Jump to the courts

The WSJ reports an amusing scrap over Sagittarius, a $985M CDO sold to investors in March by Wachovia and structured, it appears, by Deutsche (who is the trustee). Several UBS funds are investors, and an MBIA affiliate, LaCrosse, is a swap counterparty to Sagittarius. Sagittarius has MBS assets so apparently there was a default event. What happened next is the interesting part:

The day after the event of default, LaCrosse sent Deutsche Bank a letter saying that no interest or principal should be paid to other junior noteholders.

Other investors, unnamed in the legal filing, disagreed, telling Deutsche that MBIA's position "is neither reasonable nor correct," according to court papers filed by Deutsche Dec. 3. These other bondholders also might disagree about how they would share continuing payments, assuming they got any money. The disputed payments total several million dollars and will pile up until the dispute is settled, according to a person familiar with the matter.

With its legal filing, Deutsche is essentially asking the court to guide it on whom exactly should be paid.

It appears MBIA's view is that it is supersenior via the swap, and hence no one should get any cash until they are whole. The others, unsurprisingly, disagree. In any event this highlights the importance of understanding where any derivatives sit in seniority vis a vis the note investors. Default contingent market risk can be ugly, and it's quite hard to hedge.

JP has the right take here I think. Analyst Chris Flanagan wrote in a report recently:

"If there's one safe prediction for 2008, it is that legal teams will be busy".

May all your reindeer in 2008 be made of pecans, or not, as you desire. Unless you are a lawyer, of course. They can find their own nuts.