation allowance on the changes in our net deferred tax asset.
As of March 31, 2020 and December 31, 2019, the Company’s valuation allowance against its net deferred tax asset was $923 million and $873 million, respectively. Notwithstanding the full valuation allowance on its net deferred tax asset, the Company believes that it may be able to use some of its net deferred tax asset before the expirations associated with that asset based upon expected earnings at National and potential future sources of taxable income to be identified by the Company. Accordingly, the Company will continue to
re-evaluate
its net deferred tax asset on a quarterly basis. There is no assurance that the Company will reverse any of its valuation allowance on its net deferred tax asset in the future. Refer to “Note 9: Income Taxes” in the Notes to Consolidated Financial Statements for a further discussion of income taxes, including the valuation allowance against the Company’s net deferred tax asset and its accounting for tax uncertainties.
The CARES Act established new tax provisions including, but not limited to: (1) five-year carryback of NOLs generated in 2018, 2019 and 2020; (2) accelerated refund of alternative minimum tax (“AMT”) credit carryforwards; and (3) retroactive changes to allow accelerated depreciation for certain depreciable property. The legislation does not have a material impact on the Company’s tax positions due to the lack of taxable income in the carryback periods. The Company expects to receive a cash benefit for its remaining AMT credits in 2020 as provided by the CARES Act.
The Company manages its capital resources to minimize its cost of capital while maintaining appropriate claims-paying resources (“CPR”) for National and MBIA Corp. The Company’s capital resources consist of total shareholders’ equity, total debt issued by MBIA Inc. for general corporate purposes, surplus notes issued by MBIA Corp., and MBIA Corp.’s financing facility between MZ Funding LLC (“MZ Funding”) and certain purchasers, pursuant to which the purchasers or their affiliates agreed to refinance the outstanding insured senior notes of MZ Funding (“Refinanced Facility”). Total capital resources were $2.1 billion and $2.4 billion as of March 31, 2020 and December 31, 2019, respectively.
In addition to scheduled debt maturities, from time to time, we reduce unsecured debt through calls or repurchases. Also, MBIA Inc. may repurchase or National may purchase outstanding MBIA Inc. common shares when we deem it beneficial to our shareholders. Purchases or repurchases of debt and common stock may be made from time to time in the open market or in private transactions as permitted by securities laws and other legal requirements. We may also choose to redeem debt obligations where permitted by the relevant agreements. MBIA Inc. or National may acquire or redeem outstanding common shares of MBIA Inc. and outstanding debt obligations at prices when we deem it beneficial to our shareholders.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
CAPITAL RESOURCES
(continued)
MBIA Inc. supports the MTN and investment agreement obligations issued by the Company. We seek to maintain sufficient liquidity and capital resources to meet the Company’s general corporate needs and debt service. Based on MBIA Inc.’s debt service requirements and expected operating expenses, we expect that MBIA Inc. will have sufficient resources to satisfy its debt obligations and its general corporate needs over time from distributions from its operating subsidiaries; however, there can be no assurance that MBIA Inc. will have sufficient resources to do so. In addition, the Company may also consider raising third-party capital. Refer to “Capital, Liquidity and Market Related Risk Factors” in Part I, Item 1A of Form
10-K
for the year ended December 31, 2019 and the “Liquidity—Corporate Liquidity” section included herein for additional information about MBIA Inc.’s liquidity.
MBIA Inc.’s and National’s share purchases or repurchases that were authorized under our share repurchase program for the three months ended March 31, 2020 and 2019 are presented in the following table:
| | | | | | | | |
In millions except per share amounts | | Three Months Ended March 31, | |
| | | | | | |
Number of shares purchased or repurchased | | | | | | | | |
Average price paid per share | | $ | | | | $ | | |
Remaining authorization as of March 31 | | $ | | | | $ | | |
Insurance Statutory Capital
National and MBIA Insurance Corporation are incorporated and licensed in, and are subject to primary insurance regulation and supervision by New York State Department of Financial Services (“NYSDFS”). MBIA Mexico is regulated by the Comisión Nacional de Seguros y Fianzas in Mexico. MBIA Corp.’s Spanish Branch is subject to local regulation in Spain. National and MBIA Insurance Corporation each are required to file detailed annual financial statements, as well as interim financial statements, with the NYSDFS and similar supervisory agencies in each of the other jurisdictions in which it is licensed. These financial statements are prepared in accordance with New York State and the National Association of Insurance Commissioners’ statements of U.S. STAT and assist our regulators in evaluating minimum standards of solvency, including minimum capital requirements, and business conduct.
National had statutory capital of $2.1 billion as of March 31, 2020 compared with $2.4 billion as of December 31, 2019. As of March 31, 2020, National’s unassigned surplus was $1.0 billion. For the three months ended March 31, 2020, National had a statutory loss of $80 million. Refer to the “Claims-Paying Resources (Statutory Basis)” section below for additional information on National’s statutory capital.
In order to maintain its New York State financial guarantee insurance license, National is required to maintain a minimum of $65 million of policyholders’ surplus. National is also required to maintain contingency reserves to provide protection to policyholders in the event of extreme losses in adverse economic events.
New York Insurance Law (“NYIL”) regulates the payment of dividends by financial guarantee insurance companies and provides that such companies may not declare or distribute dividends except out of statutory earned surplus. Under NYIL, the sum of (i) the amount of dividends declared or distributed during the preceding
12-month
period and (ii) the dividend to be declared may not exceed the lesser of (a) 10% of policyholders’ surplus, as reported in the latest statutory financial statements or (b) 100% of adjusted net investment income for such
12-month
period (the net investment income for such
12-month
period plus the excess, if any, of net investment income over dividends declared or distributed during the
two-year
period preceding such
12-month
period), unless the Superintendent of the NYSDFS approves a greater dividend distribution based upon a finding that the insurer will retain sufficient surplus to support its obligations.
National had positive earned surplus as of March 31, 2020 from which it may pay dividends, subject to the limitations described above. We expect the
as-of-right
declared and paid dividend amounts from National to be limited to prior year adjusted net investment income for the foreseeable future.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
CAPITAL RESOURCES
(continued)
Claims-Paying Resources (Statutory Basis)
CPR is a key measure of the resources available to National to pay claims under its insurance policies. CPR consists of total financial resources and reserves calculated on a statutory basis. CPR has been a common measure used by financial guarantee insurance companies to report and compare resources and continues to be used by MBIA’s management to evaluate changes in such resources. We have provided CPR to allow investors and analysts to evaluate National using the same measure that MBIA’s management uses to evaluate National’s resources to pay claims under its insurance policies. There is no directly comparable GAAP measure. Our calculation of CPR may differ from the calculation of CPR reported by other companies.
National’s CPR and components thereto, as of March 31, 2020 and December 31, 2019 are presented in the following table:
| | | | | | | | |
| | | | | | |
| | | | | | |
| | $ | | | | $ | | |
| | | | | | | | |
| | | | | | | | | |
| | | | | | | | |
| | | | | | | | |
Present value of installment premiums (1) | | | | | | | | |
| | | | | | | | | |
| | | | | | | | |
Net loss and LAE reserves (1) | | | | | | | | |
| | | | | | | | |
| | | | | | | | | |
Gross loss and LAE reserves | | | | | | | | |
| | | | | | | | | |
Total claims-paying resources | | $ | | | | $ | | |
| | | | | | | | | |
(1) - Calculated using a discount rate of 3.64% as of March 31, 2020 and December 31, 2019.
(2) - Includes financial guarantee and insured derivative related premiums.
MBIA Insurance Corporation
MBIA Insurance Corporation had statutory capital of $382 million as of March 31, 2020 compared with $476 million as of December 31, 2019. As of March 31, 2020, MBIA Insurance Corporation’s negative unassigned surplus was $1.8 billion. For the three months ended March 31, 2020, MBIA Insurance Corporation had a statutory net loss of $91 million. Refer to the “Claims-Paying Resources (Statutory Basis)” section below for additional information on MBIA Insurance Corporation’s statutory capital.
As of March 31, 2020, MBIA Insurance Corporation recognized estimated recoveries on a statutory basis related to
put-back
claims against Credit Suisse, excess spread recoveries on RMBS and recoveries related to CDOs. There can be no assurance that we will be successful or that we will not be delayed in realizing these recoveries. Refer to “Note 5: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements for additional information about these recoveries.
In order to maintain its New York State financial guarantee insurance license, MBIA Insurance Corporation is required to maintain a minimum of $65 million of policyholders’ surplus. As of March 31, 2020, MBIA Corp. met the required minimum requirement. Under NYIL, MBIA Insurance Corporation is required to invest its minimum surplus and contingency reserves and 50% of its loss reserves and unearned premium reserves in certain qualifying assets. As of March 31, 2020, MBIA Insurance Corporation maintained its minimum requirement of policyholders’ surplus but did not have enough qualifying assets to support its contingency reserves and 50% of its loss reserves and unearned premium reserves. As of March 31, 2020, MBIA Insurance Corporation was in compliance with its aggregate risk limits under the NYIL, but was not in compliance with certain of its single risk limits. If MBIA Insurance Corporation does not comply with the above mentioned requirements, the NYSDFS may prevent MBIA Insurance Corporation from transacting any new financial guarantee insurance business until it no longer exceeds the limitations.
Due to its significant earned surplus deficit, MBIA Insurance Corporation has not had the statutory capacity to pay dividends since December 31, 2009. Based on estimated future income, MBIA Insurance Corporation is not expected to have any statutory capacity to pay dividends.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
CAPITAL RESOURCES (continued)
The NYSDFS has not approved MBIA Insurance Corporation’s requests to make interest payments on MBIA Insurance Corporation’s 14%
Fixed-to-Floating
Rate Surplus Notes due January 15, 2033 (the “Surplus Notes”) since, and including, the January 15, 2013 interest payment. The NYSDFS has cited both MBIA Insurance Corporation’s liquidity and financial condition as well as the availability of “free and divisible surplus” as the basis for such
non-approvals.
As of April 15, 2020, the most recent scheduled interest payment date, there was $919 million of unpaid interest on the par amount outstanding of $953 million of the Surplus Notes. Under Section 1307 of the NYIL and the Fiscal Agency Agreement governing the surplus notes, Surplus Note payments may be made only with the prior approval by the NYSDFS and if MBIA Insurance Corporation has sufficient “Eligible Surplus”, or as we believe, “free and divisible surplus” as an appropriate calculation of “Eligible Surplus.” As of March 31, 2020, MBIA Insurance Corporation had “free and divisible surplus” of $188 million. There is no assurance the NYSDFS will approve Surplus Note payments, notwithstanding the sufficiency of MBIA Insurance Corporation’s liquidity and financial condition. The unpaid interest on the Surplus Notes will become due on the first business day on or after which MBIA Insurance Corporation obtains approval to pay some or all of such unpaid interest. No interest has been accrued or will accrue on the deferred interest.
Claims-Paying Resources (Statutory Basis)
CPR is a key measure of the resources available to MBIA Corp. to pay claims under its insurance policies. CPR consists of total financial resources and reserves calculated on a statutory basis. CPR has been a common measure used by financial guarantee insurance companies to report and compare resources, and continues to be used by MBIA’s management to evaluate changes in such resources. We have provided CPR to allow investors and analysts to evaluate MBIA Corp., using the same measure that MBIA’s management uses to evaluate MBIA Corp.’s resources to pay claims under its insurance policies. There is no directly comparable GAAP measure. Our calculation of CPR may differ from the calculation of CPR reported by other companies.
MBIA Corp.’s CPR and components thereto, as of March 31, 2020 and December 31, 2019 are presented in the following table:
| | | | | | | | |
| | | | | | |
| | | | | | |
| | $ | | | | $ | | |
| | | | | | | | |
| | | | | | | | | |
| | | | | | | | |
| | | | | | | | |
Present value of installment premiums (1) (4) | | | | | | | | |
| | | | | | | | | |
| | | | | | | | |
Net loss and LAE reserves (1) | | | | | | | | |
| | | | | | | | |
| | | | | | | | | |
Gross loss and LAE reserves | | | | | | | | |
| | | | | | | | | |
Total claims-paying resources | | $ | | | | $ | | |
| | | | | | | | | |
(1) - Calculated using a discount rate of 5.21% as of March 31, 2020 and December 31, 2019.
(2) - Includes financial guarantee and insured credit derivative related premiums.
(3) - This amount primarily consists of expected recoveries related to the Company’s CDOs, excess spread and
put-backs.
(4) - Based on the Company’s estimate of the remaining life for its insured exposures.
We use a liquidity risk management framework, the primary objective of which is to match liquidity resources to needs. We monitor our cash and liquid asset resources using cash forecasting and stress-scenario testing. Members of MBIA’s senior management meet regularly to review liquidity metrics, discuss contingency plans and establish target liquidity levels. We evaluate and manage liquidity on a legal-entity basis to take into account the legal, regulatory and other limitations on available liquidity resources within the enterprise. Additionally, we continue to monitor the current
COVID-19
pandemic with respect to our cash and liquid asset positions and resources. It remains premature to predict the full impact the pandemic may have on our future liquidity position and needs. Refer to the ”Executive Overview — COVID-19” section for additional information about liquidity and
COVID-19.
The following is a discussion of our liquidity resources and requirements for our holding company and our insurance subsidiaries.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The primary sources of cash available to National are:
| | • | principal and interest receipts on assets held in its investment portfolio, including proceeds from the sale of assets; |
| | • | recoveries associated with insurance loss payments; and |
The primary uses of cash by National are:
| | • | loss payments and LAE on insured transactions; |
| | • | payments of dividends; and |
| | • | payments of operating expenses, taxes and investment portfolio asset purchases. |
As of March 31, 2020 and December 31, 2019, National held cash and investments of $2.5 billion and $2.7 billion, respectively, of which $399 million and $442 million, respectively, were cash and cash equivalents or short-term investments comprised of highly rated commercial paper, money market funds and municipal, U.S. agency and corporate bonds.
The insurance policies issued or reinsured by National provide unconditional and irrevocable guarantees of payments of the principal of, and interest or other amounts owing on, insured obligations when due. In the event of a default in payment of principal, interest or other insured amounts by an issuer, National generally promises to make funds available in the insured amount within one to three business days following notification. In some cases, the amount due can be substantial, particularly if the default occurs on a transaction to which National has a large notional exposure or on a transaction structured with large, bullet-type principal maturities. The U.S. public finance insurance segment’s financial guarantee contracts generally cannot be accelerated by a party other than the insurer which helps to mitigate liquidity risk in this segment.
The primary sources of cash available to MBIA Inc. are:
| | • | dividends from National; |
| | • | available cash and liquid assets not subject to collateral posting requirements; |
| | • | principal and interest receipts on assets held in its investment portfolio, including proceeds from the sale of assets; |
| | • | release of funds under the tax sharing agreement; and |
| | • | access to capital markets. |
The primary uses of cash by MBIA Inc. are:
| | • | servicing outstanding unsecured corporate debt obligations and MTNs; |
| | • | meeting collateral posting requirements under investment agreements and derivative arrangements; |
| | • | payments related to interest rate swaps; |
| | • | payments of operating expenses; and |
| | • | funding share repurchases and debt buybacks. |
As of March 31, 2020 and December 31, 2019, the liquidity positions of MBIA Inc. were $314 million and $375 million, respectively, and included cash and cash equivalents and other investments comprised of highly rated commercial paper and U.S. government and asset-backed bonds.
During the three months ended March 31, 2020, $33 million was returned to National as a result of losses incurred in 2019, of which $9 million was in cash. The return was pursuant to the terms of the tax sharing agreement following the expiration of National’s
two-year
NOL carry-back period under U.S. tax rules. Under the CARES Act, National’s 2019 taxable loss is subject to a five-year NOL carry-back, which allows it to recover taxes paid in years in which the tax rate was 35%. Similarly, a taxable loss generated in 2020 will be subject to a five-year NOL carry-back under the CARES Act, after which the
two-year
NOL carry-back provision will again become effective. In addition to releases or returns following the expiration of National’s NOL carry-back period, from time to time, MBIA Inc. is permitted to withdraw assets from the Tax Escrow Account if the aggregate market value of all assets held in the Tax Escrow Account exceeds the required minimum balance. There can be no assurance that any future payments under the Tax Escrow Account from subsidiaries will be released to MBIA Inc. due to deductible or creditable tax attributes of those subsidiaries and/or the market value performance of the assets supporting the Tax Escrow Account.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Based on our projections of National’s and MBIA Corp.’s future earnings and losses, we expect that for the foreseeable future National will be the primary source of payments to MBIA Inc. There can be no assurance as to the amount and timing of any such future dividends or payments from the tax escrow account under the tax sharing agreement. Also, absent a special dividend subject to the approval of the NYSDFS, we expect the declared and paid dividend amounts from National to be limited to the prior twelve months of adjusted net investment income as reported in its most recent statutory filings. Refer to the “Capital Resources – Insurance Statutory Capital” section for additional information on payments of dividends. We do not expect MBIA Inc. to receive distributions from MBIA Corp.
Currently, a significant portion of the cash and securities held by MBIA Inc. is pledged against investment agreement liabilities, the Asset Swap (simultaneous repurchase and reverse repurchase agreement) and derivatives, which limits its ability to raise liquidity through asset sales. As the market value or rating eligibility of the assets which are pledged against MBIA Inc.’s obligations declines, we are required to pledge additional eligible assets in order to meet minimum required collateral amounts against these liabilities. To mitigate these risks, we seek to maintain cash and liquidity resources that we believe will be sufficient to make all payments due on our obligations and to meet other financial requirements, such as posting collateral. Contingent liquidity resources include: (1) sales of invested assets exposed to credit spread stress risk, which may occur at losses; (2) termination and settlement of interest rate swap agreements; and (3) accessing the capital markets. These actions, if taken, are expected to result in either additional liquidity or reduced exposure to adverse credit spread movements. There can be no assurance that these actions will be sufficient to fully mitigate this risk.
The primary sources of cash available to MBIA Corp. are:
| | • | recoveries associated with insurance loss payments; |
| | • | installment premiums and fees; and |
| | • | principal and interest receipts on assets held in its investment portfolio, including the proceeds from the sale of assets. |
The primary uses of cash by MBIA Corp. are:
| | • | loss and LAE or commutation payments on insured transactions; |
| | • | repayment of the Refinanced Facility; and |
| | • | payments of operating expenses. |
As of March 31, 2020 and December 31, 2019, MBIA Corp. held cash and investments of $221 million and $230 million, respectively, of which $120 million and $124 million, respectively, were cash and cash equivalents or liquid investments comprised of money market funds and municipal, U.S. Treasury and corporate bonds that were immediately available to MBIA Insurance Corporation.
Insured transactions that require payment of scheduled debt service payments insured when due or payment in full of the principal insured at maturity could present liquidity risk for MBIA Corp., as any salvage recoveries from such payments could be recovered over an extended period of time after the payment is made. MBIA Corp. is generally required to satisfy claims within one to three business days, and as a result seeks to identify potential claims in advance through our monitoring process. In order to monitor liquidity risk and maintain appropriate liquidity resources, we use the same methodology as we use to monitor credit quality and losses within our insured portfolio, including stress scenarios. Refer to “Note 5: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements for a discussion of our loss process.
During the three months ended March 31, 2020, MBIA Corp. requested and was denied permission by the NYSDFS to prepay approximately $26 million of the Refinanced Facility.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Information about our consolidated cash flows by category is presented on our consolidated statements of cash flows. The following table presents a summary of our consolidated cash flows for the three months ended March 31, 2020 and 2019:
| | | | | | | | | | | | |
| | Three Months Ended March 31, | | | |
| | | | | | | |
Statement of cash flow data: | | | | | | | | | | | | |
Net cash provided (used) by: | | | | | | | | | | | | |
| | $ | | ) | | $ | | ) | | | | |
| | | | | | | | | | | | |
| | | | ) | | | | ) | | | | |
Cash and cash equivalents - beginning of period | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Cash and cash equivalents - end of period | | $ | | | | $ | | | | | | |
| | | | | | | | | | | | | |
n/m - Percent change not meaningful.
Net cash used by operating activities increased for the three months ended March 31, 2020 compared with the same period of 2019 primarily due to a decrease in proceeds from recoveries and reinsurance of $50 million, partially offset by decreases in interest paid, net of interest converted to principal of $23 million, and losses and LAE paid of $20 million.
Net cash provided by investing activities increased for the three months ended March 31, 2020 compared with the same period of 2019 primarily due to increases in proceeds from short-term investment activity of $332 million and repayments of
held-to-maturity
investments of $315 million, partially offset by decreases in sales of investments of $88 million and repayments and maturities of loans receivable of $72 million.
Net cash used by financing activities increased for the three months ended March 31, 2020 compared with the same period of 2019 primarily due to increases in principal repayments of VIE notes of $155 million and purchases of treasury stock of $52 million.
The following discussion of investments, including references to consolidated investments, excludes investments reported under “Assets of consolidated variable interest entities” on our consolidated balance sheets. Investments of VIEs support the repayment of VIE obligations and are not available to settle obligations of MBIA. Our AFS investments comprise high-quality fixed-income securities and short-term investments. Refer to “Note 7: Investments” in the Notes to Consolidated Financial Statements for detailed discussion about our investments.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following table presents our investment portfolio as of March 31, 2020 and December 31, 2019:
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Available-for-sale investments: (1) | | | | | | | | | | | | |
U.S. public finance insurance: | | | | | | | | | | | | |
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Unrealized net gain (loss) | | | | | | | | | | | | |
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Unrealized net gain (loss) | | | | | | | | | | | | |
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International and structured finance insurance: | | | | | | | | | | | | |
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Unrealized net gain (loss) | | | | | | | | | | | | |
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Total available-for-sale investments: | | | | | | | | | | | | |
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Unrealized net gain (loss) | | | | | | | | | | | | |
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Total available-for-sale investments at fair value | | | | | | | | | | | | |
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Investments carried at fair value: (2) | | | | | | | | | | | | |
U.S. public finance insurance | | | | | | | | | | | | |
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International and structured finance insurance | | | | | | | | | | | | |
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Total investments carried at fair value | | | | | | | | | | | | |
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Consolidated investments at carrying value | | $ | | | | $ | | | | | | |
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(1) -
Non-credit
related unrealized gains and losses, net of applicable deferred income taxes, are reflected in accumulated other comprehensive income in shareholders’ equity. The credit related component is reported in earnings.
(2) - Changes in fair value and realized gains and losses from the sale of these investments are reflected in net income.
The fair value of the Company’s investments is based on prices which include quoted prices in active markets and prices based on market-based inputs that are either directly or indirectly observable, as well as prices from dealers in relevant markets. Differences between fair value and amortized cost arise primarily as a result of changes in interest rates and general market credit spreads occurring after a fixed-income security is purchased, although other factors may also influence fair value, including specific credit-related changes, supply and demand forces and other market factors. When the Company holds an AFS investment to maturity, any
non-credit
related unrealized gain or loss currently recorded in accumulated other comprehensive income (loss) in the shareholders’ equity section of the balance sheet is reversed. As a result, the Company would realize a value substantially equal to amortized cost. However, when investments are sold prior to maturity, the Company will realize any difference between amortized cost and the sale price of an investment as a realized gain or loss within its consolidated statements of operations.
Item 2
.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The credit quality distribution of the Company’s AFS fixed-maturity investment portfolios, excluding short-term investments, are based on ratings from Moody’s and alternate ratings sources, such as S&P or the best estimate of the ratings assigned by the Company, have been used for a small percentage of securities that are not rated by Moody’s. As of March 31, 2020, the weighted average credit quality ratings and percentage of investment grade of the Company’s AFS fixed-maturity investment portfolios, excluding short-term investments, are presented in the following table:
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Weighted average credit quality ratings | | | | | | | | | | | | | | | | |
Investment grade percentage | | | | | | | | | | | | | | | | |
MBIA’s consolidated investment portfolio includes investments that are insured by various financial guarantee insurers (“Insured Investments”), including investments insured by National and MBIA Corp. (“Company-Insured Investments”). When purchasing Insured Investments, the Company’s third-party portfolio manager independently assesses the underlying credit quality, structure and liquidity of each investment, in addition to the creditworthiness of the insurer. Insured Investments are diverse by sector, issuer and size of holding. The third-party portfolio manager assigns underlying ratings to Insured Investments without giving effect to financial guarantees based on underlying ratings assigned by Moody’s or S&P, when a rating is not published by Moody’s. When a Moody’s or S&P underlying rating is not available, the underlying rating is based on the portfolio manager’s best estimate of the rating of such investment. A downgrade of a financial guarantee insurer has historically had an adverse effect on the fair value of investments insured by the downgraded financial guarantee insurer. If the Company determines that declines in the fair values of Insured Investments are related to credit loss, the Company will establish an allowance for credit losses and recognize the credit component through earnings.
As of March 31, 2020, Insured Investments at fair value represented $241 million or 8% of consolidated investments, of which $216 million or 7% of consolidated investments were Company-Insured Investments. As of March 31, 2020, based on the actual or estimated underlying ratings of our consolidated investment portfolio, without giving effect to financial guarantees, the weighted average rating of only the Insured Investments in the investment portfolio would be in the below investment grade range. Without giving effect to the National and MBIA Corp. guarantees of the Company-Insured Investments in the consolidated investment portfolio, as of March 31, 2020, based on actual or estimated underlying ratings, the weighted average rating of the consolidated investment portfolio was in the Aa range. The weighted average rating of only the Company-Insured Investments was in the below investment grade range, and investments rated below investment grade in the Company-Insured Investments were 6% of the total consolidated investment portfolio.
For a discussion of the Company’s contractual obligations, refer to “Liquidity-Contractual Obligations” in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in the Company’s Annual Report on Form
10-K
for the year ended December 31, 2019. There were no material changes in contractual obligations since December 31, 2019.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company’s market risk exposures relate to changes in interest rates, foreign exchange rates and credit spreads that affect the fair value of its financial instruments, primarily investment securities, MTNs and investment agreement liabilities. The Company’s investments are primarily U.S. dollar-denominated fixed-income securities including municipal bonds, U.S. government bonds, corporate bonds, MBS and asset-backed securities. In periods of rising and/or volatile interest rates, foreign exchange rates and credit spreads, profitability could be adversely affected should the Company have to liquidate these securities. The Company minimizes its exposure to interest rate risk, foreign exchange risk and credit spread movement through active portfolio management to ensure a proper mix of the types of securities held and to stagger the maturities of its fixed-income securities. The following tables present updates in our market risk relating to interest rates and credit spreads. There were no material changes in market risk since December 31, 2019 related to foreign exchange rates. For a discussion of our quantitative and qualitative disclosures about market risk related to foreign exchange rates, refer to Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” included in the Company’s Annual Report on Form
10-K
for the year ended December 31, 2019.
INTEREST RATE SENSITIVITY
Interest rate sensitivity can be estimated by projecting a hypothetical instantaneous increase or decrease in interest rates. The following table presents the estimated
pre-tax
change in fair value of the Company’s financial instruments as of March 31, 2020 from instantaneous shifts in interest rates:
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Estimated change in fair value | | $ | | | | $ | | | | $ | | | | $ | | ) | | $ | | ) | | $ | | ) |
CREDIT SPREAD SENSITIVITY
Credit spread sensitivity can be estimated by projecting a hypothetical instantaneous increase or decrease in credit spreads. The following table presents the estimated
pre-tax
change in fair value of the Company’s financial instruments as of March 31, 2020 from instantaneous shifts in credit spread curves. It was assumed that all credit spreads move by the same amount. It is more likely that the actual changes in credit spreads will vary by security. The changes in fair value reflect partially offsetting effects as the value of the investment portfolios generally changes in an opposite direction from the liability portfolio:
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Estimated change in fair value | | $ | | | | $ | | | | $ | | |
Item 4. Controls and Procedures
As of the end of the period covered by this report, an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as such term is defined in Rules
13a-15(e)
and
15(d)-15(e)
under the Securities Exchange Act of 1934) was performed under the supervision and with the participation of the Company’s senior management, including the Chief Executive Officer and the Chief Financial Officer. Based on that evaluation, the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report. In addition, there have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules
13a-15(f)
and
15d-15(f)
under the Securities Exchange Act of 1934) during the fiscal quarter to which this report relates that have materially affected, or are likely to materially affect, the Company’s internal control over financial reporting.
PART II – OTHER INFORMATION
Item 1. Legal Proceedings
For a discussion of the Company’s litigation and related matters, see “Note 13: Commitments and Contingencies” in the Notes to Consolidated Financial Statements of MBIA Inc. and Subsidiaries in Part I, Item 1. In the normal course of operating its businesses, MBIA Inc. may be involved in various legal proceedings. As a courtesy, the Company posts on its website under the section “Legal Proceedings,” selected information and documents in reference to selected legal proceedings in which the Company is the plaintiff or the defendant. The Company will not necessarily post all documents for each proceeding and undertakes no obligation to revise or update them to reflect changes in events or expectations. The complete official court docket can be publicly accessed by contacting the clerk’s office of the respective court where each litigation is pending.
The following should be read in conjunction with and supplements the risk factors described under Part I, Item 1A, “Risk Factors” of the Company’s Annual Report on Form
10-K
for the year ended December 31, 2019.
Insured Portfolio Loss Related Risk Factors
Some of the state, local and territorial governments and finance authorities and other providers of public services, located in the U.S. or abroad, that issue public finance obligations we insure are experiencing fiscal stress that could result in increased credit losses or impairments on those obligations
Certain issuers are reporting fiscal stress that has resulted in a significant increase in taxes and/or a reduction in spending or other measures in efforts to satisfy their financial obligations. In particular, certain jurisdictions have significantly underfunded pension liabilities which are placing additional stress on their finances and are particularly challenging to restructure either through negotiation or under Chapter 9 of the United States Bankruptcy Code. If the issuers of the obligations in our public finance portfolio are unable to raise taxes, or increase other revenues, cut spending, reduce liabilities, and/or receive state or federal assistance, we may experience losses or impairments on those obligations, which could materially and adversely affect our business, financial condition and results of operations. The financial stress experienced by certain municipal issuers could result in the filing of Chapter 9 proceedings in states where municipal issuers are permitted to seek bankruptcy protection. In these proceedings, which remain rare, the resolution of bondholder claims (and by extension, those of bond insurers) may be subject to legal challenge by other creditors.
On June 30, 2016, after passage by the United States Congress, the President of the United States signed into law the Puerto Rico Oversight, Management and Economic Stability Act (“PROMESA”). PROMESA provides a statutory framework for the creation of an independent oversight board (“the “Oversight Board”) with powers relating to, among other things, the development and implementation of fiscal plans for Puerto Rico, as well as collective action and judicial processes—separate from the Federal Bankruptcy Code—by which Puerto Rico may restructure its debt on a consensual or
non-consensual
basis.
On May 3, 2017, the Oversight Board certified and filed a bankruptcy-like petition under Title III of PROMESA for Puerto Rico with the District Court of Puerto Rico thereby commencing a bankruptcy-like case for Puerto Rico. Under a separate petition, the Oversight Board also commenced a Title III proceeding for Puerto Rico Sales Tax Financing Corporation (“COFINA”) on May 5, 2017. Subsequently, the Oversight Board also certified and filed voluntary petitions under Title III of PROMESA for several municipalities, including the Puerto Rico Highway and Transportation Authority (“PRHTA”), the Puerto Rico Electric Power Authority (“PREPA”) and Public Buildings Authority (“PBA”) on May 21, 2017, July 2, 2017 and September 27, 2019, respectively. On February 4, 2019, the District Court for the District of Puerto Rico entered the order confirming the Third Amended Title III Plan of Adjustment for COFINA. The plan became effective on February 12, 2019.
The extent and duration of any aid from the Federal Emergency Management Agency and other federal agencies that may be offered to Puerto Rico 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 role of 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.
Item 1A. Risk Factors (continued)
As of March 31, 2020, National had $3.3 billion of debt service outstanding related to Puerto Rico. Puerto Rico may be unable or unwilling to pay their obligations as and when due, in which case National would be required to pay claims of unpaid principal and interest when due under its insurance policies, which could be material. On January 1, 2020, Puerto Rico defaulted on scheduled debt service for certain National insured bonds and National paid gross claims in the aggregate of $59 million as a result. While National will seek to recover any claim payments it makes under its guarantees, there is no assurance that it will be able to recover such payments. To the extent that its claims payments are ultimately substantially greater than its claims recoveries, National would experience losses on those obligations, which could materially and adversely affect our business, financial condition and results of operations.
On May 3, 2019, PREPA, the Oversight Board, the AAFAF, the Ad Hoc Group of PREPA bondholders (the “Ad Hoc Group”), and Assured Guaranty Corp. and Assured Guaranty Municipal Corp. entered into a Definitive Restructuring Support Agreement which was amended on September 9, 2019 to include National and Syncora Guarantee, Inc. as supporting parties (as amended, the “RSA”). The Rule 9019 hearing to approve the RSA has been delayed several times, and most recently was adjourned due to the coronavirus crisis until further notice. The Oversight Board and the Commonwealth must submit a status report to the Title III court on May 15, 2020. The debt restructuring contemplated by the RSA will not be effective until (i) confirmation of a plan of adjustment under PROMESA, (ii) negotiation and consummation of definitive documentation and legal opinions, (iii) enactment and implementation of supportive Puerto Rico legislation and (iv) receipt of Puerto Rico regulatory approval, each of which outcome is uncertain and subject to varying degrees of risk. Refer to the “U.S. Public Finance Insurance Puerto Rico Exposures” section in Part I Financial Information, Item 2 of this Form
10-Q
for additional information on our Puerto Rico exposures.
Legal, Regulatory and Other Risk Factors
The pandemic caused by the spread of
COVID-19
could have an adverse impact on our financial condition and results of operations and other aspects of our business.
The outbreak of the novel coronavirus
COVID-19
(“COVID-19”),
a respiratory disease caused by a new strain of coronavirus, was declared a pandemic by the World Health Organization in March of 2020 and has spread globally. The pandemic has caused significant economic turmoil in our country and abroad, and affected a wide range of economic activities, as well as domestic and global business and financial markets. We are closely monitoring developments related to the pandemic to assess its impact on our business. There is no assurance that global and domestic economic conditions will not continue to worsen, and at this time it is not possible to estimate the longer term impact that the
COVID-19
pandemic could have on our insured portfolios, or to account for the impact of the outbreak on most of the credits within those portfolios, investment portfolios, or general business operations. The extent of such impact will depend on future developments which are highly uncertain, including but not limited to the severity of the pandemic, and the effectiveness of financial and regulatory actions taken at the state and federal levels to contain or address its impact. While governmental and
non-governmental
organizations are engaging in efforts to combat the spread and severity of the
COVID-19
pandemic and related public health issues, the effectiveness of such measures cannot be assured. We also cannot predict how political, legal and regulatory responses to the pandemic, such as the nature of and conditions to aid to states or municipalities, tax policy, or programs designed to assist impacted individuals, will impact our business.
Adverse impacts on macroeconomic factors resulting from the spread of
COVID-19,
including without limitation reduced economic activity and certainty, increased unemployment, increased loan defaults or delinquencies, and increased stress on municipal budgets, including due to reduced tax revenues and the ability to raise taxes or limit spending, could materially and adversely affect the performance of our insured portfolio and our business, financial condition and results of operations. Specifically, such adverse effects could impact whether the individual municipal or structured finance credits we insure will be able to continue to meet their debt service obligations or avoid long term impairment, and could therefore result in an increase in defaults and on the amount of claims we will be obligated to pay on the related insurance policies. Such increases could cause us to revise our loss projections or other guidance we have previously provided. In particular, certain insured municipal credits, including those relating to the Commonwealth of Puerto Rico and its instrumentalities, could come under stress depending in part on the nature of the taxes, fees and revenues pledged to debt repayment and their sensitivity to the related slowdown in economic activity. Further, those structured finance policies in which the underlying principal obligations are comprised of residential or commercial mortgages and mortgage-backed securities, could be negatively affected by delays or failures of borrowers to make payments of principal and interest when due, or delays or moratoriums on foreclosures or enforcement actions with respect to delinquent or defaulted mortgages imposed by governmental authorities. These transactions are also subject to servicer risks, which relate to problems with the transaction’s servicer that could adversely impact performance of the underlying assets. Additionally, several of our credits, particularly within our international public finance sector, feature large, near term debt-service payments, and there can be no assurance that the liquidity position of MBIA Insurance Corporation will enable it to satisfy any claims that arise if the issuers of such credits are unable or unwilling to refinance or repay their obligations. Further, any national recession that may, result from the pandemic and its aftermath could, present additional but yet unknown credit risks to all of our insured portfolios.
Item 1A. Risk Factors (continued)
Additionally, our liquidity position and our investment portfolios (and, specifically, the valuations of investment assets we hold) have been, and may continue to be, adversely affected as a result of market developments from the
COVID-19
pandemic and uncertainty regarding its outcome. Changes in interest rates, reduced market liquidity or a continued slowdown in U.S. or global economic conditions may also adversely affect the values and cash flows of these assets or the investment portfolio yield and income. Further, extreme market volatility may impact our ability to efficiently and effectively react to market events. Market dislocations, decreases in observable market activity or unavailability of information, in each case, arising from the spread of
COVID-19,
may restrict our access to key inputs used to derive certain estimates and assumptions made in connection with estimating the values of financial instruments within our financial reporting or otherwise, including estimates and changes in long term macro-economic assumptions relating to our estimate of current expected credit losses on our financial assets. Restricted access to such inputs may make our financial statement balances and estimates and assumptions used to run our business subject to greater variability and subjectivity.
Further, while we have implemented risk management and business continuity plans and taken preventive measures and other precautions that address the pandemic, there can be no assurance that such measures will prevent a material impact on our business operations. Currently, our employees are working remotely. An extended period of remote work arrangements could strain our business continuity plans, introduce operational risks including but not limited to cybersecurity risk, and impair our ability to manage our business. We also outsource certain business activities to third parties, and thus rely upon the successful implementation and execution of those third parties’ business continuity plans as well. If one or more of the third parties to whom we outsource certain business activities experience operational failures as a result of the impacts from the spread of
COVID-19,
it may have a material adverse effect on our business, financial condition, results of operations, liquidity and cash flows.
Continuing elevated loss payments and delay or failure in realizing expected recoveries on insured transactions may materially and adversely affect MBIA Insurance Corporation’s statutory capital and its ability to meet liquidity needs and could cause the NYSDFS to put MBIA Insurance Corporation into a rehabilitation or liquidation proceeding if the NYSDFS concludes that MBIA Insurance Corporation will not be able to pay expected claims.
MBIA Insurance Corporation is particularly sensitive to the risk that it will not have sufficient capital or liquid resources to meet contractual payment obligations when due or to make settlement payments in order to terminate insured exposures to avoid losses. While management’s expected liquidity and capital forecasts for MBIA Insurance Corporation reflect adequate resources to pay expected claims, there are risks to the capital and liquidity forecasts as MBIA Insurance Corporation’s remaining insured exposures and its expected salvage recoveries are potentially volatile. Such volatility exists in the amount of putback recoverables, excess spread, and other salvage that MBIA Insurance Corporation may collect, including recoveries on the claims it paid in respect of the insured notes issued by Zohar CDO
2003-1,
Limited and Zohar II
2005-1
CDO (collectively, the “Zohar Claims Payments”), and the exposure in its remaining insured portfolio, which could deteriorate and result in significant additional loss reserves and claim payments, including claims on insured exposures that in some cases may require large bullet payments.
In July of 2019, MBIA Insurance Corporation consummated a financing facility (the “Refinanced Facility”) between MZ Funding LLC (“MZ Funding”) and certain purchasers, pursuant to which the purchasers or their affiliates (collectively, the “Senior Lenders”), agreed to refinance the outstanding insured senior notes of MZ Funding, and MBIA Inc. received amended subordinated notes of MZ Funding. In connection with the Refinanced Facility, the Senior Lenders purchased new senior notes issued by MZ Funding with an aggregate principal amount of $278 million. In addition, MBIA Inc. received amended subordinated notes issued by MZ Funding with an aggregate principal amount of $54 million. The Refinanced Facility is described in more detail under the “Liquidity—MBIA Corp. Liquidity” section in Part II, Item 7 of the Company’s Annual Report on Form
10-K
for the year ended December 31, 2019.
MBIA Insurance Corporation believes that the primary source of funds for the repayment of its obligations under the Refinanced Facility and for reimbursement for the Zohar Claims Payments will come from the monetization of the loans made to, and equity interests in, companies that, until late March 2020, were purportedly controlled and managed by the sponsor and former collateral manager of the Zohar CDOs referenced above (collectively, the “Zohar Collateral”). In late March 2020, the original sponsor resigned as director and manager of all but one portfolio company, and the Zohar CDOs have nominated or elected, or are in talks regarding the engagement of, new directors and managers at the portfolio companies, although the Zohar Sponsor may continue to serve in some capacity at select portfolio companies until a replacement is put in place.
While MBIA Insurance Corporation believes that it will receive substantial recoveries on the Zohar Collateral, there is significant uncertainty with respect to its realizable value. For example, on October 17, 2019, one of the portfolio companies, Dura Automotive Systems, LLC, and certain of its affiliates, filed for bankruptcy protection in federal bankruptcy court in the Middle District of Tennessee (the “Dura Bankruptcy Cases”). Effective November 8, 2019, the Dura Bankruptcy Cases were transferred to the District of Delaware. The Zohar debtors have substantial debt and equity interests in the Dura debtors, and any recovery on those interests is not expected to be material.
Item 1A. Risk Factors (continued)
If the amount of recoveries on the Zohar Collateral is not sufficient to repay amounts due under the Refinanced Facility on or before its maturity date and to reimburse MBIA Insurance Corporation for a substantial portion of the Zohar Claims Payments, MBIA Insurance Corporation would likely incur substantial additional losses, which could materially impair its statutory capital and liquidity. Further, MBIA Insurance Corporation believes that if the NYSDFS concludes at any time that MBIA Insurance Corporation will not be able to satisfy its obligations under the Facility and under its other issued policies, the NYSDFS would likely put MBIA Insurance Corporation into a rehabilitation or liquidation proceeding under Article 74 of the NYIL 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. The NYSDFS enjoys broad discretion in this regard, and any determination they may make would not be limited to consideration of the matters described above. As noted, however, 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, we do not believe that a rehabilitation or liquidation proceeding of MBIA Insurance Corporation by the NYSDFS would have any material economic long-term liquidity impact on MBIA Inc.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On November 3, 2017, the Company’s Board of Directors authorized the repurchase by the Company or National of up to $250 million of its outstanding shares under a new share repurchase authorization. During the three months ended March 31, 2020, we repurchased 8.1 million common shares of MBIA Inc. at an average share price of $7.99 under the November 3, 2017 repurchase program.
Subsequent to March 31, 2020 through May 4, 2020, we repurchased an additional 4.5 million common shares of MBIA Inc. at an average share price of $7.51. On May 5, 2020, the Company’s Board of Directors approved a new share repurchase authorization for the Company or National to repurchase up to $100 million of the Company’s outstanding common shares.
The table below presents repurchases made by the Company in each month during the first quarter of 2020:
| | (1) | - 1,925 shares in February and 86 shares in March were repurchased in open market transactions as investments in the Company’s non-qualified deferred compensation plan and 29,713 shares in January and 99,770 shares in March were repurchased by the Company in open market transactions for settling awards under the Company’s long-term incentive plans. |
