MBIA Inc. (MBI) Q4 2010 Earnings Report, Transcript and Summary

Good morning, and welcome to the MBIA Inc.'s Fourth Quarter 2010 Financial Results Conference Call. [Operator Instructions] I would now like to turn the call over to Greg Diamond, Managing Director of Investor Relations at MBIA. Please go ahead.

Thank you, Wes. Welcome to MBIA's conference call for our fourth quarter 2010 financial results. We're going to follow the same format as last quarter's call. Jay and Chuck will provide some comments prior to holding a question-and-answer session. Yesterday afternoon, we posted several items on our website, including our 10-K and quarterly operating supplement. The information for accessing the recorded replay of today's call is included in the financial results press release that we issued yesterday, that's also available on our website. Our company's definitive disclosures are incorporated in our SEC filings. The purpose of our call today is to discuss some of the disclosures in our most recent 10-K to facilitate a greater understanding for investors. The 10-K also contains information that will be not be addressed on today's call. Please note that anything that we say on today's call is qualified by the information provided in the 10-K and our other SEC filings. Please read our Form 10-K as it contains our most current and comprehensive disclosures about the company and its financial and operating performance. Today's Q&A session will be handled by Jay Brown, CEO; and Chuck Chaplin, President, CFO and Chief Administrative Officer. Now for our Safe Harbor disclosure statement. Our remarks on this conference call may contain forward-looking statements. Important factors such as the general market conditions and the competitive environment could cause actual results to differ materially from those projected in our forward-looking statements. Risk factors are detailed in our 10-K, which is available on our website at www.mbia.com. The company 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 not likely to be achieved. Finally, the definitions of the non-GAAP terms that are included in our remarks today may also be found on the company's website. Now Jay will provide some introductory comments. Jay?

Thanks, Greg, and good morning, everyone. Before Chuck takes you through the numbers, I'd like to give you an overview of where we stand on the completion of my third year as your CEO. When I returned to the company in 2008, I established an objective that within five years, we would transform our business into one with multiple operating platforms matching our customer bases. At this point, we are very much on track to achieve that objective. The past year has had some ups and a few downs, but net-net, I'm comfortable that over the course of 2010, the degree of uncertainty about our future has dissipated on several fronts. Although risk remains, let me take you through the reasons for my confidence. First, we believe that a lot of the uncertainty connected with our direct exposures to the U.S. residential housing market has diminished. Our most significant losses have been associated with second-lien mortgage securitizations where the majority of the collateral was fraudulently misrepresented to us when we insured the deals. We have seen a steady decline in the pace of defaults and resulting charge-offs, which is ultimately reflected in the trend of our loss payments. These payments peaked at nearly $300 million in the month of March 2009, but by year-end 2010, they were running at less than $100 million per month. And they have continued to decline in the first two months of this year. We still have sizable exposures to second-lien mortgage transaction but the trends are very promising. At the same time, we continue to litigate aggressively to enforce the contractual obligation of transaction sponsors to repurchase the ineligible mortgage loans that they wrongfully included in the securitizations we insured, in breach of the representations and warranties they made. Incredibly, some of them have refused to repurchase even a single mortgage loan even though we have presented them with hundreds, or in some cases, thousands of loans that demonstrate clear evidence of ineligibility. In 2010, we had several favorable court decisions that supported of our claims. One of the most important decisions allows us to use sampling as we pursue our court claims against Bank of America, despite their stated preference for lengthy, drawn-out, hand-to-hand combat over each and every ineligible loan. This decision will clearly expedite the resolution of both this case and our other mortgage put-back cases against Crédit Suisse, Morgan Stanley and subsidiaries of Ally Bank in the New York courts. In addition, the GSE's widely publicized settlements with Ally Bank, Bank of America and other institutions, demonstrated growing recognition of the scale of ineligible mortgage loan problem and the validity of rep and warranty claims. At this point, although I continue to be dismayed that we have had to resort to litigation, I feel very confident about the likely outcome of the put-back recovery process. Our accounting reflects mortgage put-back recoveries that are deeply discounted from our actual aggregate contract claims. And I continue to believe that our ultimate recoveries will largely offset the incurred losses from this segment of our business. The second reason for my confidence is the significant lessening of uncertainty associated with our ABS CDO and CDO-squared exposures. At year end, approximately $11.5 billion was left from our $36 billion gross exposure at the onset of the credit crisis, with about half of that reduction occurring in the last six months. The combined ultimate loss estimate for these exposures remains unchanged versus last year end, but there's one huge difference. Our exposure to CDO-squared, which represented some of our most front-loaded estimated payment obligation, has been reduced to only $200 million at year-end 2010. The CDO-squared exposure reduction of $7.2 billion since the end of 2009 resulted primarily from commutations, or rather, negotiated settlements, which I think more accurately describes these contract terminations. The costs of these settlements were essentially consistent with our loss reserves and credit impairments for their respective exposures. Importantly, these are settlements that we can time when they occur and make sure that they do not put any impairments on our liquidity for more current claims. Chuck will take you through a few more details on this in his comments. Third, at the end of 2009, there was widespread doom and gloom about commercial real estate performance. While we had almost no collateral erosion from the mortgages underlying our CMBS and CRE CDO portfolios at that time, the trends in the markets were poor, and several analysts were forecasting CMBS bond collateral losses well in excess of 10% in some scenarios. At year-end 2010, however, many of the fundamental measures of market health are now reflecting an improving trend. Most market analysts have reduced their ultimate cumulative loss expectations considerably, and the market prices of CMBS bonds have had a robust rally during the course of the year. In addition, we reduced our total commercial real estate exposure by $8 billion through negotiated settlements in the fourth quarter. We still have not experienced any significant erosion in our insured transactions with the single largest reduction and deductible being around 3% as of year end. Nevertheless, our refined forecast of expected future deterioration led us to estimate ultimate incurred losses of $1.1 billion in this portfolio during 2010 and to establish reserves for this amount. This loss estimate remains very sensitive to changing expectations about the future path of the economy, so while there are many positive signs in the market, I still consider the volatility around our loss estimates here to be the major risk factor for the company. The fourth and fifth reasons for my confidence relate to the health of MBIA Corp. and the progress made in the transformation litigations. The separation of our insurance companies, which was approved by the New York State Insurance Department in February 2009, after an extended and thorough review, has been challenged by a small group of policyholders. Some of whom are responsible for a significant portion of the losses caused by ineligible mortgage loans in our second-lien RMBS book. Despite their best efforts to bias public reporting, the PR agency retained by the bank's attorney is faced with the fact that it's becoming even more evident that the bank's claim lack factual substance. MBIA Corp. continues to be solvent and, in our view, liquid and adequately capitalized against expected losses, two years after the plaintiffs recklessly and wrongly declared MBIA Corp. insolvent. Even with significant claims paid on RMBS and payments made in connection with negotiated settlements of insured credit derivative exposures, MBIA Corp. actually had a stronger liquidity position at the end of 2010 than it did at the beginning of the year. Moreover, at this point, about a third of the original claimants have dropped out of the Article 78 proceedings, and their other plenary case has been dismissed. A timeline has been established for resolving the Article 78 and barring further delays, we do expect the case to be resolved in our favor this year. Reason number six. National Public Finance is fully staffed and stands ready to apply for higher credit ratings and write new municipal bond insurance as soon as the Article 78 proceeding is successfully resolved. Today, National is the largest U.S. public finance only municipal bond insurance company. We believe that we've put in place a very strong underwriting and risk management team, philosophy and process, reflecting our 37 years of experience in this industry. As National's capital adequacy continues to grow and its exposure leverage declines quarter by quarter, the company's strength and stability will become even more evident to the market. We continue to believe that there is ample opportunity in this space and that competition will lead to increased insurance penetration and enhanced market access for many of the 50,000 different municipal issuers Finally, in February of 2010, we restructured our fixed income asset management subsidiary, now known as Cutwater Asset Management, to transform it into a separate third-party asset manager. In 2010, Cutwater invested in its infrastructure to support its growth plans and turned in yet another year of strong investment performance for its clients. It continues to establish new distribution channels and add nonaffiliated clients and assets. So looking forward, we expect that 2011 will be shaped by three key factors. First, we'll continue to work towards additional negotiated settlements of exposures with a focus on those segments with potentially the most volatile lawsuits. To that end, we continue to have discussions with most, but not all, of our significant counter-parties. As noted in our press release, we have executed another settlement since year-end 2010, which is the evidence of this effort. Secondly, there is currently a timetable established for the Article 78 proceeding that should bring it to completion during this calendar year. And third, we expect the trial of our legal action against Bank of America/Countrywide to take place in 2011. Our trials related to Ally Bank exposures should begin in early 2012, with others to follow after that. In closing, I am confident that we remain well positioned and on track to meet the long-term objectives that we established for our company in 2008. Now I'll turn it over to Chuck for a review of the financial highlights.

Thanks, Jay, and good morning, everyone. As Jay has said, 2010 marked a decline from the extreme volatility and uncertainty of 2008 and '09. You can see it in almost any measure of our performance, but what I'd like to take you through today is the results through management's eyes, primarily using our non-GAAP measure adjusted pretax income. I'll also make some comments about Adjusted Book Value, GAAP and our statutory results and financial position, and just to indicate, our statutory filings are also available on our website as of this morning. Full year, consolidated adjusted pretax income was a loss of $377 million in 2010, much lower than the losses of $877 million in 2009 and $2.9 billion in 2008. The improving trend was due to lower invested asset impairments and lower incurred losses on insurance policies. Incurred losses in 2010 for all policies were $1.5 billion, primarily due to the establishment of $1.1 billion of reserves for CMBS-related policies. Consolidated Adjusted Book Value was $36.81 per share at year-end 2010, down approximately 5% from $38.94 per share at December 31, 2009. The decline here is due primarily to the new CMBS reserves. The fourth quarter's adjusted pretax income was a loss of $311 million compared to a loss of $541 million in the fourth quarter of 2009. The difference is due to lower insured losses this year. Overall, we continue to experience the effects of the market and economic downturn, but incurred losses in 2010 were well below the peak period of 2008. Now I'll walk through the segment contributions to the quarter's results. The Public Finance segment contributed $103 million of pretax income in the fourth quarter compared to $186 million in the fourth quarter of 2009. Incurred losses were $31 million compared to $2 million in 2009's Q4. This was driven primarily by establishing reserves for a single nonprofit institution transaction. Premiums earned were $25 million lower than in last year's fourth quarter, primarily as a result of refunding activity earlier in 2010. Net investment income and fee income were each approximately $11 million lower than last year due to lower interest rates and a 2009 reinsurance commutation. For the full year, National had $530 million of pretax income, which exceeded expectations but was slightly below 2009's level of $551 million. National continues to generate capital from operations and its stat [ph] capital was $2.4 billion at year-end 2010 compared to $2 billion at year-end 2009. Its claims-paying resources were $5.6 billion. We expect that as the transformation litigation is resolved, we will be in a position to generate new business in National. S&P's proposed new capital requirements may represent a new impediment, but it is too soon today to predict what the final criteria will be or what impact they will have on the market. And also, with regard to recent and somewhat sensationalized headlines concerning a large number of impending state or municipal defaults, National does not share this view, and as we have learned this morning, neither does Nouriel Roubini. Though under fiscal pressure now, the vast majority of state and municipal credits have significant revenue-raising flexibility and should not be confused with credits that are truly at risk of default. We believe that defaults are more likely to come from isolated and non-correlated municipalities and projects. This is precisely the kind of environment that can demonstrate the value of National's underwriting and surveillance capabilities and can prove the value of bond insurance to investors. It is frustrating that litigation is preventing us from providing value to the markets during these uncertain times, and we look forward to its conclusion in 2011. Moving on to MBIA Corp. It drives the results of our Structured Finance and International Insurance segment where we had an adjusted pretax loss of $487 million in the fourth quarter versus a loss of $766 million in 2009's fourth quarter. There are two items of significance to discuss here: The increase in reserves for CMBS pools and early policy settlements or commutations. Economic losses on all policies were $563 million in the quarter versus $821 million in 2009's last quarter. Last year, in 2009, losses were driven by our second-lien RMBS exposure while the biggest driver of this year's Q4 incurred loss came from the commercial real estate space where we increased reserves by $604 million. In the fourth quarter, we made some modifications to our loss model that generated most of the increase, including increasing the probabilities of higher severity scenarios and adding a commutation scenario, which increased the incurred loss for some of the transactions. In addition, the average current delinquency rate at the mortgage level rose slightly, which increases the projected future foreclosures and liquidations in our loss models. While there are numerous positive trends in the commercial real estate market right now around loan modifications, cap rates and liquidity, their effects were outweighed by these two factors in the Q4, this shift in probability rates and this property-level performance. Total reserve on our CMBS exposure stood at $1.1 billion at year end. We were not required to make any payments on CMBS deals in 2010. So this is a case where we are projecting losses that will take place in the rather distant future as opposed to reflecting current paid losses. We negotiated settlements on $15.7 billion of par exposure in the fourth quarter, where $8 billion was in CMBS pools and commercial real estate CDOs and $6.4 billion was in ABS CDOs and CDO-squareds. The total amounts paid were consistent with our loss reserves and, of course, the transaction substantially reduced the future potential volatility of reserves. The settlement had a major impact on the economic loss on our ABS CDO and CDO-squared portfolios. The cost to commute these deals was somewhat below our loss reserves, contributing to a net reduction in economic losses of $182 million. In addition to being accretive to statutory capital, some of the deals commuted were CDO-squared where we expected to make most of the payments in the next couple of years, and the settlements, therefore, were favorable to our projected liquidity position as well. Primarily as a result of these early settlements, the ABS CDO portfolio has declined from $22.5 billion at year end 2009 to $11.5 billion at year end 2010. And the total reserves on ABS CDOs as of December 31 were $1.6 billion. Finally, we also had a net increase of economic loss on RMBS of $121 million in the quarter. Here, we have an expectation of future payments to bondholders, as well as recoveries of ineligible mortgage put-back claims and reimbursement of paid claims from excess spread in the securitizations. Expected future claims payments increased by $458 million in the quarter. About $180 million of that is attributable to Alt-A transactions that we're taking reserves on for the first time. These deals represent about 30% of our Alt-A book, and they're predominantly backed by adjustable rate mortgages. Most of the rest of our Alt-A portfolio is made up of fixed-rate loans. The remaining increase in expected future payments is due to the fact that while new delinquencies in the second-lien space continue to decline, there was a reduction in the rate of improvement in the quarter, and as a result, we're modeling a slower return to a more normal delinquency rate. We updated our methodology for estimating put-back recoveries to one based on incurred loss rather than on mortgage files reviewed in the fourth quarter. This is consistent with the sampling decision that we received in our Bank of America litigation. We believe that all of the events of 2010, including GSE settlements and the establishment of substantial reserves by the seller/servicers, increases probability of full recovery of our contract claims. As a result, the recovery estimate recorded to the balance sheet is now $2.5 billion or 57% of our incurred losses on deals where we expect such recoveries. At year-end 2009, the recovery estimate was 43% of our then incurred loss. In the quarter, the estimated recovery from put backs of ineligible loans increased by about $337 million due to expected higher future payments and this change of approach. In addition to these sectors, there were $21 million of other insured economic losses in the quarter, which brings our total to $563 million. For the full year, the Structured Finance and International segment had an adjusted pretax loss of $692 million compared to a loss in 2009 of $1.3 billion. Given the history of paid claims and payments for commutations, we focused a lot of attention on the liquidity and asset adequacy of this segment and the MBIA Corp. legal entity. At year end, MBIA Corp. had $1.2 billion of liquid assets on hand after having paid $1.8 billion of claims payments and made payments related to early settlements of insured credit derivatives over the course of the year. Some one-time transactions contributed to maintaining a high cash balance in 2010, including a tax refund, the Channel Re transactions and the conversion of some salvage assets to cash. Although we do not expect liquidity generating activity at the same level in 2011, we do expect that MBIA's resources, including repayments on the secured loans on the ALM segment and regular premium and investment flows will prove adequate to cover all future expected payments while maintaining a cushion against adverse experience. MBIA has a healthy statutory balance sheet with $2.73 billion of statutory capital. Cash and invested assets total $3.3 billion, and its investment portfolio has had no material impairments during the entire financial crisis. Total claims-paying resources in MBIA Corp. were $5.2 billion at year-end 2010. One further note on the statutory balance sheet. MBIA Corp. has $68 million of net reserves for loss and loss adjustments on the balance sheet. Within that account is the present value of future net cash outflows for claims payments and the present value of expected recoveries, which is primarily driven by $2.5 billion of recoveries from Bank of America, Ally Bank subsidiaries, Crédit Suisse, Flagstar and Morgan Stanley for ineligible mortgages in RMBS securitizations. Beyond MBIA Corp. and National, the other meaningful contributors to our financial results are the Wind-Down Operations on the Corporate segment. The Corporate segment had pretax income of $34 million in 2010, basically flat against 2009. In both years, earnings were boosted by marks-to-market on warrants issued in connection with our equity capital raises. The Corporate segment is a natural expense centered on a run-rate basis, and for the full year, it lost $98 million. The Wind-Down Operations had pretax income of $42 million in the fourth quarter compared to $5 million in the fourth quarter of 2009, driven by mark-to-market gains on derivatives held for hedging purposes. Wind-Down lost $117 million for the full year, driven by a negative spread between the yield on assets and the book yield of liabilities. Jay has talked about the improvement in assets under management and investment performance in Cutwater Asset Management. From a P&L perspective, Cutwater operated in the year at a break-even level given the investments that Jay referred to in risk management and marketing resources. A couple of notes on our GAAP results for the full year. We had net income of $53 million in 2010 versus $623 million in 2009. The biggest driver of the change, as has been typical over the past several years, is the mark-to-market on insured credit derivatives. In 2010, the change in the mark was a $607 million loss while 2009 featured a $1.7 billion net gain. Most of the change is driven by market prices on credit default and recovery swaps on MBIA Corp. In 2010, the market's perception of our credit risk improved leading to the loss. In addition, in 2010, our consolidated VIEs, variable interest entities, contributed $281 million of income before tax compared to a loss of $120 million in 2009. A new accounting standard that took effect in 2010 required consolidating many more VIEs than we had in 2009. Many of them are RMBS securitizations, which benefited from an increase in mortgage repurchase obligations in the year. GAAP equity ended the year at $2.8 billion versus $2.6 billion at year-end 2009. The change is driven by the consolidation of additional VIEs and reduced unrealized loss on invested assets, partially offset by the mark-to-market uninsured credit derivatives and actual incurred losses. In closing, we believe that a combination of an improving macro-economic picture and the actions that we've taken to protect the balance sheet gave us a lower-stressed 2010 compared to the prior two years. The trend toward early settlements of volatile exposures has become more significant. In addition to the $20 billion settled in 2010, we've also negotiated settlement of an additional $3.3 billion in 2011 so far. In total, we've commuted $28 billion of exposure. On average, the cost of these deals, which are primarily in the ABS CDO and CMBS-related sectors, were consistent with our loss reserve estimates. The transactions dramatically reduced the potential future volatility in our results. We acknowledge that we've got a ways to go in this regard, but we're satisfied and believe that we have a positive trend at this point. And with that, we will open it up for your questions.

[Operator Instructions] And your first question comes from Darin Arita of Deutsche Bank.

Two questions here, but wanted to first start with S&P's proposed bond insurance criteria. Could you share some of your thoughts on the criteria and what MBIA has communicated to the rating agency?

Sure. Let me just give a kind of a top-down thing and then Chuck could talk about the specifics. We're actually communicating for both MBIA and National, which have, obviously, different criteria or the structured book versus the public finance book. I think when you stand back and think about what occurred during 2007, '08 and '09 and think about the position it placed S&P in, it's clear that the combination of capital charges on individual transactions, coupled with the capital levels carried by the financial guarantee industry, turned out to be inadequate. When you look back, five of the companies have now essentially disappeared from the scene. And so it's clear something had to change as we go forward. And I think it's correct that S&P has been spending the last year thinking about this, trying to come up with criteria that will serve investors going forward. That said, we think that the overall assessment of kind of leverage ratios or capital contributions in certain sectors kind of oversteps the case. Clearly, there was a problem in structured securities, which we believe needed to be addressed, particularly at the individual transaction level and in the aggregate level that companies could carry. But it looks, on first blush that in terms of trying to step forward and thinking about the amount of capital that would be necessary for a bond insurer to operate, they've gone too far. With that, I'll let Chuck handle any individual comments that he'd like to make.

Sure. I guess I would echo Jay's comments that we think that, in general, the transparency that S&P is trying to bring to this is positive. The basic approach and structure of their criteria does seem sensible. But some of the specific inputs to the model, we think, are problematic. The lack of any risk adjustments or tenor adjustment in the leverage test and the disregard for on balance sheet UPR in the leverage test that -- where we have UPR that is -- assets of which we hold already on a statutory basis, and are available to cover risk. We think that that is an overly conservative approach to measuring the risk in our business and one that we're not sure is consistent with the way that S&P looks at, or we look at other industries. Also, the reinterpretation of the Hempel study of the Great Depression also seems to move toward extreme capital standards that, frankly, might not permit capital to be attracted to the bond insurance industry but, more importantly, might put the bond insurance industry on a different footing from the ability to achieve high ratings than other financial industries. And we don't think that that's the direction that S&P ultimately wishes to take. Having said that, S&P for comment, not as an edict from on high, and we expect that they will take comments and take them seriously in the spirit of transparency. We are preparing, as Jay said to comment both for MBIA Corp. and for National because the issues are somewhat different in the two sectors.

Okay. Great. And turning to, I guess, the commercial real estate losses. Can you give an update on the sources of losses? I understand the assumption changes zero [ph] losses. But I think last quarter, the losses were primarily coming from one deal, I guess, or year-to-date as of last quarter. Is it still the case there, or do these changes affect of all the deals here?

Yes. The changes during this quarter were, as Chuck outlined, were driven far more by our aggregate look and changes to the model. There was no significant deterioration in any particular deal, which drove the results. Obviously, each and every deal is slightly different in terms of its impact during the course of a quarter. But the bulk, probably, 80%, 90% of the change, was really driven by a view that we had that the model needed to be modified, and a portion of which was the fact that we were entering into and starting negotiations on different commutations. In essence, that removed the probability that we'd have zero loss. In the past, based on trends, and we still believe that there are a number of these transactions, if not a significant number which we'll never have losses, the fact that we're willing to entertain offers and settlements, we have to put a probability that there is going to be a loss. So in a sense, the floor came up from zero versus where it was before. The contrary is also true that the ceiling in terms of the worst-case from where we are at year-end 2010 is down from where it was in 2009. But when we look at a weighted average of all the different scenarios and there are six different approaches that we use, we end up with a higher number than we had before, and we think it's our best estimate of what we think we ultimately will have to pay, either through settlements or through actual experience over the next several years in the commercial real estate sector.

Okay. And just finally, one last one, turning to reps and warranties. I was wondering if you could give a number in terms of how much of your put backs have been rejected by the servicers and what sort of reasons they've given and what MBIA's response or planned response is?

Sure, that's easy. It's virtually 100% have been rejected with no explanation whatsoever. They literally come back with the sheet and say no. And just to be clear, Darin, even on the ones they accept, they don't explain why they accept them. So the whole thing remains a mystery, which is one of the reasons why we made the decision beginning in 2008 to go under the courtroom, because the process was not working for us.

Your next question comes from Arun Kumar of JPMorgan.

A couple of questions. Chuck, I'll start with you. In terms of the recoveries, the question that has just been asked, since 100% of them have been rejected, as you just stated, is it pretty obvious that you haven't received much money at all from the counter-parties?

Yes. Virtually all of the put-back requests have been rejected. We have received several million dollars over the course of a couple of years. I think maybe $30 million, $40 million prior to litigation. And since the litigation has taken place, we've probably received another $10 million to $20 million. But as Jay just described, there's no rhyme or reason for why the ones that were accepted were accepted and the ones that were rejected were rejected.

And I think in your 10-K, on one of the filings today, you said that the maximum, I guess, the amount of ultimate put backs or recoveries could be $4.4 billion. I mean, given that you haven't received much at this point, are you going to go ahead and book these recoveries into your statutory earnings? Or are you going to wait for some of the banks or the counter-parties actually settle with you before you book the rest of it?

Yes. I would point out that we did reach one settlement in 2010. So I was excluding that from the numbers that I just cited, Arun. We have about $4.4 billion of contractual payments that are due us by the counter-parties on the securitizations where we've taken put backs. And what we are doing is risk adjusting that $4.4 billion to take account of the risk of litigation, the potential for there to be delays and the potential for one or more of the counter-parts to be in financial distress at the time that judgments are rendered or settlements entered. And that results in the recording to the balance sheet of about $2.5 billion of recoverables. So we are not recording the recovery dollar for dollar. We're taking what we believe is a pretty steep discount for those risks and recording about 57% of the contract amount to the balance sheet. I might add, Arun, that the damages that we are seeking in the litigations are well beyond the contract claims. So we're only considering, for accounting purposes, those recoveries that are clearly due under the contract and not those associated with fraud, our expenses for litigation, et cetera.

So you're seeking substantially higher than the $2.5 billion of just the recoveries then?

Correct.

Okay. Just jumping into other couple of topics, one is on the commutations that you announced, $16.5 billion, give or take, how much of cash did you actually pay out? I know you said that was consistent with the reserves taken. But in terms of the cash payouts to actually seal that deal, how much did you pay out?

There is data, Arun, in the supplement that shows that payments for ABS CDOs in the quarter were $940 million. And that is for all CDOs. And so the amounts that we paid for the commutations is within that.

Okay. Turning to the ALM business. The intercompany loan, which is down to about $980 million, around that number, I think this is due in November 2011. Are you still on track to recover that intercompany loan?

Yes. We expect that it will be repaid over the course of 2011. It's actually due in a bullet in November 2011. The holding company, or the ALM segment, has been making periodic payments to the insurance company, having reduced it from $2 billion at October '08 to $975 million at year-end '10.

And in terms of the spread between the fair value of assets in the Asset Liability business and the liabilities, I know you haven't disclosed that, but you have commented on that amount in the past. Have the asset values improved in the past six months or three months?

Yes, the asset values continue to improve. I think at the max in early 2009, we had somewhere around $2 billion of OCI, $2 billion of unrealized losses associated with those assets. At year end, that number is about $600 million or $700 million. It has been declining pretty steadily and pretty much across all the different asset classes in the portfolio.

And just turning to National for a minute. The statutory capital improvement, the permitted practices, which resulted in a favorable treatment and consequently, the capital position has grown to, I think, surplus to about $900-plus million. Now you mentioned that that's being challenged by a few people. When do you think that's going to be resolved? Clearly, it's in the balance sheet right now. But when do you expect a time line for that to be resolved?

A couple of things. One, the permitted practice doesn't have anything to do with the statutory capital of National. There is a statistic that the regulators track called earned surplus, which was reset to zero at the time of the creation of National in 2008, although the approval came later -- 2009, although the approval came later. But that does not have any impact on the stat capital number that we're showing on the face of the balance sheet. Number two, the challenge to the creation of National also is not a challenge to the capital that's on its balance sheet. What the plaintiffs have alleged is that the insurance department was arbitrary and capricious in permitting the separation of the company into two separate insurance companies. That trial is on track or that case is on track. We expect that it will be resolved in 2011. At this point, all of the papers on it should be in in the second quarter. There's no requirement that there be a trial in this type of case, so it's possible that the judge will simply rule on the papers, which we think are quite straightforward. But if there is a trial or hearing, it will take place probably in the third quarter and we're expecting to be completed in the year.

Arun, there was a separate action, separate Article 78 action filed on the surplus reset. That has been stayed. Mutual agreement on the parties, both ourselves and the insurance department and the banks have agreed to just essentially postpone that. The thinking being that we don't really need to litigate that separately. We should first get the other litigation out of the way and then determine if this litigation needs to go forward. So yes, there is a separate action, but right now, it's essentially dormant while we work on the primary one, which is the Article 78 challenge, the separation of the companies.

Just staying on National for a minute. In terms of company's $530 million pretax income for the 12 months at December 2010, now, how much of that resulted in a statutory gain? Is that half of it or more?

Yes, the increase in statutory capital was $2 billion to $2.4 billion, so $400 million for statutory after-tax.

Okay. And in terms of a dividend capacity from National of $91 million, I know you commented that you're unlikely to take that money up to the holding company. Is there any regulatory barrier preventing you from taking that money or it's just a corporate decision not to do it?

It's not a regulatory barrier. It's part of the agreement to suspend the litigation. We've agreed, because we weren't planning on taking any money out, that we wouldn't pay a dividend until that case becomes active. So it's not a regulatory limitation per se. It's just an agreement on our part with the regulator that there's no need to take a dividend at this point in time for the holding company.

Your next question comes from Marie Lunackova of UBS.

I had a question back to the S&P rating methodology. By any chance, did you look at what the capital requirements would be for National using this proposed methodology, using their new capital adequacy model?

We've spent some time looking at the model. The leverage test in and of itself would result in a very significant requirement for additional capital to get to the AA level with S&P. And it would be -- I'm trying to focus now on what the exact number is, but I believe that it's just a very large increase in capital requirement that would be in excess of $1 billion.

And that's the capital -- not the capital adequacy? That's the leverage test?

Yes, that's to get to the leverage test.

And do you have the number for the capital adequacy changes?

We really -- we run a lot of different scenarios, but we think it's premature to comment. We're not active in the business right now. Our rating is artificially suppressed because of the litigation. Both S&P and Moody's have suppressed it because of the litigation. So it's not a particularly relevant question in the short-term. By the time we get through the litigation, we believe that S&P will establish their criteria, and we'll obviously be very responsive and put out the exact way that we would plan on meeting their capital requirements. And that assumes, and it's a big assumption, that they're reasonable and it makes sense for our shareholders to have the kind of capital that S&P would require for a AA or higher company.

And then a question on that $600 million capital contribution to Asset Liability. What was behind that decision?

We had advanced $600 million to the Asset Liability segment in 2008. And the reason for it was the same as the reason for the intercompany $2 billion loan from MBIA Insurance Corp. was to enable the Asset Liability segment to avoid selling assets to meet accelerating liabilities in a depressed environment. So that was the original logic behind it. The expectation had been that we would buy back enough debt at deep discounts in the Asset Liability segment to repay all of the $600 million loan at year-end 2010. Because of the fact that liability values have appreciated pretty significantly, we no longer think that's the case. And therefore, in effect, the holding company Activity segment writes off that $600 million and it becomes a contribution to the ALM segment.

Okay. And then on the CMBS losses. I guess, looking forward, what kind of trends we should watch for to judge whether there might be additional losses or actually that environment is stabilizing beyond the delinquencies?

I think you want to look at delinquencies, you want to look severities then you want to look at cap rates. All of which, delinquencies have slowed down substantially, the rate of increase. They're peaking in the 9 1/2% range. They'll probably go up another 30, 40, 50 basis points over the next three or four months. That would be our expectation. Our cap rates have come down. And if they continue to come down, that's a huge positive because that's the refinancing. And then importantly, severities have also come down in the last six months. Some of the severities for the liquidated properties in the early part of 2009 were running in the high 60%. They're coming back down under 50% at this point. We're assuming that they eventually will trend back down towards long-term averages in the 30s. That won't happen in the next few months, but it should happen. And then importantly, you want to see continued modification of existing loans. And then the last factor, which was written up in the last few days, was a revitalization of the new issue CMBS market. We've seen issues in the last few months. There's a big schedule for March. We don't believe that all of the existing maturing commercial real estate loans will go back on bank balance sheets or into insurance companies. And so it's going to need a continued revitalization of the securitization market. The estimates for this year are somewhere in the $30 billion to $40 billion range. It would be nice if they could get up to $40 billion to $50 billion on a run rate basis for three or four years. That should provide enough adequate capacity plus cap rates, either at today's level or coming down to allow the assumptions that we're currently using to prove out to be accurate.

So I'm not seeing any more questioners in the queue, so we can wrap up the call for today.

And ladies and gentlemen, we thank you for your time. That concludes the MBIA Inc.'s Fourth Quarter 2010 Financial Results Conference Call. Have a wonderful day.