All those focusing on the politburo policy tool known as stocks have missed what is by far the biggest mover in corporate (distressed) land so far in 2011. MBIA, whose CDS had traded in 2010 at levels assuming virtually no recovery, have plunged from 55 points up front a fortnight ago to just 37 up today (a 4 pt tightening today alone), a pick up that could make many a distressed credit fund's (sorry Oaktree) quarter. And while the move has been stunning in its velocity, many have been left scratching their heads as to the reason why. Enter Protium: a Barclays 2009 spin off fund which according to the British bank's results posted yesterday, entered into a CDS commutation with an unnamed monoline effective January 2011. And since it was already known by the market that banks such as JPM and Barclays had dropped lawsuits against MBIA in 2010 in exchange for comparable CDS commutations, it was immediately assumed that the beneficiary of this generous 'Protean' gift is none other than MBIA. The net result? A boost to creditor recoveries, a surge in unsecured claim prices, and a near 20 point tightening in CDS.
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The deal - which resulted in a drop in the value of Protium's monoline-wrapped assets from $4.81BN to $225MM - would be a boon to MBIA. The firm had written down CDO recoveries, so any benefits from a drop in required reserves adds to the bottom line, the second CDS trader said.
MBIA completed other commutations similar to the Protium deal in 2010, when it settled $4.4 billion of notional, according to company filings. The company is expected to report details of more recently completed deals when it discusses Q4 earnings on 2 March, a company insider said.
Additionally, as Zero Hedge had reported, MBIA recently succeeded in making life for mortgage originators a living hell, after it successfully challenged, and was allowed to use statistical sampling in pursuing repurchase demands. While it is unclear how actively MBIA itself will pursue this strategy, which would be a viable way to pick up at least several additional points of recovery courtesy of fat-check settlements, the loophole has already opened the door for Allstate to sue both Bank of America and JP Morgan, confirming what everyone has known, namely that the two banks lied and misrepresented their products with impunity when offloading them to hapless investors.
So while those who had been selling MBIA protection into Barclays' results are drinking the bubbly tonight, there is one firm that is lamenting the move: none other than government darling Morgan Stanley.
According to a source, Morgan Stanley was short risk the monoline after it had obtained protection on a static pool of CMBS via an MBIA-related entity called LaCrosse Financial. And as LaCrosse wrote protection against the static pool that was non-transferrable by Morgan Stanley, the bank hedged its counterparty risk by purchasing protection on MBIA itself. So while CDS was blowing out, MS was profiting. Then over the past two weeks, the bank has seen hundreds of millions in paper P&L evaporate through the window. The only question is when will Morgan Stanley close its now underwater protection (which continues to bleed a substantial amount of theta), especially since the actual credit event may have just been pushed back indefinitely.
In other words, those who are short the MBIA CDS may wish to wait just a little longer, and see just what the breaking point on Morgan Stanley's collateral call is. Should the bank be forced to close its long CDS position at a moment's notice, we could very well see the mother of all squeezes, bringing the CDS well into running spread territory.