At ValueWalk we’ve reported several times in the past on Baupost’s sizable position in the distressed debt of Lehman Brothers. In 2013 the Lehman positions accounted for a massive 23% of the fund’s net asset value.
So far, the Lehman positions have produced a sizable return for Baupost, which is run by the well-respected value investor Seth Klarman. In Baupost’s fourth quarter 2013 letter to clients, partner Jim Mooney wrote:
“We received significant distributions from the various Lehman estates during the course of the year…Life to date, the IRR on all of our Lehman investments is approximately 30%. Lehman has, by any measure, produced a wonderful investment result.”
And earlier this year, Baupost provided another positive update on its Lehman positions:
“Our positions in Lehman entities, both those correlated and those substantially uncorrelated with U.S. debtors, remain both our largest credit exposures and our largest overall exposure, representing in total approximately 8.5% of partnership net assets…We received significant distributions from Lehman’s U.S. debtors in 2015, and we expect to receive substantial amounts in 2016 and 2017 as the Lehman liquidation process continues…We continue to believe that our investments in the remnants of Lehman Brothers have an extremely limited risk of permanent capital impairment and offer an attractive risk-adjusted return. Over the course of the year, we took advantage of several opportunities to make small additions to our Lehman holdings.”
One of the most profitable financial crisis trades
Lehman debt has turned out to be one of the most profitable financial crisis trades. According to the Wall Street Journal after making a payment of $1.6 billion to creditors at the beginning of April this year, the total amount distributed by the failed bank to creditors is about $107 billion. Of that amount, 73% or $78.5 billion has gone to third party creditors that purchased Lehman debt at a nominal amount as the firm’s bankruptcy was underway. General unsecured creditors, who were estimated to receive less than 20 cents on the dollar when Lehman’s bankruptcy plan went into effect in early 2012, have now received more than 35 cents on the dollar. In the days after Lehman’s September 15, 2008, bankruptcy filing the bank’s debt traded at around 8 cents on the dollar.
The Lehman debt trade isn’t the only crisis trade that’s producing windfall profits for daring hedge funds.
The July 27 issue of Hedge Fund Alert reports that Deer Park Road Management is among a handful of hedge fund operators booking handsome profits on investments in distressed mortgage bonds that Countrywide issued before the credit crisis.
These distressed mortgage bonds accounted for over 10% assets and had been a significant drag on returns since 2008. However, last month Bank of America distributed $8 billion to bondholders under terms of the 2011 settlement with institutional investors regarding the distressed debt. Deer Park received $15 million of this payout and was able to mark up its Countrywide position by nearly 50% from $150 million to $220 million. The bonds have a total face value of $940 million.
As a result, Deer Park’s flagship STS Partners Fund booked a return of 6.4% in June, its second best month ever. STS Partners has generated an annualised return of a 25% since inception, mainly thanks to its investments in mortgage-backed securities downgraded during the financial crisis.