MF Global Repo-to-Maturity trade dissected

This sort of thing happens too often. Would it perhaps be more accurate to say "chose not to" instead of "not being able to"?

 

3% adverse move on a 1 year maturity bond = $190 additional collateral
Does a 3% move sound about right or is it on the high side?

Big relative to their own August bond issue?

I would argue $6.3 bin is too much. Imagine we get 20%-50% haircuts in Italian/Portugese bonds further down the line. The real fun and games hasn't even begun yet.

MF Global could just be a taste of what is to come if the ECB cannot hold Italian bond yields down.

 

Sorry, I thought I'd attach an example to illustrate. That's the time series of the clean price of a 1y BTPS (I used 4.25% Oct12). As you can see, the implications of whole Eurozone crisis are that the bond price dropped from arnd 103 to 99.50, i.e arnd 3.5 points. On a €6bn notional position, if my calculations are correct, the market value/collateral impact of this price drop would have been €210mil. Are you telling me that MFG couldn't withstand a margin call of that magnitude?

 

They had little to no cash, and a subsequent junk rating cut off ability to garner new emergency credit lines. 50% of exposure was Italy I recall. 3% shift on the net exposure was ~200MM plus a ~$150MM prior quarter loss...then compare that to $1BB IB offer they were anxious to take for the lions share brokerage branch (albeit a firesale of sorts), these smaller figures start to make some sense. It was mix of a small poorly run business dying slow death and sudden collateral calls that a healthy firm of such size should normally have been able to survive.

We can all semantically slice it 10 different ways...reality is Corzine unilaterally put on a prop bet that netted out heavily directional in nature, was poorly protected, and highly over-levered. Weak company profile to buffer the stupidity, and met his maker.

 

I made my guestimate based on a 3% move before I saw your calculations so we are remarkably close with our numbers. (and I meant Euros not $s of course)

So whether it was ""all about bonds" or not all boils down to your question, "Are you telling me that MFG couldn't withstand a margin call of that magnitude?"

I think we are finally getting somewhere with this discussion..

 

Yes, but they had existing credit facilities that would have easily covered the margin calls on the outright bond positions. As I keep saying, that wasn't the crux of the problem and it's not what actually killed them (it might have, eventually). As far as I know, the repo book was smth like 5-6 times larger than the €6bn outright position. Inability to fund that beast is the killa, just like it was w/Bear.

 

This was my first thought as well, but when digging deeper, the health of MFG was so bleak that it was conceivable minor hits became deadly.

My conspiracy side wants to think the haircuts were not in-line with reality, malicious in-nature. Quite curious to find out who stood counter-party and who protected the cp from MFG's inability to carry out the repo-to-maturity. With the failure to segregate client funds, it opened up a box of all sorts of what-ifs.

 

Sure, but I, personally, am of the view that they would have been OK if all they had was the piddly €6bn worth of short-dated peripheral paper.

As to the haircuts, a counterparty normally cannot raise them on an existing term repo (although it does depend on the exact legal language, as there may be triggers). Whatever revisions are done apply to new trades. For EUR periphs, the floor is normally the LCH number, which, by way of an example, is <1% for both Italian and Spanish short-dated (shorter than 1y) paper. The cap is the ECB, which offers a more punitive rate, but the maximum haircut would have been arnd 2%. It is unlikely that MFG would have seen terms worse than 3% or 4% on their regular bilateral trades.

 

For a €30bn repo book a 1% rise in the funding cost is €300m annually, or €25m per month.

When MF Global issued their bonds in August the coupon was around 6% and the bond yield got to 18% last week.

A 12% rise in funding costs would then equal €300 million per month.

So if MF Global had to borrow €30bn each day to maintain their repo book, yes, these numbers (€300 million per month) dominate the €200BN estimated collateral increase.

Is this in essence what you are saying Martinghoul?

 

Which assets where in this repo book?