With one of Lynn Tilton's Zohar funds on the auction block, MBIA Insurance Corp. creditors struck a $363 million deal to help the insurance company absorb an expected default on another of her soured investment vehicles.

MIC, the structured-finance subsidiary of financial guarantor MBIA Inc., said Monday it had raised $325 million in rescue financing from a group of so-called surplus noteholders to cover a guaranteed claims payment on Zohar debt. The parent company will also kick in at least $38 million and up to $88 million under the proposed transaction toward the Zohar maturity, giving MIC a lifeline to avoid defaulting itself.

The insurer still needs to secure several regulatory approvals, including from the New York Department of Financial Services and the U.K.'s Financial Conduct Authority.

"The surplus noteholders likely think that MIC is worth more to keep it out of liquidation," said Chas Tyson, vice president at investment bank and broker-dealer Keefe, Bruyette & Woods. "My guess is they think there's some value there, and that value will only be realized if you extend the life of MIC."

If a monoline insurer fails to make policyholders whole, its regulator can restructure its debts via rehabilitation, a quasi-bankruptcy process that helped save Financial Guaranty Insurance Company, Ambac Assurance Corp. and MBIA from extinction after the financial crisis. Rehabilitations can bring years of delay and litigation. Surplus notes, which are treated as equity interests, are subordinated in such a restructuring.

But the surplus noteholders whoare extending new loans also received an MIC insurance wrap, moving their claims up in the repayment line, said Andrew Gadlin of broker-dealer Odeon Capital. The deal also provides them?as well as the parent company?with interest over the three-year life of the rescue loan.

"That's a lot of cash to pull out for the three-year fix," he said.

Soon after founding the investment Patriarch Partners in 2000, Ms. Tilton lined up investors for a new kind of collateralized loan obligation, packed with loans to distressed businesses rather than with credit-card debt or mortgages. She dubbed the funds, which were designed to funnel high-yield interest payments from her companies back to investors, Zohar I, II and III.

Zohar I defaulted last year, putting MBIA on the hook for $149 million to underlying noteholders. Ms. Tilton filed an involuntary bankruptcy to get more time to rehabilitate the companies that own the loans, but instead she had to resign from managing the Zohar funds, the last of which matures in 2019.

If Zohar II defaults in January, as expected, MBIA will be on the hook for another $770 million, according to a November analysis by financial adviser Houlihan Lokey that was entitled "Project Phantom" and disclosed publicly on Monday.

To secure the new debt, MIC gave its noteholders first dibs on its rights to the proceeds of collateral underlying the Zohar I and Zohar II funds.

The financing proposal comes amid an auction for the Zohar I collateral. MBIA can credit-bid, or forgive, the $149 million it is owed in exchange for the collateral up for auction, which was scheduled to wrap up its first round of bidding Tuesday night. The noteholders then had three days to weigh whether to submit a competing cash bid. On Tuesday, the Zohar bond trustee postponed the auction indefinitely, citing "newly received information" on the assets.

MBIA itself holds $385 million of the Zohar II notes. Investors holding the other half of the Zohar II maturity had bought credit default swaps on MBIA as a hedge against a potential default, according to people familiar with the matter. CDS sales rose after Chief Executive Jay Brown warned in a Nov. 9 earnings call that MBIA was preparing "contingency plans with respect to a potential rehabilitation proceeding" if it couldn't restructure the underlying Zohar II notes or find a liquidity source to pay them off. Now, the noteholders will be paid in full.

A spokesperson for Ms. Tilton's Patriarch Partners didn't respond to a request for comment.

MBIA entered rehabilitation in 2009 and emerged under a contentious arrangement that transferred $5 billion in MIC assets to prop up a separate subsidiary focused on insuring municipal bonds. It was designed to keep the parent and the municipal unit safe from MIC's structured-finance exposures.

Monday's deal benefits stockholders of the parent entity, which had suffered in the marketplace from MIC's troubles despite their supposed legal separation, Mr. Tyson said.

(END) Dow Jones Newswires

November 29, 2016 12:55 ET (17:55 GMT)

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