Indebted oil producers are forcing banks to prepare for the worst
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