Does It Seem Strange To Anyone Else That CNBC Is MF Global's Seventh Largest Creditor?

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If as a generally informed person who had not yet seen MF Global's bankruptcy petition, you were to guess who's going to be knocking on MF's door most forcefully, you might come up with a list something like this:

1. The banks that were repo'ing its $6.3 billion in Eurozone exposure
2. The lenders on its $1.3 billion in credit facilities that it drew last week (oops!)
3. Bondholders on its four series of public debt totaling ~$1bn
4-99. Other repo, derivatives, securities lending, etc. etc. counterparties and clearinghouses, including maybe the Fed
.
.
.
100. John Corzine, for his $12mm severance
101. CNBC, for advertising and/or Dick Bové's strategic advice
102-.... Law firms, accountants, PR firms, Bloomberg, and other trade creditors.

If you then went and checked your work against the actual petition, you might be a bit surprised. At the top of the list are JPMorgan as admin agent for the credit facility (misleadingly listed as trustee for public bonds) and the indenture trustees for the bonds. Those top five total about $2.2 billion. The rest is trade creditors, maybe $10mm or so. CNBC is there, as are Bloomberg and a bevy of law firms and consultants. (Not nearly as many as there will be!)

But there's not a repo counterparty in sight, and the total of about $2.3 billion in listed claims seems pretty light compared to the total liabilities of $39.7 billion. (Corzine's not there either, though to be fair that severance is not crystallized quite yet.) If all you had was this petition, you might think that MF Global was in the business of raising money just to buy exposure on CNBC.

So where'd the other $37 billion or so go? Well, it's reasonably clear that it lives in MF Global's subsidiaries*, specifically its regulated broker-dealer entities that did not file for bankruptcy and are carrying on business as usual except for the minor setback of not being allowed into their place of business. You'd know this, sort of, if you'd bought the bonds that MF Global issued in August and read the prospectus:

In the event of a bankruptcy, liquidation or dissolution of any of our subsidiaries, the creditors of such subsidiary will be paid first, after which the subsidiary may not have sufficient assets remaining to make any payments to us as a shareholder or otherwise so that we can meet our obligations under the notes. As of June 30, 2011, our subsidiaries had outstanding indebtedness to third parties of $24.1 million, excluding trade payables of our subsidiaries, which include, for example, securities sold under repurchase agreements, securities sold, not yet purchased, obligations to return securities borrowed and securities loaned (collectively referred to herein as “trade payables”) and excluding the guarantees of our subsidiaries under the liquidity facility and the secured credit facility.

Well that takes care of ... $24 million. The other $37 billion is in that "excluding trade payables of our subsidiaries" bit. Here's the last balance sheet, showing $17bn+ of repo liabilities and $15bn+ of customer, broker, and clearinghouse payables:

The lesson is that, if you bought those bonds in more innocent times, three months ago, you were presumably so seduced by the extra 100bps that you didn't care that there was up to $37 billion in structurally senior (and mostly secured) debt in front of you. Or that the document turned "$37 billion" into "$24.1 million, excluding a few little items ..."

Now, in less innocent times, those bondholders are listed as creditors in the filing - while that $37 billion remains nowhere to be seen. And Jefferies, of all people, has felt compelled to announce that they own $9mm of those bonds, as a market maker, but that everything will be okay.

Nine million dollars is not very much money in a $40 billion bankruptcy. You'll notice that the banks and customers with $37 billion of trade and repo obligations from MF have mostly not chimed in to discuss how okay they'll be. Of course many of them are probably secured, but the fact that MF filed makes it pretty clear that at least some of them were feeling a little less secured than they wanted to be. One suspects that the banks repo'ing the $6.3 billion European portfolio are not getting 100 cents on the dollar from their collateral.

This is nothing new or scandalous, or specific to MF Global. Lehman's filing looked similar; their last balance sheet reflected $613bn in liabilities but the petition listed well under $200bn in bank debt and bonds, though Lehman at least had the class/scale to leave out its unpaid Bloomberg bills.

But as the world gets more and more excited about too-big-to-fail and the Volcker Rule, and about increasing the transparency and reducing the systemic risks of banks, quasi-banks and shadow banks, it's worth laying this out to encourage a bit of epistemic humility about the interconnections of MF Global. Everything in its bankruptcy petition, and most of what's in its SEC filings, is irrelevant to MF Global's situation.

Any public discussion of the losers from MF's meltdown is necessarily incomplete and focused on the relatively trivial (shareholders, preferred stock, Jefferies, media companies). The people facing $37 billion of uncertainly collateralized exposure are still mostly opaque.

There are excellent corporate finance reasons for MF's structure: if they could issue unsecured debt at a lightly regulated (but investment grade) public parent, while keeping their trading liabilities in regulated and private subs, they should - and did. (So does everyone else in the industry.) But the result is not only a more efficient capital structure; it's also much greater privacy. Which is nice for MF in good times, and is nice for its counterparties now: no one has a definitive list of whose money is tied up in MF's filing, so there's not likely to be a near-term run on them.

But if you like transparency in your capital markets, it's less encouraging. And while MF's demise is unlikely to do much harm to the broader markets, the disclosure of the next Lehman is going to look much the same.

* There may be some parent company secured debt, too. The petition omits secured debt "unless the value of the collateral is such that the unsecured deficiency places the creditor among the holders of the 50 largest unsecured claims." Given what markets have done to MF's positions, it would be surprising if there are no secured creditors with more than a $10k deficiency.

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