Description

I believe MBIA's Global Funding Unsecured Notes represent a "heads I win, tails I don't lose" investment.  In this case, I believe it is a "heads I win big, tails I still do quite well" situation, and for this reason have made this the largest investment in our portfolio.

To save many the time, I believe there are strong structural reasons for why this opportunity is unknown to the market.  All of the MBIA Global Funding notes ("GFL notes") are unregistered and thus require the investor to be a QIB ("Qualified Institutional Buyer") to buy them which means you must be an investment entity with more than $100 million in assets.  So if you not a QIB, you can stop reading now.  Further, there are $845 million face of GFL notes, but they are across 14 issues, all of which are small and generally very low or 0 coupon, so the market value of the entire stack is roughly half this amount.  All of the issues are small and thus reasonably illiquid so it is an odd situation where the market only allows "large" investors to participate but the market value of bonds to buy is quite small so it is generally not worth the time for a QIB to even take the effort to understand the situation.  It is for this reason that we believe current GFL noteholders (generally legacy holders from the issuance in the 2000s) or prospective buyers are unaware of the impending catalyst causing a significant re-rating of the notes.

Company Description and History

MBIA Inc. (NYSE: MBI) is a publicly traded holding company of two financial guarantee insurance subsidiaries: National Public Finance Guarantee Corp. ("National") and MBIA Insurance Corp. ("Corp.").  Financial guarantee insurance is exactly as the name suggests - these companies provide a guarantee (a "wrapper") for specific cusips of other debt issuers.  The debt issuer is obligated to make the interest and principal payments on the debt, but should the issuer fail to make these payments, the financial guarantee provider then becomes obligated to make the payments on the stated terms of the debt.  Traditionally, these policies were for municipal and other public finance entities (the name "MBIA" was originally an acronym for Municipal Bond Insurance Association) which was historically a strong business.  Like all forms of insurance, the bond insurers could diversify risk for all of their wrapped issuers which would allow lower cost of financing even after the cost for the insurance (MBIA Corp. insurance had a AAA credit rating prior to the GFC).  

In the lead up to the GFC, MBIA and other bond insurers began expanding their policies beyond public finance and started wrapping structured credits (CDOs, CLOs, and MBSs).  We all know how that worked out which effectively blew up all of the pure play financial guarantee insurers.  Prior to the GFC, MBI was just a holding company for MBIA Insurance Corp.  In early 2009, MBI separated all its public finance policies and moved them to a newly formed insurance company called National Public Finance Guarantee Corp., leaving behind its structured credit and non-U.S. policies with Corp.  The only reason Corp. is not in rehabilitation today is due to lawsuits against the banks that underwrote the structured credit transactions (notably, Corp. received $1.6 billion from Bank of America from a settlement in 2013).

Unfortunately, the National credits weren't quite as strong as they thought (really just due to the large exposures to Puerto Rico) and both companies are currently in wind-down.  Corp. has not written a third party new policy since 2007 and National had a small window where its surplus was large enough to write new policies from 2014-2016 but they were not material.  The MBIA complex today exists solely to manage its assets and liabilities until all policies have been paid or expire (some policies extend beyond 2040).

The Opportunity

The trade I am recommending is to buy the long dated GFL notes.  The cusip referenced at the top is the largest issue and I think the best risk/reward but the trade is the same for all of the issues (I'm recommending long duration notes because the trade is for massive yield compression so the greatest upside comes from the longest duration notes).  MBIA Global Funding LLC is a shell financing entity for MBIA Inc. (the parent holding company).  It is a direct credit of MBIA Inc. but the kicker is that all of the GFL notes also benefit from an MBIA Corp. wrapper.  The market has completely ignored the Corp. wrapper as the GFL notes trade in line with the MBIA Inc. notes (without the wrapper).

Why has the market ignored the MBIA Corp. wrapper?  Corp. is a nuisance entity with respect to MBIA Inc.  Corp. has $953 million face of Surplus Notes and has not paid a coupon since 2012 so the claim has accrued to $1.9 billion.  There is no shot of Corp being worth more than the accrued claim so all of the value to MBIA Inc is from assets at the holding company and its equity value in National.  Aside from anyone interested in the GFL notes or the Corp. surplus notes, there is no reason for anyone analyzing MBIA to spend any time on Corp. as it will have no impact to the parent.

The Corp. Surplus Notes, however, are the critical piece to causing a re-rating of the GFL notes (or any other notes with a Corp. wrapper).  The surplus notes currently trade around 42, or a $400 million market value.  These notes trade at this value because Corp. has two major assets which have not converted to cash yet.  The first is a mortgage putback lawsuit against Credit Suisse from 2008 (similar to their case against BofA and the 8-10 other bond insurance lawsuits against the other banks, all of which have either resulted in a win for the insurer or a settlement).  The damages claim has now accrued to ~$750 million.  The other source of value is from ~$1.0 billion of payments made on two defaulted CLOs, Zohar 1 and 2.  Corp. has made this payment to the wrapped Zohar noteholders and is now entitled to the recovery value on those insured notes.  Covid has materially negatively impacted the recovery value for these notes (the CLOs consists of loans and equity ownership in ~50 private companies, mostly in industrial industries).  

I will not go into detail on the value (and thus recovery to the Surplus noteholders), because the precise value is not relevant to owning the GFL notes.  The only aspect relative to the GFL notes is that there is ANY recovery.  I have done a lot of work on these two sources of value so am happy to discuss if there any questions in the comments.

With that background, now to the opportunity.  Generally speaking, what has been described above is known to anyone looking at MBIA.  What the GFL noteholders are not appreciating is what happens to MBIA Corp. after they receive their CS litigation proceeds and after the Zohar funds collateral is sold and the funds are distributed to MBIA Corp. (both of which I expect in the next 6-18 months).  Rather than sitting on $1.1 billion of salvage assets (listed claims paying resources for Corp. as of 3/31/20), it will be sitting on $1.1 billion of cash.  At that point, the Surplus noteholders can either sit and wait 20+ years for $9.1 billion of insured par value to roll off, or they can cause MBIA Corp. to re-insure these liabilities and distribute the excess cash to themselves (the insurance regulator will not allow a distribution to the surplus noteholders, junior in priority to the policyholders, without adequate assurance that the policyholders are at zero risk of impairment).  I'm confident the surplus noteholders will not wait all of this time with severe restrictions on how the cash can be invested but will rather opt for the re-insurance route.  Once Corp. reinsures all of its policies (including the GFL notes), anything wrapped by Corp. will be re-rated to the credit quality of the re-insurer.  Using the referenced cusip of the 0 coupon notes due 2033 currently trading at 28, I think the notes will conservatively re-rate to T+150, which would cause price appreciation to 77.5, or a 177% increase in price.

There is precedent for this transaction.  Syncora was in exactly the same position in 2018 and paid Assured Guaranty $360 million to insure $13 billion in par amount of policies which allowed for a $400 million distribution to the surplus noteholders (eventually getting paid in full).

Upside/Downside

Even more exciting about this trade is that I think the GFL notes are cheap without the Corp. wrapper.  So even if the transaction described above doesn't occur, I think the GFL notes are an attractive investment.  At 28 on the referenced GFL notes, the bonds yield 10% to maturity.  This is an attractive return for what I believe is low risk paper.  Using just current market values (rather than going into detail on the value of MBIA Inc./National) demonstrates that the GFL notes are mispriced. MBIA Inc. has an adj book value of $2.17 billion, a market cap of $527 million, 5yr CDS trading at 550 basis points, and the surplus notes (which can only be paid once the Corp. policies are satisfied) market value of $400 million.  All of these securities within the MBIA complex demonstrate that the credit risk of the GFLs should be lower than 10%.  Lastly, the extremely low dollar price of the notes (due to the low coupons) provide further downside protection as there are no senior liabilties so recovery for the unsecured credit should be decent if it cannot be paid in full (which the other referenced market values indicate is low likelihood).

In summary, I think these are low risk notes with a highly likely near-term catalyst to earn nearly 3x on your invested capital.

Catalyst

MBIA Corp. re-insurance transaction