2/26/17

Hello guys,

I'm an Economics graduate from the University of Iceland. I thought I'd share with you some information that I believe has never been made public before, at least not in English. It's a story about some brilliant investments that made a select few hedge funds A LOT of money. This post will be very long but hopefully you will enjoy it. As for graphs, I don't quite get how to post pictures here and I'm not allowed to share links, so I uploaded the pictures as files/attachments with the article. You can scroll down to see them, I recommend starting by scrolling down and opening all pictures in new tabs. I'll let you know at which point in the article each picture is relevant. Sorry for the sloppiness. Note that the graphs are very important for the story.

As for my story. The short version: For my Bachelor's thesis, I performed a detailed analysis on the global hedge funds who purchased distressed debt on the collapsed Icelandic banks following the financial crisis in 2008. As some of you might know, Iceland was one of the countries that was hit worst by the financial crisis but it has also experienced a miraculous recovery (at least on paper). So, after the banks collapsed, creditors needed to get rid of their almost-worthless bonds and that's when the hedge funds came in. These are their stories (read with Law and Order voice).

Shortly after Iceland's three major banks, Kaupthing, Glitnir and Landsbankinn, collapsed in the fall of 2008, there was a CDS auction in London, where creditors tried to get rid of their debt. Icelandic banks had been borrowing A LOT prior to the crisis, and this auction was the first time that their debt was to be traded. At this auction, held by ISDA, debt on Kaupthing was sold for 6.625% of face value, debt on Glitnir was sold for 3% of face value and debt of Landsbankinn was sold for 1.25% of face value. Of course nobody really knew how much this debt was worth, but let's say that it ended up growing quite substantially in value. Those who managed to buy the debt at this CDS Auction were the guys who ended up making the most money, as the value started rising pretty fast.

Picture 1: Prices of claims (as % of face value, from CDS Auction until Composition Agreement)
image1

After the collapse of the banks, winding-up boards were established and creditors got the chance to make claims to the assets of the banks. This took about a year, and in late 2009/early 2010, after the claims registration period had ended, all the winding-up boards published (privately) their first claims registries. They included a list of every single claim, amount of the claim, status, and name of claimholder. If you want to see how they looked, click here to see Kaupthing's first claims registry courtesy of Wikileaks. Claims are in Icelandic kronas (1 USD = 113 ISK today). The registries are clearly quite massive. So they were regularly updated throughout the years, because there was a very active market with these claims.

At the time of the first claims registries,, hedge funds had already purchased A LOT of claims. This is about a year after the collapse. As you can imagine, getting information from these claims registries required huge work. Each fund usually had claims in the names of some shelf companies, ranging from Luxembourg to Delaware. The largest creditor by far in the beginning was Baupost, Seth Klarman's famous fund. That fund ended up being the winner of this whole Iceland bet, more about that later. Other funds included Davidson Kempner (through Irish shelf company Burlington Loan Management), York Capital, Anchorage Capital, Eton Park and Centerbridge.

Picture 2: Ten largest hedge fund creditors of the Icelandic banks in 2009/10 (in billions ISK, NOMINAL value):
image2Picture 3: Ten largest hedge fund creditors of the Icelandic banks in 2009/10 (in billions ISK, REAL value):
image3

It's impossible to say exactly when these funds purchased their claims between the CDS auction and the end of the claims registration period, and prices certainly increased during that time. However, a Bloomberg source stated that Baupost had gotten their claims in late 2008. Anyways, it was the earlybirds who made the most profits.

To make a long story short, the winding-up process ended up being tremendously long and it wasn't until the end of 2015, that things finally started happening. The problem was that the Icelandic government didn't allow the funds to escape the country with their money. Immediately following the Icelandic financial crisis, the government installed capital controls, so you couldn't change your Icelandic kronas to foreign currency without special permission from the Central bank and the authorities. So the creditors were stuck in Iceland with their money, that their winding-up board had been earning by selling assets, etc. Including assets were two of Iceland's banks who had been built upon the ashes of the old ones (Glitnir became Islandsbanki and Kaupthing became Arion banki).

Originally, they thought that they'd have everything wrapped up (mostly) around the end of 2012. At that time, the Icelandic government didn't seem to be all too concerned whether they left or not. But then there was a shift in the political atmosphere. A new government arrived in early 2013 and the Central Bank started stressing, that if the hedge funds were allowed to leave the country with billions of dollars, it would have a tremendously negative effect on Iceland's Current Account (bare in mind that we're a country of only 330,000 people). So instead of happily getting paid in late 2012 or early 2013, the funds weren't able to reach a Composition agreement to finish winding-up proceedings until late 2015. And basically, the only way for the funds to start getting paid, was to get the Central bank's and government's permission to finish a Composition agreement. And they had to suffer through a painful three year delay.

When authorities started losing patience, the government threatened to place a 35% "stability tax" on the funds for them to get to leave the country with their money. However, after some negotiations, the funds agreed to some "stability conditions". For example, Glitnir's creditors agreed to give up billions of USD in assets, including the Islandsbanki bank. Yes, the hedge funds gave Iceland's second largest bank to the government for free in exchange for permission to get their money. The other creditors made similar agreements, although Arion banki is still owned mostly by Kaupthing (and therefore foreign hedge funds).

So after the creditors had finally made a deal with the government, it was time for them to finish the Composition agreement. Composition simply signals the end of winding-up proceedings. At that time, six years after the first claims registries had been published, the group of creditors had changed a lot. Still, five of the ten largest funds in the beginning were still among the largest funds in the end. Anchorage Capital was now the largest creditor, with claims of 550 billion ISK (just under 5 billion USD) in nominal value, but they purchased A LOT of Landsbanki claims later on. As you saw, the Landsbanki claims prices started rising much later, so you could still make big bucks on those later (why was that? Well, google Icesave :) ). Other funds included Abrams Capital, Soros Fund Management and Solus Alternative Asset Management, Och-Ziff was there as well.

Picture 4: Ten largest hedge fund creditors of the Icelandic banks after winding-up was finished in late 2015: Billions of ISK, nominal value):
image4Picture 5: Ten largest hedge fund creditors of the Icelandic banks after winding-up was finished in late 2015 (Billions of ISK, real value):
image5

So, now that you've gotten the basic story: Which funds were the largest in the beginning and which ones were the largest at the end (or time of composition), the question remains: Who made the most money??

DISCLAIMER: My thesis, and this analysis, made the assumption that the hedge fund creditors at the time of composition would sell their claims for cash at the day of composition. Truth is, even though the winding-up proceedings ended, the funds are still getting paid as assets are being sold. They received equity and bonds relative to their claims after composition and they get paid as assets are sold for cash. The process could still take years and they could earn more/less. Also, there's an active market with the bonds so the speculation is ongoing. But the composition was a good place to draw the line.

With that being said, the funds who made the most profits, were of course the funds who left early. This you can see by looking at the prices of claims. The prices stayed the same pretty much after they reached their peak quite early, so staying on longer means that you were just being stuck with your cash without getting any further returns.

So the WINNER, according to my analysis, was Baupost Group. If we assume that Baupost went in around the CDS auction, they made a great investment. At the link below, you can see, they started selling off around 2012-2013 and had almost completely exited their positions late 2013. I also like Baupost because they purchased their claims through shelf companies with names of famous Icelandic places, such as Gullfoss Partners, Geysir Fund, Thingvellir fund etc. (They were hard to track down).

Picture 6: Baupost investments in Iceland (In Billions of ISK, nominal and real value)
image6

According to my calculations, Baupost had an IRR of 51,3% (ignoring taxes, currency fluctuations etc) and assuming a 15% discount factor,, they made a profit of 45,6 billion ISK (NPV of the investment), or around 400 million USD. In my opinion, that's pretty impressive! Ignoring the time value of money, the fund pretty much made an 880 million dollar profit.

Other guys did really well too. The fund who managed to get the highest IRR according to my calculations was Eton Park Capital Management. Eton Park's investment was much smaller than Baupost's but they exited even earlier.

Picture 7: Eton Park Investments in Iceland (In Billions of ISK, nominal and real value)
image7

Eton Park managed to get an IRR of 64,4% and with a 15% discount factor, they made 18.3 billion ISK in profit, or around 161 million USD.

Davidson Kempner was by far the most "notorious" creditor in Iceland, mainly because it was one of the largest creditors and also because it also made other investments in Iceland. The manager of their Iceland operations actually got the nickname Mr. Iceland! But the problem is that due to their size and influence, they were also kind of stuck, so they weren't able to "cash out" as early as Baupost and Eaton Park. Which negatively affected their profits, unless of course they'll end up recouping much more than was expected at the time of composition. But their IRR was 14,54% based on my calculations and aforementioned assumptions, and therefore they made a loss considering a 15% discount factor.

Here's a list of the ten funds who profited the most from their Iceland investments (ranked by NPV of investment with a 15% discount factor). As you see, a lot of familiar names:

Baupost - NPV of 400 million USD and IRR of 51.3%
Eton Park - NPV of 161 million USD and IRR of 64.4%
CarVal - NPV of 39 million USD and IRR of 36.3%
Anchorage - NPV of 34 million USD and IRR of 18.1%
Arrowgrass - NPV of 31 million USD and IRR of 23.3&
Fortress - NPV of 22 million USD and IRR of 21%
York - NPV of 18 million USD and IRR of 16.4%
Highfields - NPV of 7 million USD and IRR of 16.5%
Centerbridge - NPV of 5 million USD and IRR of 15.5%

Note that these are only approximations, in the best of my knowledge this should be fairly accurate but obviously it's impossible to be spot-on with this.

The guys who barely made any profits at all, or even losses, were the funds who entered too late and/or exited too late. These funds include Och-Ziff, Abrams Capital, Solus Alternative Asset Management, Paulson & Co and George Soros, to name a few.

With time, when everything is done, perhaps I'll be able to do an even more detailed analysis. But this was absolutely fascinating to look at and got me very interested in distressed debt investing. I hope I can maybe work in that area one day.

Just a few notes: I apologize that my graphs are in Icelandic and Icelandic kronas. I didn't have access to the original data when I all of a sudden wanted to write about this so I just took graphs from my thesis. And, I'll be willing to answer any questions I can and provide further details if you have any curiosities. The thesis was around 100 pages long, so obviously I'm not delving into the details here. I hope you found this stuff interesting, I certainly did, and I think it's a great example of a successful distressed investing job (at least for some), and a REALLY interesting case study, with the capital controls, hostile government and all that.

Comments (46)

2/21/17

Great post! Are you able to share your thesis for a more in-depth study as well?

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2/22/17

Hi, my thesis is unfortunately in Icelandic but if you guys are interested, I can also tell the story about their battle in Iceland and how they had to deal with authorities to get their money out of the country.

2/22/17
afe9:

Hi, my thesis is unfortunately in Icelandic but if you guys are interested, I can also tell the story about their battle in Iceland and how they had to deal with authorities to get their money out of the country.

Great read! I would absolutely be interested in hearing more about it

2/23/17

Would also be very interested - thanks a lot this is great.

2/24/17
afe9:

Hi, my thesis is unfortunately in Icelandic but if you guys are interested, I can also tell the story about their battle in Iceland and how they had to deal with authorities to get their money out of the country.

I highly recommend that you translate your entire thesis into english and get it published. If not in journals, then with finance media like Bloomberg, etc.
That might get you on the radar of a lot of interesting people (if you're not yet already).

2/24/17

Thanks, I appreciate it. I've thought about that for sure. I might go for it.

A part of my thesis actually became a chapter in a book that was just published by Palgrave Macmillan, "The Icelandic Financial Crisis". My professors who supervised my thesis wrote this book, and i think it's going to be a very interesting book. Still, my thesis was obviously much more extensive when it came to the hedge funds per se, so for sure, I might go for a translation!

2/24/17

I thank you greatly for this amazing insight and analysis. I implore you to please share with us your translated thesis! We are all extremely interested in the financial battle of foreign creditors, in Iceland. Thank you again Afe9! Or Alfie, as I will nickname you...

Greed is but a word jealous men inflict upon the ambitious.

2/24/17

Haha thanks, I love the nickname! I might translate the thesis, next step is a webinar here on WSO next month where I'll delve into more details!

5/11/17

Any update on whether you'll translate the thesis?

2/21/17

This is a great post. The Icelandic bank claims were one of the best and few true special situations plays around the past decade.

2/22/17

Yes, this is a fun read... Thank you!

2/22/17

great read. SB'ed.

2/22/17

I'm glad you guys liked it. Seemed at first that noone really cared so I'm glad to see it picked up :) I thought it was perhaps a bit disorganized, and of course it's kinda bad with the pictures.. but I'm happy you guys enjoyed it! It was truly a good performance from these funds.

2/22/17

It's a very difficult question to answer, but I can't imagine that, for the ones lower down in your table, such as Centerbridge, this was a worthwhile investment, given the time and effort spent, as well as the opportunity cost.

2/22/17

Yeah I should clarify that I meant the top ones... the lower ones didn't do that well. And there are hundreds who did even worse, much worse! So yeah there was a handful that did extremely well but some who didn't do nearly as well. But I guess we'll never know exactly how they fared, there were some minor fluctuations so I guess there were gains to be made, but my guess is that most of them didn't get an acceptable return.

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2/22/17

One of the guys who became the largest was Taconic Capital, they're still big in Iceland. But they weren't there immediately.

2/22/17

Nice post. Tangentially, interesting to see how Iceland responded to the crisis.

+1 SB.

2/22/17

Great post! I honestly how to see more actual finance posts here, getting tired of all the "how to break into ____" stuff.

"There's nothing you can do if you're too scared to try." - Nickel Creek

2/22/17

Really great read. SB'd

2/22/17

SBd, thanks for taking the time to write it up! Fascinating to see the response by the Icelandic gov

2/22/17

That was really well done. Does anyone recommend any distressed debt investing resources?

2/23/17

Thanks for making this post - always love learning more about special situations / macro events such as this.

I just have two questions. They are nitpicky, and deal more with details tangential to the underlying analysis (and most likely will reveal my complete lack of expertise in this area, but I just wanted clarify my understanding):

1) The initial distressed debt auction was referred to as the "CDS auction". Aren't CDS (credit default swaps) most valuable when the underlying debt is considered riskiest. For example, on graph #1, wouldn't the value of the CDS be highest at the beginning of the time series, when default risk is highest?

2) "the Central Bank started stressing, that if the hedge funds were allowed to leave the country with billions of dollars, it would have a tremendously negative effect on Iceland's Current Account (bare in mind that we're a country of only 330,000 people"
Why would this have a negative effect on the current account. As far as I understand, the current account is exports minus imports. Obviously, a mass exodus of capital would be bad to the extent that it would cause severe currency devaluation and disruption of the Icelandic financial markets - but I wouldn't necessarily describe these direct consequences as a "negative effect on the Current Account". Please let me know if I'm missing something (I suspect I am).

2/24/17

I think what OP is meaning is the balance of payments of Iceland. The balance of payments has a primary income section (returns on investments and interest on debt securities), so I would assume what the Central Bank was talking about the balance of payments and not the current account

2/23/17

Great post. SB'd it. Easily going to be in the HoF posts.

On a different note, since I am taking International Finance this trimester, I wanted to know if you could explain how taking billions out of Iceland would affect the CA of Iceland. Because if we were to consider it as currency transfer then would it not affect the Capital account?

2/23/17

Maybe the author meant the effect on Iceland's capital account, rather than the current account...

Best Response
2/23/17

You guys are absolutely right, I'm sorry but I simply ended mixing up terms. What I meant is that the transfer would have a very negative effect on our BALANCE OF PAYMENTS (through the capital account of course, not the current account, a pretty awkward slip-up).

As for WBI2994, you are right regarding the CDS.. what I'm doing is that I am not showing the value of the CDS itself, but the value of the claims with regards of the results of the CDS auction. Here's a text for clarification:
http://www.lexology.com/library/detail.aspx?g=8bc6...

Thanks for your interest guys, I really appreciate it!

2/23/17

Wow this is great! Enjoyed reading your post and would love to hear more about your in-depth analysis/thesis. Kudos to you man

2/23/17

Really interesting, thanks! Would love to see more posts like this on this site..

2/23/17

Awesome post

2/24/17

Really great, interesting read! SB'd

I would love if WSO had more content like this

2/24/17

agreed

2/24/17

Great work, man.

2/24/17

What this analysis misses is that a large proportion of the assets of the banks were non-ISK and non-Iceland denominated. Assets such as building developments in London, UK retailers, Spanish plots of land, Swedish RE, Yachts...all manner of weird stuff the banksters wanted to lend against. The point being, the funds were willing (and made multiple proposals) to "give-up" or severely discount their rights to the ISK assets (primarily the "new" banks like islandsbanki) in order to be able to have their non-ISK asset which wouldn't affect the BoP of Iceland.

It came down to political posturing and ultimately internal inflationary pressures and demands from the likes of pension funds (and a scandal or two) to break the stalemate.

"After you work on Wall Street it's a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side." - David Tepper

2/24/17

You are right. Of course this was all covered in my thesis, the fact that most of the assets were foreign. But still, the thing is that the Icelandic assets (especially the banks) were still enough to really damage our BoP. Being able to hold the foreign assets "hostage" gave Icelandic authorities great leverage.

Don't know about the "scandal", the Panama Papers came way after that and there weren't really any political scandals I think relate to this, but yes there was pressure to get this over with, mostly because we wanted to get rid of the capital controls. But for sure it seems you know your stuff about this.

But as I said, the whole story is a point for another article. This post was more about just showing you guys who these funds were and how successful some of them are. Maybe there will be a Part II , because what you are sayimg is really important and a huge part of the story. I'm not taking any sides btw, I was actually really fascinated with the funds, and first and foremost this is a really interesting case study.

2/24/17

Amazing work man, really thank you! I love this community!

Nicest haircut than Bateman

2/24/17

Really great stuff, thanks again for sharing.

Quick question -- how were you able to track down/confirm the shell companies that Baupost was using?

2/24/17

I would piggyback on this question and say that having spent several years here on WSO, I think the entire community would love to hear about your data-mining/research methods throughout the research process.

2/24/17

Haha.. I wonder if you work there and are trying to learn from your mistakes!! ;) But honestly, it was through a ton of work and a little bit of luck that I finally found ONE link. I might talk more about my research process in the future.

2/24/17

thanks for the post!

keep an eye out for a webinar on this topic (presented by the OP) soon...

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2/26/17

Fantastic post!

2/27/17

A very nice read. would like to read the English version of your thesis, as and when it's available.

3/8/17

Great stuff Afe9! Definitely looking forward to the webcast!
Thanks for sharing this!

3/22/17

Is there any chance you can share your bibliography / sources you consulted when writing this thesis?

5/12/17
9/10/17
9/17/17

The name of the game, moving the money from the client's pocket to your pocket

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