Puerto Rico Finds It Has New Friends in Hedge Funds

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Puerto Rico Finds It Has New Friends in Hedge Funds

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La Perla is a slum in the heart of the tourist district of Old San Juan, Puerto Rico.Credit Christopher Gregory for The New York Times

Forget, just for a moment, depictions of sharp-elbowed hedge funds, seizing Navy ships from deadbeat nations or pushing for federal investigations into the companies they are betting against.

In Puerto Rico, the hedge funds are there to help.

A group of 28 hedge funds and other investment firms are dispensing unofficial advice, providing public relations support and offering to lend money to a Puerto Rican government wrestling with high unemployment and mistrust from municipal bond investors. The hedge funds, including Perry Capital, Fir Tree Partners and other members of the self-styled Ad Hoc Group of investors, have bought $4.5 billion of Puerto Rico government guaranteed and tax-supported bonds — or roughly 10 percent of the total — making them a financial and political force on the island.

The investors are seeking to make money by bolstering the value of their bonds, many of which they snapped up at a discount when mutual funds and wealthy individuals — the typical holders of municipal bonds — dumped their holdings fearing the island was near financial calamity. The rosier picture the hedge fund group can paint, the more likely their investments gain in value, as other investors step in to buy the bonds.

“The hedge funds are controlling the narrative, and the government is a willing participant,” said Robert Donahue, managing director at Municipal Market Advisors, a research group.

Acting as part sleuth and part coach, one of the hedge funds pointed out, for instance, that Puerto Rico was using outdated economic indicators — arguably making the fiscal picture look worse than it actually was, said people briefed on the matter who were not authorized to speak publicly about the discussions.

Some of the other funds told officials that Puerto Rico had possibly shortchanged itself on as much as $1 billion in federal grants that the commonwealth never applied for. No detail seems too small: The government’s sometimes rambling investor presentations should be more focused, one of the hedge funds advised.

The hedge funds are also offering to lend the island more money in case banks and other traditional lenders refuse. This standing offer could be put to the test in the next several weeks, when Puerto Rico is expected to sell about $900 million in short-term debt, according to the people briefed on the matter. If JPMorgan Chase, which is likely to arrange financing, has trouble completing the deal, the hedge funds could step in.

Such friendly tactics are not always part of the hedge fund playbook. The same investors now rooting for Puerto Rico’s recovery have, in other situations, shorted, or bet against, the euro and pressured Argentina to pay its debts.

Indeed the budding romance between Puerto Rico’s leaders and hedge fund managers could be short-lived if the commonwealth strays from its current efforts to balance its budget, shrink the government work force and reinvigorate the economy. Any financing by the hedge funds would probably force Puerto Rico to pay substantially higher interest rates than lenders have required in the past.

Publicly, finance officials in San Juan say they welcome any and all investors. The hedge fund suggestions, they add, are not that different from the unsolicited advice other investors have made in the past. Privately, the officials view the hedge funds with caution.

Last fall, when the hedge funds started investing in Puerto Rico, they talked directly to officials at the Government Development Bank, the commonwealth’s fiscal agent. Now, the officials prefer that the hedge funds communicate their ideas to the development bank’s financial adviser — Millstein & Company, the restructuring firm founded by a former United States Treasury official, Jim Millstein.

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The tourist district of Old San Juan.Credit Christopher Gregory for The New York Times

Still, the hedge funds are not shy about their willingness to help.

“The Ad Hoc Group has the capacity to assist Puerto Rico with potential funding needs, while the commonwealth continues to make necessary reforms to balance its budget, strengthen the economy and shore up the finances of its public utilities,” the group’s spokesman, Russell Grote, said in a statement.

Some of the island’s politicians are also looking to tap that generosity. Last month, hedge funds and other asset managers were invited to a fund-raiser at the Peninsula hotel in Midtown Manhattan to benefit Puerto Rico’s representative to the United States Congress, Pedro Pierluisi, who is running for governor in 2016. The suggested contribution, according to an invitation sent to one hedge fund, was $2,600.

A year ago, hedge funds were bit players in Puerto Rico and municipal bonds in general, long regarded as a sleepy market dominated by mutual funds that buy and hold the same bonds for years.

Hedge funds began descending en masse last fall, after a wave of bond selling — particularly by rich Puerto Ricans — caused prices to fall. Fund executives made frequent trips to the island — visiting shopping malls in San Juan, meeting with government officials and speaking with pharmaceutical executives with major manufacturing plants there.

To show how irrational the municipal market had become, one hedge fund pointed out this summer that Puerto Rico bonds were trading at higher yields than debt in Iraq and Ukraine — values that suggested that the commonwealth was riskier than a war zone.

Over the last year, the hedge funds have bought the government’s general obligation bonds, bonds used to prop up public employee pensions, and bonds that built the island’s highways.

Big-name investors like the $20 billion BlueMountain Capital and David Tepper’s Appaloosa Management scooped up debt owed by the island’s electric power authority.

In total, 60 hedge funds have come to hold about $16 billion, or 22 percent, of the island’s $70 billion of public debt — both government and government-created corporations — according to the ratings firm Fitch.

The bet seemed to pay off, as yields on many Puerto Rico bonds, which move in the opposite direction from their prices, began to fall through the winter, according to Thomson Reuters Municipal Market Data.

But the faith of the investors was tested in late June, when the government enacted a law to restructure the debts of the island’s public corporations, a right the commonwealth previously lacked. Like states, Puerto Rico cannot seek federal bankruptcy protection.

The new law split the hedge funds into essentially two camps. The majority of the Ad Hoc Group’s holdings are general obligation bonds, the government development bank’s bonds and bonds backed by sales tax revenue, which are exempt from restructuring. The law, however, allowed the government to cut billions of dollars of debt owned by some of the island’s public corporations that provide services like electricity.

BlueMountain, which manages funds that own $400 million of the electrical authority bonds, sued the governor, arguing that the restructuring law violated the United States Constitution.

The electrical authority recently agreed with BlueMountain and other creditors to come up with a voluntary restructuring by next March. That most likely sets up a showdown between the island’s powerful public worker unions, representing the electrical workers, and the hedge funds and banks over which group should take the biggest cuts.

Still, the prices of some bonds have been on the rise, as traditional investors have started to tiptoe back into the market — potentially giving the hedge funds their exit, said Mr. Donahue, the municipal market analyst.

“There are a lot of portfolio managers who could be tempted by the hedge funds’ spin,” he said. “But they will be looking through rose-colored glasses.”

Charles Hortenise

Greenwich, CT 45 minutes ago

Organized crime made similar moves in Cuba before The Castro revolution. If the people’s dissatisfaction mounts, then they may be susceptible to the siren’s call of a «people’s revolution.» If history repeats itself, we may see U.S. military covert operations supporting hedge fund militias in Puerto Rico in a few years, as Big Capital continues its silent coup of our Great Republic.

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taopraxis

is a trusted commenter nyc 1 hour ago

How bigshot moneyed interests create pools, manipulate markets and fleece the rubes in one easy lesson…

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Uziel

Florianopolis – SC 15 hours ago

When Greece started to have problems with its debt, a hedge fund owned by Goldman Sachs got into the game. As a result, accounts were doctored and junk debt continue to be sold as investment grade. The end game is well known.
Hedge funds involved with debt-ridden Puerto Rico could be a bad omen.

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David Vos

Boston, MA 16 hours ago

«I’m from the hedge fund, I’m here to help» Those of us from Puerto Rico watch in horror at the downward spiral of our beloved island, in recession since 2006 and 70+ Billion in debt. The same «vultures» crippling Argentina have smartened up and rather than wait for bones to pick over, are coming in early. New laws in PR lure the rich to domicile there and thus bypass capital gains and other taxes. These mega rich come to park their money, and little else other than buy up distressed properties for pennies on the dollar. Wall street lobbyists are tussling over the island, writing their laws only to be rubber stamped by the local government. It was these forces that drafted and rammed through in the last hours of legislative session the new authorization for local government agencies to «restructure», it was opposing huge Wall Street who sued in federal court to challenge the constitutionality, one side will win- neither will be Puerto Rican. Meanwhile 100 schools will close in Puerto Rico this year alone, programs and pensions are being slashed. Wall street is calling the shots and will win. The losers? Puerto Rico and the countless mom and pops stateside who were hoodwinked bu US brokers into buying Puerto Rican debt in bonds that permeate the majority of US Mutual Funds and retirement accounts. Mr. Corkery’s sentence is significantly incomplete, yes, the «hedge funds are here to help», he somehow forgot to include the last word, «themselves».

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STC

NH, CT 16 hours ago

PR has a lot of upside with regards to its location, relationship with the US, and a huge capacity to serve as a financial bridge to both Latin America and Europe. The hedge funds probably see a real opportunity for growth in light of these advantages. Its real problem has been to waste valuable time and resources regarding the question of political status (statehood, independence, etc.), rather than concentrating on the structural changes necessary to facilitate the debate regarding status.

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Craig

Springfield, MO 17 hours ago

As they may be saying in Argentina and in many governments in the world, beware of hedge funds bearing gifts. The idea that the «interest» that a hedge fund «earns» from its investment activities is subject to the risks of the free market is the stuff of totems. Hedge funds create much of the instability that then encourages the financial manager to hedge even more.

Can we admit that the current financial markets are just a bunch of fat cats playing the world like a giant casino and the rest of us are just serving the free drinks with the government is comping their taxes. Of course the servers are also paying the taxes that fund the bonds that back the slots. It’s complicated. These heels are killing me and I’ve got a run in my stockings and that guy keeps pinching my bum.

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Andres

NYC 17 hours ago

Well, the hedge funds aren’t very good at doing the public relations side at least. The Financial Times article that came out a few weeks ago about how Puerto Rico may have been miscalculating the strength of its economy was pretty transparently the hedge fund’s self serving spin. And not very convincing either given that PR’s miscalculations do not affect the fact that it has a massive structural deficit. Also, if anything, it seems’s that PR’s projections of tax revenue, at least, are pretty consistently higher than the tax revenue that eventually flows in. Regardless of the size of the economy, it is definitely true that the money coming in to the government is NOT enough to pay expenses.

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terry brady

new jersey 18 hours ago

The debt holders might start by convincing young people to stay home and not move away to NYC. The island is shrinking in population and if the trend continues things will certainly worsen.

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don

Texas 18 hours ago

Weren’t various forms of «creative» financing provided to the governments in Greece and Italy by large monied interests in the last decade precursor to the European financial meltdown that lingers on today?
Who said «there’s a sucker born every minute».

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Peter

is a trusted commenter New Haven 19 hours ago

Money-shifting and profiting off the illusion of stability. Could you create a better example of why hedge fund profits should be taxed as income or at even higher rates? There is simply no reason to give this type of activity preferential tax treatment unless, of course, the politician voting to do so is already bought and paid for by the same characters profiting off these smokescreens. Oligarchy, anyone?

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south shore bond daddy

New York NY 19 hours ago

Either I am obtuse or there is a non sequitur embedded in your paragraph. How does that article lead you to the conclusion that hedge funds should be taxed as income or in your words at a higher rate? Those funds took risk and stepped in when there were no buyers. Perhaps when the previous owners of those bonds were vomiting all over their own shoes if the hedge funds had not bought the discounted bonds maybe the island would have gone financially belly up. If the hedge funds had not been the buyer of last resort interest rates on the commonwealth’s debts would have spiraled out of control creating an aura of panic and instability. In that environment the island would have not gotten funded and we would have another ward of the Federal Government.
I do not think that you have the remotest concept of trading, risk taking or risk management.

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Andres

NYC 18 hours ago

Totally agree with bond daddy in the criticism of P’s comment. If there is an argument to be made for carried interest to be taxed as ordinary income, this isn’t it. However, the fact that hedge funds are lenders of last resort and may have, at least temporarily, saved PR is not much of an argument in defense of current tax treatment of carried interest. How exactly does this preferential tax treatment work to encourage hedge funds to lend when others won’t? I don’t see it. They could simply pay for the extra tax by either taking home fewer profits or raising the rates at which they lend. It may be, though, that they can be lenders of last resort because they are less bound by regulations than other entities. Tax ‘em at oi rates!

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