MBIA Inc. (NYSE:MBI)
Q3 2010 Earnings Call
November 10, 2010 8:00 am ET
Greg Diamond - MD, IR
Jay Brown - CEO
Chuck Chaplin - President, CFO and CAO
Darin Arita - Deutsche Bank
Marie Lunackova - UBS
David Williams - CQS
Good morning and welcome to the MBIA Incorporated third quarter 2010 financial results conference call. (Operator Instructions)
I would now like to turn the call over to Greg Diamond, Managing Director of Investor Relations at MBIA.
Welcome to MBIA's conference call for our third quarter 2010 financial results. We're going to follow the same format as last quarter's call. Jay and Chuck will provide some comments prior to holding a Q&A session.
Yesterday afternoon, we posted several items on our website, including our 10-Q and quarterly operating supplement. The information for accessing the recorded replay of today's call is included in our third quarter 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 disclosures in our most recent 10-Q to facilitate a greater understanding for investors. The 10-Q also contains information that will not be addressed on today's call.
Please note that anything that we say on today's call is qualified by the information provided in the 10-Q and our other SEC filings. Please read our 10-Q as it contains our most current and comprehensive disclosures about the company and its financial and operating performance.
Today's Q&A session would be handled by Jay Brown, CEO; and Chuck Chaplin, President, CFO and Chief Administrative Officer.
Now for our Safe Harbor disclosure. 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 will provide some introductory comments. Jay.
I just would like to touch on a few things that occurred during the quarter, and then a couple of general comments, kind of an overview of where we are in the mortgage area and in the litigation area.
In terms of the quarter, the quarter as Chuck will go through in detail was impacted by five different types of transactions, all of which are detailed in different parts of our financial statement but are not always easy to understand exactly what the impacts were. Some good transactions occurred late at the beginning of the quarter and we talked about them on the last conference call.
First, we had a significant commutation of $4.4 billion of par reduction for approximately $70 million going out the door. We announced last quarter that $2.9 million was done immediately. It's not been completed in the $4.4 billion of exposures left to our books.
There are no other commutations that we are going to announce today, although I do expect that you're going to see a number of them occur in the fourth quarter, which we'll discuss approximately 90 days from now. Second, we did have at the beginning of the quarter our first recovery outside of litigation involving RMBS put backs. This recovery occurred early in the quarter.
Unlike the commutation which involved about $70 million going out the door, the recovery involved about $50 million in payments coming in the door, net payments to the company.
The next two transactions that were important were really Channel Re and CapMAC. Channel Re was our reinsurer that we established several years ago. During the quarter, we purchased the remaining shares that we owned by third parties. We commuted all of the existing reinsurance and then liquidated the company.
This was an important part of our transformation strategy to simplify the structure of the company. And Chuck will take you through some of the important financial details associated with that transaction. Second, we merged CapMAC, which was a dormant company that we acquired back in 1998. We merged it into MBIA Corp., again, to simplify our structure.
This sort of increases our liquidity and it appears in a couple different parts to the financial statement, both in terms of increased assets on MBIA Corp's balance sheet directly and a change in the invested assets, and Chuck will go through that a little bit.
The last significant transaction that occurred in the quarter is, we were able to finally sell an asset that had been under remediation for the better part of the last two-and-a-half years. We have purchased a number of the bonds associated with that. In the course of the remediation the asset was sold in the third quarter and the company received a substantial amount of liquidity in return for those bonds that we then owned, and this was an important remediation.
The net overall effect was basically neutral to the company over the two-and-a-half years, but the timing of when losses occurred and FX changes because it was outside of the United States and appears in a couple of different parts in the financial statement, again, confusing us.
If you stand back and ignore all of those five transactions, most of the quarterly numbers are fairly straightforward.
As Chuck noted in his comments, in the press release, our volatility continues to decrease. We did have a little bit of movement on our estimate of RBS payments going out. We also had a similar or slightly greater movement on our estimate of recoveries under our put backs in the RBS second lien area.
In addition, we did have some, both accretion and a modest amount of change in a couple of our ABS CDO estimates. Those were detailed in the press release.
And then finally, we did have what I would consider a significant change in one transaction in our CMBS area, which was impacted not because of an eradication of deductible, it still has its full deductible, but our estimate of the underlying performance of the many hundreds of loans that are behind that particular transaction, and it's been our worst performing transaction really for the last two years. And so it significantly caused an increase in our reserve impairments for CMBS CDOs.
Moving on to the mortgage market, obviously there's two big things that were occurring during the last 90 days that have received a lot of press. First, there has been an increased emphasis in the marketplace of discussion over put backs. We have seen a large number of the originators and underwriters of mortgage securities have acknowledged our greater involvement in potential put back liabilities in terms of their estimates. So we sort of changed and increased exposure, including in some of the Qs that were filed yesterday.
I would say from our perspective nothing has really changed in the put back area. We believe our contractual rights are the same; nothing significant has been decided in the quarter. But we are 90 days close to the trial. We have two significant trials scheduled for next year. The trials really are over the interpretation of the contracts and a disagreement between ourselves and the originators about the process of reps and warranties.
And we believe both, what exists and along what's happened in the past would justify our position. But unfortunately we were forced to go to court a couple of years ago to pursue this issue and we do expect that we'll be in trial next year on both of these issues. And it will be consistent with what we've already resourced for in terms of estimates for those particular two originators.
On the mortgage front, we obviously saw the, I don't know what the right word is for closure date or the latest glitch that's occurred across the country with a large number of the servicers halting foreclosures while they straightened out the effects of robo-signing etcetera.
We've spent some time looking at that in terms of its impact on our ultimate loss position. And in terms of the micro, meaning at the individual transaction level, we see no real effect on the second lien area because those in the second lien area for us, basically when a loan becomes significantly overdue and eventually is charged off, it does not have to go through an underlying foreclosure for us to incur a loss. So in that case we really don't see a change in pattern occurring because of a change in foreclosure pattern.
Secondarily, in our CDO book or in our direct first lien mortgage area, we don't see that it's going to change the ultimate losses by a significant amount. There could be a 1% or 2% difference in our estimates over the next 12 months if it gets extended over a six-month timeframe. But ultimately, we don't think it's going to change negatively or positively the ultimate losses that we've already incurred in our estimates.
Well, we are concerned about, and what we have tried to reflect on and are watching most carefully is whether in fact the overall effect on the economy becomes significant because of a significant change in what happens in foreclosures and its effect on the broader real estate market and the mortgage market.
So far, our view is, the basic economic scenario that we see over the next 12 to 18 months is a gradual recovery. We think the QE2 effects will amplify what's already been a good sign over the last six or nine months of a slow but steady recovery, and that at this point in time I think we're pretty comfortable. We're not going to see a second dip in the economy and that's where they reflected in the reduced volatility that you'd see in our reserve estimates of ultimate loss.
And primarily on the litigation front, we continue to move forward both in the litigation as I mentioned earlier, where we are the plaintiff, pursuing contractual rates under both RMBS and CDO recovery. We've had no significant deficients during the quarter. We've had a lot of interim motions.
There continues to be great consistency in the decisions that are made in the individual cases on the RMBS front, and that we believe that the first trials that we have scheduled should set the tone for any other individual litigation that we have to pursue.
We also believe that there are still a certain number of originators out there that would rather settle than pursue a litigation approach, and so we continue to empower sessions with two or three smaller originators where we would hope to avoid having to enter into litigation.
On the transformation front, we have had a large amount of discovery, depositions in our Article 78. Both the plaintiffs and ourselves and the judge, all continue to shoot for trying to get to a resolution phase through a hearing in early January. That could be difficult, given the last minute requests on both sides for information.
But we're still hopeful that we will get our day in court and we've since had many, many days in court, but ultimately we would like to get this resolved in the early part of next year. And certainly, I believe that the plaintiffs, ourselves and the judge all believe that that's feasible if we can stick to the schedules that have been tentatively agreed to.
So as we stand back and look at the quarter and the first nine months of the year, I think we are pretty much where we had hoped to be at this point. We continue to husband liquidity, as Chuck noted in his comments. Liquidity at MBI Corp. improved significantly during the quarter because of the transactions that we engaged in.
Liquidity at National stays positive; liquidity at the holding company remains very, very comfortable that will get us through the next three or four years without anydividend coming up from our operating companies.
So with those comments, I'd like to turn it over to Chuck for a more detailed review of the quarterly numbers.
Overall, this quarter shows a continuation of moderation in loss activity in our RMBS sector and lower volatility in our financial results and position. Our GAAP equities and our adjusted book value at September 30, 2010, are both modestly below the levels at year end 2009.
However, our net loss and adjusted pretax loss for the third quarter compared favorably to the comparable data for 2009.
In the next few minutes I'll just go over some details on our balance sheet and the quarterly performance and add some numbers to some of the comments that Jay has made before we throw it open for your questions.
As in the past few quarters, perhaps the most important financial information to which I can direct your attention is about our balance sheet and liquidity. We manage our balance sheets by entity. Within MBIA Insurance Corp., our liquidity position improved in the third quarter. Holdings of cash and highly liquid assets increased to over $2 billion from $1.1 billion as a result of several actions that came to fruition which Jay summarized.
Most significantly, the acquisitions and commutations and liquidation of Channel Re increased liquid assets by about $595 million. We also concluded the remediation of an international infrastructure, a transaction where MBIA Corp. had become the majority bond holder and that remediation added $365 million of liquid assets to the balance sheet.
We also merged an insurance subsidiary, CapMAC, which had approximately $130 million in liquid assets and whose liabilities had previously been reinsured into MBIA Insurance Corp. But the same time that liquid assets increased, loss payment trends also improved. Our payments on second lien RMBS securitizations were $329 million in the third quarter, or $278 million net of recoveries and reinsurance. And that $329 million should be compared to $421 million in the second quarter of 2010.
The high point in payments for the second lien securitizations was in second quarter of 2009, when payments were $636 million. So although the insurance company's operating cash flow run rate continued to be negative in the quarter, and certainly there is some potential for payment volatility, the trend has been positive, and we believe that our actions to build liquidity have given us a solid cushion.
We also believe that the capital resources in MBIA Corp. continue to be adequate. We had $3.1 billion in statutory capital at September 30, and a clean investment portfolio which had had no permitted impairments in 2010. Again, while there is potential for adverse development in the future, particularly if the economy does not improve, we think we have an adequate cushion against a reasonably adverse scenario on the balance sheet.
Put back recoveries recognized in our statutory loss reserves totaled $2 billion. And based on the REIT rates that we have observed so far, our ultimate recoveries may be as much as our incurred losses on the deals for which we are seeking put backs since we believe that those claims are the result of ineligible loans being included within the securitizations. So the amount that we recorded is less than half of our contract claims.
Accordingly, we believe that as we continue our loan file reviews and proceed with litigation, our put back reserve will continue to increase in future quarters until the cash is actually collected.
Moving on to the ALM portfolio, it had nearly $1 billion in cash and short term assets at September 30, at which $232 million were cash and free assets above all specific collateralization requirements.
ALM didn't pay down any principal on the inter-company secured loan from MBIA Corp. in the quarter, partly reflecting the insurance company's improved liquidity position. We believe that ALM has the resources it needs to pay the remaining $1.1 billion balance of that loan by November of next year when it's due.
However, the ALM portfolio does have a deposit of book value assets to liabilities of $910 million at September 30, 2010, including $310 million which is owed to third parties. We are seeking to eliminate this deposit over time through debt repurchases at discounts.
The holding company MBIA Inc. or the corporate segment of the holding company closed the third quarter with $360 million in cash and short term assets. We expect that that will be enough, together with interest income and other sources to cover the whole Co's needs through 2015 assuming there is no discretionary activity.
As for National, virtually its entire investment portfolio, with $5.7 million of fair value is high quality and liquid. National had statutory capital at September 30 of $2.3 billion. So we also believe that each of these segments has a reasonable cushion against diverse experience.
Third quarter financial results reflect the lower volatility of loss experience that we have seen in 2010, compared to 2009 and 2008 with a consolidated net loss of $213 million in the quarter compared with a net income loss of $728 million in the third quarter of 2009. Both periods featured adverse marks to market on insured credit derivatives, mostly due to contracting spreads on MBIA Insurance Corp.
2010's results also include the consolidation of some MBIA insured structures, the Variable Interest Entities or VIE's, which further confuses the GAAP presentation. As a result, we provide an additional non-GAAP measure, adjusted pretax income that omits the mark-to-market effects on our insurance policies and reflects the actual statutory bases, losses and recoveries that we expect on the insured credit derivatives and the consolidated variable interest entities.
For 2010's third quarter, adjusted pretax income was a loss of $68 million versus a loss of $446 million in the third quarter of 2009. The difference is attributed to lower losses on residential mortgage related exposures, partially offset by increased expected losses on CMBS pools.
Our book value fell in the third quarter as a result of the unrealized loss on insured credit derivatives, while adjusted book value grew. In our non-GAAP ABV measure, the impact of National's operating performance and growth in unearned premium reserves from the Channel Re transaction more than offset insured losses. ABV improved modestly in the quarter from $35.76 to $36.11 per share.
There are several one-time items that affected our consolidated financial reporting for Q3. First, the acquisition of Channel Re and its commutations. Basically, in that transaction our par insured, our loss reserves, unearned premium reserves and invested assets, all increased. The net effect of all of this on the GAAP income statement is a loss of $61 million, and those effects are largely captured in the realized and unrealized gains and losses on insured credit derivatives lines on the GAAP income statement.
On a statutory accounting basis, capital increases by $132 million, and the transaction is accretive to adjusted pretax income.
Secondly, in the quarter, a major transportation infrastructure asset was sold. It was an asset in Australia. At the time of the sale, MBIA owned most of the bonds financing that asset.
Now considering this remediation from an economic perspective over its two-year time period, we had a loss in local currency terms since the sale price of the asset was less than the amounts that we paid over time for the bonds. But the unexpected appreciation in the Australian dollar more than offset that loss.
So the impact on GAAP in the third quarter is $122 million dollar gain, while the statutory result is about $60 million gain. The transaction also had a favorable impact on adjusted pretax income.
Finally, as we disclosed at second quarter, and Jay touched on, we did negotiate the settlement of mortgage repurchase obligations of one counterparty during the quarter and commuted three CDO-Squared transactions during the quarter. The net effect of all of these on third quarter adjusted pretax income is an incurred loss of about $35 million.
Now, regarding the segment results I'll provide some information on adjusted pretax basis. First, that National Public Finance adjusted pretax income was $167 million compared to $132 million in the third quarter of 2009. Refunding premiums earned were only $18 million compared to $46 million in last year's third quarter.
Investment incomes was lower as the rate on the internal asset swap with the wind-down operations was reset to a lower rate versus last year, and investment yields were also lower.
Realized capital gains on the investment portfolio were $45 million compared to virtually nil in Q3, 2009. National's expenses in DAC, amortization and other operating expenses were $11 million lower than last year's third quarter.
Loss reserves in third quarter of 2010 was $6 million, which reflects increases in reserves for affordable housing and student housing transactions, partially offset by a release of loss reserves for healthcare-related credit that was favorably resolved in the quarter.
The structured finance in the international segment shows an adjusted pretax loss of $50 million for the third quarter. The driver was an increase in insured losses of $299 million, partially offset by revenues from premium fees and investment income, net of operating expenses and debt service.
But to drill in on the $299 million of economic loss, I'll take each of the components in turn. On RMBS exposures, the trend that we've seen in the past few quarters continued. Our claim payments of $329 million were again below our projections as they have been since Q3, 2009.
However, initial delinquencies of mortgage loans in our insured second lien RMBS were flat compared to the second quarter, and we are now expecting a somewhat slower burnout of delinquencies over the next 18 months in some of our loss scenarios. This increased the present value of future net payments by about $107 million.
We also increased the value of expected recoveries by $131 million, reflecting primarily higher probabilities of more significant put back recoveries.
The net impact of all of this is a decrease in the expected incurred loss for RMBS by $24 million.
Impairments of our ABS CDOs increased by $159 million. Less than 20% of this increase reflects interest accretion; the balance is primarily due to deterioration in subprime and Alt-A collaterals and projected acceleration of those losses. We also had $172 million of incurred loss or recognized impairments on our insured static pooled CMBS portfolio.
Now there are some positive trends that we observe in this sector, like slowing growth of delinquency pipelines, increased capital markets activity, firming real estate prices and rents, and more modifications of delinquent loans, especially in larger transactions.
However, trustees are still reporting, following net operating incomes for properties in many deals, and when properties are liquidated, the losses tend to be at high severity levels. Our forward-looking loss projection model is sensitive to changes in actual, analyzed and debt service coverages. We had one deal in particular where our projections became materially more adverse in the quarter, and it contributes most of the projected increase and loss.
At this point, we've seen minimal reductions in deductibles in the static pool transactions due to property level liquidations. Commercial real estate is a significant uncertainty for our future, as our losses could be substantially above or below the cumulative $525 million estimated impairment that we have recognized.
Again, all told, insured losses totaled $299 million for MBIA Corp., which is below the quarterly average loss level that we have seen since Q4, 2007.
The Structured Finance and International segment also includes the results of MBIA U.K., which produced $11 million on a pretax basis in the quarter, as its $28 billion insurance portfolio continues to exhibit low levels of loss. The segment also includes the result of our Latin America operations.
Our LatAm Capital Advisors business completed an assignment in the quarter that resulted in fee income to LCA and an insurance premium to MBIA Insurance Corp. However, LCA's impact on adjusted pretax income is not material at this time.
In our Advisory segment conducted through Cutwater Asset Management, we had a pretax loss of $1 million in the quarter compared to breakeven performances in last year's third quarter.
The company continues to incur growth-related expenses for marketing and risk management personnel, as well as for advertising. Average third party assets under management were 6% higher than in 2009's third quarter.
The corporate segment had a pretax loss of $80 million in the quarter compared to a loss of $58 million in last year's third quarter. Both of these quarters are affected by marks-to-market on the liability that we have for warrants issued in conjunction with our capital raises in 2007 and 2008.
As our observed share price volatility increases, and of course as the share price itself increases, the Black-Scholes value of the warrants increase, and that's reflected as a loss on financial instrument, that fair value on our books.
Ultimately, the actual value of this liability will be settled in cash or via share issuance. The wind-down operations had adjusted pretax loss of $104 million dollars, also driven by losses on financial instruments at fair value.
The value of our euro-denominated liabilities increased by $100 million as the U.S. dollar depreciated about 10% versus the euro in the quarter. We believe the remaining turn on these liabilities does provide time for that unrealized loss to be reversed. Nonetheless, we do expect that the run rate of earnings on this business segment will continue to be negative in the near term.
So our conclusion on the third quarter, similar to that over the course of 2010, we are being vigilant in managing the balance sheet and actively pursuing recoveries and loss mitigation strategies. We believe we are well positioned to handle expected loss scenarios.
There are potentially serious headwinds if the economy does not get any better or turns down again, but adverse volatility in our book does appear to be declining.
And with that we'll open the line up to your questions.
(Operator Instructions) Your first question comes from the line of Darin Arita with Deutsche Bank.
Darin Arita - Deutsche Bank
Two questions here, one on the mortgage put backs. So you did $2 billion that have been recognized thus far. I believe that reflects only about 30% of ultimate recoveries. What do you need to see to increase this percentage?
The $2 billion that we've recognized on a statutory basis relates to about a $4.3 billion of incurred loss on the deals for which we are reflecting those put backs. And we have a scenario-based approach to valuing the put backs that takes into account things like the estimated time to receipt of payment, the risk associated with litigation, the potential that counterparts might be unable to take judgments against them because of the value of all liabilities that they would carry at that time.
And so, all of those factors result in a discount on the amount of our contract claim relative to that which we are recording to the balance sheet. Over time, Darin, we would expect that as we have more information, as we have reviewed additional files, as we have gotten specifically significant valid samples on the cases, and as the court process proceeds, we would expect to see the probability associated with all recovery to increase.
And in fact that's the driver of a part of the increase in put back value that we're recognizing in the third quarter. So over time it's our expectation that that value will rise until the receivable is settled and paid.
Darin Arita - Deutsche Bank
And turning to that $50 million settlement realized during the quarter and that single market transaction, what percent of the initial put back request did that represent?
I just want to be clear. The $50 million is a net number. So that is the net recovery that we have in the third quarter. So it includes the settlement, it includes other recoveries, it also includes amounts that we owed to re-insurers, including Channel Re of recoveries received.
So the amount that was received was not exactly $51 million; it's just a contributor to that number.
I think Darin, the question you had in terms of how did it compare to our estimated recovery, or what was needed, it's very consistent with what we expected to incur as a loss on that particular originator. And so, it's essentially the difference between what we received. And our estimate was immaterial.
Darin Arita - Deutsche Bank
And just lastly, on the CMBS side, can you give a little more detail on the transaction that's giving you more difficulty, and how that's similar or different from your other CMBS transactions?
It has a concentration of mortgages that have falling debt service coverages. And one of the, when you look at the way that we estimate reserves, the debt service coverage on the individual mortgages is a driver. And so this transaction, because of its poor underlying performance is attracting a much higher reserve. So it is performing much worse than most of the rest of the portfolio.
Yes, the transaction its not really constructed that differently than other transactions. It's just basically the underlying projected collateral performance - and I emphasize the word 'projected', because we don't know and won't know for quite a while what the ultimate performance of that collateral is. It's just projected to be significantly worse than the rest of the book.
And in a sense, it's been the standout negative transaction that we've referred, but as we move through the reserving estimates, it was one of the first transactions to get a reserve, and this quarter it had far and away the most significant impact because of the change in the underlying performance of the individual mortgages that underline this reference to CMBS bonds.
I think Jay pointed out earlier that there actually isn't any deterioration in the deductible in that deal so far.
Darin Arita - Deutsche Bank
Okay, and what is the size of that deal?
Offhand, I don't recall.
(Operator Instructions) Your next question comes from the line of (Ann Holtwick with Devfast).
A couple of questions; one, could you please amplify a little on how you value recoveries on the put backs? I think you said that you use sort of time to recovery and all these other factors.
So, how much, which would create a rising recovery amount as you get closer to when you think you're going to recover, how much has that changed over the last few months? How much are you increasing the recoveries by?
Yes, the timing hasn't really changed in the past few quarters, and it's based on the fact that one of the most significant cases, we do have trials upcoming in 2011. The amount that we increased recoveries by in this quarter is about $130 million. And there have been increases in other quarters as well.
And a couple different drivers that we've seen; one is, as we have received and reviewed our mortgage files and identified the most serious of the material breaches in those files, we've increased our recovery estimate. And I said it's sort of probabilistic; we placed the heaviest probability on files that we've actually reviewed I suppose to recovery amounts that are estimated via extrapolation from files reviewed.
So as we have reviewed files over time, the amount has increased. I think we initially recognized about $1.2 billion, and it's grown to $2 billion over the past several quarters. And the other thing that is going to happen over time we expect is that the probability of high recovery i.e. full recovery will increase as we get through both the legal process and also, as you pointed out, with the passage of time.
So long as we still expect that payments will be received in 2012 as we currently forecast, then each quarter you're going to have a kind of an interest accretion amount that we just put out.
Are you changing that probability of full recovery, based on sort of exogenous factors like FHSAA's, subpoenas to major servicers or anything like that?
In part, but also due to the process that we observe on the transactions that we're litigating.
I think the fact that we're getting consistent results in each of the litigations has increased our confidence that once we get through the first litigation, most of the major legal issues that are not nuanced by the individual transactions will be determined. And as I've said, although there are no major decisions, we continue to see consistency in court decisions as they've unfolded during the quarter.
I also, personally, it's not reflected in our numbers, but I do think there is a growing awareness across the entire industry that this is a real issue, that there will be settlements, that there is going to be a significant amount of put backs that's reflected in a variety of originators' estimates both in terms of put back recoveries and increased litigation reserves.
And we do expect that we're going to have some originators decide that they don't really want to go through the court process and want to avoid the legal costs associated with that and would agree to settle before we get those determinations.
But I don't expect you're going to see a significant change in our estimate quarter-to-quarter unless we have a major settlement or we actually get through the actual trial. Because the actual number of files that we are reviewing, because the majority of our cases are in litigation, we're not actually putting additional put backs into the queue right now in most of those situations because we're trying to work through the right approach to handle in court.
So you'd see a modest change perhaps each quarter of anywhere from $50 million or $100 million, but you're not going to see a significant closing of the gap, as Chuck would say from the $2 billion or so to the $4 billion until we get out towards late 2011, early 2012.
And finally, have you been contacted by the FHSAA in their investigation on behalf of Fannie and Freddie?
Not that I am aware of. Let me just check. No, we have not been.
Your next question comes from the line of Marie Lunackova with UBS.
Marie Lunackova - UBS
I have a question on RMBS losses. I wanted to ask what expectation for mortgage delinquencies are modeled in your RMBS losses? What delinquency trends you would have to see to get no material loss development in the future?
And then the second question is, what is the impact of lower interest rates on your loss estimates, or how significant it was in the third quarter?
With respect to RMBS delinquencies, the change in our loss in this quarter really deals with lengthening the period of time between our sort of elevated level of delinquency and when delinquencies actually get down to a level where there is no net loss being paid.
If you look at what we have done historically, we've tended to assume that there is a kind of a six-month burnout period that when delinquencies started to fall, they would fall to a normal level over a six-month period.
We have enough data now to give us confidence that while we believe that will happen that it will take a longer period of time. And so that's a contributor to the increase in recognized loss.
I think the initial delinquencies that we're seeing are in the 2% range, and they would need to get under the 1% range in order to get to the point where the cash inflows from excess spread in the deals covered any net loss payments on charge-offs.
And the other part of your question, I am sorry was?
Marie Lunackova - UBS
The interest rate, the low interest rate environment. What impact it has on the loss estimates because it is a present value number?
Yes, I actually don't have the number. I know the risk-free rates on the GAAP side declined in the quarter, and that would have the effective increasing loss reserves for GAAP. However, our loss reserves for GAAP are primarily driven by the RMBS exposures where there's not much time value because they are expected to be paid out in the short term.
So the real impact that you would see of changes in interest rates would be on the impairments of the CDOs and the CMBS pools which are longer tailed liabilities.
On a statutory basis, we're setting those rates only on an annual basis. So for example, there's no decrease in the discount rate that's taken place over the course of 2010. They will be reset at year end. Obviously if they reset lower, reserves would be higher all other things being equal and vice-versa.
Your next question comes from a line of a David Williams with CQS.
David Williams - CQS
Could you give us a breakdown of the $22 billion of additional exposure that MBIA Insurance obtained via the Channel Re transaction?
That is actually detailed in our supplement. Now, what page is it on? I see. So if you compare the spread that's shown on Page 47 of insured exposure to last quarter, basically the only thing that's really happened that's material is the Channel Re commutation.
David Williams - CQS
I guess the question I am asking is, I am assuming your MBIA Insurance now, the $22 billion, is more exposure to the insurance company. I was wondering what asset buckets that $22 billion fell into?
Sure, and you could see the detail on Page 47. I can tell you just without eyeballing the two supplements to get the number, that there is a meaningful portion of ABS CDOs that come back with the Channel Re commutation. And most of the loss reserves that come back are driven by those exposures.
So while we've got about $600 million of liquid assets, there also is about $400 million of reserves that come back with the Channel Re commutation. So when we talk about it as accretive to liquidity, to get a full picture of that there are payments that we expect on that portfolio but they are over a long period of time where the assets are current.
And in response to the earlier question about the one individual CMBS transaction that has caused us the most difficulty, our total exposure to that transaction is about $1.3 billion.
Thank you. There are no further questions. I'll now turn it back over to Mr. Diamond for closing remarks.
I'd like to point out that we've actually answered or responded to all questions that were put into the queue today, there's been no exclusions.
Thanks to all of you who have joined us for today's call. Please contact me directly if you have 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.
This concludes the formal Q&A. You may now disconnect.
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