CDS Market On Verge Of "Irreparable Damage" In Escalating Feud Over Hovnanian Debt

Back in November, Bloomberg first profiled  a fascinating story involving Hovnaian, whose credit derivatives swaps were soaring as if New Jersey’s largest homebuilder was about to default, even as its stocks and bonds show no signs of panic.


What was behind the divergence? As Bloomberg uncovered, the catalyst was a bizarre battle raging among hedge funds, with one group saying that the other has offered Hovnanian financing in return for taking steps that would trigger payouts on those derivatives. The claim came in a letter from law firm White & Case, which said it’s been made aware of a proposal in which Hovnanian would pursue a refinancing deal with the main intention of triggering a credit event that would lead to a payout on the credit-default swaps.

At the time, Bloomberg identified the main actors as hedge fund Solus Alternative Asset Management, which owns both Hovnanian’s bonds and sold CDS guaranteeing the company won’t miss a debt payment, while its counterparty was Blackstone’s GSO Capital partners hedge fund, an investor with which Hovnanian has explored a restructuring that would trigger a CDS payout. What makes the deal unique, is that in order to secure the funds from GSO, Hovnanian had agreed to skip a payment on some of its existing bonds, triggering a technical default and a big payday for the hedge fund, which unlike Solus, was long Hovnanian CDS.

This latest quirk in the CDS market demonstrates once again how any human system - when enough money is at stake - will eventually be gamed beyond its breaking point.

Furthermore, 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. Furthermore, while 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.

* * *

Fast forward to today, when the FT reports that derivatives traders are "crying foul" over the Blackstone-led refinancing deal for the US housebuilder Hovnanian, saying the controversial arrangement threatens to further undermine the shrinking market for credit default swaps.

According to the FT, 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.

While Goldman and Solus had offered Hovnanian an alternative refinancing deal, 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 utilized the most attractive financing techniques available,” said a GSO spokesperson.

“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.

What makes the situation poetically ironic, is none it is Goldman - well known for creating numerous such deals before the peak of the financial crisis involving CDOs - that is now on the receiving end and stands to lose millions if the company proceeds with the GSO transaction.

To be sure, Goldman isn't alone in selling HOV CDS: "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.

What happens nest?

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.

Should Hovnanian go with the GSO deal, it stands to further undermine the credibility of the nearly defunct CDS market.

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.

Quoted by the FT, Peter Tchir at Academy Securities 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.

He is right, but we already knew that when ISDA - and the ECB - decided to make a mockery of selling or buying CDS at the sovereign level as part of the Greek debt crisis. All that Hovnanian is doing is bringing the CDS "mockery" to the corporate level.

* * *

Meanwhile, ahead of tomorrow's nailbiter of a decision, Bloomberg reported that on Monday, Solus sued Hovnanian GSO accusing them of manipulating the market on insurance tied to Hovnanian’s debt.

According to Solus, GSO was close to suffering “massive” losses after betting that Hovnanian would default on its debt. The only way for GSO to avoid the losses was if the homebuilder defaulted on existing debt and issued a certain type of new debt, Solus claimed. Because that was unlikely to occur, GSO bribed Hovnanian to do so, Solus said in the complaint.

As one would expect, Solus claimed that the illegal scheme could cost it and other sellers of Hovnanian credit default swaps hundreds of millions of dollars.

And just to underscore the above point, Solus also stated that "the integrity of the CDS market - which is predicated on the expectation that companies seek to avoid payment default, not to accept illicit payments to default intentionally - will be irreparably damaged," Solus said.

The suit in New York state court seeks a court ruling blocking GSO and Hovnanian from entering into any transaction that includes a commitment by Hovnanian to voluntarily default on debts it could otherwise pay. Hovnanian responded that the company acted “properly at all times and that any attempt to block this transaction will not be successful.”

So will yet another formerly efficient market be irreparably harmed tomorrow? The answer should be revealed tomorrow.


glenlloyd sabaj49 Fri, 01/12/2018 - 11:07 Permalink

You had to know that eventually the system would be distorted to serve the purposes of greed. If they had wanted to prevent this type of 'intentional default' they should have considered that it was a possibility and written it into the legal language of the contracts. It's really the people who failed to do that part that should be dragged across the stage kicking and screaming. Let's see, who invented these things...Blythe so and so?

That's pretty much what happens to most systems these days where humans are involved.

In reply to by sabaj49

aurum4040 Herodotus Thu, 01/11/2018 - 21:36 Permalink

Hey its basically what many home owners did over the last 10 years. Default to trigger new financing. For some it didnt work. But for many it did....The CDS should be tied to cash flow, not the mere action of making payment. This could very easily be accomplished via Ethereum protocol DaPP, with far less financial compensation paid out to financial 'analysts'. 

In reply to by Herodotus

wisehiney Thu, 01/11/2018 - 21:11 Permalink

Desert loving in your eyes all the way
If I listen to your lies, would you say 
I'm a man without conviction
I'm a man who doesn't know
How to sell a contradiction? 
You come and go, you come and go

Karma, karma, karma, karma, karma chameleon
You come and go, you come and go


Karmasabitch, aint she boy george?

gdgenius Thu, 01/11/2018 - 21:33 Permalink

Its fraud, pure and simple. If you purposely burn down your house with the explicit goal of benefitting financially, you go to jail. Where are the arson investigators?

HRH of Aquitaine 2.0 Thu, 01/11/2018 - 22:23 Permalink

Never heard of Hovnanian debt.  I was a professional groom for a Hanoverian stallion imported from Belgium.  Asshole had killed a handler in Europe and the horse was sent to the US for a cool $250K.  (In the 1980s).  Asshole horse ruined another horse while being trailered (ripped open its neck) and ripped into the groom (they were gutted, basically, and ended up with a few hundred stitches).  So they fly me into this fancy boarding school in Chambersburg, Maryland, to be the private groom to this bitch that thought she was going to the Olympics.  Did she?  No.  Did the horse?  No.  We called him Mad Max (short for Maximillion).

I am guessing someone wanted to collect insurance on that $60K horse and I spoiled their plans. Yes, those horses were insured. Quite the scam.

Anyhow the horse would try and body slam you (which meant trying to crush you between his body and the stall walls) or bite you or kick you.  Me?  I did fine.  The horse wasn't the problem.  People?  Oh yes.  They were the problem.  Cohen's.  Never been treated so crappy in my life, less than a dog. After saving a $60K Arabian horse from an allergic reaction I quit.  Fuck people that don't treat their help well.   I thought I had saved their precious horse. Apparently they were playing another game, let's collect the insurance on our-poor-old-dead-horse. I thought I had saved their horse when I had cost them $60K in fraudulent insurance payments.

LaugherNYC HRH of Aquitaine 2.0 Thu, 01/11/2018 - 22:42 Permalink

HRH is that an apocryphal story, or did you just need to get it off your chest? Hovnanian and Hanoverian aren’t really that close.


Shitty story though. A nasty horse better be a winner, or there are plenty of Frenchmen who would be happy to pan roast a joint or loin. Cranky horses can be charismatic and fun. Nasty ones aren’t worth keeping. $250k for a horse to go to the Olympics for a major flag ain’t gonna happen. $2.5 million maybe.

In reply to by HRH of Aquitaine 2.0

Giant Meteor HRH of Aquitaine 2.0 Thu, 01/11/2018 - 23:23 Permalink

Great story. I know a bit of what you speak, from within the thouroughbed world several lifetimes ago ..

You made me think back to a particular punishment detail one fine Sunday afternoon, I was tasked with brushing out a particularly rank breeding stud, relegated back in those days to mostly teasin. The real deal, no short hand pony.  Mean as a mug, and shit who could blame him, adding insult to injury .. Of course it didn't help matters he was mostly now, a forelorn jughead, whose most recent progeny how shall we say, had not exactly been hittin the board.

The sheer arrogance of folks possessing more money than brains, and less class than a bar room drunk is one thing, but lord almighty, how they do fuck up their stock ..



In reply to by HRH of Aquitaine 2.0

Dr. Venkman Thu, 01/11/2018 - 22:30 Permalink

Legal? Sure i guess. It seems to be tortious interference with a contract, easy peasy. GSO is fucked. If the lender were ballsy, they'd declare default, trigger the CDO and sue GSO for the proceeds. Lender is out and whole (punitive damages with showing of malice), GSO loses their money, and HOV will lose all financing forever for being shitbags. 

LaugherNYC Thu, 01/11/2018 - 22:48 Permalink

There is no depth too great for the scum of finance. Undermine their own golden goose for one shitty trade.

Manufactured defaults are old news - know a guy who built a true fortune on them. But this is special.

I don’t see Blackstone winning this one in court. Slimebuckets

holdbuysell Thu, 01/11/2018 - 23:08 Permalink

ISDA put a fork in that farce a decade ago. Whatever comes next is buyer/seller beware, knowing that the GS of the world will not be denied their payout regardless of their position.

What side are you one?