The Bankwatch

Tracking the consumer evolution of financial services

MF Global had over 10 times capital in off balance sheet derivative and short selling contracts

There are more than a few nervous people on Wall St, Threadneedle St, La Défense, Ōtemachi, and all the other financial centres of the world held their breath Friday when MF Global, a Prime Broker in New York announced they were in trouble and selling their assets.  That fell through over the weekend, and today MF Global are bankrupt. 

This is a big deal and might be another Oliver Stone movie in the future when we look back. 

http://dealbook.nytimes.com/2011/10/31/mf-global-files-for-bankruptcy/?hp

http://www.ft.com/intl/cms/s/0/138241f6-03dd-11e1-98bc-00144feabdc0.html#axzz1cOQ3SoMc

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The bad part of this is how it could be allowed to happen.  MF were downgraded by the ratings agencies when, as reported in the NY Times:

The agencies said they were concerned that MF Global lacked a sufficient capital cushion if its $6.3 billion in European debt went bad.

Well, just is how much?  They are publicly traded so I looked up their balance sheet.  As usual it is horribly laid out, as is the case with all banks, and clearly designed to ensure basic items such as revenue, capital, liabilities and assets are as hard as possible to locate.

Anyhow, here is their fiscal year to Mar 2011 results:

Annual revenue:                                           $2.2 Bn

Gross revenue after transaction expenses   $1.0 Bn

Total Assets                                               $40.5 Bn

Equity                                                         $  1.4 Bn

So we can calculate Debt to Equity at 27.9:1 (39.1/ 1.4) so we are certainly in bank territory there.  To a traditional banker sense this company is unbankable.

Next and most important, being the thing that brought them to down, lets look at off-balance sheet items.  Again from their own financial statements here is their derivative position.  There are $1.1 Bn on the asset side, and $4.5Bn on the liability side or $3.4 Bn or two and a half times capital base.

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Then on page 104 there are $5.1 Bn in stocks with the ubiquitous title of “Total Securities sold, not yet purchased” – this is perfectly legal ”short selling”. 

The ratings agencies marked MF down when they discovered $6.4 Bn in Euro derivative exposure.  So it seems that since March the company has become even more extended.  But lets stick with the Financial Statements amount.  The derivative liability and the short selling amount to $9.6 Bn.  If there is a 10% movement, they lose $1 Bn, 25% 2.4 Bn etc.  This potential for loss must be co-related to the capital base of $1.4 Bn or even total revenue at $2.2 Bn.

Relevance to Bankwatch:

This is a classic example of why banks make regulators make governments nervous.  The entire financial system (banks & brokers) is based on a set of liabilities which no one member of the financial system can manage and pay for alone.  In normal business, if one person or business goes bankrupt there is some disruption, but the ripple effect is very limited, and generally life carries on. 

When a bank or broker goes under the impact is felt across the entire financial system.  The good news, is that this one was allowed to go bankrupt.  The more interesting news is yet to be heard.  Financial markets are renowned for their lemming type behavior.  If MF were caught offside with too much derivative exposure against the Euro, how many others are in the same or similar category.  Clearly the ratings agencies are watching this very closely and are not going to get caught out as they were 4 years ago.

Written by Colin Henderson

October 31, 2011 at 16:23

Posted in Uncategorized

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