Blackstone Had One Odd `Daily Show' Moment. Another Looms.

(Bloomberg) -- It’s the sort of Wall Street maneuver that may get its moment on "The Daily Show."

In fact, it has.

Back in 2013, Jon Stewart, the show’s host at the time, pilloried Blackstone Group for enticing Spanish gaming company Codere SA to delay an interest payment and trigger payouts on its credit-default swaps. Blackstone shot back, saying the “funniest guy on TV” had misunderstood how its move had actually helped keep the company afloat.

Now, a similar story is emerging. Only this time, the company at the center of the credit-swaps tussle is the big U.S. homebuilder Hovnanian Enterprises Inc.

Blackstone’s GSO has discussed a plan that would refinance some of the company’s debt, but with an unusual provision that could trigger payouts on CDS contracts that GSO purchased, according to people with knowledge of the matter.

Rival Group

The New York investment firm is pitted against a rival group of hedge funds, many of which sold credit-default insurance to firms like GSO and are looking to save their own bet by derailing the Blackstone unit’s plan. Led by Solus Alternative Asset Management, the group has offered to prop up the company with a debt deal of its own, which it says is more in line with market rates, the people said.

Representatives for Solus, GSO and Hovnanian declined to comment.

As recently as last month, there were more than $660 million outstanding credit-default swaps wagers on whether Hovnanian will default. That’s more than a third of Hovnanian’s $1.7 billion debt load. 

Sometimes the trades are made by firms hedging existing positions, other times they’re pure speculation. But as the outstanding wagers swell, they can exert a greater influence on a company’s future. And at a time when high-yielding opportunities have become few and far between, the Hovnanian play has attracted a Who’s Who of Wall Street trading powerhouses.

An Apollo Global Management hedge fund is said to be among those that have bought up front-end CDS and could stand to profit if the credit swaps are triggered, people with knowledge of the matter said. And investors like CQS UK LLP are among those that have held positions on the other side of the trade and could stand to lose along with Solus if the swaps are triggered, the people said. 

Other firms that have been involved in Hovnanian credit trades include Ken Griffin’s Citadel LLC, Goldman Sachs Group Inc. and BlackRock Inc. the people said. Representatives for the firms declined to comment.

Surging CDS

Amid the maneuvering, the battle has sent the price of Hovnanian’s default insurance surging to levels that signal a high risk of imminent default -- even though the company’s stock and bonds show no hint of panic.

The erupting battle offers another look at how credit derivatives -- which have no legal bearing on Hovnanian and have essentially become high-stakes side wagers by hedge funds, banks and other sophisticated investors -- can end up influencing companies’ finances. Hovnanian has to labor over the proposals at hand as it battles declining sales, deteriorating credit metrics and a daunting debt maturity wall sneaking up on it.

An investor may "take a position as a speculator and you’re not only speculating, you’re looking to exert some sort of pressure on the operating company,” said Darrell Duffie, a finance professor at Stanford University who who has written about how credit default swaps can affect borrowers.

Cheaper Financing

To be sure, Hovnanian has an obligation to its investors to pick the best financing option available to it, regardless of how it affects the derivatives markets. The company has previously said it has received various debt refinancing proposals but hasn’t been happy with the interest it would have to pay on the new debt and is exploring alternatives.

According to the people with knowledge of the matter, GSO has been buying protection against default in the near term on Hovnanian’s debt. Peter Grauer, chairman of Bloomberg LP, is a non-executive director at GSO’s parent Blackstone.

GSO has offered to provide the homebuilder with relatively cheaper financing on terms that would fit the definition of a credit event in credit-swaps contracts.

One theory among market participants is that at least a portion of the new debt would be structured with a low coupon, which would cause it to trade at a low price in the secondary market. Such a move would allow the holders of the CDS to deliver that discounted security in a settlement auction. The lower the price is set in that auction, the higher the payout for investors that bought the swaps.

Despite buying up front-end protection, GSO still has a net long position on the company’s debt, according to one of the people. The hedge fund has a given lifelines to the homebuilder before-- in 2012 for example, it agreed to buy a group of housing development sites from Hovnanian and sell them back to the company over time.

--With assistance from Nabila Ahmed

To contact the reporters on this story: Sridhar Natarajan in New York at snatarajan15@bloomberg.net, Katherine Burton in New York at kburton@bloomberg.net, Lisa Abramowicz in New York at labramowicz@bloomberg.net.

To contact the editors responsible for this story: Rick Green at rgreen18@bloomberg.net, Shannon D. Harrington, Dan Wilchins

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