In­debted oil pro­duc­ers are forc­ing banks to pre­pare for the worst

Bloomberg Businessweek (Europe) - - NEWS - The bot­tom line In­vestors look­ing for a way to have Dan Loeb in­vest for them can buy Third Point Re. But they may not get Loeb’s re­turns.

Many in­de­pen­dent drillers, the pro­duc­ers who drove the U.S. shale boom, were out­spend­ing their cash flow even when oil was at $100 a bar­rel. They made up the dif­fer­ence with debt. Now that crude is trad­ing at $42 a bar­rel, the pro­duc­ers’ rev­enue has tanked.

most in­vestors can’t ac­cess hedge funds, they can buy shares in the in­surance com­pany. The in­surer in­vests its cap­i­tal and the cash it gets from pre­mi­ums with the hedge fund man­agers. Third Point Re’s port­fo­lio is $2.3 bil­lion, about 13 per­cent of the as­sets Loeb’s com­pany man­ages. Green­light Cap­i­tal Re in­vests $1.1 bil­lion with DME.

But own­ing stock in the in­surer can be quite dif­fer­ent from in­vest­ing in the fund. As of March 31, in­vestors in Loeb’s fund had earned about 11 per­cent since the end of Au­gust 2013, the month Third Point Re went pub­lic. The in­surer’s stock fell 14 per­cent dur­ing that time.

The stock of Green­light Cap­i­tal Re traded on March 31 for just 15 per­cent above its ini­tial pub­lic of­fer­ing price in May 2007. Green­light Cap­i­tal, the hedge fund, has re­turned more than 50 per­cent since the end of that month. Rep­re­sen­ta­tives for Ein­horn’s and Loeb’s in­vest­ment com­pa­nies de­clined

to com­ment, as did both in­sur­ers.

Money man­agers see hav­ing an af­fil­i­ated in­surer as a “good deal,” says Dean Ru­bino, pres­i­dent of Ter­rapin As­set Man­age­ment, be­cause “they es­sen­tially view it as per­ma­nent cap­i­tal.” A typ­i­cal hedge fund client might pull money out af­ter a pe­riod of poor per­for­mance. The in­sur­ers are less likely to do that with the as­sets they in­vest, mut­ing pres­sure on the money man­ager to sell se­cu­ri­ties at low prices dur­ing a down­turn. The in­sur­ers pony up fees sim­i­lar to those most in­vestors pay, in­clud­ing a man­age­ment fee of 1.5 per­cent to 2 per­cent and as much as 20 per­cent of prof­its.

The in­surance setup has a tax ad­van­tage for in­vestors—one that U.S. pres­i­den­tial hope­ful Hil­lary Clin­ton has de­scribed as a loop­hole that should be closed. An af­flu­ent U.S. in­vestor in a hedge fund would owe the 39.6 per­cent or­di­nary in­come tax rate on short-term gains made by the fund. With the in­surer, in­vest­ment gains can stay in­side the com­pany. The in­vestor only pays taxes when sell­ing the stock for a cap­i­tal gain, which can be sub­ject to a lower rate.

But Ru­bino says those tax ad­van­tages may not out­weigh other risks to in­vest­ing this way. Along­side the com­pa­nies’ in­vest­ment port­fo­lios there are still in­surance busi­nesses to run. Hedge-fund-af­fil­i­ated in­sur­ers typ­i­cally write rein­sur­ance poli­cies, which back up cov­er­age sold by pri­mary in­sur­ers. Third Point Re has writ­ten con­tracts on crops, while Green­light Re has in­sured Florida home­own­ers.

The rein­sur­ance busi­ness has be­come tougher as the prices com­pa­nies are able to charge have de­clined. That’s partly a con­se­quence of in­creased com­pe­ti­tion from money man­agers crowd­ing into the in­dus­try. Gold­man Sachs last year raised

$1.5 bil­lion to help cre­ate an in­surer it plans to take pub­lic, ac­cord­ing to a mar­ket­ing doc­u­ment ob­tained by Bloomberg. Howard Marks’s Oak­tree Cap­i­tal Group re­cently raised about $600 mil­lion to start an in­surance ven­ture.

At the same time, in­vestor in­ter­est in the com­pa­nies may be wan­ing. Gold­man Sachs fell $500 mil­lion short of its max­i­mum fundrais­ing tar­get. Robert Bredahl, Third Point Re’s chief op­er­at­ing of­fi­cer, told in­vestors in Septem­ber that he’s not hope­ful for an im­me­di­ate rein­sur­ance in­dus­try re­bound. Given such con­cerns, “you’re prob­a­bly not go­ing to see vast amounts of new in­vestor in­ter­est in the model,” says Meyer Shields, an an­a­lyst with Keefe, Bruyette & Woods.

Some still see an op­por­tu­nity for pa­tient in­vestors—as long as the hedge fund man­agers de­liver strong re­turns. “In one or two years of good earn­ings on the in­vest­ing side,” says Ken Billings­ley, an an­a­lyst at Com­pass Point Re­search & Trad­ing, “they could make up for three or four years of un­der­per­for­mance.”

Si­mone Fox­man and Son­ali Basak

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