MBIA Inc. (NYSE:MBI) Q1 2014 Earnings Conference Call May 13, 2014 8:00 AM ET
Greg Diamond - Managing Director, IR
Jay Brown - Chief Executive Officer
Bill Fallon - President & Chief Operating Officer
Chuck Chaplin - President, Chief Administrative Officer and Chief Financial Office
Brian Charles - RW Research
Welcome to the MBIA Incorporated First Quarter 2014 Financial Results Conference Call. (Operator Instructions)
Thank you. It’s now my pleasure to turn the call over to Greg Diamond, Managing Director of Investor Relations at MBIA. Please go ahead.
Thank you, Maria. Welcome to MBIA's conference call for our first quarter 2014 financial results. After the market closed yesterday, we posted several items on our website, including our financial results press release, Form 10-Q and the quarterly operating supplement for the first quarter of this year.
We also posted the statutory financial statements for MBIA Insurance Corporation and National Public Finance Guarantee Corporation as well as updates to our frequently asked questions and insured portfolio listings. Yesterday’s financial results press release includes the information for accessing the recorded replay of today's call, which would become available approximately one hour after the end of the call.
Please note that anything said on today's call is qualified by the information provided in the company's 10-Q, 10-K and other SEC filings, as our company's definitive disclosures are incorporated in these filings. Please read our 2013 10-K and our first quarter 2000 (sic) 10-Q as they contain our most current disclosures about the company and its financial and operating results. The 10-K and 10-Q also contain information that may not be addressed on today's call. The definitions and reconciliations of the non-GAAP terms that will be included in our remarks today may be found in the financial results press release that we issued yesterday afternoon.
And now here is our Safe Harbor disclosure statement. Our remarks on this conference call may contain forward-looking statements. Important factors such as 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 mbia.com. The company cautions not to place undue reliance on any such forward-looking statements. The company also undertakes no obligation to publicly correct or update any forward-looking statement if it later becomes aware that such statement is no longer accurate.
For our call today, Jay Brown, Bill Fallon and Chuck Chaplin will provide some brief introductory comments. Then Anthony McKiernan will join Jay, Bill and Chuck for the question-and-answer session that will follow.
Without further ado, here's Jay.
Thanks, Greg and good morning everyone. Only 70 days have passed since we last spoke in March. But in that time we’ve made significant progress in our efforts to re-enter the domestic public finance market as the largest U.S. muni only bond insurer and in further reducing the potential volatility of our structured finance and international insurance business.
The biggest news of the quarter was that National achieved a AA- rating from S&P in March, and then just yesterday, a AA+ rating from Kroll Ratings. As a result, National is now in a strong position to write new policies. However it will be a slow ramp up and I don't expect a material amount of new business for at least two or three quarters. Bill will talk more about what's going on at National in a few minutes.
At MBIA Corp. we commuted over $3 billion of CMBS exposure in the first quarter, dramatically reducing the potential volatility of that book of business and saw terminations of note -- of nearly another $3 billion corporate CDOs.
That's not new news though as we discussed in the conference call in early March. But we also achieved commutation and terminations later in March that together with contract maturities reduced MBIA Corp.’s insured par outstanding by a total of $10 billion in the first quarter, to about $70 billion as of March 31.
Incurred losses as well as paid losses in the quarter reflect the ongoing trend towards greater stability in the MBIA Corp. The keys to MBIA Corp.’s ongoing balance sheet stability and liquidity adequacy will be the collection of recoveries from excess spread and insured mortgage securitizations and the collection of putback recoverables from Credit Suisse for its representation and warranty violations.
With the addition of installment premiums, the total from these three categories is about $2.4 billion in expected cash inflows. We're still making net payments on the second lien transactions but in the first quarter we made net payments averaging less than $5 million per month, excluding loss adjustment expenses compared to $8 million per month in the fourth quarter. We think that this trend will continue and become a net cash inflow by the end of 2014.
Litigation is becoming a smaller and smaller part of our story. We're in the midst of the discovery process in our lawsuit against Credit Suisse, so that I don't have much to report there. However the judge’s recent ruling in our case against JP Morgan which granted JP Morgan’s motion for summary judgment, nevertheless allows us to propose an amended complaint that should ultimately let us bring our claims to trial.
As a reminder, we haven't booked recovery in connection with the JP Morgan litigation. So this decision has no impact on our financials.
Finally, the last remaining lawsuit challenging the reorganization of our insurance operations in 2009 was dismissed with prejudice about a week ago.
In addition to our focus on managing risk, we continue to reduce financial and operating leverage across the company. There was particular progress in our operating expenses which were less than half of what they were in the first quarter of 2013. Despite these efforts, we posted another adjusted pretax losses quarter which was $99 million compared to $20 million in last year's first quarter. This is largely the result of mark-to-market items but this quarter result also includes another $90 million of incurred loss in LAE which is clearly unacceptable at this point in our transformation.
We believe we are doing the right things in terms of the resources we put in this surveillance and remediation of the factors we can control to reduce this expense. But we will need continued cooperations from the macroeconomy. An environment of positive economic growth in the U.S. and in Europe coupled with higher interest rates will help us pursue National’s new business objectives as well as reduce the volatility of remaining legacy exposures.
Now I’ll hand it over to Bill for an update on National.
Thanks, Jay. As Jay mentioned, National was upgraded to AA minus by S&P in mid-March, which was an extremely important event for us as it opened the door for our reentry into the municipal finance market in a meaningful way. An S&P rating in a AA range is what the market is looking for in order to be considered a serious industry participant on the new business side.
As for other agencies, Kroll Ratings initiated ratings coverage of National yesterday with a AA plus stable rating, which is the highest rating currently achievable from them for financial guarantor. The rating underscores the strength of National’s balance sheet and business plan.
We’ve been active in marketing National over the past five years, meeting with issuers and fixed income investors, not only to keep them up-to-date but also to keep on top of investor concerns and developments in the marketplace. These efforts have increased in recent months as we readied the company to write new business. We expect to further enhance our marketing and business origination capabilities through select additions to staff in the coming months.
We’ve been actively pricing and bidding on transactions since shortly after the S&P upgrade but as of this date, have not issued a new policy. We’re incredibly focused on maintaining the discipline of our underwriting and pricing processes and we will only wrap business that meets our underwriting criteria and has an acceptable expected return on shareholder capital.
However I am confident that as the market recognizes the value that National’s wrap adds for issuers and investors, we will start to add new business to our portfolio that will be accretive to our shareholders.
That’s supported by our view of the overall market where we’re starting to see signs of greater demand for bond insurance. Although total issuance in the first quarter was down about 25% from last year, insured penetration of the insurable market increased from about 6% in last year's first quarter to a little over 11% in the first quarter of 2014.
The insurable market as we define it excludes issues with ratings we won't wrap over. Essentially anything that’s none investment grade, as well as AAA and AA rated issues where demand for our wrap is likely to be limited.
To give you a sense of the size of that market, we estimate that insurable par was around 40% of total issuance in the first quarter. While the improvement in insured penetration is encouraging, the current low absolute level of interest rates remains the biggest impediment to a more significant increase in insured penetration of the insurable market.
Turning for a moment to the headline exposures of National’s portfolio. We, together with two other bond insurers, reached an agreement with the City of Detroit with respect to our insured unlimited tax deal bonds that will become part of the city’s plan of adjustment. Importantly, the agreement validates the special status of UTGO bonds and ensures that the property tax revenues that were pledged for the repayment of these bonds will be used to fund future debt service. It also provides for some additional security should tax revenues decline further in the future.
There is still lot to be done to resolve this case, particularly on the water and suicide. But the UTGO agreement represents real progress. While we’ve incurred a loss on the UTGO exposure, we believe that it highlights the value of bond insurance for investors as holders of National wrapped Detroit UTGO debt will not suffer losses on their insured bonds.
It also highlights a less appreciated benefit of bond insurers, which is our ability to actively remediate transactions and achieve outcomes that support the integrity of long-held principles in the municipal finance market.
In Puerto Rico, the Commonwealth government delivered on its plan to tap capital markets to give it more breathing room on liquidity. Its successful bond offering is another in a string of positive steps the government has taken to work through a difficult fiscal position.
The commonwealth also recently announced the balanced budget for fiscal 2015 and stated that it would not seek a restructuring of the Puerto Rico Electric Power Authority, also positive indications. We believe the island needs to begin to see economic growth to provide a more permanent fix for these problems, but we’re encouraged by the proactive steps that the island’s leadership has taken in recent months.
Now Chuck will take you through the company's financial results for the quarter. Chuck?
Thanks, Bill and good morning everyone. I will make some comments now about our consolidated results and the segments and then provide some information on balance sheet and liquidity positions in our major legal entities.
Net income in the first quarter of 2014 was $256 million compared to $164 million in the first quarter of 2013. In last year's first quarter, we had a $61 million loss on insured credit derivatives driven by improving spreads on MBIA Corp. credit default swaps. This year we saw a $469 million net gain in this line, driven by the commutation of the $3 billion of CMBS contract that Jay referred to earlier. The potential for this kind of volatility should be much lower in the future as the remaining portfolio of insured CDS has shrunk significantly.
The balance sheet mark-to-market with respect to insured credit default swaps as of March 31, 2014 was $309 million, down from $7.2 billion at its peak in 2008.
Another thing to note in our GAAP results is that the observed tax rate is about 37% compared to 24% in last year's first quarter. Last year's first quarter included a reduction in the valuation allowance that we've taken on the tax impact of realized losses and reflected a lower tax liability for our foreign earnings. In this year's first quarter, the rate is slightly above 35% because the expense associated with outstanding warrants is not tax-deductible.
We also report a non-GAAP measure adjusted pretax income that treats all of our insurance policies using an insurance accounting model. It avoids the mark-to-market treatment that GAAP requires on insured credit derivatives and unwind the consolidation of certain securitizations which we consolidate as variable interest entities under GAAP. It provides a useful alternative view of our financial results.
We had an adjusted pretax loss in the first quarter of 2014 of $99 million compared to $20 million in the first quarter of 2013. The primary drivers of this change are market sensitive items that we don't make any adjustment for. At the consolidated level, they swung from a $63 million gain last year to a $55 million loss this year. These effects include foreign exchange, gains and losses on sales of investment and marks to market on hedging related swaps, liabilities for warrants and certain structured debt instruments. They are all reported in the line net gains or losses on financial instrument at fair value and foreign-exchange on our income statement.
The other income statement items don't affect the consolidated result this quarter nearly as much as these gains and losses. Premiums earned, fees and investment income at the consolidated level declined by about $40 million, reflecting smaller insurance and investment portfolios.
On the expense side, incurred insurance losses declined by $12 million and operating expenses were $60 million lower this year. In last year's first quarter, we had operating expenses associated with major settlement that totaled approximately $45 million which were nearly nil in this year's first quarter.
Now I’ll turn to the major segments. Our public finance insurance segment is conducted in National Public Finance Guarantee Corp. which reported pretax income of $92 million compared to $142 million in the first quarter of 2013.
National’s total revenues were $105 million in the first quarter of 2014 compared to $186 million in last year's first quarter. Premiums earned declined from $103 million to 65 million, reflecting a drop in refunding activity in this year's Q1, as well as the impact of substantial refundings and natural runoff of the portfolio over the prior three quarters. Like the overall market, we saw about a 50% reduction in refunding activity in this year's first quarter versus last year's.
Investment income was $16 million lower as last year's first quarter benefited from National’s $1.7 billion high-yield intercompany loan to MBIA Corp. The investment portfolio is more diversified and higher quality at this point but also lower yielding.
Also in last year’s first quarter, National had about $30 million in realized gains on sales of investments which did not recur this year.
On the expense side, National have lower loss and loss adjustment expense than last year. In the first quarter of 2014, we had negative incurred loss of $14 million versus a $4 million expense in last year's first quarter.
Finally, operating expenses were $13 million compared to $18 million last year, reflecting our ongoing expense reduction efforts.
Now in the structured finance and international segment, primarily operated through MBIA Corp. and subsidiaries, we had an adjusted pretax loss of $110 million in the first quarter of ‘14 compared to a loss of $97 million in the first quarter of 2013.
Premiums and fees were $55 million compared to $75 million in 2013’s first quarter. This is the results of the reduction in insurance in force and lower ceding commission income.
Investment income was $5 million compared to $20 million last year, as Corp. sold some higher-yielding assets to the holding company later in 2013 to boost its liquidity. We had losses on financial instrument at fair value and foreign exchange of $3 million in this segment compared to gains of $22 million last year. Almost all of the change year-over-year is due to foreign exchange effects.
Moving to the expense side. The most important driver of the result continues to be insured loss where we saw $104 million in the Q1 2014 compared to $98 million last year. In last year's first quarter, we had substantial losses on RMBS and CMBS policies, largely offset by a substantial increase in the recoverable for rep and warranty claims. In this year's first quarter, we had more modest losses and were spread across several sectors of portfolio.
On second lien RMBS, we increased our expectations of future claims payments by approximately $16 million as the decline in new delinquencies was modestly below our expectations. We also reduced expected recoveries primarily from excess spread by approximately $21 million. The reduction in mortgage loan prepayment volume that we've been expecting is progressing but at a slower pace than we expected.
As Jay said, the actual loss payments continue to decline and we expect them -- to see them become net inflows around year-end 2014. We also saw $28 million in incurred loss for first lien exposures and about $16 million on our ABS CDOs. In both of these cases, there were small adjustments made to many individual exposures. The CMBS incurred loss of $20 million reflects additional expected payments on the one remaining deal with original triple B collateral.
Operating expenses, DAC amortization and interest expense were $62 million compared to $117 million last year. Half of the difference is due to the repayment of the intercompany loan from National.
Now moving on from the structured finance and international business, the corporate segment and wind-down operations, both operated within MBIA Inc. had a loss of $75 million in the quarter and this was largely due to $52 million of mark-to-market losses and there are basically three factors affecting this.
In corporate, we mark the liability for warrants issued to Bank of America and Warburg Pincus. As our stock price rose in the quarter, we incurred $17 million of expense.
In wind-down, we’re a net payer of fixed rates on interest rate swaps. So as rates fall, that liability grows. We incurred $15 million of such expense in the quarter. In addition, we have about $200 million of euro denominated debt outstanding that's marked to market as well. As our credit quality improves, that liability also grows, including by about $11 million in the quarter.
Finally, there is about $8 million of interest expense associated with periodic payments on the interest rate swaps. Operating expenses in these two segments were $24 million in the quarter compared to $69 million in the first quarter last year. The 2013 amount includes the initial expense associated with the grant of warrants to Bank of America as well as other settlement and legal expenses. Interest expense declined modestly as we reduced financial and operating leverage borrowings.
Now moving on from the income statement. Consolidated GAAP equity at March 31, 2014 was $3.6 billion compared to $3.3 billion at year-end 2013. National’s balance sheet continues to be strong with $3.3 billion of statutory capital and claims paying resources of $5.2 billion as of March 31, 2014. On this measure alone, we believe National qualifies for the highest ratings from the three rating agencies.
At MBIA Corp., our statutory capital was $787 million and claims paying resources were $3 billion on March 31. Liquidity position was approximately $423 million. This represents a substantial improvement compared to last year at this time. At March 31, 2013 liquidity was only $258 million and we indicated that there was substantial doubt about MBIA Corp.’s going concern status.
At this point, we believe that our liquidity is adequate to cover expected policy claims for the foreseeable future with a cushion against adverse experience. However it's important to the long-term health of this subsidiary that the excess spread of the second lien RMBS begin to exceed the claims paid and that ultimately we collect the putback recoveries owed to us by Credit Suisse with respect to rep and warranty breaches.
No payments were made on the surplus notes in the first quarter and the regulator did not approve the payment that would've been due on April 15, 2014. As of April 15, the cumulative amount of interest that has not been approved for payment is approximately $204 million.
Unpaid interest is an accrued expense on our GAAP income statement and is part of the long-term debt on the GAAP balance sheet but is not reflected in Corp.’s statutory financials. In support of the regulator’s decisions on surplus note interest payment request, we provide them substantial information about Corp.’s capital adequacy and liquidity in base and stress scenarios.
In addition to their consideration, though, of our financial conditions, the terms of the note themselves also provide a constraint. Payments can only be made out of so-called free and divisible surplus, of which the company have $110 million at March 31. So if the regulator were to be satisfied with the company's financial condition, then the free and divisible surplus would limit the cash that could be distributed. While we continue to seek approval for the interest payments as required, we do not expect that payments will be able to be made for the foreseeable future.
At the holding company level, we continue to reduce financial and operating leverage. We repurchased $28 million of debt of our Global Funding subsidiary and $104 million of debt of our conduit Meridian during the quarter.
Based on current conditions, we expect to bring holding company leverage in line with middle investment-grade ratings in approximately 3 years. And based on our first quarter results, the company's consolidated net operating loss carry-forward has increased to $3.1 billion, up from $2.8 billion at year-end.
Finally, holding company liquidity was adequate as of March 31 as we held $499 million of cash and other liquid assets.
And that is it for my comments. And at this point we will open the line for your questions.
(Operator Instructions) Our first question comes from the line of Brian Charles of RW Research.
Brian Charles - RW Research
I just have a couple questions about your expected losses. I think that you reflect on your supplemental package on page 25. It looks like you broke it out for the first time, there is a table in the middle there that breaks out CDO and other in the two categories for the first time. And between the two, I count 574 million of expected losses, I guess, at the present value, that's down from $924 million. Is that essentially reflecting the commutation activity and CDO terminations that occurred during the first quarter?
Brian Charles - RW Research
Okay, good enough. And within that, do you have any color on your remaining triple B CMBS exposure? I know you talked about increasing loss estimates by $20 million. But has that $391 million of exposure that you expect to realize some sort of loss on – has that changed from year end?
The 390 at this point is down to approximately 375 as of first quarter.
Brian Charles - RW Research
Okay. Is that a result of loss payments made during the quarter just to get rid of exposure that was expected to lose?
Essentially yes. Yes, claims were presented in the quarter that we paid.
Brian Charles - RW Research
And then finally, you did talk about cash flows at MBIA Corp. between installment premiums, excess spread and putback recoveries totaling about $2.4 billion. I just want to make sure that includes installment premiums coming at the subsidiary level, is that right?
Brian Charles - RW Research
Coming in at MBIA Corp. Okay, good. Okay. That's all I have for now. Thank you.
Our next question comes from the line of Brian Cindley from BAM [ph].
Appreciate the additional disclosures this quarter. Question for you, though, I was a little bit confusing on the commutations because obviously on your year-end call you disclosed that the commutations that had occurred after the end of the quarter, I think the math that we’re coming up with, because at that time you said you had commuted just below 6 billion of risk and I believe now you're saying during the quarter you commuted roughly 6.7 billion total. So that would be -- I guess the quick math would be, that’d be an additional 700 million of commutations after the announcement at the end of the year, or for the end of your call, is that accurate?
Yes, basically we had an additional commutation in the month of March but after the year-end call. It was in that order of magnitude.
And was that effectively CMBS?
It was a commutation of a secondary program that contains a variety of asset types.
So there's a disclosure I guess on page 82 where you say you now are -- really have two pools of CMBS that are being monitored -- one that the gentleman before me asked about, where you’re paying out claims on?
And I believe that that was four pools as of the 12/31 period, so the reduction of two pools, that relates to those prior commutations or this additional 700 million?
Perfect, that's correct.
Meaning it relates to the prior 6 billion?
Right, we’ve commuted 3 billion in the first quarter that we reported on at year-end which brings – sorry –
I think what you are asking is how many of the pools we were monitoring disappeared after the conference call, and I believe there were two transactions included in that that were part of the 700 million that was commuted.
So it was related to the 700 million?
And then just trying to connect some dots on Corp., given the existence of the line item that you are carrying for the potential CSFB recovery, if that were to go away for some reason, is that were go to zero, that would be a direct hit to stat capital and further sort of influence some of the dynamics that you describe on page 90 with respect to the surplus notes, is that fair?
It certainly would be a direct hit to statutory surplus.
It would affect obviously [multiple speakers] -- affect any calculation association with surplus notes.
(Operator Instructions) I am showing there are no further questions at this time. I would like to turn the floor back over to Mr. Greg Diamond for any concluding remarks.
Thanks, Maria, and thanks to all of you who have joined us for today's call. Please contact me directly at 914-765-3190 if you have any additional questions. We also recommend that you visit our website at www.mbia.com for additional information on our company. Thank you for your interest in MBIA. Good day and goodbye.
Thank you. This concludes today's MBIA’s first quarter 2014 earnings conference call. You may now disconnect and have a wonderful day.
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