If earnings reporting wasn't painful enough for public home builders these days, the sector's flailing financial news is now attracting high-risk investors like chum lures sharks.

In an 8-K filed on Nov. 6, the same day the company released 3Q2006 financials, Dublin, Ohio-based Dominion Homes disclosed that hedge funds control 73 percent of its bank debt—strongly implying that little equity remains.

Hedge funds are high-risk/high-return vehicles with little regulation. The huge flow of capital into hedge funds–which are estimated to manage assets of around $1 trillion–has sped a proliferation of new fund managers, forcing hedge funds to diversify into new sources of return.

An evolving iteration of these vehicles appears to focus on event-driven circumstances like merger arbitrage and distressed debt. “Quite a few banks … have been selling loans [on] companies that are [already] in trouble, or are on their way, to hedge funds, and they're getting pretty good prices for them,” says a hedge fund source.

Distressed-debt funds take positions in the debt of a financially troubled company, often to influence financial restructuring by exercising creditors' rights.

In fact, if any covenant of the financial terms is breached, a hedge fund can demand full payment, pocketing a quick profit. Plus, if the fund sets itself up in the stock market to short the stock, it can double the bang for its buck. Demanding a loan repayment, the fund forces distressed companies to liquidate, presumably sending the stock price plummeting.

Dominion has struggled for the past 12 months to meet hefty financial obligations while battling litigious buyers, HUD violations, operational woes, and tough market conditions in Ohio and Kentucky. An oversupply of owned land and a miniscule backlog mean continued woes.

Sources around the Dominion transaction report that the aggregate lender commitments, which totaled approximately $213 million on Oct. 31, 2006, were sold for $0.90 to Field Point and Silver Oak Capital.

According to the 8-K, “two commercial banks continue to hold the remaining 20 percent of the lender commitments under the Credit Agreement, as amended. The Amendment was approved by the required two-thirds majority of the participating lenders after the execution of these assignments.”

“I'd be surprised if there was a hedge fund out there that hasn't been looking at home builders,” says another hedge fund source. “A lot of them have probably shorted or longed them, too.”