MF Global claims, 90+ cents on the dollar?

As you are probably aware, MF Global filed for bankruptcy on Oct. 31, 2011 after sustaining substantial losses and using client money to pay for losses. In total, $1.6 billion dollars of client money was unaccounted for. Banks are now vying for these claims, with Barclays leading the charge.

What might be surprising at a cursory glance is the amount offered per dollar on these claims. Offers are as high as $0.9125 cents on the dollar for US Exchanges and $0.6625 for Foreign Exchanges. You might think that these banks are sure sticking their neck out to make a relatively small and uncertain return, but there's more than meets the eye.

http://www.reuters.com/article/2012/03/16/mfglobal-customerclaims-idUSL2E8EFBFO20120316

Roughly $3.9 billion dollars have been paid back to the US Exchange customers, equalling about $0.72 on the dollar of the claims. Furthermore, there's a plan for a distribution of $600 million in the next two months, another ~$.11 on the dollar.

Thus if you are offering $.90 on the dollar, you are really paying 18 cents (.90-.72) to receive 28 cents (1.00 - .72). Factor in a distribution of 0.11 cents on the dollar in the next two months, and with a couple assumptions the IRR looks pretty sweet. Even if you're not going to get 100 cents on the dollar, that is still a great return.

Another point that many people bring up is that if you're a big bank sitting on a pile of cash that was paid to you from MF Global, you:

1. Know where the missing money is
2. Will be forced to pay it back, so you might as well make some money in the process

After you buy up all the claims at $.72, take a look under your seat and find x millions of dollars from MF Global. You gladly return it knowing that it'll come right back to you.

I think it's a solid trade and the banks prove yet once again how clever they can be.

What Happened to TVIX?

This write-up is based on a Seeking Alpha article I read by Paulo Santos. He hit the nail right on the head with his analysis, and today’s 29% drop can be explained by his investment proposal.

First, we have to ask, what is TVIX?

TVIX is an Exchange-traded note (ETN), a debt security issued by an underwriting bank that tracks a particular benchmark/strategy. In this case, the bank is Credit Suisse and the benchmark is 2x the VIX. TVIX is meant to be a short term holding, as if you read the prospectus, you come across this statement:

“As explained in “Risk Factors” in this pricing supplement, because of the way in which the Closing Indicative Value of the ETNs and the underlying Indices are calculated, the amount payable at maturity or upon redemption or acceleration is likely to be less than the initial principal amount of the ETNs, and you are likely to lose part or all of your initial investment. In almost any potential scenario the Closing Indicative Value (as defined below) of your ETNs is likely to be close to zero after 20 years and we do not intend or expect any investor to hold the ETNs from inception to maturity.”

An ETN usually tracks closely to its Net Asset Value (NAV), the value of the underlying futures that the issuer holds (though the ETN doesn’t own it). The catalyst to the break in TVIX not tracking its NAV was Credit Suisse’s suspension of issuing new units of TVIX. This breaks the no-arbitrage rule, as the supply is gone. The usual supply is from the issuer (Credit Suisse), when it issues the shares at NAV and collects fees, Authorized Participants (AP’s) then make money by selling it at market prices when they’ve created it at NAV cost. They keep selling until the market price tracks closely to NAV again (re-establishing no-arbitrage).

However, when there are no shares to be sold, then the ETN trades like a closed-end fund. A closed-end fund usually trades at a huge premium to NAV due to the difficulty of finding shares to borrow. Paulo noticed/mentioned this when the premium was 18.3% greater than the underlying. Before it reverted back towards NAV levels today, the premium had gotten close to 80%.

The reversion could probably be due to people becoming aware of the mispricing, leaked information about new issuances, hedge funds wanting to take profits, etc. Lots of reasons on why it could revert, it was only a matter of time before it would.

In the future, when you are considering trading in ETFs/ETNs, be sure to read the prospectus and take a look at the underlying.

TVIX Prospectus:

http://velocityshares.com/pdf/VelocityShares.ETN.Final.Pricing.Supplement.VIXlong.pdf

Here's a nice picture mapping TVIX to it's intrinsic value (NAV):

Chartist Friend from Pittsburg's graphs

Thanks Jim Montier for this pic

Analysts expect profit margins to continue their incredible rise. Though on a P/E basis I agree that the market is not overvalued, this chart certainly grabs my attention.