U.S. HOUSEBUILDER´S DEBT DEAL SPARKS OUTCRY / THE FINANCIAL TIMES

US housebuilder’s debt deal sparks outcry 
Traders say Blackstone-led refinancing undermines legitimacy of $5tn CDS market
Joe Rennison in New York


Derivatives traders are crying foul over a Blackstone-led refinancing deal for the US housebuilder Hovnanian, saying the controversial arrangement threatens to further undermine the shrinking market for credit default swaps.
 
Hovnanian, which is based in New Jersey and is one of America’s largest homebuilders, has agreed with Blackstone-owned hedge fund GSO to refinance up to $320m of its debt — but the deal has a catch.
 
In order to secure the funds from GSO, Hovnanian has agreed to skip a payment on some of its existing bonds, triggering a technical default and a big payday for the hedge fund, which placed bets on a default in the CDS market.

While legal, traders say the arrangement makes a mockery of a market designed to be used to hedge the risk of real defaults at companies in genuine financial distress.

“We fear that the Hovnanian situation could embolden investors to pursue manufactured credit events with other corporate issuers, which would undermine the true intention and spirit of the CDS market,” said Adam Savarese, co-head of leveraged finance trading at Goldman Sachs.

GSO is able to offer attractive financing terms precisely because they stand to receive a payout on its CDS contracts. Others, including Goldman and credit hedge funds Citadel and Solus Alternative Asset Management, are on the other side of the CDS trades and stand to lose money, according to people familiar with their positions. Goldman and Solus had offered Hovnanian an alternative refinancing deal.

“You can do your credit work but you may not know what is going on behind the scenes where someone could be trying to manufacturer a credit event,” said another fund that had sold Hovnanian CDS.

Hovnanian’s investors face a deadline of this Friday to give a green light to the plan, although it also rests on the approval of a market committee of banks and credit investors, which will have to certify an event of default to trigger the CDS payout.

The tactic of making refinancing conditional on triggering CDS has been used on occasion before, although the Hovnanian situation is unusual because of the size of the deal and because the company is not in financial distress, according to analysts and traders.

CDS fell out of favour after the credit crisis and trading has further shrivelled as market players complain about a lack of transparency and liquidity. The value of outstanding “single-name” CDS, designed to hedge the risk of default on individual companies, has fallen from $33tn in November 2008 to $5tn in the middle of 2017, according to data from the Bank for International Settlements.

GSO and Hovnanian say their deal represents the best financing that was available to the company for replacing debt coming due in 2019. “The company appropriately utilised the most attractive financing techniques available,” said a GSO spokesperson.

But Peter Tchir at Academy Securities, who spearheaded the use of CDS during the early 2000s, said the controversy would have an impact on the market. “CDS was never designed for something like this,” he said. “I think this is going to create more and more pressure to create a better synthetic hedging vehicle than CDS.”