Borrowin' Themselves Rich at MBIA

As a former shareholder of MBIA, I remain interested in the company's progress - if that's what you call the price move from $67 per share in October to today's $13 per share. Today, MBIA announced that it would be raising $1 billion in new capital, cutting its annual dividend by about 62%, to 52 cents a share, and doing an insurance deal that will effectively free up additional money for the firm.

I assumed that the $1 billion would be equity capital, much like the recent one by Warburg Pincus and was curious to see the terms. A close friend of mine told me that the capital infusion would be debt. I told him that was impossible, as increased equity capital was needed to maintain MBIA's AAA rating.

Then I read this in the WSJ: "The $1 billion in new capital will be raised by issuing a kind of debt known as surplus notes." I had never heard of surplus notes. Having been trained by my children, I turned to Wikipedia. It defined surplus notes as "a bond issued by an insurance company."

"These securities are subordinated obligations, and fall at the very bottom of the operating insurance company's capital structure. Surplus notes are debt-like in that they pay a coupon and have a finite maturity. However, in many cases, state insurance regulators have allowed insurance companies to classify the capital raised via surplus notes as “surplus” (which is the statutory equivalent of equity), because surplus note holders are last in line to make a claim on the company's assets in a default scenario, much like where equity holders reside in a public company. While surplus note holders have last claim on the assets of the operating insurance company, it is important to realize that this claim is at the operating company level, which is still ahead of holding company obligations."

Essentially, these surplus notes are equity capital with a coupon. However, unlike a preferred stock, the interest payment would be fully taxable to the purchaser as ordinary income and fully deductible to MBIA. The advantages here accrue to MBIA. So what kind of deal would incent an investor to purchase the surplus notes? I can only imagine an extraordinarily high interest rate accompanied by a conversion privilege.