MBIA Inc. (NYSE:MBI)
Q4 2009 Earnings Call
March 2, 2010 8:00 am ET
Greg Diamond – Director IR
Edward Chaplin – President & CFO
Jay Brown - CEO
Arun Kumar – JPMorgan
[Joseph Compagna – Barish LB]
[Rob Halder – Taos]
Diane Jaffey – TCW
Andrew Oliver – Transatlantic Capital
Good morning and welcome to the MBIA Inc. fourth quarter and fiscal year end 2009 financial results conference call. (Operator Instructions) I would now like to turn the call over to Greg Diamond, Director of Investor Relations at MBIA; please go ahead.
Welcome to MBIA’s conference call for our fourth quarter and full year 2009 financial results. We're going to follow the same format as last quarter's call. Jay and Edward will provide some comments prior to holding a Q&A session. We have posted several items on our website including our 2009 Form 10-K.
We've also posted the quarterly operating supplement for the fourth quarter. The information for accessing the recorded replay of today's call is in our financial results press release, which is also available on our website.
Our company's definitive disclosures are incorporated in our SEC filings. The purpose of our call today is to discuss some of the points raised in our most recent 10-K to facilitate a greater understanding for investors. The 10-K also contains information that will not be addressed on today's call.
Please note that anything we say on this call is qualified by the information provided in the 10-K in our other SEC filings. You should read our Form 10-K as it contains our most comprehensive disclosures as of the end of 2009 about the company and our financial and operating performance.
Today’s Q&A session will be handled by Jay Brown, CEO and Edward Chaplin, President, CFO and Chief Administrative Officer. Now for our Safe Harbor disclosure statement, our remarks on this conference call may contain forward-looking statements. Important factors such as the general market conditions and the competitive environment, could cause actual results to differ materially from those projected in our forward-looking statements.
Risk factors are detailed in our 10-K, which is available on our website at www.mbia.com. The company undertakes no obligation to revise or update any forward-looking statements to reflect changes in events or expectations. In addition, the definitions of the non-GAAP terms that are included in our remarks today may also be found on our website.
Before we begin the Q&A session, Jay and Edward will provide a few introductory comments.
Thank you Greg and good morning to everyone on the call. I’m happy to have the opportunity to speak with all of our owners at one time again. This morning Edward Chaplin is going to comment on the details of our 2009 financial results. But before he does I would like to make a few comments on our transformation efforts, and some of the litigation we are involved in.
It was a year ago during our year-end 2008 conference call when I commented on the then very recent transformation of our insurance operations and the launch of National Public Finance Guarantee Corporation. Unfortunately shortly afterwards a number of parties initiated legal action against our insurance transformation.
So here we are a year later and National’s financial strength ratings assigned by Moody’s and S&P remain depressed as a result of the litigation even while their AAA, AA capital strength rate underlying strength continues to grow ever stronger.
There are many attorneys in various courtrooms that have been kept very busy. But rather than take you through all the iterations, I’ll keep my comments brief. For those of you who are more interested in more details, we have posted documents from many of our legal proceedings on our MBIA website.
In addition several of the court jurisdictions also provide internet access to their rulings, calendars, and the documentation associated with their court cases. I’d like to frame the economics of the litigation before I go into any details. As we look at the transformation litigation the real economic impact on MBIA is our inability to provide new insurance in the muni bond area to 50,000 different issuers.
It has no impact on our current ABV valuation but at this point is limiting our ability to grow ABV in the public finance sector. Although it gets all the press the real economics of litigation for MBIA lie where we are the plaintiff. In the various cases that we have filed in mortgage and CDO related litigation the stakes are extremely high. We are seeking reimbursement for our contractual rights to put backs, in the mortgage related litigation and we are suing for fraud and misrepresentation in the CDO litigation.
The dollars involved here are substantial and easily exceed $4 or $5 billion. Regarding the transformation related actions filed against us, we continue to assert our strong belief that the Article 78 petition is the only appropriate procedure for challenging our insurance transformation. And the New York State insurance department and the New York State Attorney General’s office share this view of New York State law.
As a reminder an Article 78 petition has a very high threshold and in this case plaintiffs have to prove that the New York State insurance department was arbitrary and capricious in its approval of our insurance transformation. [inaudible] by statute, its an expedited procedure, that challenge has made the most progress and we believe it will be positively resolved during 2010.
Our motions to dismiss the federal and one of the New York State debtor and creditor law challenges to our transformation have been denied at this point in time and we have initiated the appropriate appeal. Regardless of how many forms we may find ourselves in, litigating the same case, we continue to believe that the law is on our side and that we will prevail.
We took great pains over the course of the year to work with the New York State insurance department to restructure our insurance operations and maintain adequate resources to [inaudible] both National and MBIA Insurance Corp. to satisfy their policyholders and other obligations. I will talk about the magnitude of the obligations that we’ve already satisfied in another minute or so, but the decisions we made to split our insurance business into separate legal entities as I announced when I returned in February 2008, were intended to properly balance our fiduciary obligation to our shareholders with our duty to provide adequate protection to all of our policyholders and to fulfill other obligations.
We are confident that we accomplished that. Put a handful of large institutional plaintiffs in these suits are attempting to improve their relative position at the expense of millions of individual public finance policyholders. National is the only bond insurance company solely dedicated to the US public finance market. It is extremely well capitalized, notwithstanding its current assigned credit ratings and it is staffed with well-regarded and highly experienced municipal credit professionals.
Millions of individual owners of our insured bonds now have dedicated resources to meet any losses that arise in the US public finance market as municipalities across America grapple with today’s tough economic environment. The company is especially well positioned to engage with the US public finance market and help bond issuers gain greater access to the credit markets at more affordable costs.
The need for National has never been greater and we continue to look forward to the day when it can maximize its full benefit to the US public finance market. Turning to the litigations where MBIA is the plaintiff, the number of cases continued to increase in 2009. In addition to further amending the mortgage loan put back legal complaints that we initiated in 2008 and adding complaints against other issuers, we have also filed complaints alleging fraud and misrepresentation against a small handful of the financial institutions that manufactured CDOs and then purchased insurance coverage from us on those same transactions.
In retrospect it is clear to us that they had far greater knowledge in understanding of the problematic content of those CDOs then they had represented to us at that time. It also turns out that a few of the institutions that we have cited in legal complaints are also the same plaintiffs or affiliated with the plaintiffs of the two 19 bank legal actions being pursued against our insurance transformation.
It is somewhat ironic that they are alleging MBIA Insurance Corp. has insufficient capital when they are the ones who have created the defective structured transaction that have led to a maturity of our insured losses. There are very significant dollars related to these litigations and I’m not just talking about the attorney’s fees. As we noted in our press release last night, we are now including about $1.5 billion of aggregate put back recoveries for the breeched contractual obligations of the mortgage lenders involved with these RMBS transactions.
In actuality that represents a small portion of the total liability that should and will be assessed against these mortgage lenders. Our estimate of the actual amount of ineligible and defaulted mortgage loans on which we are seeking to enforce our contractual representation and warranty provisions currently exceeds $4 billion. For the CDO related litigation the amount at stake represents a significant portion of the $2.5 billion of present value of ultimate incurred loss that we are estimating for our CDO portfolio.
While we are in the early stages of litigation we’re pursuing in connection with improperly originated and service second lien and CDO transactions we are encouraged by a few recent developments. We have discovery proceeding in multiple court cases and have established trial dates beginning in 2011. We have also noticed that we are no longer alone in our efforts to force compliance with contractual obligation.
A number of financial institutions including Fannie and Freddie are seeking the same kinds of improperly originated in service loans as we are. Equally important some of the originators are beginning to establish substantial reserves for rep and warranty buybacks. In the meantime we continue to honor all of our insurance obligations and pay out meaningful sums of money. Given the magnitude of the global credit crisis we were positioned and expected that we would pay out a significant number of claims around the world.
As Edward will note we paid out slightly more than $3 billion of gross claims before reinsurance and recoveries last year. A majority of the payments went to third party policyholders of MBIA Corp. insured RMBS transactions. In most cases they are the exact same transactions referenced in our RMBS put back litigations.
Unlike other forms of insurance claim payments on our bond insurance are not precluded by fraud as long as it isn’t the policyholder perpetuating the fraud. It is up to us to fulfill our obligations to our policyholders and then the burden in on us to seek restitution for any wrongs that may have been committed against.
As evidenced by the litigation we have already initiated, we have every intention of pursuing restitution if contractual representations and warranties are not being fulfilled. However such restitutions is likely to come a few years after we’ve paid our policyholders. Having made our payments on time we think that investors will have a renewed appreciation for the value of our product and the protection it provides.
Another value that our company provides is the products and services of our asset management operations. We restructured and renamed our asset management platform earlier this year to give it more financial and operational flexibility. Cutwater Asset Management provides advisory services to institutional clients. While it will continue to manage the wind down of MBIA’s legacy asset liability and conduit businesses, as well as our insurance investment portfolios, Cutwater’s new business initiatives will focus on continuing the 25% growth of third party assets under management that they achieved in 2009.
Cutwater currently has $42 billion in total fixed income assets under management with $25.4 billion of those assets coming from third party clients, placing it among the 50 largest fixed income asset managers in the world. For the time being until National is free from its litigation stranglehold Cutwater will be one of our few opportunities for modest growth in the short-term. However we will continue to focus on loss mitigation and remediation as well as loss recoveries and capital market purchases of our debt instruments to maintain and enhance our adjusted book value on a per share basis.
We continue to actively pursue commutation discussions with first party financial institution counter parties who created, managed, and often booked a profit at inception on cash and derivative CDO structures. The transactions under discussion include those that today contain substantial but manageable expected losses and those that will probably have losses are extremely remote.
In closing the credit and capital markets continue to be challenging. But our balance sheet continues to meet these challenges. As conditions remain difficult we will remain keenly focused on the liquidity needs of our different businesses. We have suffered greater losses than we had anticipated but we have also been far more resilient than many had predicted and we are [husbanding] substantial embedded value for our shareholders.
We owe it to ourselves and our shareholders to learn the important lessons from these difficult times. As CEO of your company I am committed to this. As we move through the next few years rebuilding our company’s foundation I will not let the hard lessons of the past several years fade away and potentially lead to a repeat of the events that has consumed years of accumulated shareholder value.
While we have many challenges ahead of us and much that is not under our direct control, we have an abiding confidence in our product and our markets to guide us forward. I am extremely comfortable that the path we charted two years ago will ultimately lead to both stability and the realization of substantial shareholder value. Now I will turn it over to Edward who will review our 2009 financial results, operating performance, and liquidity profiles.
Thanks Jay and good morning everyone, now I as Jay said, I’ll provide an overview of our financial reporting, our economic value creation and some detail on our balance sheet and liquidity. First I’ll walk through the income statement which is the third exhibit to the press release.
Our consolidated net income for 2009 was $623 million versus a loss of $2.7 billion in 2008. Our pre-tax pre-dividends income was $1.2 billion. The biggest driver of our pre-tax income was a reduction in the fair value of derivatives liabilities of $1.6 billion pre-tax.
As we’ve reported for many quarters now this gain is no cause for celebration and when that same items swings to loss there will be no cause for alarm. We continue to provide guarantees of credit performance and not the periodic changes of valuations in insured credit derivatives. We had $746 million of premiums earned in the year down from $850 million in 2008.
Essentially all of this change is due to a reduction in accelerated premiums for refunded bonds. Investment income was $655 million versus $1.55 billion last year. Here we see the effects of debt buybacks, maturities, and claim payments in the year which lowers invested assets, as well as lower average investment yields. Fees and reimbursements were $145 million or $103 million more than last year. Reinsurance commutations contributed $81 million to this total. Realized losses on derivatives consisted of claims, payments, and commutations partially offset by premiums received and where $166 million.
Unrealized gains are the aforementioned $1.65 billion driven by changes in spreads and securities prices both on the underlying collateral in the CDOs we’re wrapped and on MBIA. Gains on financial instruments at fair value were $166 million driven by the change in value of warrants issued in connection with our capital raise in 2008, mark to market on interest rate swaps and foreign currency translation effect.
Net realized losses were $46 million for the year. We had write-downs of a loan in a variable interest entity, write-downs on our home office property and goodwill all partially offset by investment gains in the core investment portfolios. We also had $467 million of invested asset impairments in the year primarily effecting the asset liability management business.
We had $259 million of gains on debt buybacks in the year, again also primarily in ALMs and that’s down from $410 million in 2008. So total revenues were $2.95 billion versus a comparable negative $856 million in 2008. If you exclude the mark to market on insured credit derivatives 2009’s revenues were $1.3 billion versus last year’s $967 million.
Loss and loss adjustment expense for the year was $864 million driven by $770 million of loss in MBIA corp. This was lower than 2008’s total of $1.3 billion in loss. Operating expenses were $316 million up from $306 million in 2008. That reflects increasing legal fees partially offset by cost savings from staff reductions in 2008.
Interest expense was $475 million versus $1.17 billion last year reflecting primarily debt and guaranteed investment contract pay downs and maturities. Total expenses were $1.74 billion and pre-tax income again $1.2 billion versus last year’s loss of $3.7 billion. Excluding the unrealized mark to market on insured credit derivatives that comparison would be a $433 million loss this year versus a loss last year of $1.9 billion.
Now the fourth quarter which is also shown in our release in the second exhibit produced a pre-tax loss of $205 million which would be a $633 million loss without the impact of the mark to market on insured credit derivatives. That loss is driven largely by incurred losses for RMBS, securitizations of $474 million pre-tax and $30 million of invested asset impairments. Last year’s fourth quarter pre-tax loss was $1.9 billion or $242 million excluding the impact of the unrealized mark to market on insured credit derivatives.
To better understand the economic value creation in our businesses we use the concept of adjusted book value per share. This non-GAAP statistic takes our reported GAAP book value and adjusts out the impacts of unrealized gains and losses and adjusts in the impact of expected cash losses on insured derivatives and the present value of future income or loss already contracted in our insurance or ALM businesses net of a future loss estimate for currently performing credits.
We believe that the change in ABB over time best tracks changes in the fundamental value of the company. In 2009 that value declined by $3.71 per share or about 9%. It ended the year at $36.35. We did engage in some share repurchases in 2009 which added about $0.79 per share at the consolidated level and you can see details on adjusted book value on the fourth exhibit to our press release.
Reflecting back on 2008 ABB declined from $77.89 per share to $40.06, a change of $37.84. That change in 2008 was due to pre-tax insured losses of approximately $3 billion and the issuance of 111 million new shares of common stock. So while 2009 was an adverse year in which we lost ABB the performance was significantly better than that of 2008.
Now I’ll take a few minutes and go through the contributors to that result at the segment level, National Public Finance added $1.75 to ABB, and ended the year at $20.70 per share. That growth was primarily driven by its net income. The impacts of the implementation of FAS 163, the amortization of unearned premium and reduction in loss provision as well as the impact of share repurchases all basically net to zero.
National’s pre-tax earnings of $551 million were consistent with our expectations excluding the impact of new business. Both refunded premiums and insured losses though were somewhat higher than we expected. The pace of refunded premium was pretty level over the year and was $42 million in the fourth quarter. That pace of refundings in the first quarter of 2010 does appear to be slower than that of Q4.
Loss and loss adjustment expense of $94 million in the year was basically derived from two transactions, an affordable housing deal and a student loan transaction. Although each of these has a unique story, our exposure to these two sectors in total is less than 2% of National’s portfolio. We also have exposure to the health care sector where there’s been both macroeconomic and regulatory uncertainty and health care is about 3% of our portfolio.
Finally and Jay referenced this, we do expect that there will be continued pressure on the general obligation and tax back sectors due to lower property and sales tax revenues at the local level as well as additional health care and pension costs and we don’t see losses in these sectors at the moment and they make up about half of National’s portfolio.
I should mention that in the fourth quarter of 2009 National’s loss provision was only $2 million. Our investment management services group comprises our asset management advisory business and our wind down ALM and conduit activities. The wind down ALM business is by far the biggest driver of the group’s contribution to ABV.
It had negative ABV at year-end 2008 and that deficit increased by $0.86 per share in 2009. During the year we generated a $247 million gain from debt buybacks but suffered $365 million of loss due to asset impairments which drives a pre-tax loss of about $90 million. In addition ABV includes the asset liability products adjustment which reflects the change in the present value impact of future spread income, it also declined slightly by $0.03 a share in 2009.
As Jay has said in early 2010 we created more operational independence for our asset management advisory business within IMS which we have rebranded as Cutwater Asset Management. And we believe that this will provide a meaningful growth opportunity for us in the near-term. Cutwater’s results are reported as our advisory services segment.
This segment earned $7 million in 2009 including the impact of expenses related to the rebranding. These earnings add approximately $0.02 per share to ABV. As part of the rebranding and launching of Cutwater as an independent manager its fees and cost sharing arrangements with affiliate entities were reset at market rates in the fourth quarter.
MBIA Insurance Corp. continues to be the largest contributor to our ABV. At year-end 2009 it was $20.79 per share. Conserving that value is among our highest priorities. And we were not able to do so in 2009. ABV declined by $4.38 per share in MBIA Insurance Corp. eliminating nearly $900 million of shareholder value.
The primary driver of this was insured losses which in our reporting shows up in three separate places depending on the form of the transactions that have losses. So first many contracts are subject to insurance accounting where we record loss reserves. The loss and loss adjustment expense that runs through the GAAP income statement was approximately $770 million pre-tax, $575 million of that is associated with our insured RMBS.
We incurred $2.8 billion net of reinsurance related to payments that we made or expect to make partially offset by $1.5 billion of expected recoveries due to contractual rights to have seller services buyback ineligible loans and approximately $700 million representing an increase in expected recoveries from excess interest flows within the securitizations.
Cumulatively we have made $3.8 billion of payments on RMBS since September of 2007. As of year end 2009 we estimate that we’ll make another $2 billion of payments net of reinsurance which are offset with aggregate future recovery expectations of about $3 billion, $1.5 billion each from excess spread reimbursement from the RMBS trusts, and from repurchases of ineligible mortgages by the sellers.
The amount of $2.2 billion of these recoveries are shown in the insurance recoveries line on the GAAP balance sheet while $800 million is net in the loss reserve item. Now beyond the $575 million of RMBS incurred loss, $175 million of GAAP incurred loss is primarily due to reserves established for two CDOs that we wrapped with financial guarantee policies, and the commutation of an ABS transaction.
These losses that is to say the $770 million pre-tax drive a reduction in ABV of $2.44 per share. We then have the second flavor of loss, we estimate the impairments of insured credit derivatives using our loss reserve process and while not directly recognized for GAAP ABV does directly recognize these impacts.
In the year 2009 we recognized impairments on these exposures as our expectations of loss on subprime collateral in those deals primarily increased significantly. On our statutory books we added $777 million to loss reserves, the impact of this in terms of ABV is $2.98 per share, obviously its negative $2.98 per share.
As Jay referenced the RMBS and CDO portfolios are the subjects of several litigations over improper practices by the originators or arrangers. In the case of the put backs of residential mortgages we directly reflect the impact of our contractual rights in our loss calculations. Jay also mentioned the amount of discount reflected in our estimate of $1.5 billion recovery.
We expect the ultimate value of our put back claims to be in excess of $4 billion based on an extension of the ineligibility rates that we’ve observed to date. That discount reflects the fact that seller servicers have withheld information on the loan files, reflects the risk of litigation, the credit quality of some of the seller servicers, and all other known uncertainties. However we currently expect that these uncertainties will decline over time and the value of the recognized put back rights will increase.
Our litigations against certain sponsors of multi sector CDOs on the other hand do not directly effect our loss estimates but they may increase the probability that our economic losses on those CDOs will be lower in the range of possible outcomes. One sector in which we did not record any loss in 2009 was commercial real estate.
We have a portfolio consisting of $35 billion of CMBS pools, and $10 billion of commercial real estate CDOs. As a result we’ve been monitoring the trends in that space. While delinquencies continued to increase and have nearly reached the 6% level in early 2010 very little collateral has been liquidated to date. We do not see enough data to estimate the propensity of delinquent loans to roll to loss because very few actually have rolled to loss.
Recently there has been some non-negative news on this sector including a two-month increase in the Moody’s commercial property price index and anecdotal evidence of substantial equity interest in this space. However that could change and adverse developments in the property market or the economy could cause future losses in our portfolio.
So the insured losses associated with transactions accounted for as insurance and as derivatives reduce our ABV by $5.42 per share. Finally we have some transactions that by their form are required to be consolidated for GAAP. Insured losses on those deals that would take the form of asset impairments were $0.13 worth of ABV. So its $0.13 of the ABV impact of investment related losses for MBIA Corp. as shown in our supplement are associated with an insured but consolidated deal.
So the total impact of insured loss is a reduction of ABV of $5.55 that’s from all three flavors. This loss is partially offset by income from other sources, the impact of share repurchase, and the FAS 163 transition amounts which total to about $1.17 per share. Given the size and scope of our consolidated credit risk portfolio we shouldn’t be surprised to have had significant losses in the deepest economic downturn in our corporate history.
The pervasive fraud and misrepresentation apparent in securitizations and CDOs we wrapped multiplied our losses and led to credit rating downgrades and severe liquidity stress. As a result we had heightened losses in both our insurance and our ALM businesses. Fortunately we have also found that the company’s balance sheet was strong enough to withstand these unprecedented losses.
We have absorbed them and paid all of our claims and today maintain adequate balance sheet strength to pay all expected claims and obligations. Our most significant focus in this regard is on MBIA Insurance Corp. where we paid $3.1 billion in gross claims before reinsurance in 2009. On our GAAP balance sheet we had $1.6 billion of loss and LAE reserves at year-end 2009 and equity of $1.6 billion and that equity is after the mark to market on insured credit derivatives of about $3.8 billion.
While we believe that the GAAP balance sheet demonstrates adequate financial resources we think the better way to analyze MBIA Corp. financial position is to focus on its statutory balance sheet and cash position. On a statutory basis, there’s no distinction between insurance recoveries and loss reserves when a policy is outstanding. So all of the recoveries that I discussed a minute ago are net in our loss reserves for stat accounting.
This form of accounting follows the economics of our transaction rather than their form so all three flavors of loss if you will are shown in one account. There are also minor differences in stat and GAAP reserve calculations. As a result statutory loss reserves at year-end 2009 were $561 million. In addition to loss reserves our regulatory accounts include a contingency reserve which is intended to insulate policyholder surplus from volatility and loss estimates.
It was $1.45 billion at year-end 2009 and policyholder surplus was $2 billion. Credit analysts typically sum the policyholder surplus and contingency reserve and refer to it as statutory capital. For MBIA Corp. that figure was $3.45 billion at year-end 2009 which is on top of the loss reserves. MBIA’s balance sheet and capital position are smaller than they were on a pro forma basis at year-end 2008 but we believe that the company continues to have ample capacity to absorb potential future stress.
And that stress can come from two sources, if the economy does not continue to recover, if there’s a double dip recession, our insured losses could be significantly higher. At the same time there is some risk that our recoveries from excess spread in the RMBS transactions could be smaller. We feel more confident in the outcome of litigation with the seller servicers and CDO arrangers but a deeper longer recession could also impair their ability to meet their obligations in the future.
As it was for many other financial institutions 2009 was a worse year than we thought it would be in terms of both incurred loss and payments. Our cumulative incurred loss for RMBS and CDOs increased from $3.9 billion at year-end last year to $5.3 billion at year-end 2009. And from a liquidity standpoint 2009 was worse than our expectations.
While we always believed 2009 would represent our peak loss payments, we underestimated the magnitude of those payments. We paid out approximately $3.1 billion of gross payments of which $2.4 billion paid down principal on RMBS bonds. Those payments were far higher than our earlier estimate and reflected not only a prolonged period of high defaults on losses but also a higher level of initial delinquencies than we had seen in 2008.
In addition to RMBS we also made claim payments of approximately $130 million on CDO squared transactions and made principal payments, commutations, or bond purchases of approximately $487 million on four other structured finance and one international public finance deal. And almost all of those payments were associated with risk remediation efforts.
In response to payments being in excess of our expectations we actively managed our liquidity position. MBIA Corp. started 2009 with $1.9 billion in cash and short-term assets on the balance sheet and closed the year with approximately $1.1 billion. Aside from investment income and installment premiums we also engaged in asset sales and reinsurance commutations to bolster the cash position.
In addition the asset liability management portfolio accelerated repayment of the $2 billion inter company secured loan that MBIA Corp. made to it in 2008 and $400 million in total was repaid in 2009. Although the total delinquency pipeline in our RMBS portfolio is lower than in early 2009 and payments have been running somewhat below our forecasts for the last several months, and we started our 2010 with $4.2 billion less net par outstanding in our second lien and Alt-A transactions, we still believe that potential volatility in RMBS payments is the most significant source of liquidity risk to MBIA Corp.
We believe our current cash position, the expected cash flows in the ordinary course, repayments of the secured loan, and other sources of cash will give us the ability to absorb reasonable downside scenarios. In the wind down ALM portfolio 2008 appears to have been the period of greatest stress from early 2008 to today balance sheet liabilities have gone from $25 billion down to $8 billion at year-end 2009.
We began selling assets to raise cash before we lost our AAA rating in June, 2008 but in the aftermath of the Freddie, Fannie, Lehman, AIG, and Merrill events, we put in place the secured loan from MBIA, expanded use of an asset swap facility that’s now with National, and put in place the inter segment loan from our holding company to forestall any need for a fire sale of assets.
In 2009 that strategy started to pay off as we saw unrealized losses in ALM decline by $1.3 billion from March 31 to December 31. As I said ALM repaid $400 million of the secured loan in 2009 and accelerated payments have continued into 2010. The ALM portfolio has positive expected cash flow for the next several years and adequate resources including $1.2 billion of cash and short-term assets to cover all remaining terminable liabilities. While we did have asset impairments in 2009 they were mostly offset by gains from debt extinguishments.
At the holding company level, we had $332 million of cash and short-term assets at year-end. We expect that $222 million of our $502 million tax refund will remain at the hold co level providing MBIA Inc. with substantial capacity to cover its obligations. Even if it does not receive dividends from its operating affiliates and subsidiaries, expected cash position plus ordinary course inflows will currently cover more than five years’ worth of MBIA Inc. debt service and operating expenses.
We expect that Cutwater will be in a position to pay dividends to the hold co in 2010 and we are working with the New York state insurance department to get National ready to provide dividends. All in all 2009 was a year in which our balance sheet strength enabled us to endure extraordinary stress, and as 2010 begins some of the uncertainty around our housing related exposures appears to be declining and there’s additional clarity about the survivors among bond insurance companies.
We’re looking forward to serving the public finance market in 2010 and expanding our business platform and investment management and other advisory services and restoring some of the value our shareholders have lost. And with that we will open the lines for your questions.
(Operator Instructions) Your first question comes from the line of Arun Kumar – JPMorgan
Arun Kumar – JPMorgan
You commented on the secured loan between the insurance operating company and the asset liability management company down, repaid $400 million over the past several months, what is your timeline for the full repayment of the inter company facility and the second question relates to the op co again relating to the amount of capital and the potential of the regulator to step in, in terms of surplus now, do you expect to continue to pay on the surplus now for the foreseeable future or have there been and discussions with the regulator on that fund.
Two questions then, the secured loan by its terms the secured loan is to be paid off by November, 2011. The loan does not have periodic principal payments so that as we see asset maturities in the collateral for the secured loan we are making choices about where that cash can be best deployed, whether it could be best deployed in the business in terms of debt buyback or whether its better deployed against reducing the amount of the secured loan and reducing the interest expense related thereto and as you can see it did make sense in 2009 to make that choice to pay down the loan.
So it is the payment that we’ve been making are optional but understand we’ve got to pay it all off at November, 2011. And we currently expect that we’ll be in a position to do so. And then on the surplus—
Our current plans and all of our internal forecasts continue to call for us to make the interest payments on the surplus notes and also a reminder the first call date is five days from issuance. On current trajectory our intent would be to call those either all of those notes or a majority of those notes at that point in time. I will put in the caveat, appropriate caveat, that that will depend on our cash and any changes in our forecast for losses. But our plan from the very beginning has been to both meet those interest rate payments and to call those notes in at the earliest possible time.
The most recent payment was January 15.
Arun Kumar – JPMorgan
Just a quick question on National you mentioned that you’re having some kind of preliminary discussions with the insurance commissioner in terms of dividends would that potentially be a 2010 event or 2011 event do you think.
At this point I’m not including in our plan dividends in 2010 and as I said the holding company has enough resources to carry it for about five years. However we do anticipate that National will be a dividend provider over time. It has substantial operating cash flow.
When we went through the insurance transformation part of the plan because of the way National received its capital and the effects of the reinsurance transaction it has at inception had a negative surplus. We had to wait until the company was redomesticated to New York which happened in December. We have applied and expect to work with the department to reset surplus, earned surplus at zero and then as future earnings flow through the company that will then provide the ability to pay dividend.
But as Edward pointed out we have no plans and have made no requests to pay any dividends out of National in 2010, so the earliest that you might see dividends coming out of National would be 2011.
Your next question comes from the line of [Joseph Compagna – Barish LB]
[Joseph Compagna – Barish LB]
Can you talk a little bit about the HELOC and close end second exposure and the loss reserves against that particular exposure at this time.
If you look at our GAAP financial statements, you’ll see loss reserves of about $1.6 billion most of which are associated with our insured RMBS transactions. In addition though we do have an expectation of repurchases of collateral out of those transactions by the seller servicers as well as collection of excess interest on those transactions that’s also reflected on the balance sheet in the insurance recoveries item which is on the asset side of the balance sheet.
So reserves about 1.6 most of which are associated with RMBS and then recoveries, about $2.5 billion all of which or essentially all of which is associated with the RMBS.
[Joseph Compagna – Barish LB]
So the increase in the fourth quarter reserves in terms of the LAE or the credit derivatives was that regarding the RMBS portfolio or that’s in some other part of the portfolio.
Really the driver of the, there are a number of effects but the most significant driver in the increase in expected loss on our CDOs as been the underperformance of the subprime mortgage collateral in those transactions. So its RMBS generally but they are first lien subprime assets primarily in the CDOs.
The other piece of the increase in loss on CDOs reflects a change in the discount rate that’s associated with valuing them. We’re discounting at a risk free rate which tends to increase the amount.
[Joseph Compagna – Barish LB]
Can you comment a little bit on any Chilean exposure you have and any potential losses against that.
We have in Latin America and South America our largest exposure is probably in Chile. We have five different transactions in Chile. One is the airport and then there are four different roads, the total exposure is approximately $2.1 or $2.2 billion gross exposure. Obviously three days after the earthquake it’s a little uncertain as to the amount of damage. We’ve had reports on one road which is already fully operational and preliminary reports on two of the other roads which look as if they’ll be back in operation relatively quickly.
All five transactions have substantial property casualty insurance for both damage to the roads themselves or the airport plus business interruption insurance. They all also have very adequate cash reserves so we don’t expect that there will be any liquidity short-term liquidity events in the next 12 months and we don’t see any long-standing issues associated with these transactions.
All five of these are extremely essential assets to how the country infrastructure is constructed. They’ve all been performing well and we expect that over the course of the next two or three weeks we’ll have a better handle if there’s going to be any issues whatsoever.
Your next question comes from the line of [Rob Halder – Taos]
[Rob Halder – Taos]
I have a quick housekeeping question on your operating supplement, for MBIA Insurance Corp. on page 51 there’s a gross loss payment and receipt estimate chart that looks like its missing a scale, I was hoping you could just help me out with the scale on that one please.
We have eliminated the scale on that exhibit for a reason, and the purpose of the graph is to give you a sense of the direction and magnitude of the payments that we’ll make and it sort of shows that in the early years we expect to have very substantial payments associated with RMBS and CDO squareds. You can also see that in the medium term there is an expectation that we have net recoveries and reasonably substantial recoveries on RMBS transactions and all of those recoveries there are associated with excess interest in the securitization as opposed to realization of the put backs that we have recorded to the balance sheet.
And then you can see in the somewhat longer term the payments of interest on very long tailed CDOs and then at the back end of that picture you have the payments of principal on the CDOs. Now the reason that we don’t have numbers on it is because these won’t tie into the loss reserves that we have calculated because this is a single scenario of payment and it sort of an unmanaged scenario.
When we assess loss reserves we’re required to consider all possible outcomes and to calculate kind of a probability weighted average of the payments which is hard to grasp, and we do expect over time that they are in effect managed exposures and that there may be commutations and other actions that effect the ultimate payments.
So we wanted to try to give a sense of what we think in terms of the shape of that curve but not frankly be tied to the numbers that would relate to this individual scenario because its only one of many.
[Rob Halder – Taos]
Is there anything you can give us to just give us some sense for the magnitude.
We have at the bottom of the page we do show our 2009 payments and the total payments that we incurred in 2009 were about $2.7 billion and that’s net of reinsurance as well as cash recoveries in the year. We do anticipate that 2010 payments will be substantially lower than 2009’s primarily because we expect the trend that we currently observe in terms of payments on the second lien RMBS transactions to continue to fall.
Your next question comes from the line of Diane Jaffey – TCW
Diane Jaffey – TCW
I was just curious about your recourse in terms of getting either better mortgages or [inaudible] from the originators.
Could you repeat it, we didn’t hear the question clearly.
Diane Jaffey – TCW
I’m sorry, I’m on my cell, I was wondering what your ability, what your methods of recourse are to get the payments back from the originators who did not adhere to the guidelines.
Unfortunately in many cases the only recourse is to effect the contractual enforcement through the courts and that is in fact the action that we have initiated against over half a dozen different issuers. Its unfortunate that we have to go to court to enforce that but given the magnitude of the dollars and the reluctance of the issuers to provide either all of the files or to address the individual put back requests in a timely manner has caused that to happen.
I will say that there are a few issuers who would prefer not to go into court and waste that amount of time who have initiated alternative resolution discussions with us and that we hope that over the course of 2010 we can both close on a couple of those and perhaps as the litigation proceeds, rather than see it all the way to conclusion that we can work out some kind of a resolution with the half dozen or so issuers that are out there that are involved in the bulk of our contractual put back claims. It’s a big deal and I think when we started in 2008 and initiated the process of going through the put back process and started litigation we were early movers in that. I think if you’ve been following the information flow over the past three or four months, it is a much more visible and much, much larger issue than just MBIA.
There’s more and more people who are responsible for the mortgages, such as Fannie, Freddie, ourselves, other bond insurers and some trustees are putting mortgages back and importantly a large number of responsible financial institutions are starting to establish reserves in recognition that some of the mortgages or maybe a significant portion of the mortgages that were put into the pool didn’t meet the representations and warranties that were associated with those specific pools.
Your final question comes from the line of Andrew Oliver – Transatlantic Capital
Andrew Oliver – Transatlantic Capital
I wondered if you would be kind enough to explain what happens if a municipality defaults as far as MBIA is concerned and what MBIA’s responsibility is for paying interest and principal on insured securities issued by such a municipality.
Unfortunately we’ve already had a lot of practice in that over the last 35 years. In 2010 although there weren’t ultimate losses beyond the two that Edward mentioned for National we did have a number of instances where individual communities or counties missed an interest payment, sometimes just by mistake, sometimes because their tax collections have lagged.
And so what happens in those situations assuming the trustee is on time, we get a notification approximately 48 hours before the interest payments are made, are due to be made, we actually fund the interest payment and the holder of the security doesn’t even know that the city or county or who ever didn’t, had missed their payment.
Ultimately there will be situations particularly in the revenue related bond area and for us the same issue that we’ve viewed as the most critical in the hospital area over the last 15 years, those are situations that could result in ultimate short fall. In those cases we will meet the interest and principal payments as they are due.
Occasionally we have stepped in where we had the rights to call the bonds or we have purchased bonds in the open market to mitigate losses. This is going to be a very interesting area in terms of how municipalities face the issues in 2011 beyond. We have several high profile cases out there, Vallejo in California, Jefferson County in Alabama, Harrisburg, they’re facing very serious financial difficulties or have already filed a form of municipal bankruptcy which is different than typical corporate bankruptcy.
This is why insurance is out there. We think it’s the most valuable thing we provide in the long run and we believe although its painful to pay losses we think it improves the value of the products and people perceive they’re getting something for which they’re paying and that ultimately that’s why we continue to be very, very optimistic that the particularly the US public finance market is going to be a robust opportunity for bond insurers going forward.
Andrew Oliver – Transatlantic Capital
Are there any circumstances in which an acceleration can be forced upon your payments beyond payments as they fall due.
Every transaction is different and the vast majority that cannot occur in the public finance sector because there are some different variable note issuers that the banks have taken over those notes because they weren’t able to be remarketed. They have an accelerated pay down typically five years, so I would say we are facing in some situations the potential for higher payments than originally planned but it’s a pretty rare instance where we have an accelerated demand for cash.
Actually in most, even in our structured business that’s also true. We have occasionally found individual contracts where the liquidity risk is much higher and they’re for whatever reason maybe it’s a different interpretation of the contract there can be a forced acceleration.
We made one payment in the fourth quarter that was noted, that we did not have a reserve on of approximately I think it was $63 million and that was the exact kind of situation where there’s a potential for a $875 million liquidity call in 2010 and we made the decision and negotiated with the note holder to settle that out at $63 million rather than argue about that potential liquidity call that was going to occur in 2010.
There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.
Thanks to all of you who have joined us for today’s call. Please feel free to contact me directly if you have any additional questions. I can be reached at 914-765-3190. We also recommend that you visit our website at www.mbia.com for additional information. Thank you for your interest in MBIA. Good day and good-bye.
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