MF Bonds Dive as Broker Is Cut to Junk

By Matthew Leising and Zachary R. Mider - Oct 29, 2011 5:32 AM GMT+0700

Bonds of MF Global Holdings Ltd. (MF) declined to as low as 35 cents on the dollar after the futures broker run by Jon Corzine drew on its credit lines and Moody’s Investors Service and Fitch Ratings cut the firm’s ratings to junk.

The company’s $325 million of 6.25 percent bonds, issued at par in August, fell 11.9 cents to 50 cents on the dollar as of 5:17 p.m. in New York, for a yield of 25.2 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

MF Global has declined 67 percent this week and its bonds started trading at distressed levels as the firm seeks a buyer for its futures brokerage to raise capital. In its second downgrade this week of the firm, Moody’s said “weak core profitability” drove the broker to increase risk buying European sovereign debt.

“When things start to go bad it tends to spiral down fairly quickly,” said Craig Pirrong, a finance professor at the University of Houston. Drawing on the credit lines “is another indication of the financial stress they’re undergoing.”

MF Global is in discussions with five potential buyers for all or parts of the company, according to a person with knowledge of the matter. Banks, private-equity firms and brokers are examining the firm’s books, said the person, who asked not to be identified because the talks are private.

Credit Lines Tapped

The company tapped the entirety of two bank lines, said three people with knowledge of the matter, speaking on condition of anonymity because the move wasn’t disclosed. New York-based MF Global said in an Oct. 25 investor presentation that it had $1.3 billion in unused credit facilities, without giving a date for the tally.

The company fell 16 percent, to $1.20 as of 4:15 p.m. in New York after declining as much as 31 percent.

MF Global’s lenders include Citigroup Inc., Bank of America Corp., and JPMorgan Chase & Co., according to data compiled by Bloomberg. Spokesmen for the banks and MF Global’s Jeremy Skule, declined to comment.

The firm is getting advice from Evercore Partners Inc. as it seeks buyers.

‘Broker Positions’

“We believe MF could generate proceeds from sale of its customer asset portfolio or FCM which frees up capital,” Niamh Alexander, an analyst at KBW Inc. in New York, wrote in a note to clients today, referring to a so-called futures commission merchant, or futures brokerage. “However, we cannot quantify the cost of wind down or exiting broker positions that could offset those proceeds and wipe out equity.”

Yesterday, Alexander estimated MF Global could get about $765 million for the futures unit. A sale would also free up as much as $1.3 billion in regulatory capital MF Global is required to hold against its $12.7 billion in customer collateral, Alexander said.

The credit lines consist of a $511 million portion that matures in June 2012 and a $690 million revolver coming due two years later, Bloomberg data show. MF Global had used about $192 million on the lines by Sept. 30. In a revolving credit facility, money can be borrowed again once it’s repaid.

It also has a $300 million revolving credit line maturing in June for its U.S. broker dealer and as much as $200 million in letters of credit and bank overdrafts, according to the company.

Moody’s Downgrades

Moody’s downgraded the company on Oct. 24 one level to Baa3 citing its struggles to earn a profit, increased risk appetite and low interest rates. MF Global said the next day it had a net loss of $191.6 million for the quarter. It has lost money in nine of the previous 11 quarters.

The ratings firm reduced MF Global two more steps yesterday to Ba2 and put it under review for more possible cuts, according to a statement.

That followed Fitch, which reduced the grade to BB+, the highest junk rating, from BBB. Fitch cited increased trading with its own capital and the challenges of earning profits from interest in the current “low interest rate environment.” The Federal Reserve target on overnight loans has been between zero and 0.25 percent since late 2008. Standard & Poor’s grades the company BBB-, the lowest investment-grade.

Interest Income

MF Global’s futures unit earns interest income from the collateral it holds to back its customers’ trades. It earned $113.2 million in interest income in the quarter ended in September. When rates were at 5.25 percent in 2007, the company earned $1.77 billion in the quarter ended in March.

Under U.S. law, the client funds of U.S. customers that MF Global holds -- $7.3 billion as of Aug. 31, according to the Commodity Futures Trading Commission -- is kept in segregated accounts and is protected in the event the broker files for bankruptcy protection.

Corzine, the former co-chief executive officer of Goldman Sachs Group Inc., began adding sovereign debt about a year ago, according to a company presentation. The positions accounted for 16 percent and 12 percent of net revenue in the quarters ended in March and June, MF Global said.

The firm, which has a market value of $198 million, holds $6.3 billion of sovereign debt from Italy, Spain, Belgium, Portugal and Ireland that it’s using in repurchase agreement trades with customers.

“The tactical decision to assume this outsized proprietary position highlights the core profitability challenges faced by MF Global and the scope of the re-engineering challenge facing the firm’s management,” Al Bush, a Moody’s analyst wrote in yesterday’s report.

In a regulatory filing last month, MF Global said Finra required the firm to boost capital in its U.S. unit because of the repurchase transactions.

The repurchase transactions are financed to maturity and don’t need to be re-funded on an ongoing basis, Diana DeSocio, a spokeswoman for MF Global, said this week.

“Time is of the essence in order to maximize value for MF stakeholders,” Alexander wrote in the note to clients yesterday. “We’re thinking days not weeks.”

To contact the reporters on this story: Matthew Leising in New York at mleising@bloomberg.net; Zachary R. Mider in New York at zmider1@bloomberg.net

To contact the editors responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net; Jennifer Sondag at jsondag@bloomberg.net