MBIA Risk Plunges On CDS Commutation Speculation, And Is There More In Store

Tyler Durden's picture

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.

More from Debtwire:

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.

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Quinvarius's picture

Something tells me these losses, while real, will never see the light of day on a balance sheet.  Not even Nick Leeson could bring a bank down anymore.

homersimpson's picture

But for the right amount of cash he'll tell you how he did it..


The ol' chap is doing quite fine, I guess. $1.4 billion in losses seems like such a pittance nowadays. He probably would've been promoted nowadays..

For entertainment purposes, he should've posted a pic of his golddigging ex-wife..

disabledvet's picture

Fight the Fed at your peril.  Their job is to take care of "the correctly long Wall Street" and not the economy and not the short seller set.  Still is it perplexing the CB encourages deficit spending by governments State, Local and Federal to the point of what a reasonable observer might call a national catastrophe?  Only Wall Street could be so lucky.  And now "Enter the Sandman."  I think of it as setting the Quentin Tarantino classic "Finding Zoe" in Cairo and so far I haven't been "disappointed" in the sense that there's unique edginess to the edginess.

Yen Cross's picture

 Credit Default Swaps? Oh vultures do exist outside of rotting carcases in third world countries.

william the bastard's picture

The equity is only up a tad the last 2 days, 70 cents. At $12 it's still $3 under January's blowoff.


Threeggg's picture

Isnt this why the Deutsche Boerse AG and NYSE are merging, so they can take this derivative trading off-shore and not have to see the light of day. (I would say and not be scrutinized by the SEC) but that would be just silly --  right ?