DERIVATIVES: Banks cite Illinois muni CDS trades

3 min read
Americas

In response to a request by the State of Illinois’ Governor’s Office of Management and Budget to explain their municipal credit default swap activity, Goldman Sachs, JP Morgan, Bank of America Merrill Lynch and Morgan Stanley said they entered into trades regarding municipal CDS on the state of Illinois between January 1, 2011 and March 31. The banks, however, said they did not enter proprietary trades regarding Illinois CDS.

Illinois’ Office of the Comptroller released the municipal CDS data today on its Web site. The state has made headlines lately due to its inability to close a US$13bn budget gap.

CDS on the state of Illinois is over 200bp, about 50bp wider than other states’ CDS.

Goldman’s cumulative notional volume of trades in the state of Illinois CDS during the past fiscal quarter was US$190m, according to a letter sent to Illinois’ governor’s office. Its net notional position as of March 31 in Illinois CDS was US$77.5m, while its gross notional position in Illinois CDS was more than US$1.7bn.

However, Goldman said it is not feasible to assess whether it is long or short exposure to the state of Illinois credit solely by reference to notional amounts of CDS since other considerations including the various maturities of its CDS positions and its risks related to market-making activities in Illinois’ bonds are key determinants and drivers of the firm’s risk profile.

JP Morgan also said during the relevant period it entered into trades in the state of Illinois CDS. Its trades totaled a cumulative notional amount of US$25.8m, reflecting US$0.8m of unwind activity and US$25m in new transactions.

“As of the end of the relevant period, J.P. Morgan was party to State of Illinois CDS having a gross notional amount of US$389.2 milion and a net notional short credit protection position of US$0.8 million,” it said in a letter to Illinois’ Governor’s Office of Management and Budget.

Similarly, Bank of America Merrill Lynch said in its letter it makes regular two-way markets in municipal CDS, including CDS on Illinois general obligation (GO) bonds. For the quarter ending March 31, the cumulative notional volume of Illinois CDS purchases was US$39.7m and sales were US$10m. As of March 31, its outstanding gross notional amount of Illinois CDS was US$655.4m. It also has a prime brokerage outstanding gross notional amount of Illinois CDS of US$100m.

Morgan Stanley said the cumulative notional volume of state of Illinois CDS trades during the review period was US$122m. The outstanding gross and net notional amount of state of Illinois CDS at the end of the review period is US$2.2bn and US$22.1m, respectively.