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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the Quarter Ended June 30, 2002
OR
[ ] TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period from to
---------- ----------
Commission File No. 1-9583 I.R.S. Employer Identification No.06-1185706
MBIA INC.
A Connecticut Corporation
113 King Street, Armonk, N. Y. 10504
(914) 273-4545
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes[X] NO[ ]
As of August 5, 2002 there were outstanding 147,099,425 shares of Common Stock,
par value $1 per share, of the registrant.
INDEX
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PAGE
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
MBIA Inc. and Subsidiaries
Consolidated Balance Sheets -- June 30, 2002
and December 31, 2001 3
Consolidated Statements of Income -- Three months
and six months ended June 30, 2002 and 2001 4
Consolidated Statement of Changes in Shareholders' Equity
-- Six months ended June 30, 2002 5
Consolidated Statements of Cash Flows
-- Six months ended June 30, 2002 and 2001 6
Notes to Consolidated Financial Statements 7 -10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11-25
Item 3. Quantitative and Qualitative Disclosures About Market Risk 26
PART II OTHER INFORMATION, AS APPLICABLE
Item 1. Legal Proceedings. 26-27
Item 4. Submission of Matters to a Vote of Security Holders. 27
Item 6. Exhibits and Reports on Form 8-K. 28
SIGNATURES 29
(2)
MBIA INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Unaudited)
(Dollars in thousands except per share amounts)
June 30, 2002 December 31, 2001
------------- -----------------
Assets
Investments:
Fixed-maturity securities held as available-for-sale
at fair value (amortized cost $7,241,678 and $7,274,848) $ 7,533,589 $ 7,421,023
Short-term investments, at amortized cost
(which approximates fair value) 422,958 293,791
Other investments 106,001 135,376
----------- -----------
8,062,548 7,850,190
Investment agreement portfolio held as available-for-sale
at fair value (amortized cost $5,901,045 and $5,957,089) 6,063,124 6,079,066
Investment agreement portfolio pledged as collateral
at fair value (amortized cost $1,074,644 and $577,790) 1,090,809 586,915
----------- -----------
Total investments 15,216,481 14,516,171
Cash and cash equivalents 100,807 115,040
Accrued investment income 197,779 181,984
Deferred acquisition costs 287,209 277,699
Prepaid reinsurance premiums 510,343 507,079
Reinsurance recoverable on unpaid losses 39,927 35,090
Goodwill 90,041 97,772
Property and equipment, at cost (less accumulated depreciation
of $79,194 and $72,088) 131,832 129,004
Receivable for investments sold 71,026 157,864
Other assets 224,736 181,982
----------- -----------
Total assets $16,870,181 $16,199,685
=========== ===========
Liabilities and Shareholders' Equity
Liabilities:
Deferred premium revenue $ 2,601,985 $ 2,565,096
Loss and loss adjustment expense reserves 530,775 518,389
Investment agreement obligations 5,282,205 5,150,374
Investment repurchase agreement obligations 691,764 904,744
Long-term debt 816,185 805,062
Short-term debt 21,451 47,751
Securities sold under agreements to repurchase 939,125 555,496
Current income taxes -- 22,419
Deferred income taxes 340,203 272,665
Deferred fee revenue 26,728 27,629
Payable for investments purchased 145,133 130,098
Other liabilities 395,185 417,324
----------- -----------
Total liabilities 11,790,739 11,417,047
Shareholders' Equity:
Preferred stock, par value $1 per share; authorized
shares -- 10,000,000; issued and outstanding -- none -- --
Common stock, par value $1 per share; authorized
shares -- 400,000,000; issued shares --
152,516,975 and 151,950,991 152,517 151,951
Additional paid-in capital 1,219,993 1,195,802
Retained earnings 3,663,236 3,415,517
Accumulated other comprehensive income, net of
deferred income tax provision of $154,450 and $91,222 268,883 145,321
Unallocated ESOP shares (1,138) (1,983)
Unearned compensation -- restricted stock (15,542) (11,335)
Treasury stock -- 5,271,250 and 3,516,921 shares (208,507) (112,635)
----------- -----------
Total shareholders' equity 5,079,442 4,782,638
Total liabilities and shareholders' equity $16,870,181 $16,199,685
=========== ===========
The accompanying notes are an integral part of the consolidated
financial statements.
(3)
MBIA INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(Dollars in thousands except per share amounts)
Three months ended Six months ended
June 30 June 30
--------------------------- ---------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
Insurance
Revenues:
Gross premiums written $ 205,812 $ 206,559 $ 392,584 $ 391,464
Ceded premiums (36,155) (42,996) (88,470) (98,145)
------------ ------------ ------------ ------------
Net premiums written 169,657 163,563 304,114 293,319
Scheduled premiums earned 124,582 115,402 249,068 225,195
Refunding premiums earned 13,187 12,837 27,739 23,179
------------ ------------ ------------ ------------
Premiums earned (net of ceded premiums of
$43,093, $41,937, $85,961 and $80,253) 137,769 128,239 276,807 248,374
Net investment income 108,370 102,235 214,569 204,117
Advisory fees 12,255 13,903 19,344 20,850
------------ ------------ ------------ ------------
Total insurance revenues 258,394 244,377 510,720 473,341
Expenses:
Losses and LAE incurred 14,950 16,819 29,888 31,041
Amortization of deferred acquisition costs 11,022 10,259 22,145 19,870
Operating 20,597 20,347 39,335 38,882
------------ ------------ ------------ ------------
Total insurance expenses 46,569 47,425 91,368 89,793
Insurance income 211,825 196,952 419,352 383,548
------------ ------------ ------------ ------------
Investment management services
Revenues 25,727 31,824 55,578 63,718
Expenses 14,068 15,909 28,385 32,360
------------ ------------ ------------ ------------
Investment management services income 11,659 15,915 27,193 31,358
------------ ------------ ------------ ------------
Municipal services
Revenues 5,908 7,998 11,599 13,928
Expenses 5,802 8,776 11,406 15,532
------------ ------------ ------------ ------------
Municipal services income (loss) 106 (778) 193 (1,604)
------------ ------------ ------------ ------------
Corporate
Net investment income 2,043 1,568 4,260 3,344
Interest expense 12,956 14,151 25,790 29,894
Corporate expenses 3,056 6,952 7,261 11,572
------------ ------------ ------------ ------------
Corporate loss (13,969) (19,535) (28,791) (38,122)
------------ ------------ ------------ ------------
Gains and losses
Net realized gains (losses) 439 3,058 (397) 942
Change in fair value of derivative instruments (14,530) (1,113) (2,663) (7,037)
------------ ------------ ------------ ------------
Net gains and losses (14,091) 1,945 (3,060) (6,095)
------------ ------------ ------------ ------------
Income before income taxes 195,530 194,499 414,887 369,085
Provision for income taxes 51,549 51,493 109,406 96,885
------------ ------------ ------------ ------------
Income before cumulative effect of accounting changes 143,981 143,006 305,481 272,200
Cumulative effect of accounting changes -- -- (7,731) (13,067)
------------ ------------ ------------ ------------
Net income $ 143,981 $ 143,006 $ 297,750 $ 259,133
============ ============ ============ ============
Net income per common share:
Basic $ 0.98 $ 0.97 $ 2.01 $ 1.75
Diluted $ 0.97 $ 0.96 $ 2.00 $ 1.74
Weighted-average common shares outstanding:
Basic 147,568,448 148,160,339 147,809,271 148,043,734
Diluted 148,761,391 149,297,865 149,033,999 149,162,308
The accompanying notes are an integral part of the consolidated financial
statements.
(4)
MBIA INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS'EQUITY (Unaudited)
For the six months ended June 30, 2002
(In thousands except per share amounts)
Accumulated
Common Stock Additional Other Unallocated
------------------ Paid-in Retained Comprehensive ESOP
Shares Amount Capital Earnings Income(Loss) Shares
------- -------- ---------- ---------- ------------- -----------
Balance, January 1, 2002 151,951 $151,951 $1,195,802 $3,415,517 $145,321 $(1,983)
Comprehensive income:
Net income -- -- -- 297,750 -- --
Other comprehensive income (loss):
Change in unrealized
appreciation of investments
net of change in deferred
income taxes of $67,618 -- -- -- -- 122,785 --
Change in fair value of
derivative instruments net of
change in deferred income
taxes of $(4,390) -- -- -- -- (8,153) --
Change in foreign currency
translation -- -- -- -- 8,930 --
Other comprehensive income
Total comprehensive income
Treasury shares acquired -- -- -- -- -- --
Exercise of stock options 441 441 15,091 -- -- --
Allocation of ESOP shares -- -- 40 -- -- 845
Unearned compensation-
restricted stock 125 125 6,529 -- -- --
Fair value of stock options - SFAS 123 -- -- 2,531 -- -- --
Dividends (declared per common share
$0.340, paid per common share $0.320) -- -- -- (50,031) -- --
------- -------- ---------- ---------- -------- -------
Balance, June 30, 2002 152,517 $152,517 $1,219,993 $3,663,236 $268,883 $(1,138)
======= ======== ========== ========== ======== =======
Unearned
Compensation- Treasury Stock Total
Restricted ------------------ Shareholders'
Stock Shares Amount Equity
------------- ------ --------- -------------
Balance, January 1, 2002 $(11,335) (3,517) $(112,635) $4,782,638
Comprehensive income:
Net income -- -- -- 297,750
Other comprehensive income (loss):
Change in unrealized
appreciation of investments
net of change in deferred
income taxes of $67,618 -- -- -- 122,785
Change in fair value of
derivative instruments net of
change in deferred income
taxes of $(4,390) -- -- -- (8,153)
Change in foreign currency
translation -- -- -- 8,930
----------
Other comprehensive income 123,562
----------
Total comprehensive income 421,312
----------
Treasury shares acquired -- (1,754) (95,872) (95,872)
Exercise of stock options -- -- -- 15,532
Allocation of ESOP shares -- -- -- 885
Unearned compensation-
restricted stock (4,207) -- -- 2,447
Fair value of stock options - SFAS 123 -- -- -- 2,531
Dividends (declared per common share
$0.340, paid per common share $0.320) -- -- -- (50,031)
-------- ------ --------- ----------
Balance, June 30, 2002 $(15,542) (5,271) $(208,507) $5,079,442
======== ====== ========= ==========
The accompanying notes are an integral part of the consolidated financial
statements.
2002
--------
Disclosure of reclassification amount:
Unrealized appreciation of
investments arising
during the period, net of taxes $130,018
Reclassification adjustment,
net of taxes (7,233)
--------
Net unrealized appreciation,
net of taxes $122,785
========
(5)
MBIA INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In thousands)
Six months ended
June 30
-------------------------
2002 2001
----------- -----------
Cash flows from operating activities:
Net income $ 297,750 $ 259,133
Adjustments to reconcile net income to net cash
provided by operating activities:
Increase in accrued investment income (15,795) (13,081)
Increase in deferred acquisition costs (9,510) (6,156)
Increase in prepaid reinsurance premiums (3,265) (15,272)
Increase in deferred premium revenue 30,572 60,217
Increase in loss and loss adjustment expense reserves, net 7,549 9,795
Depreciation 7,106 7,434
Amortization of goodwill -- 3,276
Amortization of bond discount, net 8,200 (6,580)
Net realized (gains) losses on sale of investments 397 (942)
Current income tax benefit (52,820) --
Deferred income tax provision (benefit) 4,084 (7,670)
Fair value of derivative instruments 2,663 13,981
Cumulative effect of accounting changes, net 7,731 13,067
Other, net (22,934) (17,322)
----------- -----------
Total adjustments to net income (36,022) 40,747
----------- -----------
Net cash provided by operating activities 261,728 299,880
----------- -----------
Cash flows from investing activities:
Purchase of fixed-maturity securities, net
of payable for investments purchased (7,707,393) (9,219,543)
Sale of fixed-maturity securities, net of
receivable for investments sold 7,409,750 8,829,300
Redemption of fixed-maturity securities, net of
receivable for investments redeemed 233,651 190,752
(Purchase) sale of short-term investments, net (63,007) 16,617
Sale (purchase) of other investments, net 22,749 (19,331)
Purchases for investment agreement
portfolio, net of payable for investments purchased (2,991,244) (4,297,884)
Sales from investment agreement
portfolio, net of receivable for investments sold 2,679,505 3,840,925
Capital expenditures, net of disposals (10,634) (2,731)
Other, net -- 499
----------- -----------
Net cash used by investing activities (426,623) (661,396)
----------- -----------
Cash flows from financing activities:
Net repayment from retirement of short-term debt (26,300) (91,492)
Dividends paid (47,247) (42,646)
Purchase of treasury stock (95,872) (743)
Proceeds from issuance of investment
and repurchase agreements 1,489,755 1,835,047
Payments for drawdowns of investment
and repurchase agreements (1,568,834) (1,415,735)
Securities sold under agreements to repurchase, net 383,629 37,477
Exercise of stock options 15,531 17,279
----------- -----------
Net cash provided by financing activities 150,662 339,187
----------- -----------
Net decrease in cash and cash equivalents (14,233) (22,329)
Cash and cash equivalents - beginning of period 115,040 93,962
----------- -----------
Cash and cash equivalents - end of period $ 100,807 $ 71,633
=========== ===========
Supplemental cash flow disclosures:
Income taxes paid $ 153,362 $ 91,377
Interest paid:
Investment and repurchase agreements $ 149,153 $ 145,584
Long-term debt 29,587 33,604
The accompanying notes are an integral part of the consolidated financial
statements.
(6)
MBIA Inc. and Subsidiaries
Notes to Consolidated Financial Statements
1. Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the instructions to Form 10-Q and, accordingly, do
not include all of the information and disclosures required by accounting
principles generally accepted in the United States of America. These statements
should be read in conjunction with the consolidated financial statements and
notes thereto included in Form 10-K for the year ended December 31, 2001 for
MBIA Inc. and Subsidiaries (the "Company"). The accompanying consolidated
financial statements have not been audited by independent accountants in
accordance with auditing standards generally accepted in the United States of
America, but in the opinion of management such financial statements include all
adjustments, consisting only of normal recurring adjustments, necessary to
summarize fairly the Company's financial position and results of operations. The
results of operations for the six months ended June 30, 2002 may not be
indicative of the results that may be expected for the year ending December 31,
2002. The December 31, 2001 balance sheet presented was derived from audited
financial statements, but does not include all disclosures required by
accounting principles generally accepted in the United States of America. The
consolidated financial statements include the accounts of the Company and its
wholly owned subsidiaries. All significant intercompany balances have been
eliminated. Business segment results are presented gross of intersegment
transactions, which are not material to each segment.
2. Dividends Declared
Dividends declared by the Company during the six months ended June 30, 2002
were $50.0 million.
3. Recent Accounting Pronouncements
Effective January 1, 2002 the Company adopted Statement of Financial
Accounting Standards (SFAS) 141, "Business Combinations" and SFAS 142, "Goodwill
and Other Intangible Assets." SFAS 141, which supercedes Accounting Principles
Board Opinion (APB) 16, "Business Combinations," requires that the purchase
method of accounting be used for all business combinations initiated after June
30, 2001 and provides specific criteria for initial recognition of intangible
assets apart from goodwill. SFAS 142 supercedes APB 17, "Intangible Assets," and
requires that goodwill and intangible assets with indefinite lives no longer are
amortized but be subject to annual impairment tests in accordance with the
Standard. The Standard includes a two-step process aimed at determining the
amount, if any, by which the carrying value of a reporting unit exceeds its fair
value. Other intangible assets are to be amortized over their useful lives.
The following table contains a reconciliation of reported net income to net
income adjusted for the effect of goodwill amortization for the three months and
six months ended June 30, 2001:
(7)
MBIA Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
2nd Quarter Year-to-Date
------------- -------------
2002 2001 2002 2001
- ---------------------------------------------------------------------
Net income (in millions):
As reported $ 144 $ 143 $ 298 $ 259
Amortization of goodwill $ -- $ 2 $ -- $ 3
-----------------------------
Adjusted net income $ 144 $ 145 $ 298 $ 262
Net income per share*:
As reported $0.97 $0.96 $2.00 $1.74
Excluding amortization of goodwill $0.97 $0.97 $2.00 $1.76
- ---------------------------------------------------------------------
* All earnings per share calculations are diluted.
The Company completed its transitional impairment testing on its existing
goodwill as of January 1, 2002 in accordance with SFAS 142.
Insurance As of January 1, 2002, goodwill in the insurance segment totaled $76.9
million. SFAS 142 requires a two step approach in determining any impairment in
goodwill. Step one entails evaluating whether the fair value of a reporting
segment exceeds its carrying value. In performing this evaluation the Company
determined that the best measure of the fair value of the insurance reporting
segment is its book value adjusted for the after-tax effects of net deferred
premium revenue net of deferred acquisition costs, and the present value of
installments to arrive at adjusted book value. As of January 1, 2002, the
Insurance reporting segment's adjusted book value significantly exceeded its
carrying value, and thus there was no impairment of its existing goodwill.
Investment Management Services Total goodwill for the investment management
services segment totaled $13.1 million as of January 1, 2002. In performing step
one of the impairment testing, the fair value of the reporting segment was
determined using a multiple of earnings before income tax, depreciation and
amortization (EBITDA) as this is a common measure of fair value in the
investment management industry. The multiple was determined based on a review of
current industry valuation practice. As of January 1, 2002 the fair value of the
investment management services reporting segment significantly exceeded the
carrying value indicating that goodwill was not impaired.
Municipal Services The municipal services reporting segment had goodwill of $7.7
million as of January 1, 2002. The fair value of the reporting segment was based
on net assets. In comparing fair value to carrying value, it was determined that
goodwill was potentially impaired. In performing step two of the impairment
testing the implied fair value of goodwill was calculated by subtracting the
fair value of the net assets from the fair value of the reporting segment. In
comparing the implied fair value of goodwill to the carrying amount of goodwill,
it was determined that the entire amount was impaired and was therefore written
off as of January 1, 2002 and reported as a cumulative effect of accounting
change.
(8)
MBIA Inc. and Subsidiaries
Notes to Consolidated Financial Statements(Continued)
4. Employee Stock Option Plans
In the second quarter of 2002, the Company adopted the expense recognition
provisions of SFAS 123, "Accounting for Stock-based Compensation," retroactive
to January 1, 2002. In accordance with SFAS 123 the Company valued all stock
options granted in 2002 using the "Black-Scholes" option pricing model. The
value is recognized as an expense over the period in which the options vest. The
Company believes that recognizing the expense associated with stock option
grants is preferential to the prior method of accounting for stock options under
Accounting Principles Board Opinion 25, "Accounting for Stock Issued to
Employees" because it produces a complete picture of compensation expenses
within the Company's consolidated statements of income for the three and six
month periods ending June 30, 2002. The following table shows the effect on
income and earnings per share of recognizing employee stock option expense:
2nd Quarter Year-to-Date
------------------- -------------------
2002 2001 2002 2001
-------- -------- -------- --------
Net income (in thousands):
Net income before stock
option expense $144,386 $143,006 $298,556 $259,133
After-tax stock option expense (405) -- (806) --
-----------------------------------------
As reported $143,981 $143,006 $297,750 $259,133
Net income per share:
Before stock option expense $ 0.97 $ 0.96 $ 2.00 $ 1.74
As reported $ 0.97 $ 0.96 $ 2.00 $ 1.74
- -----------------------------------------------------------------------------
Due to the adoption, below are restated first quarter 2002 results:
1st Quarter 2002
-------------------------------------
Stock Option
(in thousands) As Reported Expense Restated
----------- ------------ --------
Insurance operating expense $18,363 $375 $18,738
Investment Management Services expenses $14,076 $241 $14,317
- -------------------------------------------------------------------------------
1st Quarter
2002
-----------
Net income (in thousands):
As reported $154,169
After-tax stock option expense (400)
--------
Restated $153,769
Net income per share:
As reported $ 1.03
Restated $ 1.03
- -----------------------------------------------------
(9)
MBIA Inc. and Subsidiaries
Notes to Consolidated Financial Statements(Continued)
5. Recent Litigation
On July 15, 2002 MBIA Insurance Corporation and Subsidiaries ("MBIA Corp.")
and Wells Fargo Bank Minnesota, N.A. ("Wells Fargo"), in its capacity as
trustee, jointly filed suit in Delaware federal district court against Royal
Indemnity Company ("Royal") to enforce insurance policies that Royal issued (the
"Royal Policies") to guarantee vocational loans originated by Student Finance
Corporation ("SFC"). MBIA Corp. insured eight securitizations, which had a total
gross par outstanding of approximately $380 million as June 30, 2002, that were
collateralized by the vocational student loans originated by SFC and guaranteed
by Royal. The Royal Policies guarantee the payment of all the principal plus 90
days interest on all of the vocational loans in the securitizations insured by
MBIA Corp. and state that "notwithstanding any other provision of (the) policy
to the contrary, the right of the beneficiary to receive payment for loss under
(the) policy after payment of the initial premium by the insured shall be
absolute, irrevocable and unconditional."
In their complaints, MBIA Corp. and Wells Fargo allege that Royal has committed
anticipatory breaches of the Royal Policies. Previously, in June 2002, Royal
brought suit against Well Fargo and other parties, not including MBIA Corp.,
seeking a declaration that it is not obligated to pay on the Royal Policies, and
seeking rescission of the Royal Policies, on the grounds that SFC, its
subsidiaries, and other related parties engaged in fraudulent behavior and/or
made negligent misrepresentations regarding the collateralized loans.
To date, claims in the amount of approximately $290 million have been made under
the Royal Policies, and MBIA Corp. expects that there will be additional claims
made under the Royal Policies. In the event that Royal does not honor claims
under the Royal Policies during the pendency of the litigation, MBIA Corp. will
be required to make payments under its policies in respect of scheduled interest
and principal on the notes insured under the MBIA Corp. policies. MBIA Corp.
expects ultimately to recover from Royal any payments it makes under its
policies.
MBIA Corp. believes that it will prevail in the litigation and will have no
ultimate loss on these policies, although there can be no assurance that MBIA
Corp. will prevail in the litigation. If MBIA Corp. does not prevail in the
litigation and Royal does not make payments under the Royal Policies, MBIA Corp.
expects to incur losses under its policies. MBIA Corp. does not believe,
however, that any such losses will have a material adverse effect on its
financial condition.
(10)
MBIA Inc. and Subsidiaries
Management's Discussion and Analysis
of Financial Condition and Results of Operations
Overview
MBIA Inc. and Subsidiaries ("MBIA" or the "Company") is engaged in providing
financial guarantee insurance, investment management services and municipal
services to public finance clients and financial institutions on a global basis.
The Company had a solid quarter as we continue to focus on our triple-A ratings,
no-loss underwriting standards, and building of shareholder value. Our
disciplined approach to pricing and risk selection enabled the Company to post
another quarter of profitable business in our Insurance segment, especially in
our global structured finance sector. Our asset management business continued to
operate in a very difficult market environment. The Company is well positioned
to capitalize on strong long-term growth prospects in our Insurance and
Investment Management Services segments.
Forward-Looking and Cautionary Statements
Statements included in this discussion 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 1998. 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 as of their respective
dates. The following are some of the factors that could affect our financial
performance or could cause actual results to differ materially from estimates
contained in or underlying our Company's forward-looking statements:
.. fluctuations in the economic, credit or interest rate environment in the
United States and abroad;
.. level of activity within the national and international credit markets;
.. competitive conditions and pricing levels;
.. legislative and regulatory developments;
.. technological developments;
.. changes in tax laws;
.. the effects of mergers, acquisitions and divestitures; and
.. uncertainties that have not been identified at this time.
Our Company undertakes no obligation to publicly correct or update any
forward-looking statement if we later become aware that such results are not
likely to be achieved.
11
MBIA Inc. and Subsidiaries
Management's Discussion and Analysis
of Financial Condition and Results of Operations (Continued)
Recent Accounting Pronouncements
Effective January 1, 2002 the Company adopted Statement of Financial Accounting
Standards (SFAS) 141, "Business Combinations" and SFAS 142, "Goodwill and Other
Intangible Assets." SFAS 141, which supercedes Accounting Principles Board
Opinion (APB) 16, "Business Combinations," requires that the purchase method of
accounting be used for all business combinations initiated after June 30, 2001
and provides specific criteria for initial recognition of intangible assets
apart from goodwill. SFAS 142 supercedes APB 17, "Intangible Assets," and
requires that goodwill and intangible assets with indefinite lives no longer are
amortized but be subject to annual impairment tests in accordance with the
Statement. The Statement includes a two-step process aimed at determining the
amount, if any, by which the carrying value of a reporting unit exceeds its fair
value. Other intangible assets are to be amortized over their useful lives. The
Company completed its transitional impairment testing on its existing goodwill
as of January 1, 2002 in accordance with the Statement. See Note 3 in the Notes
to Consolidated Financial Statements for further discussion of the impact of the
adoption of this statement on the financial statements of the Company.
Results of Operations
Summary
The Company, the investor community, equity analysts and the rating agencies use
various measures of profitability and intrinsic value, namely, core earnings,
adjusted book value ("ABV") and adjusted direct premiums ("ADP"), which are not
in accordance with accounting principles generally accepted in the United States
of America. We view these measures as a meaningful way to measure our
performance and the intrinsic value of the Company. The Company has historically
defined core earnings as GAAP net income less the impact of realized gains and
losses from activity in our investment portfolio, changes in the fair value of
derivative instruments, the cumulative effect of accounting changes, and the
effect of refundings and calls on our insured issues. In the second quarter of
2002, based on a new definition from Standard and Poor's ("S&P"), the Company
changed its definition of core earnings. The new core earnings is defined as
GAAP net income less the cumulative effect of accounting changes and the change
in fair value of derivative instruments plus the amortization of prior years'
stock option grant expenses.
ABV is defined as book value plus the after-tax effects of net deferred
premium revenue net of deferred acquisition costs, the present value of
installment premiums, and the unrealized gains or losses on investment contract
liabilities. ADP includes our upfront direct premiums as well as the estimated
present value of current and future direct premiums from installment-based
insurance policies issued during the period and does not include any premiums
assumed or ceded.
12
MBIA Inc. and Subsidiaries
Management's Discussion and Analysis
of Financial Condition and Results of Operations (Continued)
The following table shows the Company's net income and net income per share for
the second quarter and first six months of 2002 and 2001, as well as book value
per share and ABV per share at the end of June 30, 2002 and 2001:
Percent Change
--------------------------
2nd Quarter Year-to-date
----------- ------------
2nd Quarter Year-to-date 2002 2002
------------- --------------- vs. vs.
2002 2001 2002 2001 2001 2001
----- ----- ------ ------ ----------- ------------
Net income (in millions):
As reported $ 144 $ 143 $ 298 $ 259 1% 15%
Excluding accounting change $ 144 $ 143 $ 305 $ 272 1% 12%
Per share data: *
Net income:
As reported $0.97 $0.96 $ 2.00 $ 1.74 1% 15%
Excluding accounting change $0.97 $0.96 $ 2.05 $ 1.82 1% 13%
Book value $34.51 $30.09 15%
Adjusted book value $47.63 $42.23 13%
- ------------------------------------------------------------------------------------------------
*All earnings per share calculations are diluted.
Our second quarter net income and earnings per share increased 1%. This
increase was the result of an 8% growth in pre-tax Insurance income, which was
offset by a 27% decrease in Investment Management Services pre-tax income and
the change in fair value of derivative instruments. For the first six months of
2002, net income and earnings per share increased by 15%. Excluding accounting
changes, net income and earnings per share increased 12% and 13%, respectively.
These increases are driven by better results in Insurance Operations, a modest
profit in Municipal Services, and a 24% decrease in total Corporate expenses,
partially offset by lower Investment Management Services results.
Core earnings per share increased 7% to $1.02 in the second quarter and 11%
to $2.03 for the six months ended June 30, 2002. The following table shows the
reconciliation from net income per share to core earnings per share for the
second quarter and six months of 2002 and 2001:
Percent Change
--------------------------
2nd Quarter Year-to-date
----------- ------------
2nd Quarter Year-to-Date 2002 2002
-------------- -------------- vs. vs.
2002 2001 2002 2001 2001 2001
------ ----- ------ ------ ----------- ------------
Net income $ 0.97 $0.96 $ 2.00 $ 1.74 1% 15%
Cumulative effect of accounting changes -- -- (0.05) (0.09) -- 44%
-------------------------------------------------------------
Reported income before accounting changes 0.97 0.96 2.05 1.82 1% 13%
Change in fair value of derivative
instruments (0.06) -- (0.01) (0.03) (100%) 67%
Amortization of prior years' stock option
grants* 0.02 0.02 0.03 0.03 -- --
-------------------------------------------------------------
Core earnings $ 1.02 $0.95 $ 2.03 $ 1.83 7% 11%
- ------------------------------------------------------------------------------------------------------------
*Not included in net income per the requirements of SFAS 123.
13
MBIA Inc, and Subsidiaries
Management's Discussion and Analysis
of Fincancial Condition and Results of Operations (Continued)
Our book value at June 30, 2002 was $34.51 per share, up 15% from $30.09 at
June 30, 2001. The increase was due primarily to income from operations and the
increase in the market value of our investment portfolio. A more meaningful
measure of a financial guarantee company's intrinsic value is its ABV. Our ABV
was $47.63 per share at June 30, 2002, a 13% increase from June 30, 2001. The
following table presents the components of our adjusted book value per share:
Percent Change
June 30, June 30, --------------
2002 2001 2002 vs. 2001
- ---------------------------------------------------------------------
Book value per share $34.51 $30.09 15%
After-tax value of:
Net deferred premium
revenue, net of deferred 7.97 7.51 6%
acquisition costs
Present value of
installment premiums* 5.03 4.26 18%
Unrealized gain on
investment contract
liabilities 0.12 0.37 (68)%
- ---------------------------------------------------------------------
Adjusted book value per share $47.63 $42.23 13%
- ---------------------------------------------------------------------
*A conservative discount rate of 9% was used to present value installment
premiums and provide consistency for both periods.
Insurance Operations
The Company's gross par insured, ADP, gross premiums written (GPW) and net
premiums written (NPW) for the second quarter and first six months of 2002 and
2001 are presented in the following table:
Percent Change
--------------------------
2nd Quarter Year-to-date
----------- ------------
2nd Quarter Year-to-date 2002 2002
----------- ------------ vs. vs.
2002 2001 2002 2001 2001 2001
- ------------------------------------------------------------------------------------
Par * insured (in billions) $ 39 $ 36 $ 60 $ 65 7% (7)%
Premiums written:
(in millions)
ADP $305 $307 $460 $539 (1)% (15)%
GPW $206 $207 $392 $391 -- --
NPW $170 $164 $304 $293 4% 4%
- ------------------------------------------------------------------------------------
* Par is defined as the face amount of a bond or issue that is paid at maturity.
In the second quarter of 2002, total par insured increased 7% compared with
the second quarter of 2001, reflecting a 16% increase in our global structured
finance business partially offset by an 8% decrease in our global public finance
business. ADP was down 1% compared with the second quarter of 2001. This was the
result of a decrease in global public finance business insured during the
quarter, offset by the strong second quarter recorded in our global structured
finance business.
14
MBIA Inc, and Subsidiaries
Management's Discussion and Analysis
of Fincancial Condition and Results of Operations (Continued)
GPW primarily reflects cash receipts and does not include the value of
future premium receipts expected from installment policies originated in the
period. GPW was $206 million in the second quarter of 2002, virtually flat with
the second quarter of 2001. Here too, a second quarter decrease in global public
finance was offset by an increase in global structured finance. NPW, which is
net of reinsurance ceded to reinsurers, was up 4% as our cession rate decreased
to 18% from 21% in the second quarter of 2001.
For the first six months of 2002 par insured was down 7% compared with the
first six months of 2001 as the increase in the second quarter did not offset
the 26% decrease recorded in the first quarter of this year. ADP was down 15%
compared with the same period a year ago, again due to the low first quarter
volume. Business rated A and above totaled 79% for the six months ended June 30,
2002 compared with 78% in the comparable 2001 period. GPW was relatively
unchanged from the first six months of 2002 despite an 18% increase in global
structured finance, which was offset by a 13% decrease in global public finance.
NPW grew 4% for the six-month period as our year-to-date cession rate declined
to 23% from 25% last year.
We estimate the pre-tax present value of our total installment premium
stream on outstanding policies to be $1.1 billion at June 30, 2002, compared
with $972 million at June 30, 2001.
Total premiums ceded to reinsurers were $36 million and $88 million for the
second quarter and first six months of 2002, respectively. Reinsurance enables
the Company to cede exposure and comply with our single risk and credit
guidelines. The majority of our reinsurers are rated Triple-A by S&P. On March
13, 2002, S&P announced it had lowered its outlook on four monoline financial
guarantee reinsurance companies on MBIA's reinsurance treaty from stable to
negative. The Company remains liable on a primary basis for all reinsured risks.
Global Public Finance Market MBIA's par insured and premium writings in both the
new issue and secondary global public finance markets are shown in the following
table:
Percent Change
--------------------------
2nd Quarter Year-to-date
----------- ------------
2nd Quarter Year-to-date 2002 2002
Global ----------- ------------ vs. vs.
Public Finance 2002 2001 2002 2001 2001 2001
- ----------------------------------------------------------------------------------
Par insured (in billions) $13 $ 14 $ 23 $ 22 (8)% 5%
Premiums written:
(in millions)
ADP $98 $197 $196 $339 (50)% (42)%
GPW $95 $123 $193 $222 (22)% (13)%
NPW $90 $104 $164 $176 (13)% (7)%
MBIA's global public finance par insured decreased 8% from 2001's second
quarter while ADP decreased by 50%. The decrease in ADP was largely the result
of lower
15
MBIA Inc, and Subsidiaries
Management's Discussion and Analysis
of Fincancial Condition and Results of Operations (Continued)
business outside the United States where a lower volume of transactions closed
during the quarter.
Global public finance GPW decreased 22% from the second quarter of 2001.
This decrease was driven by a 67% decrease in business written outside the
United States as well as by an 11% decline in domestic public finance business.
Ceded premiums as a percent of gross premiums decreased from 15% in the second
quarter of 2001 to 6% in the second quarter of 2002, a result of the decrease in
insured business outside of the United States during the quarter. As a result,
NPW was down 13% from the second quarter of 2001.
For the six months ended June 30, 2002, par insured was up 5% while ADP was
down 42%, driven by a decrease in business insured outside the United States.
For the six-month period ended June 30, 2002 global public finance GPW was down
13%, with non-United States business decreasing 59% and domestic public finance
GPW increasing 4%. Cession rates declined from 21% in the first six months of
2001 to 15% in the first six months of 2002, largely due to fewer cessions
outside the United States. This resulted in global public finance NPW decreasing
by 7% over last year's first six months.
Global Structured Finance Market Details regarding MBIA's par insured and
premium writings in both the new issue and secondary global structured finance
markets are shown in the following table:
Percent Change
--------------------------
2nd Quarter Year-to-date
----------- ------------
2nd Quarter Year-to-date 2002 2002
Global ----------- ------------ vs. vs.
Structured Finance 2002 2001 2002 2001 2001 2001
- ----------------------------------------------------------------------------------
Par insured (in billions) $ 26 $ 22 $ 37 $ 43 16% (14)%
Premiums written:
(in millions)
ADP $207 $110 $264 $200 87% 32%
GPW $111 $ 84 $199 $169 31% 18%
NPW $ 80 $ 60 $140 $117 33% 20%
Issuance in the asset-backed market increased 64% over the second quarter
of 2001. MBIA insured $26 billion of par in the second quarter, up 16% from the
$22 billion insured in the second quarter of last year. ADP was up 87% for the
quarter to a record $207 million. The result was largely driven by higher
business written in the United States. Second quarter GPW and NPW increased 31%
and 33%, respectively, as installments received from business written in prior
periods remain very strong. The higher growth in NPW when compared with GPW is
the result of a decreased cession rate outside of the United States.
For the first six months par insured was down 14% while ADP was up 32% over
the comparable period in 2001. Global structured finance GPW increased 18% in
the first
16
MBIA Inc, and Subsidiaries
Management's Discussion and Analysis
of Fincancial Condition and Results of Operations (Continued)
six months of 2002, to $199 million from $169 million last year. The cession
rate on global structured finance decreased slightly from 31% last year to 30%
this year, resulting in an increase in NPW of 20%.
Premiums Earned The composition of MBIA's premiums earned in terms of its
scheduled and refunded components is illustrated as follows:
Percent Change
--------------------------
2nd Quarter Year-to-date
----------- ------------
2nd Quarter Year-to-date 2002 2002
----------- ------------ vs. vs.
In millions 2002 2001 2002 2001 2001 2001
- --------------------------------------------------------------------------
Premiums earned:
Scheduled $125 $115 $249 $225 8% 11%
Refunded 13 13 28 23 3% 20%
- --------------------------------------------------------------------------
Total $138 $128 $277 $248 7% 11%
- --------------------------------------------------------------------------
In the second quarter and first six months of 2002 scheduled premiums
earned increased by 8% and 11%, respectively, over the same periods of last
year. The lower growth rate in the second quarter was due to new business being
booked later than expected. Also, in the structured finance book of business,
there has been a higher level of terminations, and as a result of lower interest
rates, there has been an increase in prepayments.
Refunded premiums earned increased significantly in the first half of this
year compared with the first half of last year, reflecting the lower interest
rate environment. When an MBIA-insured bond issue is refunded or retired early,
the related deferred premium revenue is earned immediately. The level of bond
refundings and calls is influenced by a variety of factors such as prevailing
interest rates, the coupon rates of the bond issue, the issuer's desire or
ability to modify bond covenants and applicable regulations under the Internal
Revenue Code.
Investment Income Our insurance-related investment income (exclusive of realized
gains and losses) increased 6% to $108 million in the second quarter of 2002, up
from $102 million in the second quarter of 2001. In the first six months of
2002, investment income is up 5% over the first six months of 2001. These
increases were primarily due to the growth in invested assets partially offset
by lower portfolio yield as market interest rates have declined.
Advisory Fees The Company collects various advisory fees in connection with
certain transactions. The Company also earns advisory fees in connection with
its administration of certain third-party-owned special purpose vehicles.
Depending upon the type of fee received, the fee is either earned when it is due
or deferred and earned over the life of the related transaction. Work, waiver
and consent, termination, administrative and management fees are earned when
due. Structuring and commitment fees are earned on a straight-line basis over
the life of the related insured transaction or commitment period. In the second
quarter of 2002, advisory fee revenues
17
MBIA Inc, and Subsidiaries
Management's Discussion and Analysis
of Fincancial Condition and Results of Operations (Continued)
decreased 12% to $12 million from $14 million in the second quarter of 2001.
Advisory fees decreased 7% from $21 million to $19 million for the six-month
period. These decreases were primarily due to a large one-time, "non-deferrable"
fee recognized during the second quarter of last year.
Losses and Loss Adjustment Expenses (LAE) Loss and loss adjustment expense (LAE)
reserves are established in an amount equal to the Company's estimate of
identified or case basis reserves and unallocated losses, including costs of
settlement, on the obligations it has insured.
In 2001 losses and LAE were calculated by applying a loss factor to net
debt service written. Management determined this factor based on an independent
research agency study of bond defaults, which management feels is a reliable
source of bond default data.
Beginning in 2002, the Company refined the manner in which it provides for
losses and LAE. The loss reserve factor continues to be based on an independent
research agency study of bond defaults, however, the Company started accruing
losses and LAE based upon a percentage of scheduled earned premiums instead of a
percentage of net debt service written. The intent of the change is to better
match the recognition of incurred losses with the related revenue. If the new
manner of providing for losses and LAE was applied in 2001, the Company would
have reserved essentially the same amount for the full year as it did under the
net debt service written method.
Case basis reserves are established when specific insured issues are
identified as currently or likely to be in default. Such a reserve is based on
the present value of the expected loss and LAE payments, net of expected
recoveries under salvage and subrogation rights and reinsurance, based on a
discount rate of 5.86%, which is updated each quarter. The discount rate is
based on the estimated yield of our fixed-income investment portfolio. When a
case basis reserve is recorded, a corresponding reduction is made to the
unallocated reserve.
Management of the Company periodically reevaluates its estimates for losses
and LAE, and any resulting adjustments are reflected in current earnings.
Management believes that the reserves are adequate to cover the ultimate net
cost of claims. Because the reserves are based on estimates, however, there can
be no assurance that the ultimate liability will not exceed such estimates.
The following table shows the case-specific, reinsurance recoverable and
unallocated components of our total loss and LAE reserves at the end of the
second quarters of 2002 and 2001, as well as our loss provision for the first
six months of 2002 and 2001:
18
MBIA Inc. and Subsidiaries
Management's Discussion and Analysis
of Financial Condition and Results of Operations (Continued)
Percent Change
June 30, June 30, --------------
In millions 2002 2001 2002 vs. 2001
- ----------------------------------------------------------------------------------
Case-specific:
Gross $254 $240 6%
Reinsurance recoverable on unpaid losses 40 31 29%
- ----------------------------------------------------------------------------------
Net case reserves 214 209 3%
Unallocated 277 269 3%
- ----------------------------------------------------------------------------------
Net loss and LAE reserves $491 $478 3%
Provision $ 30 $ 31 (4)%
Insurance Expenses Expenses related to the production of our insurance business
(policy acquisition costs) are deferred and recognized over the period in which
the related premiums are earned. Our Company's amortization of deferred
acquisition costs, operating expenses and total insurance operating expenses, as
well as related expense ratios, are shown in the following table:
Percent Change
--------------------------
2nd Quarter Year-to-date
----------- ------------
2nd Quarter Year-to-date 2002 2002
------------- ------------- vs. vs.
In millions 2002 2001 2002 2001 2001 2001
- -------------------------------------------------------------------------------------
Amortization of deferred
acquisition costs $ 11 $ 10 $ 22 $ 20 7% 11%
Operating expenses 21 20 40 39 1% 1%
----------------------------------------------------------
Total insurance
operating expenses $ 32 $ 30 $ 62 $ 59 3% 5%
Expense ratio:
GAAP 23.0% 23.9% 22.2% 23.7%
Statutory 17.3% 14.7% 18.6% 15.4%
- -------------------------------------------------------------------------------------
For the second quarter of 2002, the amortization of deferred acquisition
costs increased 7% over the second quarter of 2001, reflecting the increase in
insurance business written. For the first six months of 2002, the amortization
of deferred acquisition costs increased 11% to $22 million compared with $20
million in the first six months of 2001.
Operating expenses increased 1% from the second quarter and the first six
months of 2001. Excluding expenses related to goodwill amortization that existed
last year but not this year and stock option expense that exists this year but
not last year, operating expenses increased 5% in the second quarter and 6% on a
year-to-date basis. These increases were primarily the result of increased
compensation and related costs. Financial guarantee insurance companies use the
statutory expense ratio (expenses before deferrals divided by net premiums
written) as a measure of expense management. The Company's statutory expense
ratio increased due to an increase in operating expenses combined with low
growth in net premiums written.
Insurance Income The Company's insurance income of $212 million for the second
quarter of 2002 increased 8% over the second quarter of 2001. For the first six
months
19
MBIA Inc. and Subsidiaries
Management's Discussion and Analysis
of Financial Condition and Results of Operations (Continued)
insurance income rose 9% to $419 million from $384 million a year ago due
primarily to the 11% increase in total premiums earned and the 5% increase in
investment income.
Investment Management Services
Since 1998, ownership of our four investment management companies has been
consolidated under MBIA Asset Management, LLC. In the first quarter of 2002, we
experienced a slow down in growth due to a weakening in the equity markets
causing asset withdrawals and slower than anticipated client drawdowns in our
municipal investment agreement portfolio causing negative interest rate spreads.
This trend intensified in the second quarter as revenues declined 19%. The table
below summarizes our consolidated investment management results for the second
quarter and first six months of 2002 and 2001:
Percent Change
--------------------------
2nd Quarter Year-to-date
----------- ------------
2nd Quarter Year-to-date 2002 2002
----------- ------------ vs. vs.
In millions 2002 2001 2002 2001 2001 2001
- ---------------------------------------------------------------------
Revenues $26 $32 $55 $64 (19)% (13)%
Expenses 14 16 28 33 (12)% (12)%
- ---------------------------------------------------------------------
Income $12 $16 $27 $31 (27)% (13)%
MBIA Asset Management, LLC is comprised of 1838 Investment Advisors, LLC
(1838), MBIA Municipal Investors Service Corp. (MBIA-MISC), MBIA Investment
Management Corp. (IMC) and MBIA Capital Management Corp. (CMC). The following
provides a summary of each of these businesses:
1838 is a full-service asset management firm with a strong institutional focus.
It manages $7.8 billion in equity, fixed-income and balanced portfolios for a
client base comprised of municipalities, endowments, foundations, corporate
employee benefit plans and high-net-worth individuals, down from $13.1 billion
at June 30, 2001 due to the decline in the equity markets.
MBIA-MISC provides cash management, investment fund administration and
fixed-rate investment placement services directly to local governments and
school districts. MBIA-MISC is a Securities and Exchange Commission
(SEC)-registered investment adviser and at June 30, 2002 had $10.2 billion in
assets under management, up 6% over June 30, 2001.
IMC provides state and local governments with tailored investment agreements for
bond proceeds and other public funds, such as construction, loan origination,
capitalized interest and debt service reserve funds. At June 30, 2002 principal
and accrued interest outstanding on investment and repurchase agreements and
securities sold under agreements to repurchase was $6.9 billion, compared with
$5.4 billion at June 30, 2001. At market value, the assets supporting these
agreements were $7.2 billion and $5.7
20
MBIA Inc. and Subsidiaries
Management's Discussion and Analysis
of Financial Condition and Results of Operations (Continued)
billion at June 30, 2002 and 2001, respectively. These assets are comprised of
high-quality securities with an average credit quality rating of Double-A.
IMC uses derivative financial instruments to manage interest rate risk and
foreign currency risk. Credit default swaps are entered into as an extension of
our credit enhancement business. Forward delivery agreements are offered to
clients and involve the periodic sale of securities to clients. We have
established policies limiting the amount, type and concentration of such
instruments. At second quarter-end 2001, our exposure to derivative financial
instruments was not material.
CMC is a SEC-registered investment adviser and National Association of
Securities Dealers member firm. CMC specializes in fixed-income management for
institutional funds and provides investment management services for IMC's
investment agreements, MBIA-MISC's municipal cash management programs and the
Company's insurance related portfolios. At June 30, 2002, CMC's third-party
assets under management were $2.3 billion compared with $2.5 billion at June 30,
2001.
Municipal Services
MBIA MuniServices Company (MBIA MuniServices) delivers revenue enhancement
services and products to public-sector clients nationwide, consisting of
discovery, audit, collections/recovery, enforcement and information (data)
services. During 1999, the Company completed a reorganization of the operations
of two of its subsidiaries into one entity, MBIA MuniServices. The municipal
services segment also includes Capital Asset Holdings GP, Inc. and certain
affiliated entities (Capital Asset), a servicer of delinquent tax certificates.
In the second quarter of 2002, Municipal Services operations reported pre-tax
income of $0.1 million compared with a loss of $0.8 million during the same
period of 2001. For the six month period ended June 30, 2002, Municipal Services
operations reported pre-tax income of $0.2 million compared with a loss of $1.6
million during the same period last year.
The Company is the majority owner of Capital Asset, which was in the
business of acquiring and servicing tax liens. The Company became the majority
owner in December 1998 when it acquired the interest of the company's founder.
MBIA Corp. has insured three securitizations of tax liens that were originated
and continue to be serviced by Capital Asset. These securitizations were
structured through the sale by Capital Asset of substantially all of its tax
liens to three off-balance sheet qualifying special purpose vehicles that were
established in connection with these securitizations. The qualifying special
purpose vehicles are not included in the consolidated financial statements of
the Company. In the third quarter of 1999, Capital Asset engaged a specialty
servicer of residential mortgages to help manage its business and operations and
to assist in administering the portfolios supporting the securitizations insured
by MBIA Corp. As of June 30, 2002, the aggregate gross insured amount in
connection with these securitizations was approximately $228 million. MBIA Corp.
has established case reserves related to these policies, and there can be no
assurance that such reserves will be sufficient to cover all losses under these
policies.
21
MBIA Inc. and Subsidiaries
Management's Discussion and Analysis
of Financial Condition and Results of Operations (Continued)
In addition, Capital Asset has other contingent liabilities, including
potential liabilities in connection with pending litigation in which it is
involved. Plaintiffs in one of the class action lawsuits have filed a lawsuit
against MBIA, Inc., MBIA Corp. and certain other affiliates of Capital Asset
claiming that the securitization completed by Capital Asset in 1999 was a
fraudulent transfer under state law because the tax liens sold to the special
purpose vehicle were sold at less than their fair value and because the
transaction allegedly was done to avoid the effect of an adverse legal ruling
against Capital Asset on certain issues. Although there are inherent risks in
any litigation, the Company believes that it has substantial defenses on the
merits of those claims and intends to defend against the claims vigorously.
Corporate
Net Investment Income Net investment income was $2.0 million in the second
quarter of 2002 compared with $1.6 million in the second quarter of last year.
For the first six months of 2002, net investment income totaled $4.3 million
compared with $3.3 million for the comparable period in 2001. Investment income
is greater this year because of an increased asset base and higher yields due to
the composition of the portfolio compared to last year.
Interest Expense In the second quarter of 2002, interest expense was $13 million
compared with $14 million during the second quarter of 2001. The decrease is the
result of interest rate swaps which enabled the Company to benefit from the
current low interest rate environment by converting the interest rates on
certain of our long-term debt issues from fixed rates to floating rates. The
counterparties can terminate these swaps at specific future dates.
Corporate Expenses Corporate expenses, which no longer include goodwill
amortization expense this year, are comprised primarily of general corporate
overhead. Corporate expenses decreased 56% in the second quarter of 2002 and 37%
in the first half of 2002.
Gains and Losses
Net Realized Gains Net realized gains were $0.4 million in the second quarter of
2002 compared with $3.1 million during the second quarter of 2001. For the first
six months of 2002, net realized losses were $0.4 million compared with $0.9
million in the comparable 2001 period. These gains and losses were generated as
a result of the ongoing management of the investment portfolio.
Change in Fair Value of Derivative Instruments In the second quarter of 2002,
unrealized losses were $14.5 million due primarily to the widening of credit and
interest rate spreads. Unrealized losses for the first six months of 2002
totaled $2.7 million.
22
MBIA Inc. and Subsidiaries
Management's Discussion and Analysis
of Financial Condition and Results of Operations (Continued)
Taxes
Our tax policy is to optimize our after-tax income by maintaining the
appropriate mix of taxable and tax-exempt investments. However, our tax rate
will fluctuate from time-to-time as we manage our investment portfolio on a
total return basis. Our effective tax rate decreased slightly from 26.5% for the
second quarter of 2001 to 26.4% for the second quarter of 2002.
Capital Resources
We carefully manage our capital resources to optimize our cost of capital while
maintaining appropriate claims-paying resources to sustain our insurance
companies' Triple-A claims-paying ratings. At June 30, 2002, our total
shareholders' equity was $5.1 billion, with total long-term borrowings at $816
million. We use debt financing to lower our overall cost of capital, thereby
increasing our return on shareholders' equity. We maintain debt at levels we
consider to be prudent based on our cash flow and total capital. The following
table shows our long-term debt and the ratios we use to measure it:
June 30, December 31,
2002 2001
- ---------------------------------------------------------
Long-term debt (in millions) $ 816 $ 805
Long-term debt to total capital 13.8% 14.4%
Earnings to fixed charges 16.8 14.8
In July of 1999, the Board of Directors authorized the repurchase of 11.25
million shares of common stock of the Company. The Company began the repurchase
program in the fourth quarter of 1999. As of June 30, 2002 the Company has
repurchased a total of 5.2 million shares at an average price of $39.62.
MBIA Corp. has a $900 million irrevocable standby line of credit facility
with a group of major Triple-A-rated banks to provide funds for the payment of
claims in excess of the greater of $900 million or 5.6% of average annual debt
service with respect to public finance transactions. The agreement is for a
seven-year term, which expires on October 31, 2008, and, subject to approval by
the banks, may be renewed annually to extend the term to seven years beyond the
renewal date. MBIA Corp. also maintains stop-loss reinsurance coverage of $211
million on its global structured finance portfolio. The attachment point is
calculated annually as a percentage of the global structured finance portfolio
and was $1.01 billion as of June 30, 2002. In addition, MBIA Inc. maintains an
option to place $150 million of subordinated securities contingent upon MBIA
Corp. and other insurance subsidiaries incurring losses in excess of $1.65
billion. The attachment point is calculated annually as a percentage of the
insured portfolio.
At quarter end, total claims-paying resources for MBIA Corp. stood at $10.4
billion, a 10% increase over June 30, 2001.
23
MBIA Inc. and Subsidiaries
Management's Discussion ans Analysis
of Financial Condition and Results of Operations (Continue)
Liquidity
Cash flow needs at the parent company level are primarily for dividends to our
shareholders and interest payments on our debt. These requirements have
historically been met through dividend payments from MBIA Corp., which generates
substantial operating cash flow from premium writings and investment income. In
the first six months of 2002, MBIA Corp.'s operating cash flow totaled $258
million.
Under New York state insurance law, financial guarantee insurance companies
can pay dividends from earned surplus subject to retaining a minimum capital
requirement. In the case of MBIA Corp., dividends in any 12-month period cannot
be greater than 10% of policyholders' surplus as shown in its most recent
statutory financial statement on file with the New York State Insurance
Department without prior approval of the superintendent of the state insurance
department. During the second quarter of 2002, MBIA Corp. paid dividends of
$56.6 million and based upon the filing of the June 30, 2002 statutory statement
had dividend capacity of $67.2 million without special regulatory approval.
The Company has significant liquidity supporting its businesses. As of June
30, 2002, cash equivalents and short-term investments totaled $524 million.
Should significant cash flow reductions occur in any of our businesses, for any
combination of reasons, we have additional alternatives for meeting ongoing cash
requirements. They include selling or pledging our fixed-income investments from
our investment portfolio, tapping existing liquidity facilities and new
borrowings.
The Company has substantial external borrowing capacity. We maintain two
short-term bank lines totaling $675 million with a group of worldwide banks. As
of June 30, 2002, there were no balances outstanding under these lines.
The investment portfolio provides a high degree of liquidity since it is
comprised of readily marketable high-quality fixed-income securities and
short-term investments. As of June 30, 2002, the fair value of our consolidated
investment portfolio was $15.2 billion, as shown in the following table:
Percent Change
June 30, December 31, --------------
In millions 2002 2001 2002 vs. 2001
- ------------------------------------------------------------------------
Insurance operations:
Amortized cost $ 7,771 $ 7,704 1%
Unrealized gain 291 146 99%
- ------------------------------------------------------------------------
Fair value $ 8,062 $ 7,850 3%
- ------------------------------------------------------------------------
Municipal investment
agreements:
Amortized cost $ 6,976 $ 6,535 7%
Unrealized gain 178 131 36%
- ------------------------------------------------------------------------
Fair value $ 7,154 $ 6,666 7%
- ------------------------------------------------------------------------
Total portfolio at fair value $15,216 $14,516 5%
24
MBIA Inc. and Subsidiaries
Management's Discussion ans Analysis
of Financial Condition and Results of Operations (Continue)
The growth of our insurance-related investments in 2002 was the result of
positive cash flow from operations. The fair value of investments related to our
municipal investment agreement business has increased to $7.2 billion from $6.7
billion at December 31, 2001. This increase was a result of growth in IMC's
municipal investment and repurchase agreement program.
The investment portfolios are considered to be available-for-sale, and the
differences between their fair value and amortized cost, net of applicable
taxes, are reflected as an adjustment to shareholders' equity. Differences
between fair value and amortized cost arise primarily as a result of changes in
interest rates occurring after a fixed-income security is purchased, although
other factors influence fair value, including credit-related actions, supply and
demand forces and other market factors. The weighted-average credit quality of
our fixed-income portfolios has been maintained at Double-A since our inception.
Since we generally intend to hold most of our investments to maturity as part of
our risk management strategy, we expect to realize a value substantially equal
to amortized cost.
25
PART I - FINANCIAL INFORMATION
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes in the Company's market risk during the
quarter ended June 30, 2002. For additional information on market risk, refer to
page 37 of the Company's 2001 Annual Report, portions of which were filed as
Exhibit 13 to the Company's Form 10-K for the year ended December 31, 2001.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
On July 15, 2002 MBIA Insurance Corporation and Subsidiaries ("MBIA Corp.")
and Wells Fargo Bank Minnesota, N.A. ("Wells Fargo"), in its capacity as
trustee, jointly filed suit in Delaware federal district court against Royal
Indemnity Company ("Royal") to enforce insurance policies that Royal issued (the
"Royal Policies") to guarantee vocational loans originated by Student Finance
Corporation ("SFC"). MBIA Corp. insured eight securitizations, which had a total
gross par outstanding of approximately $380 million as June 30, 2002, that were
collateralized by the vocational student loans originated by SFC and guaranteed
by Royal. The Royal Policies guarantee the payment of all the principal plus 90
days interest on all of the vocational loans in the securitizations insured by
MBIA Corp. and state that "notwithstanding any other provision of (the) policy
to the contrary, the right of the beneficiary to receive payment for loss under
(the) policy after payment of the initial premium by the insured shall be
absolute, irrevocable and unconditional."
In their complaints, MBIA Corp. and Wells Fargo allege that Royal has committed
anticipatory breaches of the Royal Policies. Previously, in June 2002, Royal
brought suit against Well Fargo and other parties, not including MBIA Corp.,
seeking a declaration that it is not obligated to pay on the Royal Policies, and
seeking rescission of the Royal Policies, on the grounds that SFC, its
subsidiaries, and other related parties engaged in fraudulent behavior and/or
made negligent misrepresentations regarding the collateralized loans.
To date, claims in the amount of approximately $290 million have been made under
the Royal Policies, and MBIA Corp. expects that there will be additional claims
made under the Royal Policies. In the event that Royal does not honor claims
under the Royal Policies during the pendency of the litigation, MBIA Corp. will
be required to make payments under its policies in respect of scheduled interest
and principal on the notes insured under the MBIA Corp. policies. MBIA Corp.
expects ultimately to recover from Royal any payments it makes under its
policies.
(26)
MBIA Corp. believes that it will prevail in the litigation and will have no
ultimate loss on these policies, although there can be no assurance that MBIA
Corp. will prevail in the litigation. If MBIA Corp. does not prevail in the
litigation and Royal does not make payments under the Royal Policies, MBIA Corp.
expects to incur losses under its policies. MBIA Corp. does not believe,
however, that any such losses will have a material adverse effect on its
financial condition.
Item 4. Submission of Matters to a Vote of Security Holders
The following matters were voted upon at the Annual Meeting of Shareholders
of the Company held on May 9, 2002, and received the votes set forth below:
1: The proposal to ratify the Company's Board of Directors was adopted with
the following number of votes per director:
Nominees In Favor Withheld
- ----------------------------------------------
Joseph W. Brown 125,332,871 1,128,926
David C. Clapp 125,325,490 1,136,307
Gary Dunton 125,342,432 1,119,365
Claire Guadiani 125,321,358 1,140,439
William H. Gray, III 124,465,537 1,996,260
Freda S. Johnson 125,542,363 1,919,434
Daniel P. Kearney 125,340,805 1,120,992
James A. Lebenthal 125,540,407 1,921,390
John A. Rolls 124,550,928 1,910,869
2: The proposal to ratify the Company's Annual and Long Term Incentive Plan
was adopted, with 123,618,964 votes in favor, 2,061,347 votes against and
781,485 votes abstaining.
3: The proposal to ratify the Company's Amended and Restated Deferred
Compensation and Stock Ownership Plan for Non-Employee Directors was adopted,
with 124,016,513 votes in favor, 1,493,755 votes against and 951,528 votes
abstaining.
4. The proposal to ratify the Company's Restricted Stock Plan for
Non-Employee Directors was adopted, with 116,344,476 votes in favor, 9,223,248
votes against and 894,072 votes abstaining.
5: The proposal to ratify the apointment of PricewaterhouseCoopers LLP,
Certified Public Accountants, as independent auditors for the Company for 2002
was adopted, with 121,417,602 votes in favor, 4,466,063 votes against and
578,131 votes abstaining.
(27)
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
11. Computation of Earnings Per Share Assuming Dilution
99.1 Additional Exhibits - MBIA Insurance Corporation and
Subsidiaries Consolidated Financial Statements
99.2 Additional Exhibits - Chief Executive Officer Certification
99.3 Additional Exhibits - Chief Financial Officer Certification
b) Reports on Form 8-K: No reports on Form 8-K were filed for the
first six months of 2002.
(28)
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MBIA INC.
------------------------------------
Registrant
Date: August 14, 2002 /s/ Neil G. Budnick
------------------------------------
Neil G. Budnick
Chief Financial Officer
Date: August 14, 2002 /s/ Douglas C. Hamilton
------------------------------------
Douglas C. Hamilton
Controller
(Principal Accounting Officer)
(29)