This time, the bank's credit trading desk has been drawn into a fierce battle waged by hedge funds over the debt of major US homebuilder Hovnanian Enterprises Inc. The fuse was lit by GSO Capital Partners, the credit arm of Blackstone Group LP, which tried to persuade the homebuilder to accept a bond refinancing plan. GSO's plan would trigger default insurance it bought in the credit derivatives market.
What is Goldman's problem? According to people familiar with the matter, Goldman has accumulated credit default swap and bond trading positions totalling about $200 million and may have to bear part of the payout liability on the default insurance. As the battle enters a critical phase, Wall Street giants are staring each other down, each hoping to influence the homebuilder's next move.
It is exactly this kind of situation that has put Goldman's appetite for risk in the spotlight. The bank has been grappling with declining trading revenue across financial markets, a problem that magnifies its mistakes. Its main business still comes from hedge funds rather than peers, and it sometimes invests alongside clients.
Sometimes that brings huge returns - and sometimes it leaves Goldman dealing with losses other banks would find hard to stomach.
Representatives of New York-based Goldman Sachs Group, GSO and Hovnanian declined to comment.
*Debt burden*
Goldman's trading on Hovnanian has been led by Adam Savarese, a partner and head of distressed debt trading. In 2016, his first full year at Goldman, he racked up a string of wins, but some trades later ran into trouble.
At the heart of the Hovnanian dispute is the homebuilder's attempt to get its $1.6 billion debt burden under control. The company has some bonds maturing in a year. According to people familiar with the matter who asked not to be identified because the information is not public, Goldman initially helped a group of investment firms put forward a refinancing proposal suggesting Hovnanian issue new bonds with an 11.5% coupon.
Then Blackstone came up with what it called a better deal, but with an unusual condition attached: Hovnanian must agree to do it in a way that triggers credit default swaps, which are essentially one-way bets on whether the homebuilder will honour all of its debts. That would let GSO make a quick profit, since it has been buying short-term insurance contracts.
*Weighing carefully*
Hovnanian is still considering its options. In a letter to employees, according to a copy seen, the company said it intends to adopt the most favourable financing approach to preserve flexibility.
People familiar with the matter said the options facing the company include the original proposal from investment firms led by Goldman and Solus Alternative Asset Management. These investors have been urging Hovnanian to reject GSO's proposal, saying it risks embroiling the company in litigation with creditors. Goldman has also been lobbying the company through its lawyers at Cleary Gottlieb, the people said.
Peter Grauer, chairman of Bloomberg LP, is a non-executive director of GSO's parent Blackstone.
*Earnings call*
Hovnanian may reveal more when it reports results on 21 December. People familiar with the matter said that even if Hovnanian sides with GSO, simply delaying a decision could help Goldman contain its losses. That is because most of the default insurance Goldman sold expires on 20 December.
According to people familiar with the matter, one hurdle was cleared on 1 December when Hovnanian repaid maturing debt. If no default event occurs within the next two weeks, the December credit swaps will expire without payment.
Outside the derivatives market, the situation has caused little anxiety. Although credit rating agencies consider Hovnanian's bonds risky, their prices remain mostly above par.
Source: Youcai.com 2017-12-11