EX-99.1

EX-99.1 6 d617219dex991.htm EX-99.1 EX-99.1

Exhibit 99.1

NATIONAL PUBLIC FINANCE GUARANTEE CORPORATION AND SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS

As of September 30, 2013 and December 31, 2012

and for the periods ended September 30, 2013 and 2012

NATIONAL PUBLIC FINANCE GUARANTEE CORPORATION AND SUBSIDIARIES

INDEX


	PAGE

Consolidated Balance Sheets as of September 30, 2013 and December 31, 2012 (Unaudited)		1

Consolidated Statements of Operations for the three and nine months ended September 30, 2013 and 2012 (Unaudited)		2

Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2013 and 2012 (Unaudited)		3

Consolidated Statement of Changes in Shareholder’s Equity for the nine months ended September 30, 2013 (Unaudited)		4

Consolidated Statements of Cash Flows for the nine months ended September 30, 2013 and 2012 (Unaudited)		5

Notes to Consolidated Financial Statements (Unaudited)		6

NATIONAL PUBLIC FINANCE GUARANTEE CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (Unaudited)

(In thousands except share and per share amounts)


	September 30, 2013		December 31, 2012
Assets
Investments:
Fixed-maturity securities held as available-for-sale, at fair value (amortized cost $3,125,396 and $2,335,832)	$	3,075,730	$	2,425,240
Investments carried at fair value		177,275		190,321
Investments pledged as collateral, at fair value (amortized cost $475,297 and $487,880)		469,573		501,873
Short-term investments held as available-for-sale, at fair value (amortized cost $1,001,399 and $175,763)		1,001,901		176,015
Other investments (includes investments at fair value of $5,810 and $7,554)		10,954		16,216

Total investments		4,735,433		3,309,665
Cash and cash equivalents		516,392		265,409
Securities purchased under agreements to resell		443,500		480,500
Secured loan to an affiliate		-		1,651,408
Accrued investment income		30,875		54,465
Premiums receivable		241,362		254,363
Deferred acquisition costs		344,215		400,970
Insurance loss recoverable		16,721		248,925
Property and equipment at cost (less accumulated depreciation of $1,735 and $9,725)		30,351		61,719
Receivable for investments sold		5,836		16,457
Other assets		9,337		10,031

Total assets	$	6,374,022	$	6,753,912


Liabilities and equity
Liabilities:
Unearned premium revenue	$	1,645,270	$	1,928,351
Loss and loss adjustment expense reserves		93,311		151,892
Securities sold under agreements to repurchase		443,500		480,500
Current income taxes		40,384		16,418
Deferred income taxes, net		106,048		232,165
Payable for investments purchased		144,107		49,893
Derivative liabilities		7,045		7,336
Other liabilities		13,953		11,653

Total liabilities		2,493,618		2,878,208

Commitments and contingencies (See Note 9)

Equity:
Common stock, par value $30 per share; authorized, issued and outstanding shares—500,000		15,000		15,000
Additional paid-in capital		2,341,486		2,341,599
Retained earnings		1,550,145		1,441,992
Accumulated other comprehensive income (loss), net of tax of $19,045 and $36,598		(35,369)		67,967

Total shareholder’s equity		3,871,262		3,866,558
Noncontrolling interest		9,142		9,146

Total equity		3,880,404		3,875,704

Total liabilities and equity	$	6,374,022	$	6,753,912

The accompanying notes are an integral part of the consolidated financial statements.

NATIONAL PUBLIC FINANCE GUARANTEE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

(In thousands)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
Revenues:
Premiums earned:
Scheduled premiums earned	$	48,315	$	50,621	$	156,450	$	164,784
Refunding premiums earned		26,947		79,338		120,950		190,088

Premiums earned (net of ceded premiums of $0, $0, $0, and $1)		75,262		129,959		277,400		354,872
Net investment income		26,213		56,392		109,452		166,513
Fees, reimbursements and other		1,640		1,730		4,892		4,905
Change in fair value of insured derivatives:
Realized gains (losses) and other settlements on insured derivatives		103		147		315		356
Unrealized gains (losses) on insured derivatives		10		28		(19)		50

Net change in fair value of insured derivatives		113		175		296		406
Net gains (losses) on financial instruments at fair value and foreign exchange		(859)		22,501		29,151		43,445
Other net realized gains (losses)		(29,331)		-		(29,331)		-

Total revenues		73,038		210,757		391,860		570,141
Expenses:
Losses and loss adjustment		34,912		3,842		105,118		15,139
Amortization of deferred acquisition costs		15,839		26,922		58,385		75,030
Operating		17,078		19,701		69,593		128,175
Interest		3		5		11		20

Total expenses		67,832		50,470		233,107		218,364

Income before income taxes		5,206		160,287		158,753		351,777
Provision (benefit) for income taxes		(969)		45,593		50,760		102,717

Net income		6,175		114,694		107,993		249,060
Net income (loss) attributable to noncontrolling interest		63		166		(160)		518

Net income available to common shareholder	$	6,112	$	114,528	$	108,153	$	248,542

The accompanying notes are an integral part of the consolidated financial statements.

NATIONAL PUBLIC FINANCE GUARANTEE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)

(In thousands)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
Net income (loss)	$	6,175	$	114,694	$	107,993	$	249,060
Other comprehensive income (loss):
Unrealized gains (losses) on available-for-sale securities:
Unrealized gains (losses) arising during the period		(6,013)		31,912		(128,660)		84,082
Provision (benefit) for income taxes		(2,104)		11,145		(45,031)		29,424

Total		(3,909)		20,767		(83,629)		54,658
Reclassification adjustments for (gains) losses included in net income (loss)		(898)		(6,611)		(30,318)		(15,403)
Provision (benefit) for income taxes		(314)		(2,314)		(10,611)		(5,391)

Total		(584)		(4,297)		(19,707)		(10,012)

Total other comprehensive income (loss)		(4,493)		16,470		(103,336)		44,646

Comprehensive income (loss)		1,682		131,164		4,657		293,706
Less: comprehensive income (loss) attributable to noncontrolling interest		63		166		(160)		518

Comprehensive income (loss) attributable to common shareholder	$	1,619	$	130,998	$	4,817	$	293,188

The accompanying notes are an integral part of the consolidated financial statements.

NATIONAL PUBLIC FINANCE GUARANTEE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDER’S EQUITY (Unaudited)

For The Nine Months Ended September 30, 2013

(In thousands except share amounts)


	Common Stock				Additional Paid-in Capital		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Total Shareholder’s Equity		Noncontrolling Interest		Total Equity
	Shares		Amount		Additional Paid-in Capital		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Total Shareholder’s Equity		Noncontrolling Interest		Total Equity
Balance, December 31, 2012		500,000	$	15,000	$	2,341,599	$	1,441,992	$	67,967	$	3,866,558	$	9,146	$	3,875,704
Net income		-		-		-		108,153		-		108,153		(160)		107,993
Other comprehensive income (loss)		-		-		-		-		(103,336)		(103,336)		-		(103,336)
Share-based compensation, net of tax of $113		-		-		(113)		-		-		(113)		-		(113)
Distributions to noncontrolling interest		-		-		-		-		-		-		(994)		(994)
Contributions by noncontrolling interest		-		-		-		-		-		-		1,150		1,150

Balance, September 30, 2013		500,000	$	15,000	$	2,341,486	$	1,550,145	$	(35,369)	$	3,871,262	$	9,142	$	3,880,404

The accompanying notes are an integral part of the consolidated financial statements.

NATIONAL PUBLIC FINANCE GUARANTEE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(In thousands)


	Nine Months Ended September 30,
	2013		2012
Cash flows from operating activities:
Premiums, fees and reimbursements received	$	13,560	$	15,254
Return of refunded premiums		(3,038)		(17,711)
Investment income received		100,370		123,683
Financial guarantee losses and loss adjustment expenses paid		(133,969)		(101,948)
Proceeds from recoveries and reinsurance		84,784		7,185
Operating and employee related expenses paid		(73,624)		(129,701)
Income taxes (paid) received		(97,383)		(106,195)

Net cash provided (used) by operating activities		(109,300)		(209,433)

Cash flows from investing activities:
Purchase of fixed-maturity securities		(1,516,881)		(777,518)
Sale and redemption of fixed-maturity securities		1,115,852		1,061,082
Repayment (issuance) of secured loan to an affiliate		1,595,620		(443,000)
Sale (purchase) of short-term investments, net		(839,187)		293,431
Sale (purchase) of other investments, net		5,440		1,776
Capital expenditures		(717)		(3,610)

Net cash provided (used) by investing activities		360,127		132,161

Cash flows from financing activities:
Contributions by noncontrolling interest		1,150		-
Distributions to noncontrolling interest		(994)		(1,730)

Net cash provided (used) by financing activities		156		(1,730)

Net increase (decrease) in cash and cash equivalents		250,983		(79,002)
Cash and cash equivalents - beginning of period		265,409		137,170

Cash and cash equivalents - end of period	$	516,392	$	58,168

Reconciliation of net income to net cash provided (used) by operating activities:
Net income	$	107,993	$	249,060
Adjustments to reconcile net income to net cash provided (used) by operating activities:
Change in:
Accrued investment income		(34,513)		(69,497)
Premiums receivable		13,003		17,330
Deferred acquisition costs		56,755		76,792
Unearned premium revenue		(283,081)		(380,769)
Loss and loss adjustment expense reserves		(58,581)		(38)
Insurance loss recoverable		114,514		(79,583)
Payable to affiliates		(2,480)		(4,859)
Accrued expenses		(476)		5,611
Current income taxes		23,966		23,716
Amortization (accretion) of bond premiums (discounts), net		14,411		15,780
Depreciation		2,755		2,632
Other net realized (gains) losses		29,331		-
Unrealized (gains) losses on insured derivatives		19		(50)
Net (gains) losses on financial instruments at fair value and foreign exchange		(29,151)		(43,445)
Deferred income tax provision (benefit)		(70,588)		(27,194)
Other operating		6,823		5,081

Total adjustments to net income		(217,293)		(458,493)

Net cash provided (used) by operating activities	$	(109,300)	$	(209,433)

The accompanying notes are an integral part of the consolidated financial statements.

National Public Finance Guarantee Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 1: Business Developments and Risks and Uncertainties

Summary

National Public Finance Guarantee Corporation is a wholly-owned subsidiary of MBIA Inc. through an intermediary holding company, National Public Finance Guarantee Holdings, Inc. National Public Finance Guarantee Corporation and its subsidiaries are referred to as “National.” National Real Estate Holdings of Armonk, LLC is a wholly-owned subsidiary of National.

Through its reinsurance of United States (“U.S.”) public finance financial guarantees from MBIA Insurance Corporation and transfers by novation of all policies under a reinsurance agreement with Financial Guaranty Insurance Company (“FGIC”) as discussed below, National’s insurance portfolio consists of municipal bonds, including tax-exempt and taxable indebtedness of U.S. political subdivisions, as well as utility districts, airports, health care institutions, higher educational facilities, student loan issuers, housing authorities and other similar agencies and obligations issued by private entities that finance projects that serve a substantial public purpose. Municipal bonds and privately issued bonds used for the financing of public purpose projects generally are supported by taxes, assessments, user fees or tariffs related to the use of these projects, by lease payments or by other similar types of revenue streams.

Business Developments and Risks and Uncertainties

As of September 30, 2013, National was rated A with a stable outlook by Standard & Poor’s Financial Services LLC and Baa1 with a positive outlook by Moody’s Investors Service, Inc. In addition, National is considering seeking ratings from additional rating agencies.

In May of 2013, MBIA Inc., together with its subsidiaries MBIA Insurance Corporation and National, entered into a comprehensive settlement agreement and related agreements (the “BofA Settlement Agreement”) with Bank of America Corporation and certain of its subsidiaries (collectively, “Bank of America”). Additionally, in May of 2013, MBIA Inc., together with its subsidiaries, MBIA Insurance Corporation and National, entered into a settlement agreement with Societe Generale. As a result of the BofA Settlement Agreement, the repayment of MBIA Insurance Corporation’s secured loan from National and recent credit ratings upgrades, National is currently evaluating strategies for such re-entry into the U.S. public finance market. Subsequent to the BofA Settlement Agreement and the Societe Generale settlement, all litigation brought originally by the group of eighteen domestic and international financial institutions, relating to the establishment of National, has been resolved.

Subsequent to September 30, 2013, National declared and paid a dividend of $214 million to its ultimate parent, MBIA Inc.

In August of 2013, the novation agreement between FGIC and National, whereby FGIC transfers, by novation, to National all the rights and liabilities under each of the policies covered under a reinsurance agreement with FGIC, became effective. This novation agreement included covered policies that previously benefited from the reinsurance agreement and second-to-pay policies entered into by MBIA Insurance Corporation in 2008 that were subsequently assigned to and reinsured by National in 2009. As a result of this novation, National is now the primary insurer under these policies.

In order to better position MBIA Inc. for future business opportunities, in the third quarter of 2013, MBIA Inc. initiated cost reduction measures, one of which focused on head office occupancy costs. As a result of the potential sale of the office used in its operations, National recorded an impairment charge of $29 million on its Armonk, New York facility. The carrying value of the facility was adjusted to its fair market value, which was determined based on an independent third-party appraisal of the facility. This impairment charge is reported within “Other net realized gains (losses)” on National’s consolidated statements of operations.

National maintains simultaneous repurchase and reverse repurchase agreements (“Asset Swap”) with MBIA Inc. The Asset Swap provides MBIA Inc. with eligible assets to pledge under investment agreements and derivative contracts in MBIA Inc.’s asset/liability products business. As of September 30, 2013, the notional amount utilized under each of these agreements was $444 million and the fair value of collateral pledged by National and MBIA Inc. under these agreements was $470 million and $475 million, respectively. The net average interest rate on these transactions was 0.23% and 0.56% for the nine months ended September 30, 2013 and 2012, respectively. The New York State Department of Financial Services (“NYSDFS”) approved the Asset Swap in connection with the re-domestication of National to New York. National has committed to the NYSDFS to use commercially reasonable efforts to reduce the amount of the Asset Swap over time.

National Public Finance Guarantee Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 1: Business Developments and Risks and Uncertainties (continued)

Extreme financial and budgetary stress in certain local governments has increased the risk of losses within National’s insured portfolio. Refer to “Note 4: Loss and Loss Adjustment Expense Reserves” for information about National’s insured losses. National’s claim paying resources are supported by its investment portfolio, which primarily consists of fixed-maturity securities. Fixed-maturity securities are subject to a number of risks, including interest rate risk and default risk, among others. National manages these risks by maintaining a diversification across issuers and maturities of investments. Refer to “Note 6: Investments” for information about National’s investment portfolio.

Note 2: Significant Accounting Policies

National has disclosed its significant accounting policies in “Note 2: Significant Accounting Policies” in the Notes to Consolidated Financial Statements included in Exhibit 99.1 to MBIA Inc.’s Annual Report on Form 10-K for the year ended December 31, 2012. The following significant accounting policies provide an update to those included under the same captions in Exhibit 99.1 to MBIA Inc.’s Annual Report on Form 10-K.

Basis of Presentation

The accompanying unaudited consolidated financial statements include the accounts of National and its wholly-owned subsidiaries and do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America (“GAAP”) for annual periods. These statements should be read in conjunction with National’s consolidated financial statements and notes thereto included in Exhibit 99.1 to MBIA Inc.’s Annual Report on Form 10-K for the year ended December 31, 2012. The accompanying consolidated financial statements have not been audited by an independent registered public accounting firm in accordance with the standards of the Public Company Accounting Oversight Board (U.S.), but in the opinion of management such financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for the fair statement of National’s consolidated financial position and results of operations.

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. As additional information becomes available or actual amounts become determinable, the recorded estimates are revised and reflected in operating results.

The results of operations for the three and nine months ended September 30, 2013 may not be indicative of the results that may be expected for the year ending December 31, 2013. The December 31, 2012 consolidated balance sheet was derived from audited financial statements, but does not include all disclosures required by GAAP for annual periods. Certain amounts in prior years’ financial statements have been reclassified to conform to the current presentation. Such reclassifications had no impact on total revenues, expenses, assets, liabilities, or shareholder’s equity for all periods presented.

Subsequent Events

National evaluated all subsequent events as of November 12, 2013, the date of issuance of the consolidated financial statements, for inclusion in National’s consolidated financial statements and/or accompanying notes.

Note 3: Recent Accounting Pronouncements

Recently Adopted Accounting Standards

Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (ASU 2013-02)

In February 2013, the Financial Accounting Standards Board issued Accounting Standards Update 2013-02, “Comprehensive Income (Topic 220)—Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income” that requires an entity to present information about the amounts reclassified out of accumulated other comprehensive income (“AOCI”) by component and to present significant amounts reclassified out of AOCI by the respective line items of net income. The amendment only affects National’s disclosures and does not affect National’s consolidated balance sheets, results of operations, or cash flows. National adopted this standard in the first quarter of 2013.

Refer to the Notes to Consolidated Financial Statements of National included in Exhibit 99.1 to MBIA Inc.’s Annual Report on Form 10-K for the year ended December 31, 2012 for further information regarding the effects of recently adopted accounting standards on prior year financial statements.

National Public Finance Guarantee Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 4: Loss and Loss Adjustment Expense Reserves

U.S. public finance insured transactions consist of municipal bonds, including tax-exempt and taxable indebtedness of U.S. political subdivisions, as well as utility districts, airports, health care institutions, higher educational facilities, student loan issuers, housing authorities and other similar agencies and obligations issued by private entities that finance projects that serve a substantial public purpose. National estimates future losses by utilizing probability-weighted scenarios that are customized to each insured transaction. Future loss estimates consider debt service due for each insured transaction, which includes par outstanding and interest due.

Certain local governments remain under extreme financial and budgetary stress and several have filed for protection under the United States Bankruptcy Code, or have entered into state statutory proceedings established to assist municipalities in managing through periods of severe fiscal stress. This could lead to an increase in defaults by such entities on the payment of their obligations and losses or impairments on a greater number of National’s insured transactions. National monitors and analyzes these situations closely; however, the overall extent and duration of such events are uncertain.

National has exposure to the Commonwealth of Puerto Rico and certain governmental issuers in the territory. The Commonwealth is experiencing fiscal stress; however, it has taken proactive actions to address its significant economic challenges. National continues to monitor the situation closely, but does not expect a default by Puerto Rico.

As of September 30, 2013, National had $131.5 billion of gross par outstanding on general obligations, of which $251 million was reflected on National’s Classified List. Capital appreciation bonds are reported at the par amount at the time of issuance of the insurance policy.

For the nine months ended September 30, 2013, National recognized $105 million of loss and loss adjustment expense (“LAE”) primarily related to certain general obligation bonds and the loss related to the difference in the value of the salvage receivable recorded and the fair market value of the marketable securities received in connection with the restructuring of a gaming revenue transaction.

Refer to “Note 5: Loss and Loss Adjustment Expense Reserves” in the Notes to Consolidated Financial Statements included in Exhibit 99.1 to MBIA Inc.’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012 for information about National’s monitoring of outstanding insured obligations and for additional information about its loss reserving process.

The following table provides information about the financial guarantees and related claim liability included in each of National’s surveillance categories as of September 30, 2013:


	Surveillance Categories
$ in millions	Caution List Low		Caution List Medium		Caution List High		Classified List		Total
Number of policies		66		2		6		39		113
Number of issues⁽¹⁾		16		2		5		15		38
Remaining weighted average contract period (in years)		13.2		2.6		9.6		13.4		13.1
Gross insured contractual payments outstanding:⁽²⁾
Principal	$	3,174	$	9	$	65	$	820	$	4,068
Interest		2,741		2		32		998		3,773

Total	$	5,915	$	11	$	97	$	1,818	$	7,841

Gross claim liability	$	-	$	-	$	-	$	249	$	249
Less:
Gross potential recoveries		-		-		-		209		209
Discount, net		-		-		-		(14)		(14)

Net claim liability (recoverable)	$	-	$	-	$	-	$	54	$	54

Unearned premium revenue	$	25	$	-	$	-	$	16	$	41

(1) -

An “issue” represents the aggregate of financial guarantee policies that share the same revenue source for purposes of making debt service payments.

(2) -

Represents contractual principal and interest payments due by the issuer of the obligations insured by National.

National Public Finance Guarantee Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 4: Loss and Loss Adjustment Expense Reserves (continued)

The following table provides information about the financial guarantees and related claim liability included in each of National’s surveillance categories as of December 31, 2012:


	Surveillance Categories
$ in millions	Caution List Low		Caution List Medium		Caution List High		Classified List		Total
Number of policies		20		9		7		48		84
Number of issues⁽¹⁾		9		4		7		18		38
Remaining weighted average contract period (in years)		11.1		7.4		12.8		13.1		11.7
Gross insured contractual payments outstanding:⁽²⁾
Principal	$	817	$	190	$	122	$	843	$	1,972
Interest		1,161		88		80		999		2,328

Total	$	1,978	$	278	$	202	$	1,842	$	4,300

Gross claim liability	$	-	$	-	$	-	$	310	$	310
Less:
Gross potential recoveries		-		-		-		387		387
Discount, net		-		-		-		(6)		(6)

Net claim liability (recoverable)	$	-	$	-	$	-	$	(71)	$	(71)

Unearned premium revenue	$	12	$	4	$	2	$	18	$	36

(1) -

An “issue” represents the aggregate of financial guarantee policies that share the same revenue source for purposes of making debt service payments.

(2) -

Represents contractual principal and interest payments due by the issuer of the obligations insured by National.

National’s potential recoveries are typically based on either salvage rights, the rights conferred to National through the transactional documents (inclusive of the insurance agreement), or subrogation rights embedded within financial guarantee insurance policies. Expected salvage and subrogation recoveries, as well as recoveries from other remediation efforts, reduce National’s claim liability. Once a claim payment has been made, the claim liability has been satisfied and National’s right to recovery is no longer considered an offset to future expected claim payments, it is recorded as a salvage asset. The amount of recoveries recorded by National is limited to paid claims plus the present value of projected future claim payments. As claim payments are made, the recorded amount of potential recoveries may exceed the remaining amount of claim liability for a given policy.

While National believes it will be successful in realizing recoveries from contractual claims, the ultimate amounts recovered may be materially different from those recorded by National given the inherent uncertainty in the manner of resolving the claims (e.g. litigation) and the assumptions used in the required estimation process for accounting purposes which are based, in part, on judgments and other information that are not easily corroborated by historical data or other relevant benchmarks.

The following table presents the components of National’s loss and LAE reserves and insurance loss recoverable as reported on National’s consolidated balance sheets as of September 30, 2013 and December 31, 2012 for insured obligations within National’s “Classified List.” The loss reserves (claim liability) and insurance claim loss recoverable included in the following table represent the present value of the probability-weighted future claim payments and recoveries reported in the preceding tables.


In millions	As of September 30, 2013		As of December 31, 2012
Loss reserves (claim liability)	$	67	$	143
LAE reserves		26		9

Loss and LAE reserves	$	93	$	152


Insurance claim loss recoverable	$	(15)	$	(216)
LAE insurance loss recoverable		(2)		(33)

Insurance loss recoverable	$	(17)	$	(249)

National Public Finance Guarantee Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 4: Loss and Loss Adjustment Expense Reserves (continued)

The following table presents changes in National’s loss and LAE reserves for the nine months ended September 30, 2013. Changes in the loss and LAE reserves attributable to the accretion of the claim liability discount, changes in discount rates, changes in the timing and amounts of estimated payments and recoveries, changes in assumptions and changes in LAE reserves are recorded in “Losses and loss adjustment” expenses in National’s consolidated statements of operations. LAE reserves are expected to be settled within a one-year period and are not discounted. The weighted average risk-free rate used to discount the claim liability was 2.48% as of September 30, 2013.


In millions		Changes in Loss and LAE Reserves for Nine Months Ended September 30, 2013

Gross Loss and LAE Reserve as of December 31, 2012		Loss Payments for Cases with Reserves	Accretion of Claim Liability Discount		Changes in Discount Rates		Changes in Assumptions		Changes in Unearned Premium Revenue		Changes in LAE Reserves		Other⁽¹⁾		Gross Loss and LAE Reserve as of September 30, 2013
$	152	$ (120)	$	1	$	-	$	45	$	-	$	17	$	(2)	$	93

(1) -

Primarily changes in amount and timing of payments.

The decrease in case reserves for the nine months ended September 30, 2013 primarily related to the change in loss payments for cases with reserves, partially offset by changes in assumptions due to an increase in reserves associated with certain general obligation bond exposures.

The following table presents changes in National’s insurance loss recoverable for the nine months ended September 30, 2013. Changes in the insurance loss recoverable attributable to the accretion of the discount on the recoverable, changes in discount rates, changes in the timing and amounts of estimated collections, changes in assumptions and changes in LAE recoverable are recorded in “Losses and loss adjustment” expenses in National’s consolidated statements of operations.


In millions		Changes in Insurance Loss Recoverable for the Nine Months Ended September 30, 2013

Insurance Loss Recoverable as of December 31, 2012		Collections for Cases with Recoverables	Accretion of Insurance Loss Recoverable		Changes in Discount Rates		Changes in Assumptions		Changes in LAE Recoverable		Other⁽¹⁾	Insurance Loss Recoverable as of September 30, 2013
$	249	$ (170)	$	-	$	(1)	$	(46)	$	(32)	$ 17	$	17

(1) -

Primarily changes in amount and timing of collections.

The decrease in insurance loss recoverable for the nine months ended September 30, 2013 primarily related to the receipt of salvage in the form of investment notes related to a gaming revenue transaction, which resulted in transferring the recoverable to an investment asset.

Remediation actions may involve, among other things, waivers or renegotiations of financial covenants or triggers, waivers of contractual provisions, the granting of consents, transfer of servicing, consideration of restructuring plans, acceleration, security or collateral enforcement, actions in bankruptcy or receivership, litigation and similar actions. The types of remedial actions pursued are based on the insured obligation’s risk type and the nature and scope of the event giving rise to the remediation. As part of any such remedial actions, National seeks to improve its security position and to obtain concessions from the issuer of the insured obligation. From time to time, the issuer of a National-insured obligation may, with the consent of National, restructure the insured obligation by extending the term, increasing or decreasing the par amount or decreasing the related interest rate, with National insuring the restructured obligation.

National Public Finance Guarantee Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 4: Loss and Loss Adjustment Expense Reserves (continued)

Costs associated with remediating insured obligations assigned to National’s “Caution List—Low,” “Caution List—Medium,” “Caution List—High” and “Classified List” are recorded as LAE. LAE is primarily recorded as part of National’s provision for its loss reserves and included in “Losses and loss adjustment” expense on National’s consolidated statements of operations. The following table presents the gross expenses related to remedial actions for insured obligations:


	Nine Months Ended September 30,
In millions	2013		2012
LAE incurred, gross	$	24	$	10

Note 5: Fair Value of Financial Instruments

Fair value is a market-based measure considered from the perspective of a market participant. Therefore, even when market assumptions are not readily available, National’s own assumptions are set to reflect those which it believes market participants would use in pricing an asset or liability at the measurement date. The fair value measurements of financial instruments held or issued by National are determined through the use of observable market data when available. Market data is obtained from a variety of third-party sources, including dealer quotes. If dealer quotes are not available for an instrument that is infrequently traded, National uses alternate valuation methods, including either dealer quotes for similar instruments or modeling using market data inputs. The use of alternate valuation methods generally requires considerable judgment in the application of estimates and assumptions, and changes to such estimates and assumptions may produce materially different fair values.

The accounting guidance for fair value measurement establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available and reliable. Observable inputs are those National believes that market participants would use in pricing an asset or liability based on available market data. Unobservable inputs are those that reflect National’s beliefs about the assumptions market participants would use in pricing an asset or liability based on the best information available. The fair value hierarchy is broken down into three levels based on the observability and reliability of inputs, as follows:

•

Level 1—Valuations based on quoted prices in active markets for identical assets or liabilities that National can access. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail any degree of judgment.

•

Level 2—Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly. Level 2 assets include debt securities with quoted prices that are traded less frequently than exchange-traded instruments, securities which are priced using observable inputs and derivative contracts whose values are determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data.

•

Level 3—Valuations based on inputs that are unobservable and supported by little or no market activity and that are significant to the overall fair value measurement. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques where significant inputs are unobservable, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

The availability of observable inputs can vary from product to product and period to period and is affected by a wide variety of factors, including, for example, the type of product, whether the product is new and not yet established in the marketplace, and other characteristics particular to the product. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, National assigns the level in the fair value hierarchy for which the fair value measurement in its entirety falls, based on the least observable input that is significant to the fair value measurement.

National Public Finance Guarantee Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 5: Fair Value of Financial Instruments (continued)

Financial Instruments

Financial instruments held by National primarily consist of investments in debt securities. Substantially all of National’s investments are priced by independent third parties, including pricing services and brokers. Typically National receives one pricing service value or broker quote for each instrument, which represents a non-binding indication of value. National reviews the assumptions, inputs and methodologies used by pricing services to obtain reasonable assurance that the prices used in its valuations reflect fair value. When National believes a third-party quotation differs significantly from its internally developed expectation of fair value, whether higher or lower, National reviews its data or assumptions with the provider. This review includes comparing significant assumptions such as prepayment speeds, default ratios, forward yield curves, credit spreads and other significant quantitative inputs to internal assumptions, and working with the price provider to reconcile the differences. The price provider may subsequently provide an updated price. In the event that the price provider does not update their price, and National still does not agree with the price provided, National will try to obtain a price from another third-party provider, such as a broker, or use an internally developed price which it believes represents the fair value of the investment. The fair values of investments for which internal prices were used were not significant to the aggregate fair value of National’s investment portfolio as of September 30, 2013 or December 31, 2012. All challenges to third-party prices are reviewed by the staff of National with relevant expertise to ensure reasonableness of assumptions.

In addition to challenging pricing assumptions, National obtains reports from the independent accountants for significant third-party pricing services attesting to the effectiveness of the controls over data provided to National. These reports are obtained annually and are reviewed by National to ensure key controls are applied by the pricing services, and that appropriate user controls are in place at the third-party pricing services organization to ensure proper measurement of the fair values of its investments. In the event that any controls in these reports are deemed as ineffective by independent accountants, National will take the necessary actions to ensure that internal user controls are in place to mitigate the control risks. No deficiencies were noted for significant third-party pricing services used.

Internal Review Process

All significant financial instruments are reviewed by committees created by National to ensure compliance with National’s policies and risk procedures in the development of fair values of financial assets and liabilities. These valuation committees review, among other things, key assumptions used for internally developed prices, significant changes in sources and uses of inputs, including changes in model approaches, and any adjustments from third-party inputs or prices to internally developed inputs or prices. The committees also review any significant impairment or improvements in fair values of the financial instruments from prior periods. From time to time, these committees will reach out to National’s valuation experts to better understand key methods and assumptions used for the determination of fair value, including understanding significant changes in fair values. These committees are comprised of senior finance team members with the relevant experience in the financial instruments their committee is responsible for. Each quarter, these committees document their agreement with the fair values developed by management of National as reported in the quarterly and annual financial statements.

Valuation Techniques

Valuation techniques for financial instruments measured at fair value or disclosed at fair value are described below.

Fixed-Maturity Securities (and Short-Term Investments) Held as Available-For-Sale, Investments Carried at Fair Value, Investments Pledged as Collateral, and Other Investments

Fixed-maturity securities (and short-term investments) held as available-for-sale (“AFS”), investments carried at fair value, investments pledged as collateral, and other investments include investments in U.S. Treasury and government agencies, foreign governments, corporate obligations, mortgage-backed securities and asset-backed securities (“ABS”) (including commercial mortgage-backed securities and collateralized debt obligations (“CDOs”)), state and municipal bonds and other investments (including perpetual debt securities, loans receivables and money market mutual funds).

These investments are generally valued based on recently executed transaction prices or quoted market prices. When quoted market prices are not available, fair value is generally determined using quoted prices of similar investments or a valuation model based on observable and unobservable inputs. Inputs vary depending on the type of investment. Observable inputs include contractual cash flows, interest rate yield curves, credit default swap (“CDS”) spreads, prepayment and volatility scores, diversity scores, cross-currency basis index spreads, and credit spreads for structures similar to the financial instrument in terms of issuer, maturity and seniority. Unobservable inputs include cash flow projections and the value of any credit enhancement.

National Public Finance Guarantee Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 5: Fair Value of Financial Instruments (continued)

Investments based on quoted market prices of identical investments in active markets are classified as Level 1 of the fair value hierarchy. Level 1 investments generally consist of U.S. Treasury and government agency and money market securities. Quoted market prices of investments in less active markets, as well as investments which are valued based on other than quoted prices for which the inputs are observable, such as interest rate yield curves, are categorized in Level 2 of the fair value hierarchy. Investments that contain significant inputs that are not observable are categorized as Level 3.

Cash and Cash Equivalents, Receivable for Investments Sold, Accrued Investment Income and Payable for Investments Purchased

The carrying amounts of cash and cash equivalents, receivable for investments sold, accrued investment income and payable for investments purchased approximate their fair values due to the short-term nature and credit worthiness of these instruments.

Securities Purchased Under Agreements to Resell

The fair values of securities purchased under agreements to resell are determined based on the underlying securities posted as collateral for the resell agreements.

Secured Loan to an Affiliate

The fair value of the secured loan as of December 31, 2012, that was repaid in the second quarter of 2013, was determined using the net present value of expected cash flows from the loan. The discount rate is the yield to maturity of a comparable corporate bond index.

Securities Sold Under Agreements to Repurchase

The fair values of securities sold under agreements to repurchase are determined based on the underlying securities posted as collateral for the repurchase agreements.

Derivative Liabilities

Derivative liabilities are valued using market-based inputs, including interest rate yield curves, foreign exchange rates, and credit spreads. Derivative liabilities are classified as Level 2 within the fair value hierarchy.

Financial Guarantees

Gross Financial Guarantees—The fair value of gross financial guarantees is determined using discounted cash flow techniques based on inputs that include (i) assumptions of expected losses on financial guarantee policies where loss reserves have not been recognized, (ii) amount of losses expected on financial guarantee policies where loss reserves have been established, net of expected recoveries, (iii) the cost of capital reserves required to support the financial guarantee liability, (iv) operating expenses, and (v) discount rates. The CDS spread and recovery rates of a similar municipal bond insurance company are used as the discount rate for National, as National does not have a published CDS spread and recovery rate.

The carrying value of National’s gross financial guarantees consists of unearned premium revenue and loss and LAE reserves, net of the insurance loss recoverable as reported on National’s consolidated balance sheets.

Ceded Financial Guarantees—The fair value of ceded financial guarantees is determined by applying the percentage ceded to reinsurers to the related fair value of the gross financial guarantees. The carrying value of ceded financial guarantees consists of prepaid reinsurance premiums as reported within “Other assets” on National’s consolidated balance sheets.

National Public Finance Guarantee Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 5: Fair Value of Financial Instruments (continued)

Fair Value Measurements

The following tables present the fair value of National’s assets (including short-term investments) and liabilities measured and reported at fair value on a recurring basis as of September 30, 2013 and December 31, 2012:


	Fair Value Measurements at Reporting Date Using							Balance as of September 30, 2013
In millions	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)			Balance as of September 30, 2013
Assets:
Fixed-maturity investments:
U.S. Treasury and government agency	$	260	$	53	$	-		$	313
State and municipal bonds		-		1,299		17	⁽¹⁾		1,316
Foreign governments		-		18		-			18
Corporate obligations		-		1,417		1	⁽¹⁾		1,418
Mortgage-backed securities:
Residential mortgage-backed agency		-		901		17	⁽¹⁾		918
Residential mortgage-backed non-agency		-		19		-			19
Commercial mortgage-backed		-		22		3	⁽¹⁾		25
Asset-backed securities:
Collateralized debt obligations		-		5		13	⁽¹⁾		18
Other asset-backed		-		73		7	⁽¹⁾		80

Total fixed-maturity investments		260		3,807		58			4,125
Money market securities		596		-		-			596
Perpetual debt securities		3		6		-			9
Cash and cash equivalents		516		-		-			516

Total assets	$	1,375	$	3,813	$	58		$	5,246

Liabilities:
Derivative liabilities	$	-	$	7	$	-		$	7

Total liabilities	$	-	$	7	$	-		$	7

(1) -

Unobservable inputs are either not developed by National or do not significantly impact the overall fair values of the aggregate financial assets and liabilities.

National Public Finance Guarantee Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 5: Fair Value of Financial Instruments (continued)


	Fair Value Measurements at Reporting Date Using							Balance as of December 31, 2012
In millions	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)			Balance as of December 31, 2012
Assets:
Fixed-maturity investments:
U.S. Treasury and government agency	$	340	$	4	$	-		$	344
State and municipal bonds		-		1,183		33	⁽¹⁾		1,216
Foreign governments		-		1		-			1
Corporate obligations		-		573		1	⁽¹⁾		574
Mortgage-backed securities:
Residential mortgage-backed agency		-		936		-			936
Residential mortgage-backed non-agency		-		19		1	⁽¹⁾		20
Commercial mortgage-backed		-		20		1	⁽¹⁾		21
Asset-backed securities:
Collateralized debt obligations		-		11		6	⁽¹⁾		17
Other asset-backed		-		61		4	⁽¹⁾		65

Total fixed maturity investments		340		2,808		46			3,194
Money market securities		98		-		-			98
Perpetual debt securities		2		5		2	⁽¹⁾		9
Cash and cash equivalents		265		-		-			265

Total assets	$	705	$	2,813	$	48		$	3,566

Liabilities:
Derivative liabilities	$	-	$	7	$	-		$	7

Total liabilities	$	-	$	7	$	-		$	7

(1) -

Unobservable inputs are either not developed by National or do not significantly impact the overall fair values of the aggregate financial assets and liabilities.

Level 3 Analysis

Level 3 assets at fair value were $58 million and $48 million as of September 30, 2013 and December 31, 2012, respectively, and represented 1.1% and 1.3%, respectively, of total assets measured at fair value.

National Public Finance Guarantee Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 5: Fair Value of Financial Instruments (continued)

The following tables present the fair values and carrying values of National’s assets and liabilities that are disclosed at fair value but not reported at fair value on National’s consolidated balance sheets as of September 30, 2013 and December 31, 2012:


	Fair Value Measurements at Reporting Date Using						Fair Value Balance as of September 30, 2013		Carry Value Balance as of September 30, 2013
In millions	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Fair Value Balance as of September 30, 2013		Carry Value Balance as of September 30, 2013
Assets:
Securities purchased under agreements to resell	$	-	$	-	$	475	$	475	$	444
Receivable for investments sold		6		-		-		6		6
Accrued investment income		31		-		-		31		31
Other investments		-		-		5		5		5

Total assets	$	37	$	-	$	480	$	517	$	486


Liabilities:
Securities sold under agreements to repurchase	$	-	$	470	$	-	$	470	$	444
Payable for investments purchased		144		-		-		144		144

Total liabilities	$	144	$	470	$	-	$	614	$	588


Financial Guarantees:
Gross	$	-	$	-	$	1,822	$	1,822	$	1,721
Ceded		-		-		43		43		-


	Fair Value Measurements at Reporting Date Using						Fair Value Balance as of December 31, 2012		Carry Value Balance as of December 31, 2012
In millions	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Fair Value Balance as of December 31, 2012		Carry Value Balance as of December 31, 2012
Assets:
Securities purchased under agreements to resell	$	-	$	-	$	529	$	529	$	481
Secured loan to an affiliate		-		1,685		-		1,685		1,651
Receivable for investments sold		16		-		-		16		16
Accrued investment income		25		29		-		54		54
Other investments		-		-		9		9		9

Total assets	$	41	$	1,714	$	538	$	2,293	$	2,211


Liabilities:
Securities sold under agreements to repurchase	$	-	$	502	$	-	$	502	$	481
Payable for investments purchased		50		-		-		50		50

Total liabilities	$	50	$	502	$	-	$	552	$	531


Financial Guarantees:
Gross	$	-	$	-	$	2,186	$	2,186	$	1,831
Ceded		-		-		77		77		-

National Public Finance Guarantee Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 5: Fair Value of Financial Instruments (continued)

The following tables present information about changes in Level 3 assets (including short-term investments) measured at fair value on a recurring basis for the three months ended September 30, 2013 and 2012:

Changes in Level 3 Assets Measured at Fair Value on a Recurring Basis for the Three Months Ended September 30, 2013


In millions	Balance, Beginning of Period		Realized Gains / (Losses)		Unrealized Gains / (Losses) Included in Earnings		Unrealized Gains / (Losses) Included in OCI		Foreign Exchange Recognized in OCI or Earnings		Purchases		Issuances		Settlements		Sales		Transfers into Level 3⁽¹⁾		Transfers out of Level 3⁽¹⁾		Ending Balance		Change in Unrealized Gains (Losses) for the Period Included in Earnings for Assets Still Held as of September 30, 2013
Assets:
State and municipal bonds	$	18	$	-	$	-	$	-	$	-	$	-	$	-	$	(1)	$	-	$	-	$	-	$	17	$	-
Corporate obligations		-		-		-		-		-		-		-		-		-		1		-		1		-
Residential mortgage-backed agency		3		-		-		-		-		-		-		-		-		17		(3)		17		-
Residential mortgage-backed non-agency		1		-		-		-		-		-		-		-		-		-		(1)		-		-
Commercial mortgage-backed		1		-		-		-		-		-		-		-		-		2		-		3		-
Collateralized debt obligations		8		-		-		-		-		-		-		-		-		6		(1)		13		-
Other asset-backed		7		-		-		-		-		-		-		(2)		-		3		(1)		7		-

Total assets	$	38	$	-	$	-	$	-	$	-	$	-	$	-	$	(3)	$	-	$	29	$	(6)	$	58	$	-

(1) -

Transferred in and out at the end of the period.

Changes in Level 3 Assets Measured at Fair Value on a Recurring Basis for the Three Months Ended September 30, 2012


In millions	Balance, Beginning of Period		Realized Gains / (Losses)		Unrealized Gains / (Losses) Included in Earnings		Unrealized Gains / (Losses) Included in OCI		Foreign Exchange Recognized in OCI or Earnings		Purchases		Issuances		Settlements		Sales		Transfers into Level 3⁽¹⁾		Transfers out of Level 3⁽¹⁾		Ending Balance		Change in Unrealized Gains (Losses) for the Period Included in Earnings for Assets Still Held as of September 30, 2012
Assets:
Corporate obligations	$	1	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	9	$	-	$	10	$	-
State and municipal bonds		25		-		-		-		-		-		-		(2)		-		-		-		23		-
Residential mortgage-backed agency		4		-		-		(1)		-		-		-		-		-		-		(3)		-		-
Residential mortgage-backed non-agency		4		-		-		-		-		-		-		-		(1)		1		(1)		3		-
Commercial mortgage-backed		1		-		-		-		-		1		-		-		-		1		-		3		-
Collateralized debt obligations		4		-		-		-		-		-		-		-		-		1		(1)		4		-
Other asset-backed		5		-		-		-		-		2		-		-		-		4		-		11		-
Perpetual debt securities		2		-		-		-		-		-		-		-		-		-		-		2		-

Total assets	$	46	$	-	$	-	$	(1)	$	-	$	3	$	-	$	(2)	$	(1)	$	16	$	(5)	$	56	$	-

(1) -

Transferred in and out at the end of the period.

National Public Finance Guarantee Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 5: Fair Value of Financial Instruments (continued)

Transfers into and out of Level 3 were $29 million and $6 million, respectively, for the three months ended September 30, 2013. Transfers into and out of Level 2 were $6 million and $29 million, respectively, for the three months ended September 30, 2013. Transfers into Level 3 were principally related to RMBS agency, CDOs and other ABS securities where inputs, which are significant to their valuation, became unobservable during the quarter. Transfers out of Level 3 were principally for RMBS agency, RMBS non-agency, CDOs and other ABS securities where inputs, which are significant to their valuation, became observable during the quarter. These inputs included spreads, prepayment speeds, default speeds, default severities, yield curves observable at commonly quoted intervals, and market corroborated inputs.

Transfers into and out of Level 3 were $16 million and $5 million, respectively, for the three months ended September 30, 2012. Transfers into and out of Level 2 were $5 million and $16 million, respectively, for the three months ended September 30, 2012. Transfers into Level 3 were principally related to corporate obligations and other asset backed securities where inputs, which are significant to their valuation, became unobservable during the quarter. Transfers out of Level 3 were principally for RMBS agency securities where inputs, which are significant to their valuation, became observable during the year. These inputs include spreads, prepayment speeds, default speeds, default severities, yield curves observable at commonly quoted intervals, and market corroborated inputs.

There were no transfers into or out of Level 1 during the three months ended September 30, 2013 and 2012. All fair value hierarchy designations are made at the end of each accounting period.

There were no changes and no balances in Level 3 liabilities measured at fair value on a recurring basis for the three months ended September 30, 2013 and 2012.

The following tables present information about changes in Level 3 assets (including short-term investments) measured at fair value on a recurring basis for the nine months ended September 30, 2013 and 2012.

Changes in Level 3 Assets Measured at Fair Value on a Recurring Basis for the Nine Months Ended September 30, 2013


In millions	Balance, Beginning of Period		Realized Gains / (Losses)		Unrealized Gains / (Losses) Included in Earnings		Unrealized Gains / (Losses) Included in OCI		Foreign Exchange Recognized in OCI or Earnings		Purchases		Issuances		Settlements		Sales		Transfers into Level 3⁽¹⁾		Transfers out of Level 3⁽¹⁾		Ending Balance		Change in Unrealized Gains (Losses) for the Period Included in Earnings for Assets Still Held as of September 30, 2013
Assets:
State and municipal bonds	$	33	$	2	$	-	$	(1)	$	-	$	-	$	-	$	(4)	$	(13)	$	-	$	-	$	17	$	-
Corporate obligations		1		-		-		-		-		-		-		(1)		-		1		-		1		-
Residential mortgage-backed agency		-		-		-		-		-		-		-		-		-		20		(3)		17		-
Residential mortgage-backed non-agency		1		-		-		-		-		-		-		-		-		-		(1)		-		-
Commercial mortgage-backed		1		-		-		-		-		-		-		-		-		3		(1)		3		-
Collateralized debt obligations		6		-		-		-		-		-		-		(3)		-		17		(7)		13		-
Other asset-backed		4		-		-		-		-		1		-		(4)		-		11		(5)		7		-
Perpetual debt securities		2		-		-		-		-		-		-		-		-		-		(2)		-		-

Total assets	$	48	$	2	$	-	$	(1)	$	-	$	1	$	-	$	(12)	$	(13)	$	52	$	(19)	$	58	$	-

(1) -

Transferred in and out at the end of the period.

National Public Finance Guarantee Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 5: Fair Value of Financial Instruments (continued)

Changes in Level 3 Assets Measured at Fair Value on a Recurring Basis for the Nine Months Ended September 30, 2012


In millions	Balance, Beginning of Period		Realized Gains / (Losses)		Unrealized Gains / (Losses) Included in Earnings		Unrealized Gains / (Losses) Included in OCI		Foreign Exchange Recognized in OCI or Earnings		Purchases		Issuances		Settlements		Sales		Transfers into Level 3⁽¹⁾		Transfers out of Level 3⁽¹⁾		Ending Balance		Change in Unrealized Gains (Losses) for the Period Included in Earnings for Assets Still Held as of September 30, 2012
Assets:
Corporate obligations	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	10	$	-	$	10	$	-
State and municipal bonds		28		-		-		-		-		-		-		(5)		-		-		-		23		-
Residential mortgage-backed agency		-		-		-		(1)		-		-		-		-		-		4		(3)		-		-
Residential mortgage-backed non-agency		5		-		-		-		-		-		-		-		(2)		1		(1)		3		-
Commercial mortgage-backed		2		-		-		-		-		1		-		-		-		1		(1)		3		-
Collateralized debt obligations		5		-		-		-		-		-		-		-		(2)		3		(2)		4		-
Other asset-backed		8		-		-		-		-		4		-		-		-		5		(6)		11		-
Perpetual debt securities		1		-		-		1		-		-		-		-		-		2		(2)		2		-

Total assets	$	49	$	-	$	-	$	-	$	-	$	5	$	-	$	(5)	$	(4)	$	26	$	(15)	$	56	$	-

(1) -

Transferred in and out at the end of the period.

Transfers into and out of Level 3 were $52 million and $19 million, respectively, for the nine months ended September 30, 2013. Transfers into and out of Level 2 were $19 million and $52 million, respectively, for the nine months ended September 30, 2013. Transfers into Level 3 were principally for RMBS agency, CDOs and other ABS securities where inputs, which are significant to their valuation, became unobservable during the period. Transfers out of Level 3 were principally for CDOs, other ABS and RMBS agency securities, where inputs, which are significant to their valuation, became observable during the period. These inputs included spreads, prepayment speeds, default speeds, default severities, yield curves observable at commonly quoted intervals, and market corroborated inputs.

Transfers into and out of Level 3 were $26 million and $15 million, respectively, for the nine months ended September 30, 2012. Transfers into and out of Level 2 were $15 million and $26 million, respectively, for the nine months ended September 30, 2012. Transfers into Level 3 were principally for corporate obligations, other asset-backed securities, RMBS agency securities, CDOs and perpetual debt securities where inputs, which are significant to their valuation, became unobservable during the period. Transfers out of Level 3 were principally for other ABS, RMBS agency securities, CDOs and perpetual debt securities where inputs, which are significant to their valuation, became observable during the period. These inputs included spreads, prepayment speeds, default speeds, default severities, yield curves observable at commonly quoted intervals, and market corroborated inputs.

There were no transfers into or out of Level 1 during the nine months ended September 30, 2013 and 2012. All fair value hierarchy designations are made at the end of each accounting period.

There were no changes and no balances in Level 3 liabilities measured at fair value on a recurring basis for the nine months ended September 30, 2013 and 2012.

National Public Finance Guarantee Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 6: Investments

National’s AFS investments include debt and equity securities. Other invested assets designated as AFS are primarily comprised of money market funds.

The following tables present the amortized cost, fair value and corresponding gross unrealized gains and losses for AFS investments in National’s investment portfolios as of September 30, 2013 and December 31, 2012:


	September 30, 2013
In millions	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Fixed-maturity investments:
U.S. Treasury and government agency	$	295	$	1	$	(7)	$	289
State and municipal bonds		1,345		15		(47)		1,313
Foreign governments		18		-		-		18
Corporate obligations		1,337		9		(21)		1,325
Mortgage-backed securities:
Residential mortgage-backed agency		899		10		(18)		891
Residential mortgage-backed non-agency		13		2		-		15
Commercial mortgage-backed		19		1		(1)		19
Asset-backed securities:
Collateralized debt obligations		16		-		-		16
Other asset-backed		66		1		-		67

Total fixed-maturity investments		4,008		39		(94)		3,953
Money market securities		594		-		-		594
Perpetual debt securities		6		-		-		6

Total AFS investments	$	4,608	$	39	$	(94)	$	4,553


	December 31, 2012
In millions	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Fixed-maturity investments:
U.S. Treasury and government agency	$	318	$	1	$	(1)	$	318
State and municipal bonds		1,142		74		(1)		1,215
Foreign governments		1		-		-		1
Corporate obligations		471		11		(2)		480
Mortgage-backed securities:
Residential mortgage-backed agency		888		17		-		905
Residential mortgage-backed non-agency		13		2		-		15
Commercial mortgage-backed		14		1		-		15
Asset-backed securities:
Collateralized debt obligations		13		-		-		13
Other asset-backed		55		2		-		57

Total fixed-maturity investments		2,915		108		(4)		3,019
Money market securities		85		-		-		85
Perpetual debt securities		7		-		-		7

Total AFS investments	$	3,007	$	108	$	(4)	$	3,111

National Public Finance Guarantee Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 6: Investments (continued)

The following table presents the distribution by contractual maturity of AFS fixed-maturity securities at amortized cost and fair value as of September 30, 2013. Contractual maturity may differ from expected maturity as borrowers may have the right to call or prepay obligations.


In millions	Amortized Cost		Fair Value
Due in one year or less	$	372	$	373
Due after one year through five years		584		582
Due after five years through ten years		735		716
Due after ten years		1,304		1,274
Mortgage-backed and asset-backed		1,013		1,008

Total fixed-maturity investments	$	4,008	$	3,953

Deposited Securities

The fair value of securities on deposit with various regulatory authorities was $6 million as of September 30, 2013 and December 31, 2012. These deposits are required to comply with state insurance laws.

Impaired Investments

The following tables present the gross unrealized losses related to AFS investments as of September 30, 2013 and December 31, 2012:


	September 30, 2013
	Less than 12 Months				12 Months or Longer				Total
In millions	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Fixed-maturity investments:
U.S. Treasury and government agency	$	191	$	(7)	$	2	$	-	$	193	$	(7)
State and municipal bonds		668		(46)		36		(1)		704		(47)
Foreign governments		8		-		-		-		8		-
Corporate obligations		582		(21)		-		-		582		(21)
Mortgage-backed securities:
Residential mortgage-backed agency		526		(18)		1		-		527		(18)
Residential mortgage-backed non-agency		3		-		-		-		3		-
Commercial mortgage-backed		8		(1)		1		-		9		(1)
Asset-backed securities:
Collateralized debt obligations		4		-		-		-		4		-
Other asset-backed		19		-		-		-		19		-

Total fixed-maturity investments		2,009		(93)		40		(1)		2,049		(94)
Perpetual debt securities		2		-		-		-		2		-

Total	$	2,011	$	(93)	$	40	$	(1)	$	2,051	$	(94)

National Public Finance Guarantee Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 6: Investments (continued)


	December 31, 2012
	Less than 12 Months				12 Months or Longer				Total
In millions	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Fixed-maturity investments:
U.S. Treasury and government agency	$	68	$	(1)	$	-	$	-	$	68	$	(1)
State and municipal bonds		63		-		41		(1)		104		(1)
Corporate obligations		189		(2)		3		-		192		(2)
Mortgage-backed securities:
Residential mortgage-backed agency		172		-		-		-		172		-
Residential mortgage-backed non-agency		-		-		2		-		2		-
Commercial mortgage-backed		3		-		-		-		3		-
Asset-backed securities:
Collateralized debt obligations		1		-		4		-		5		-
Other asset-backed		4		-		-		-		4		-

Total fixed-maturity investments		500		(3)		50		(1)		550		(4)
Perpetual debt securities		1		-		1		-		2		-

Total	$	501	$	(3)	$	51	$	(1)	$	552	$	(4)

With the weighting applied on the fair value of each security relative to the total fair value, the weighted average contractual maturity of securities in an unrealized loss position as of September 30, 2013 and December 31, 2012 was 15 and 16 years, respectively. As of September 30, 2013 and December 31, 2012, there were 14 and 27 securities, respectively, that were in an unrealized loss position for a continuous twelve month period or longer, of which the fair values of 5 and 7 securities, respectively, were below book value by more than 5%.

National has evaluated on a security-by-security basis whether the unrealized losses in its investment portfolios were other-than-temporary considering the duration and severity of unrealized losses, the circumstances that gave rise to the unrealized losses, and whether National has the intent to sell the securities or more likely than not will be required to sell the securities before their anticipated recoveries. Based on its evaluation, National determined that the unrealized losses on these securities were temporary in nature because its impairment analysis, including projected discounted future cash flows, indicated that National would be able to recover the amortized cost of impaired assets. National also concluded that it does not have the intent to sell securities in an unrealized loss position and it is more likely than not that it would not have to sell these securities before recovery of their cost basis. In making this conclusion, National examined the cash flow projections for its investment portfolios, the potential sources and uses of cash in its business, and the cash resources available to its business other than sales of securities. It also considered the existence of any risk management or other plans as of September 30, 2013 that would require the sale of impaired securities. On a quarterly basis, National re-evaluates the unrealized losses in its investment portfolios to determine whether an impairment loss should be realized in current earnings based on adverse changes in its expectation of cash flows and changes in its intent to sell securities.

Sales of Available-For-Sale Investments

Gross realized gains and losses are recorded in “Net gains (losses) on financial instruments at fair value and foreign exchange” on National’s consolidated statements of operations. The proceeds and gross realized gains and losses from sales of AFS investments for the three and nine months ended September 30, 2013 and 2012 were as follows:


	Three Months Ended September 30,				Nine Months Ended September 30,
In millions	2013		2012		2013		2012
Proceeds from sales	$	274	$	309	$	816	$	1,622
Gross realized gains	$	-	$	18	$	35	$	32
Gross realized losses	$	(3)	$	-	$	(5)	$	(1)

National Public Finance Guarantee Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 7: Income Taxes

National’s income taxes and the related effective tax rates for the three and nine months ended September 30, 2013 and 2012 are as follows:


	Three Months Ended September 30,						Nine Months Ended September 30,
In millions	2013			2012			2013			2012
Income (loss) before income taxes	$	5		$	160		$	159		$	352
Provision (benefit) for income taxes	$	(1)	(20.0)%	$	46	28.8%	$	51	32.1%	$	103	29.3%

For the nine months ended September 30, 2013 and 2012, National’s effective tax rate was lower than the U.S. statutory rate of 35% primarily due to tax exempt interest, net of proration.

Accounting for Uncertainty in Income Taxes

As of September 30, 2013 and 2012, National did not have any uncertain tax positions and corresponding interest and/or penalties related to income taxes. National is a member of MBIA Inc.’s consolidated U.S. tax group and its only income tax jurisdiction is the U.S. National also files premium and franchise taxes in various states.

Tax Sharing Arrangement

National files its U.S. Corporation Income Tax Return as a member of MBIA Inc.’s consolidated group. National participates in a tax sharing agreement with MBIA Inc. under which it is allocated its share of consolidated tax liability or tax benefit, determined on a separate company basis. In the nine months ended September 30, 2013, National has, under the tax sharing agreement, made a tax payment to MBIA Inc. of $17 million which represented the initial payment of the additional tax liability for the tax year ended 2012. Further, National made additional tax payments to MBIA Inc. totaling $81 million which relate to the tax year ending 2013. National’s payments are being placed in escrow by MBIA Inc. and will remain in escrow until the expiration of a two-year carryback period which would allow National to carryback a separate company tax loss and recover all or a portion of the escrowed funds. After the two year period, the escrow, to the extent not recovered upon carrying back a loss, is released to MBIA Inc. During the first half of 2013, $115 million was released from escrow.

Note 8: Accumulated Other Comprehensive Income

The following table presents the changes in the components of AOCI for the nine months ended September 30, 2013:


In millions	Unrealized Gains (Losses) on AFS Securities, Net⁽¹⁾
Balance, January 1, 2013	$	68
Other comprehensive income before reclassifications		(83)
Amounts reclassified from AOCI		(20)

Net current period other comprehensive income		(103)

Balance, September 30, 2013	$	(35)

(1) -

All amounts are presented net of tax. Amounts in parentheses indicate debits.

The following table presents the details of the reclassifications from AOCI for the nine months ended September 30, 2013:


In millions	Amounts Reclassified from AOCI		Affected Line Item on the Consolidated Statements of Operations

Details about AOCI Components
Reclassification adjustments on sale of securities	$	30	Net gains (losses) on financial instruments at fair value and foreign exchange
		10	Provision (benefit) for income taxes

Total reclassifications for the period	$	20	Net income (loss)

National Public Finance Guarantee Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 9: Commitments and Contingencies

The following commitments and contingencies provide an update of those discussed in “Note 14: Commitments and Contingencies” in the Notes to Consolidated Financial Statements included in Exhibit 99.1 of MBIA Inc.’s Annual Report on Form 10-K for the year ended December 31, 2012 and should be read in conjunction with the complete descriptions provided in the aforementioned note included in Exhibit 99.1 of Form 10-K. In the normal course of operating its business, National may be involved in various legal proceedings. Additionally, MBIA Inc. together with its subsidiaries (“MBIA”) may be involved in various legal proceedings that directly or indirectly impact National.

Transformation Litigation

ABN AMRO Bank N.V. et al. v. Eric Dinallo et al.; Index no. 601846/09 (N.Y. Sup. Ct., N.Y. County)

On March 4, 2013, the court issued a decision dismissing the Article 78 proceeding. On April 2, 2013, the remaining plaintiffs filed a Notice of Appeal to the Appellate Division, First Department. In May of 2013, following the Bank of America and Societe Generale settlements, all plaintiffs in this matter dismissed their claims.

ABN AMRO Bank N.V. et al. v. MBIA Inc. et al.; Index No. 601475/2009 (N.Y. Sup. Ct., N.Y. County)

In May of 2013, following the Bank of America and Societe Generale settlements, all plaintiffs in this matter dismissed their claims.

Barclays Bank PLC., et al. v. Wrynn et al.; Index No. 651811/2010 (N.Y. Sup. Ct., N.Y. County)

In May of 2013, following the Bank of America and Societe Generale settlements, all plaintiffs in this matter dismissed their claims.

CQS ABS Master Fund Ltd., CQS Select ABS Master Fund Ltd., and CQS ABS Alpha Master Fund Ltd. v. MBIA Inc. et al.; Civil Action No. 12-cv-6840 (R.S.) (S.D.N.Y.)

On October 23, 2013, the plaintiffs filed a motion for a preliminary injunction seeking to prospectively enjoin National from issuing dividends during the pendency of the litigation. Although the motion referenced the dividend that National previously had disclosed it intended to pay in the fourth quarter of 2013, that dividend was paid prior to the filing of the motion and therefore is not subject to the relief requested by the motion. Refer to “Note 1: Business Developments and Risks and Uncertainties” for information regarding this dividend. National filed its reply to the motion on November 1, 2013, and believes it is not meritorious and should be denied. The court has adjourned oral argument on the motion to November 14, 2013. The court entered a revised Management Plan and Scheduling Order setting a fact discovery deadline of April 4, 2014.

Broadbill Partners LP, et al. v. MBIA Inc., et al.; Index No. 653865/2012 (N.Y. Sup. Ct., N.Y. County)

On June 6, 2013, the plaintiffs voluntarily dismissed the litigation without prejudice. A Stipulation of Discontinuance was filed on June 7, 2013.

Corporate Litigation

Bank of America v. MBIA Inc. and The Bank of New York Mellon, as Indenture Trustee; Index No. 70444/2012 (N.Y. Sup. Ct., Westchester County)

In May of 2013, the parties reached an agreement to resolve their respective claims in this action.

MBIA Inc. v. Bank of America Corp. and Blue Ridge Investments, L.L.C.; Index No. 51664/2013 (N.Y. Sup. Ct., Westchester County)

In May of 2013, the parties reached an agreement to resolve their respective claims in this action.

Mary Crescente v. Joseph Brown, et al.; Index No. 17595/2008 (N.Y. Sup. Ct., Westchester County)

On March 25, 2013, a Stipulation of Discontinuance was filed with the court resolving the litigation.

Ambac Bond Insurance Coverage Cases, Coordinated Proceeding Case No. JCCP 4555 (Super. Ct. of Cal., County of San Francisco)

The plaintiffs have filed a notice of appeal of the March 22, 2013 decision that granted the Bond Insurer defendants’ motion to strike pursuant to California’s Anti-SLAPP statute dismissing the plaintiffs’ claims under California’s Cartwright Act. On October 1, 2013, the Bond Insurer defendants’ filed a notice of cross-appeal.

National Public Finance Guarantee Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 9: Commitments and Contingencies (continued)

Tri-City Healthcare District v. Citibank. et al.; Case No. 30-2010-00359692 (Super. Ct. of Cal., County of Orange)

The parties reached an agreement to resolve Tri-City Healthcare District’s claims in this matter.

City of Phoenix v. AMBAC et al., Case No. 2:10-cv-00555-TMB (D. Ariz.)

On June 4, 2013, the parties reached an agreement to resolve the City of Phoenix’s claims in this matter.

National Public Finance Guarantee Corp. et al. v City of Detroit, Michigan et al.; Adv. Pro. No 13-05309-swr (Bkcy. E.D. MI)

On November 8, 2013, National (together with Assured Guaranty Municipal Corp.) commenced an adversary proceeding against the City of Detroit and certain individuals employees/managers in the Chapter 9 bankruptcy case titled In re: City of Detroit, Michigan; Case No. 13-53846, pending in the United States Bankruptcy Court for the Eastern District of Michigan. The complaint seeks, among other things, a declaration that the City of Detroit and its employees/managers must comply with Michigan state law in the collection, segregation and use of restricted ad valorem tax proceeds levied and pledged to repay the principal and interest on several series of Detroit’s unlimited tax general obligation bonds.

MBIA and National are defending against the aforementioned actions in which they are defendants and expect ultimately to prevail on the merits. There is no assurance, however, that they will prevail in these actions. Adverse rulings in these actions could have a material adverse effect on National’s ability to implement its strategy and on its business, results of operations, cash flows and financial condition. At this stage of the various litigations, there has not been a determination as to the amount, if any, of damages. Accordingly, National is not able to estimate any amount of loss or range of loss.

There are no other material lawsuits pending or, to the knowledge of National, threatened, to which National is a party.

Note 10: Subsequent Events

Subsequent to September 30, 2013, National declared and paid a dividend of $214 million to its ultimate parent, MBIA Inc.

Refer to “Note 9: Commitments and Contingencies” for information about legal proceedings that occurred after September 30, 2013.