Outside of Spring Studios, an event space at 50 Varick St. in downtown Manhattan, a small group of protesters held up a handmade Puerto Rican flag sign, then began to chant. “Cancel the debt . . . shame, shame, shame,” they called out to Baupost Group CEO Seth Klarman, who was getting ready to address the annual Robin Hood Investors Conference being held there on October 19.
A soft-spoken hedge fund manager who is one of the most revered and reclusive in the so-called value investing community, Klarman was no doubt mortified to find himself at the red-hot center of perhaps the ugliest financial debacle in nearly a decade, the $74 billion bankruptcy of Puerto Rico. Given the impact of its crushing debt load, the commonwealth of 3.4 million U.S. citizens was already facing a catastrophe before Hurricane Maria imperiled their lives, leaving the vast majority still without electricity and clean water more than two months after the hurricane hit on September 20. Official death tolls have varied widely, but recent reports suggest that hundreds of people had perished as a result of the storm.
The destruction was so severe that President Donald Trump, upon visiting, made an offhand comment to Fox News that the debt would be “wiped out,” and bond prices immediately plummeted. Puerto Rico’s general-obligation bonds fell from 44 cents on the dollar the previous day to what was then their lowest level, around 32 cents, since the debt turmoil hit in the summer of 2015. Even though Trump’s administration tried to walk back his words the next day, those bonds have continued to slide, falling to 27 cents by early November.
Klarman’s $31 billion hedge fund firm Baupost owns more than $925 million in face value of another type of Puerto Rican bond, called Cofinas, securitizations of a slice of the island’s sales tax revenue designed by Goldman Sachs that the fund bought through an alias called Decagon Holdings. Given their securitization, Cofinas, recently trading in the high 30s, have held up slightly better than the GOs. But protesters aren’t the only ones wanting that debt to be canceled. The GO bondholders — led by Mark Brodsky’s Aurelius Capital Management — along with union pension funds and even the commonwealth itself have sued Cofina bondholders like Baupost, arguing the debt is illegal and should not be paid.
“I don’t like to be attacked,” Klarman told the crowd, according to an audio recording of his off-the-record remarks obtained by Alpha. The hedge fund titan also admitted that he “hid” his firm’s ownership of the Puerto Rico debt through Decagon (only recently unmasked by The Intercept) because “the world tends to follow us and copycat us.”
Klarman also acknowledged the protesters’ pain and said the hurricane that had devastated Puerto Rico had also torpedoed the value of his already defaulted bonds. “People have died,” he said solemnly, “and protesters are very angry that the island is in debt at all. It’s got to be incredibly frustrating. Your friends and family are in a life-or-death situation, and there’s financial pressure on top of that.”
Warning that principal writedowns were ahead, a humbled Klarman added, “Almost certainly we’re going to collect less; whatever the settlement was going to be, it’s going to be less. Inevitably there will be less debt, and the coupons will be lower.”
Baupost’s stake, which the firm first took in 2015, is the second largest among what was once calculated to be 60 hedge fund owners of Puerto Rico debt. But it was worth only $300 million at the end of the third quarter.
Of course, Baupost isn’t the only hedge fund that would like to hide right about now.
“There are probably hundreds of people in this room who are owners of this debt,” Klarman told the group of about 1,000 people at the Robin Hood conference. Given that all Puerto Rico bonds are at historic lows, it seems likely almost everyone invested in Puerto Rico is losing money, and could lose even more.
“They made a bet; they got it wrong,” says one hedge fund manager.
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