MBIA Inc. (“MBIA,” the “Company,” “we” or “us”) provides financial guarantee insurance, as well as related reinsurance, advisory and portfolio services for the public and structured finance markets, and investment management services, including advisory services, on a global basis. The Company was incorporated as a business corporation under the laws of the state of Connecticut in 1986.
Financial Guarantee Business
Our financial guarantee insurance generally provides investors with an unconditional and irrevocable guarantee of the payment of the principal, interest or other amounts owing on insured obligations when due or, in the event that we have the right at our discretion to accelerate insured obligations upon default or otherwise, upon our election to accelerate. Because a financial guarantor’s ratings are generally assigned to insured obligations, the principal economic value of financial guarantee insurance for capital markets issuers has been the lower interest cost of an insured obligation relative to the same obligation on an uninsured basis. For investors, our insurance provides not only an additional level of credit protection but also the benefit of our portfolio monitoring and remediation skills throughout the life of the insurance policy. In addition, for complex financings and for obligations of issuers that are not well-known by investors, insured obligations have historically received greater market acceptance than uninsured obligations.
We conduct our financial guarantee business, as well as related reinsurance, advisory and portfolio services, through our wholly-owned subsidiaries National Public Finance Guarantee Corporation (“National”), our United States (“U.S.”) public finance only financial guarantee company, and MBIA Insurance Corporation (“MBIA Corp.”), which together with its subsidiaries, writes global structured finance and non-U.S. public finance financial guarantee insurance. MBIA Corp. is the successor to the business of the Municipal Bond Insurance Association (the “Association”), which began writing financial guarantees for municipal bonds in 1974. MBIA Corp. is the parent of Capital Markets Assurance Corporation (“CapMAC”) and until February 2009 was the parent of National, both financial guarantee insurance companies that were acquired by MBIA Corp.
In February 2009, we restructured our business to re-launch National as a U.S. public finance-only financial guarantee company (the “Transformation”) through a series of transactions, including the transfer of National (then known as MBIA Insurance Corp. of Illinois) from MBIA Corp. to a newly established holding company, National Public Finance Guarantee Holdings, Inc., that is 100% owned by MBIA Inc., and the reinsurance by National of the U.S. public finance businesses of MBIA Corp. and a third-party financial guarantor, Financial Guaranty Insurance Corporation (“FGIC”). Pending litigation challenging the establishment of National constrained our new business writings in 2009. The Transformation is described more fully under the “Our Insurance Operations—National Portfolio” section below and the Transformation-related litigation is described more fully under “Legal Proceedings” in Part I, Item 3.
After giving effect to the Transformation, MBIA Corp.’s remaining portfolio consists of global structured finance and non-U.S. public finance business. MBIA Corp. also owns MBIA UK Insurance Limited (“MBIA UK”), a financial guarantee insurance company that is regulated and supervised by the Financial Services Authority in the United Kingdom and is authorized to carry out insurance business in the United Kingdom and in the European Economic Area on a cross border services basis. MBIA UK’s principal line of business is the guarantee of both structured finance and public finance debt obligations in selected international markets. MBIA UK also insures the policies previously insured by MBIA Assurance S.A. (“MBIA Assurance”), a French insurance company owned by MBIA Corp. which was dissolved in 2007 after the transfer of MBIA Assurance’s obligations to MBIA UK. MBIA Corp. writes financial guarantee insurance in Mexico through MBIA México, S.A. de C.V. (“MBIA Mexico”). Generally, throughout the text, references to MBIA Corp. include the activities of its subsidiaries, MBIA UK, MBIA Mexico and CapMAC.
Investment Management Business
We conduct our investment management business primarily through wholly-owned subsidiaries of Cutwater Holdings, LLC (together, “Cutwater”), formerly known as MBIA Asset Management, LLC. Cutwater offers advisory services, including cash management, discretionary asset management and structured products on a fee-for-service basis. We offer these services to public, not-for-profit, corporate and financial services clients, including the Company and its subsidiaries. Cutwater also manages asset/liability products and conduit programs, which are being wound down.
OUR BUSINESS STRATEGY
Our ratings downgrades and mounting concerns about monoline insurers impaired our ability to write new business in late 2007 and 2008, and pending litigation challenging the establishment of National constrained our new insurance business writings in 2009. Furthermore, unprecedented levels of delinquency and loss in our structured finance business, primarily in our insured residential mortgage-backed (“RMBS”) and insured credit default swaps (“CDS”) portfolios, continue to place considerable stress on our economic results.
In response to these events, we are continuing efforts that we began in the fourth quarter of 2007 to strengthen our balance sheet and transform our business model.
Strategic Transformation
On February 25, 2008, we announced a strategic plan to restructure our business as soon as feasible, with a goal of within five years. A significant component of the plan is the creation of separate legal operating entities for our public finance, structured finance and international financial guarantee businesses as well as our investment management business. The objectives behind this initiative are to provide greater resilience and financial flexibility under extreme market stress, to obtain the highest possible ratings for each business, and to create more transparency to investors and policyholders. In February 2009 we completed the first key step in the strategic plan with the establishment of a U.S. public finance-only financial guarantee company through the Transformation.
The next step in the Transformation, which is unlikely to occur prior to resolution of certain of the Transformation-related litigation, will be to further position National to write new U.S. public finance financial guarantee insurance policies through the achievement of high stable ratings. It is our intent to capitalize National at a level consistent with the highest achievable credit ratings through internal capital growth at National and potentially by raising third-party capital. However, no assurance can be given that we will be able to achieve such ratings.
In February 2010, the Company took another step in its strategic plan by restructuring its investment management subsidiaries and renaming its investment advisory companies under the “Cutwater” name to reflect and communicate their organizational separation from the Company’s insurance operations and the wind-down of the Company’s asset/liability products and conduit businesses. In particular, the investment advisory business now operates under a wholly-owned “Cutwater” branded holding company of MBIA Inc. that no longer owns the wind-down businesses. Cutwater plans to continue to increase third-party assets under management by taking advantage of strong demand for advisory services resulting from recent fixed-income market volatility and secular growth in fixed-income asset classes due to demographics and product innovation. Currently, the majority of assets under management are from third-party clients and this percentage is anticipated to increase over time.
Capital Preservation, Liquidity Management and Deleveraging
We have taken several steps to preserve capital, enhance liquidity and deleverage the company, including raising $2.65 billion in new debt and equity capital and converting our $400 million soft capital facility into cash.
First, in 2008, we began aggressively pursuing our rights against sellers/servicers who we believe fraudulently induced us into writing insurance on their securitizations and breached their contractual obligations by placing ineligible collateral into the transactions and failing to cure such breaches or repurchase or replace the ineligible collateral upon demand. If we recover the expected damages for the losses resulting from ineligible loans in these transactions from these sellers/servicers, of which only a portion has been reflected in our loss reserves to date, and we receive other recoveries associated with defaulted RMBS transactions, we will substantially enhance our capital position. There can be no assurance, however, that we will recover these damages in full or in a time frame necessary to meet liquidity requirements.
Second, we have enhanced our liquidity risk management framework, the primary objective of which is to monitor potential liquidity constraints in our asset and liability portfolios and guide the proactive matching of liquidity resources to needs. Our liquidity risk management framework monitors the Company’s cash and liquid asset resources using stress-scenario testing to ensure that we maintain cash and liquid securities in an amount in excess of all stress scenario payment requirements. These measurements are performed on a legal entity and operating segment basis. When liquidity resources fall short of our target liquidity cushions at any level, we generally increase our cash holdings position by selling or financing assets and/or drawing upon one or more of contingent sources of liquidity.
Third, we have purchased and may, from time to time, directly or indirectly, seek to purchase instruments guaranteed by us or seek to commute policies where such actions are intended to reduce future expected economic losses. The amount of 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 expected impairments or loss reserves, but in all cases they are intended to limit our ultimate losses and to reduce the future volatility in loss development on the related policies.
Finally, we have repurchased debt obligations of the Company and its subsidiaries at substantial discounts, improving the Company’s book value and enhancing long term liquidity, and may continue to do so at prices that we deem to be economically advantageous.
New Business Activities and Legal Entity Changes
In addition to implementing these initiatives, we also began to expand the services offered by our businesses through reinsurance and financial advisory transactions.
Reinsurance
While the industry-wide reduction in credit ratings has led to reduced demand for bond insurance across all financial markets, National generated new business premiums in 2009 from reinsurance provided on a large portfolio of U.S. public finance exposure originally insured by FGIC with total net par assumed of $181 billion (the “FGIC Transaction”), which was completed in 2008.
Financial Advisory Services
• In 2009, the Company expanded the provision of financial advisory services to Latin American clients in the infrastructure sectors. LatAm Capital Advisors, Inc. (“LatAm”), an indirect wholly-owned subsidiary of the Company, provides advice in the valuation and structuring of capital markets transactions and is seeking to expand into third-party fund management utilizing its regional expertise in infrastructure asset management. LatAm focuses on services that benefit existing clients of the Company and will also forge new relationships in selected countries throughout Latin America and the Caribbean. Transactions completed in 2009 include the financial re-leveraging of a major toll road and infrastructure asset valuations.
• In 2009, the Company established MBIA International Advisory Limited in the United Kingdom, a new financial advisory subsidiary, and is seeking regulatory approval to begin providing financial advisory services to clients in the European Economic Area in 2010.
Legal Entity Changes
• In February 2010, we restructured and renamed our investment management subsidiaries as described above under “Strategic Transformation.”
• In addition, in 2009 the Company formed a new subsidiary, Optinuity Alliance Resources Corporation (“Optinuity”), that provides management and portfolio remediation services to MBIA Inc. subsidiaries and which is evaluating opportunities to provide portfolio remediation services to third-party financial guarantors, particularly those that are distressed.
• In 2009, the Company acquired 100% of the ownership interests in LaCrosse Financial Products, LLC (“LaCrosse”) and its parent company LaCrosse Financial Products Member, LLC from a third party who administered these special purpose vehicles. LaCrosse historically issued credit default swaps (“CDSs”) guaranteed by MBIA Corp. and MBIA UK and has historically been consolidated into the Company’s financial statements under the criteria for variable interest entities. The acquisitions permit the Company, among other things, to more easily administer the LaCrosse CDS contracts guaranteed by MBIA Corp. and MBIA UK by eliminating a third-party administrator.
The Company plans to continue to evaluate opportunities to participate in the structured finance and international markets in the future as such opportunities arise.
We continue to evaluate our business model and may pursue a different set of strategies in the future. There can be no assurance that the strategies that have been implemented or that will be pursued in the future in connection with this evaluation will result in high stable credit ratings for each of our insurance companies or for MBIA Inc., will enable us to write new financial guarantee business, will otherwise improve our financial condition, business condition or operations or will not result in a material adverse effect on the Company.
Statements included in this Form 10-K which are not historical or current facts 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,” “intend,” “will likely result,” 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. We wish to caution readers not to place undue reliance on any such forward-looking statements, which speak only to their respective dates.
Important factors that could cause our actual results and financial condition to differ materially from estimates contained in or underlying the Company’s forward-looking statements include, among others, those discussed under “Risk Factors” in Part I, Item 1A and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Forward-Looking and Cautionary Statements” in Part II, Item 7.
OUR INSURANCE OPERATIONS
Our U.S. public finance insurance business is conducted through National and our structured finance and international insurance operations are conducted through MBIA Corp. and its subsidiaries. Our ratings downgrades and mounting concerns about monoline insurers have impaired our ability to write new business since 2007. Pending litigation challenging the establishment of National has further constrained new business writing in 2009. However, we expect that once the pending litigation is favorably resolved, we will be able to obtain the highest possible credit ratings and achieve the market acceptance necessary to meet our stated objectives.
We are compensated for our insurance policies by insurance premiums paid upfront and/or on an installment basis. Historically, our financial guarantee insurance was offered in both the new issue and secondary markets on a global basis. Transactions in the new issue market were sold either through negotiated offerings or competitive bidding. In negotiated transactions, either the issuer or the underwriter purchases the insurance policy directly from an insurer. For municipal bond issues involving competitive bidding, the insurance is offered as an option to the underwriters bidding on the transaction. The successful bidder would then have the option to purchase the insurance, or at times the issuer can purchase the insurance. We also issue insurance policies to guarantee the payment of principal and interest on municipal obligations being traded in the secondary market upon the request of a broker or an existing holder of uninsured bonds. The premium is generally paid by the owner of the obligation. In addition, we have provided financial guarantees to debt service reserve funds. The primary risk in our insurance operations is that of adverse credit performance in the insured portfolio.
We seek to maintain a diversified insured portfolio and have designed each insured portfolio to manage and diversify risk based on a variety of criteria including revenue source, issue size, type of asset, industry concentrations, type of bond and geographic area. The insurance policies issued or reinsured by the Company’s licensed insurers generally provide an unconditional and irrevocable guarantee of the payment required to be made by, on or behalf of the obligor to a designated paying agent for the holders of the insured obligations of an amount equal to the payment of the principal of, and interest or other amounts owing on, insured obligations when due or, in the event that the insurance company has the right, at its discretion, to accelerate insured obligations upon default or otherwise, upon the insurance company’s election to accelerate.
In the event of a default in payment of principal, interest or other insured amounts by an issuer, the insurance company promises to make funds available in the insured amount generally on the next business day following notification for U.S. transactions and within longer timeframes for international transactions, depending on the terms of the insurance policy. Our insurance companies provide for this payment, in some cases through a third-party bank, upon receipt of proof of ownership of the obligations due, as well as upon receipt of instruments appointing the insurer as agent for the holders and evidencing the assignment of the rights of the holders with respect to the payments made by the insurer. With respect to insurance policies issued by FGIC and reinsured by National under the FGIC Transaction, National has agreed to comply with the terms of the original FGIC policies.
Because we generally guarantee to the holder of the underlying obligation the timely payment of amounts due on such obligation in accordance with its original payment schedule, in the case of a default or other triggering event on an insured obligation, payments under the insurance policy cannot be accelerated against us, except in certain limited circumstances, unless we consent to the acceleration. In the event of a default, however, we may have the right, in our sole discretion, to accelerate the obligations and pay them in full. Otherwise, we are required to pay principal, interest or other amounts only as scheduled payments come due. Typically, even if the holders are permitted by the terms of the insured obligations to have the full amount of principal, accrued interest or other amounts due, declared due and payable immediately in the event of a default, we are required to pay only the amounts scheduled to be paid, but not in fact paid, on each scheduled payment date. Our payment obligations after a default vary by deal and by insurance type. There are three primary types of policy payment requirements: (i) timely interest and ultimate principal; (ii) ultimate principal only at final maturity; and (iii) payments upon settlement of individual collateral losses as they occur after parties subordinated to us in a transaction have absorbed their share of losses. With respect to the insurance of CDS contracts, in certain events, including the insolvency or payment default of the insurer or the issuer of the CDS, the CDS contract is subject to termination and the counterparty can make a claim for the full amount due on termination.
National Portfolio
Through its reinsurance of U.S. public finance financial guarantees from MBIA Corp. and FGIC, National’s insurance portfolio consists of municipal bonds, including tax-exempt and taxable indebtedness of United States political subdivisions, as well as utility districts, airports, health care 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 generally are supported by taxes, assessments, user fees or tariffs related to the use of these projects, by lease payments or by other similar types of revenue streams.
FGIC Transaction
In the third quarter of 2008, MBIA Corp. closed the FGIC Transaction, in which MBIA Corp. assumed a significant portion of FGIC’s U.S. public finance insurance portfolio. As of the closing date, the reinsured portfolio consisted of investment grade credits, primarily in the general obligation, water and sewer, tax-backed and transportation sectors, and did not contain any CDS contracts, below investment grade credits or other credits that were inconsistent with our credit underwriting standards. The reinsurance was provided on a “cut-through” basis, which enables FGIC’s policyholders to receive the benefit of MBIA Corp.’s reinsurance by allowing them to present claims directly to MBIA Corp. The FGIC reinsurance agreement is incorporated by reference as an exhibit to this Form 10-K and any description of it in this Form 10-K is qualified in its entirety by the agreement.
Under the FGIC Transaction, MBIA Corp. assumed a total net par of approximately $181 billion and received upfront unearned premiums, net of a ceding commission paid to FGIC, of approximately $717 million. As required by the New York State Insurance Department in connection with its approval of the reinsurance transaction, the funds were placed in a trust and, in accordance with the terms of the trust, released on June 30, 2009. On December 1, 2008, MBIA Corp. entered into an Administrative Services Agreement with FGIC allowing MBIA Corp. to administer and remediate credits in the portfolio.
MBIA Corp. subsequently assigned its rights, interests, and obligations under the FGIC reinsurance agreement to National as part of the Transformation described below. In addition, MBIA Corp. assigned all of its rights and interests in the trust to National as payment to National of the amount of the net unearned premium reserve (net of ceding commission) associated with the FGIC insurance policies; as such, assets were released from the trust to National on June 30, 2009.
Transformation
Under the Transformation, the Company executed a series of transactions to establish National as a U.S. public finance-only financial guarantee company. The stock of National, formerly known as MBIA Insurance Corp. of Illinois, a financial guarantee insurance company which was acquired by the Company in 1989 and was a direct subsidiary of MBIA Corp., was transferred by MBIA Corp. to the Company, then contributed by the Company to a newly established intermediate holding company, National Public Finance Guarantee Holdings, Inc., which is itself a wholly-owned subsidiary of the Company. National was previously domiciled in Illinois until it was redomesticated to New York effective December 1, 2009.
In addition, on February 17, 2009, MBIA Corp. ceded all of its U.S. public finance business to National by entering into a Quota Share Reinsurance Agreement with National, effective January 1, 2009 (the “MBIA Corp. Reinsurance Agreement”), and by assigning to National pursuant to a separate assignment agreement its rights, interests and obligations with respect to the U.S. public finance business of FGIC that was reinsured by MBIA Corp. pursuant to a reinsurance agreement with FGIC (the “FGIC Reinsurance Agreement”). The MBIA Corp. Reinsurance Agreement is incorporated by reference as an exhibit to this Form 10-K and any description of it in this Form 10-K is qualified in its entirety by the agreement. The portfolio transferred to National by reinsurance or through the assignment of the FGIC Reinsurance Agreement consists entirely of U.S. public finance business with total net par outstanding of approximately $554 billion as of January 1, 2009. The reinsurance and assignment transactions between MBIA Corp. and National became effective as of January 1, 2009.
In connection with the reinsurance and assignment transactions, MBIA Corp. paid to National a premium to reinsure the policies covered by the MBIA Corp. Reinsurance Agreement and the assignment agreement, net of a ceding commission on the unearned premium reserve, and National was further capitalized through a dividend and return of capital paid by MBIA Corp. to MBIA Inc., which was contributed to National.
MBIA Corp. and National received the required regulatory approvals from the New York and Illinois insurance departments prior to executing the Transformation. National was previously domiciled in Illinois and redomesticated to New York effective December 1, 2009.
MBIA Corp. continues to insure its remaining book of structured finance and international business, as well as the Guaranteed Investment Contracts and medium-term notes (“MTNs”) managed by Cutwater. The Transformation has constrained the ability of National and MBIA Corp. to pay dividends to MBIA Inc. which affects the Company’s liquidity. The impact of the Transformation on the Company’s liquidity is described further in “Note 18: Insurance Regulations and Dividends” in the Notes to Consolidated Financial Statements of MBIA Inc. and Subsidiaries in Part II, Item 8.
In general, references herein to National-insured or issued policies include those insurance policies reinsured from MBIA Corp. or under the FGIC Transaction, unless indicated otherwise.
Portfolio Profile
As of December 31, 2009, National had 29,765 insurance policies outstanding diversified among 11,629 “credits,” which we define as any group of issues supported by the same revenue source.
As of December 31, 2009, the net par amount outstanding on National’s insured U.S. public finance obligations was $508.0 billion. Net insurance in force, which includes all insured debt service, as of December 31, 2009 was $821.7 billion.
National’s underwriting guidelines limit the net insurance in force for any one insured credit. In addition, National is subject to both rating agency and regulatory single-risk limits with respect to any insured bond issue. See the “Insurance Regulation” section below for a description of these regulatory requirements. As of December 31, 2009, National’s net par amount outstanding for its ten largest insured U.S. public finance credits totaled $29.8 billion, representing 5.9% of National’s total U.S. public finance net par amount outstanding.
MBIA Corp. Insured Portfolio
MBIA Corp. has insured and reinsured structured finance and international financial obligations which are sold in the new issue and secondary markets, including:
• structured finance and asset-backed obligations, including obligations collateralized by diverse pools of corporate loans or secured by or payable from a specific pool of assets having an ascertainable future cash flow;
• payments due under credit and other derivatives, including termination payments that may become due upon the occurrence of certain events, as further described below;
• privately issued bonds used for the financing of public purpose projects or entities, which are located outside of the United States and that include toll roads, bridges, airports, public transportation facilities, utilities and other types of infrastructure projects serving a substantial public purpose; and
• obligations of sovereign and sub-sovereign issuers, which includes regions, departments or their equivalent in each jurisdiction as well as sovereign owned entities that are supported by a sovereign state, region or department.
As of December 31, 2009, MBIA Corp. had 1,323 policies outstanding in its insured portfolio. In addition, MBIA Corp. had 311 insurance policies outstanding relating to asset/liability products liabilities issued by the Company and its subsidiaries. MBIA Corp.’s total policies are diversified among 865 “credits,” which we define as any group of issues supported by the same revenue source.
In addition, certain of our insurance policies guarantee payments due under CDSs and other derivatives, including termination payments that may become due upon the occurrence of certain events, such as the insolvency of or a payment default by the financial guarantor or the CDS issuer. In 2008 the Company announced that it had ceased insuring new credit derivative contracts within its insurance operations except for transactions related to the reduction of existing insured credit derivative exposure.
Structured Finance and Asset-Backed Obligations
Structured finance obligations insured by MBIA Corp. typically are securities repayable from expected 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, leases for equipment, aircraft and real property, private sector student loans, and infrastructure projects. Structured finance obligations are either secured by undivided interests or collateralized by the related assets. Additional policies have included payments due under CDSs and other derivatives, including termination payments that may become due upon the occurrence of certain events, such as the insolvency of or a payment default by the financial guarantor or the CDS issuer.
Structured finance transactions are often structured such that the insured obligations are intended to benefit from some form of credit enhancements such as over-collateralization, subordination, excess cash flow or first loss protection, to cover credit risks. Structured finance obligations contain risks including asset risk, which relates to the amount and quality of asset coverage, structural risk, which relates to the extent to which the transaction structure protects the interests of the investors from the bankruptcy of the originator of the underlying assets or the issuer of the securities, and servicer risk, which relates to problems with the transaction servicer (the entity which is responsible for collecting the cash flow from the asset pool) that could affect the servicing of the underlying assets. Additionally, the inclusion of a large number of ineligible mortgage loans in MBIA Corp.-insured transactions has resulted in unforeseen risks to many transactions which has caused, and may continue to cause, material losses beyond any stress analyses undertaken at origination.
Credit Derivatives
In 2008, the Company announced that it had ceased insuring new credit derivative contracts except in transactions related to the reduction of existing insured credit derivative exposure. In addition, the Company announced that it had suspended the writing of all new structured finance business for approximately six months.
Since that temporary suspension we adjusted target structured finance risk sectors and underwriting criteria in this business and are continuing to track developments in the structured finance industry. Currently, the structured finance industry is generating very few credit enhancement opportunities for the Company, and it is uncertain how or when the Company may re-engage this market.
International Obligations
Outside the United States, financial guarantee insurance has been used by issuers of sovereign and sub-sovereign bonds, structured finance securities, utility debt and financing for public purpose projects, among others. We have insured both structured finance and public finance obligations in select international markets and the risk profile of our international exposure is similar to that in the United States, although there are unique risk factors related to each country and region that are evaluated at origination and on an ongoing basis. These factors include legal, regulatory, economic and political variables, the sophistication of and trends in local capital markets and currency exchange risks. Ongoing privatization initiatives in some regions have shifted the financing of new projects from the government to the capital markets, where investors can benefit from the default protection provided by financial guarantee insurance. The development of structured finance securitizations has varied to date by region depending on the development stage of the local capital markets and the impact of financial regulatory requirements, accounting standards and legal systems.
Portfolio Profile
As of December 31, 2009, the net par amount outstanding on MBIA Corp.’s insured obligations, including insured obligations of MBIA UK, MBIA Mexico and CapMAC (excluding $6.0 billion of MBIA insured investment agreements and MTNs for our asset/liability products transactions) (the “Structured Finance and International Portfolio”) was $204.5 billion. Net insurance in force for the above portfolio, which includes all insured debt service, as of December 31, 2009 was $264.6 billion.
OUR INVESTMENT MANAGEMENT SERVICES
Our investment management services operations consist of our advisory services business and our wind-down asset/liability products and conduits businesses. In the advisory services segment our registered investment advisors provide fixed-income asset management services for third parties and the investment portfolios of the Company and its affiliates (including the wind-down businesses) on a fee-for-service basis.
The ratings downgrades of MBIA Corp. significantly adversely affected our funding activities in our asset/liability products and conduits businesses and resulted in the collateralization and/or termination of a substantial portion of our investment agreements. As a result of the winding down of these businesses, we are refocusing our investment management services’ new business operations solely on advisory services.
The Company has operated its advisory services segment since 1991 and had $42.1 billion in institutional assets under management as of December 31, 2009, including $16.7 billion from the Company and its subsidiaries. The segment has produced strong investment performance for its clients and has focused on providing high quality client support. The Company believes there is strong demand for its services given its track record and recent fixed-income market volatility and secular growth in fixed-income asset classes due to demographic changes and product innovation. In order to develop and grow our third-party advisory business, we have renamed our advisory services companies under the “Cutwater” name and re-branded them to reflect and communicate their organizational separation from the Company’s insurance operations and the wind-down businesses. In particular, the investment advisory business now operates under a wholly-owned “Cutwater” branded holding company of MBIA Inc. that no longer owns the wind-down businesses.
Our advisory services are offered in two major product lines, traditional and structured. Within the traditional product line, Cutwater offers cash management, customized asset management, discretionary asset management and fund accounting services to governments, insurance companies (including the Company’s insurance subsidiaries) corporations, pension funds, unions, endowments, foundations and investment companies in both pooled and separate account formats. These services are offered through registered investment advisers, and Cutwater receives asset management and administrative fees as compensation. Within the structured product line, Cutwater manages asset/liability programs, conduits, collateralized debt obligations (“CDOs”) and other funding vehicles (including the wind-down businesses) for banks, insurance companies, program trustees and investment companies, and it earns base and performance fees for its services.
Cutwater’s advisory services are offered through three principal operating subsidiaries: Cutwater Asset Management Corp. (“Cutwater-AMC” formerly MBIA Capital Management Corp.), a Securities and Exchange Commission (“SEC”)-registered investment adviser and Financial Industry Regulatory Authority (“FINRA”) member firm, Cutwater Investor Services Corp. (“Cutwater-ISC” formerly MBIA Municipal Investors Service Corp.), an SEC-registered investment adviser, and Cutwater Asset Management UK Limited (“Cutwater-UK,” formerly MBIA Asset Management UK Limited), a Financial Services Authority registered investment advisor based in London.
Investment Management Services Regulation
Cutwater is subject to various federal and state securities and investment regulations. As an SEC-registered investment adviser and a FINRA member firm, Cutwater-AMC is subject to the requirements of the Investment Advisers Act of 1940, a Federal statute which regulates registered investment advisers, and to FINRA rules and regulations. As an adviser to registered investment companies, Cutwater-AMC is also responsible for compliance with applicable provisions of the Investment Company Act of 1940. As sponsor/administrator of pooled investment programs, Cutwater-ISC and Cutwater Colorado Investor Services Corporation, each of which is an SEC-registered investment adviser, are subject to the requirements of the Investment Advisers Act of 1940, as well as certain state laws governing the operation of and permitted investments in local government investment pools. The activities of Cutwater-UK are subject to supervision by the United Kingdom’s Financial Services Authority.
OUR WIND-DOWN BUSINESSES
Since the downgrades of MBIA Corp., we have not issued debt in connection with either the asset/liability products or conduits businesses, and we believe the outstanding liability balances and corresponding asset balances will continue to decline over time as liabilities mature, terminate, or are repurchased by the Company.
Asset/Liability Products
The asset/liability products business historically raised funds for investment through several sources: (1) customized investment agreements issued by the Company and one of its subsidiaries for bond proceeds and other funds; and (2) issuance of MTNs with varying maturities issued by our subsidiary MBIA Global Funding, LLC (“GFL”). All of these products are guaranteed by MBIA Corp. In addition, GFL would lend the proceeds of its GFL MTN issuances to the Company (“GFL Loans”). Under agreements between the Company and MBIA Corp., the Company invested the proceeds of the investment agreements and GFL Loans in eligible investments, which consisted of investment grade securities with a minimum average double-A credit quality rating at purchase and which are pledged to MBIA Corp. as security for its guarantees on investment agreements and GFL MTNs. MBIA Inc. primarily purchased domestic securities and lent a portion of the proceeds from investment agreements and GFL MTNs to Euro Asset Acquisition Limited, which primarily purchased foreign assets as permitted under the Company’s investment guidelines. While MBIA Corp. enjoyed Triple-A insurer financial strength ratings, the Company generally earned a positive spread between the yields on assets and liabilities in this business, but since the third quarter of 2008 the lower yield earned on greater holdings of cash and cash equivalents coupled with the increased cost of funding liabilities has resulted in a negative spread. The primary risks in the business include the risk that assets default or fall in value and are not available to service liabilities, and liquidity risk associated with any mismatch of assets and liabilities and/or collateral posting requirements.
The Company has managed the asset/liability products segment within a number of risk and liquidity parameters monitored by the Executive Market/Investment Committee and maintains cash and liquidity resources that it believes will be sufficient to make all payments due on the investment agreement and GFL MTN obligations and to meet other financial requirements such as posting collateral and paying operating expenses. However, there can be no assurance that our liquidity resources may not decline, or be insufficient to meet our obligations, as described under “Risk Factors—Liquidity and Market Related Risk Factors” in Part I, Item 1A. In addition, the Company, National and MBIA Corp. have provided funds to the asset/liability products segment which are available to use for cash and/or collateral posting needs. In particular, as a result of the illiquidity of fixed-income markets during 2008, we implemented intercompany agreements to provide additional liquidity from MBIA Inc., National and MBIA Corp. to the asset/liability products business, which has reduced the liquidity resources available to MBIA Inc., National and MBIA Corp. for other purposes. In the event that the value of the assets in the asset/liability products business is insufficient to repay the investment agreement and GFL MTN obligations or other financial requirements when due, the Company, or MBIA Corp. as guarantor of the investment agreements and GFL MTNs, may be called upon to satisfy the obligations.
INVESTMENTS AND INVESTMENT POLICY
Investment objectives, policies and guidelines related to the Company’s insurance operations and the wind-down businesses are subject to review and approval by the Finance and Risk Committee of the Board of Directors and the Executive Market/Investment Committee of the Company. Cutwater manages the proprietary investment portfolios of the Company and its subsidiaries in accordance with the guidelines adopted for each such portfolio. Investment objectives, policies and guidelines related to investment activity on behalf of our insurance companies are also subject to review and approval by the respective Investment Committee of their Boards of Directors.
To continue to optimize capital resources and provide for claims-paying capabilities, the investment objectives and policies of our insurance operations are tailored to reflect their various strategies and operating conditions. The investment objectives of MBIA Corp. and its subsidiaries are primarily to maintain adequate liquidity to meet claims-paying and other corporate needs and secondarily to maximize after-tax yield within defined investment risk limits. The investment objectives of National set preservation of capital as the primary objective, subject to an appropriate degree of liquidity, and optimization of after-tax income and total return as secondary objectives. The investment portfolio of each insurance subsidiary is managed by Cutwater under separate investment services agreements.
The investment objectives and policies of the wind-down businesses reflect the characteristics of those programs. The primary investment objective is to provide sufficient liquidity to meet maturing liabilities (including intercompany liquidity agreements) and collateral posting obligations, while maximizing the net residual value of assets to liabilities in each program.
EMPLOYEES
As of February 25, 2010, the Company had 416 employees, including 186 in Optinuity, 39 in National, 62 in MBIA Corp. and its subsidiaries, 124 in Cutwater and 5 in other subsidiaries. None of the Company’s domestic employees is covered by a collective bargaining agreement. Certain of the Company’s employees outside the United States are governed by national collective bargaining or similar agreements. The Company considers its employee relations to be satisfactory.