Hovnanian's Latest Move to Cash In on CDS Fails to Take Off

(Bloomberg) -- Hovnanian Enterprises Inc. has failed at its latest effort to get cheap funding from hedge funds that stand to reap windfalls in the credit derivatives market, after a U.S. regulator said it was looking at these kinds of transactions.

The homebuilder said Monday it failed to meet the minimum conditions to swap outstanding notes maturing in 2022 and 2024 for new bonds with a 3 percent coupon maturing in 2047. It needed bondholders to agree to exchange at least $50 million of notes by May 11 to meet a threshold under an exchange agreement.

The exchange was the company’s second attempt to ease its debt burden by manufacturing a payout for hedge funds that were betting it would default. Late last year, it agreed to refinance debt with Blackstone Group LP’s credit unit, GSO. That deal included an agreement for the homebuilder to default on some of its debt to allow GSO to cash in on $333 million of credit default swaps, which pay off when a company defaults on debt.

Low-Priced Debt

As part of last year’s deal with GSO, the company agreed to create low-priced bonds through a debt exchange. Those securities were crucial for ensuring a payout for the hedge funds and others that had bought credit default swaps. This latest exchange would have created even lower-priced securities that would have given GSO, or any other investor that had bought CDS, an even bigger payout on those derivatives.

The manufactured defaults that were part of the GSO deal have drawn scrutiny from the Commodity Futures Trading Commission, which has warned market participants that it is keeping an eye on such events and could take action. The International Swaps & Derivatives Association has said it’s working with investors to seek a fix.

Hovnanian's Latest Move to Cash In on CDS Fails to Take Off

Investors appeared to have been spooked by the CFTC announcement. On April 24, Hovnanian said $50 million of bonds had been tendered in its latest exchange offer. Later that day, the CFTC said it was scrutinizing manufactured defaults. The next week, the homebuilder reported that just $6 million of the debt had been turned in, implying that holders who had planned to do the exchange had since withdrawn from the swap.

“Seemingly, players involved in the CDS market do not want regulators breathing down their necks and would prefer a well-functioning, self-regulated market,” CreditSights analysts Nathan Wenger and Glenn Reynolds said in a report Monday.

Extended Deadline

Hovnanian extended the deadline three times and boosted fees to holders as it sought to swap $440 million of its 10 percent secured notes due 2022 and $400 million of it 10.5 percent bonds due 2024 for 3 percent bonds due 2047. To win over holders in the latest exchange offer, Hovnanian was offering $1,400 of principal in the new debt for every $1,000 of the old bonds.

In a statement, company spokesman Ethan Lyle said: “The company continually evaluates opportunities to improve its capital structure and further strengthen the business, including the most recent exchange offer, as Hovnanian believed there was market interest in providing the company with additional favorable financing. The company is in solid financial condition and its previously closed refinancing transactions with GSO remain unaffected.”

Solus is still fighting GSO’s original refinancing in court in a case GSO has asked to be dismissed. A judge will hear arguments over the dismissal on July 11 in New York.

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