Goldman, Blackstone Make Peace in Credit-Derivative Standoff
May 24 2018 - 1:41PM
Dow Jones News
By Liz Hoffman and Andrew Scurria
Goldman Sachs Group Inc. and Blackstone Group LP recently
resolved a monthslong standoff over a controversial derivatives
trade that had alarmed regulators and investors in the $11 trillion
credit-default swaps market.
The Wall Street giants had taken opposite sides of a bet on
bonds issued by home builder Hovnanian Enterprises Inc. The trades,
engineered by Blackstone's GSO Capital Partners LP, involved the
home builder intentionally skipping a small interest payment
earlier this month in exchange for an attractive financing package
from the private-equity house.
Blackstone had bought insurance against a default, which would
allow it to make money from the skipped interest payment. It bought
this insurance, through what are known as credit-default swaps,
from Goldman and others. This put Goldman at risk of losing
money.
Goldman and Blackstone last week effectively zeroed out the
trade between them, with Blackstone agreeing to assume Goldman's
position, people familiar with the matter said. Goldman is now off
the hook for a payout that could have run tens of millions of
dollars, and Blackstone reduces its exposure to a wager that has
become increasingly fraught.
Investors have howled that the maneuver was underhanded, while
U.S. regulators issued a stern warning against "manufactured"
defaults, which was widely seen as aimed at Blackstone. Hovnanian
had the funds to make the interest payment that it missed and isn't
in dire financial straits.
The concern is that defaults engineered for profit could corrupt
the $11 trillion CDS market, which serves as a source of investor
protection and an informal gauge of the debt issuers' health.
Bloomberg News earlier reported that Goldman had sold its
position, but didn't identify the buyer.
The trade was complicated in another way: It pitted Goldman
against Blackstone, one of the bank's largest clients. Blackstone
paid Goldman $165 million in fees from 2014 to 2016, according to a
regulatory filing, and Goldman's private bank funnels clients'
money into Blackstone funds.
The trade came up in discussions between Goldman CEO Lloyd
Blankfein and Blackstone President Jonathan Gray and in
conversations between Goldman's No. 2 executive, David Solomon, and
GSO chief Bennett Goodman, a longtime friend, according to a person
familiar with the matter.
Credit-default swaps emerged in the 1990s as a way for
bondholders to protect themselves against a default. But they soon
became an instrument of naked speculation, allowing investors to
bet against a company's debt much the way they can sell short its
stock. Some blamed them for adding fuel to the financial
crisis.
The Hovnanian tussle has raised a new concern among investors
and regulators that the market is vulnerable to manipulation. They
worry Blackstone's strategy could tempt more corporate borrowers to
strike side deals with lenders and skip payments they could
otherwise afford to make.
Solus Alternative Asset Management LP, which also sold
protection on the Hovnanian bonds, has filed a lawsuit against the
Blackstone unit that engineered the trade, accusing it of
orchestrating a "sham default." An executive of Canyon Partners
LLC, a hedge fund that invests in distressed debt, called the
maneuver "unseemly" in public comments last month.
The Commodity Futures Trading Commission warned in April that
"manufactured credit events" could "severely damage the integrity"
of the market.
That warning, along with a growing chorus of complaints from
other investors and counterparties, led Blackstone to reduce the
size of its trade, a person familiar with the matter said.
Blackstone has said it would support "appropriate changes" to
credit-default swap contracts, an acknowledgment of the regulator's
concerns.
Write to Liz Hoffman at liz.hoffman@wsj.com and Andrew Scurria
at Andrew.Scurria@wsj.com
(END) Dow Jones Newswires
May 24, 2018 13:26 ET (17:26 GMT)
Copyright (c) 2018 Dow Jones & Company, Inc.
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