Patriarch Partners, led by Lynn Tilton, filed suit on Monday against monoline insurer MBIA over three CLOs that trade at distressed levels. MBIA is responsible for insuring the entire principal and interest of the first two deals, which were issued in 2003 and 2005.
Patriarch is suing MBIA because it believes they were duped by the insurer into purchasing the A3 tranche of the Zohar I CLO in March of this year for $103.9 million as a condition for MBIA extending the upcoming maturity of the CLO. The previous holder of the A3 did not consent to an extension or restructuring of the CLO. The Zohar I is scheduled to mature on November 20. Patriarch had been negotiating with MBIA for some time to have the maturity date extended until January 20, 2017, when the Zohar II is also expected to mature, according to the suit.
A holder of the A3 notes on the Zohar I had previously auctioned the notes in March, and Tilton had informed MBIA that she would bid on the notes to clear the noteholder who was an impediment to the extension.
Patriarch then alleges days after the firm purchased the notes, MBIA backed away from an extension.
Patriarch’s attorneys argue that MBIA conducted an “elaborate ruse,” as the insurer never intended to an extension but rather made such an offer in order to get more of Patriarch’s money and gain leverage in further negotiations around a restructuring of the Zohar I and Zohar II CLOs.
Lawyers representing Patriarch acknowledge the difficulty the Zohar I currently faces in repaying noteholders. “The financial crisis hit the portfolio companies hard and as a result the turnarounds did not happen as quickly as had been anticipated. More time beyond the stated maturity date of Zohar I was going to be needed to create value and pay off the notes,” the attorneys for Patriarch stated. Moelis & Company was hired by Patriarch in October 2013 as a restructuring advisor to work out an arrangement between Patriarch and MBIA.
The collateral in the Zohar CLOs is much different from the issuers that are often widely syndicated in the CLO market. The companies issuing the loans are all Patriach’s portfolio companies, and include a helicopter company, fire engine company, military armored vehicle company, building supplies manufacturer, and an imaging company among many others. Those loans have then been securitized into the Zohar CLO vehicles, since Patriarch is also the collateral manager and equity holder. In the instance of a default though, MBIA would become the controlling party, according to the governing documents of the CLOs.
The complaint says MBIA was reluctant to offer an extension because the insurer still lacked “full and unfettered access to information regarding the collateral and the borrowers,” which an executive at MBIA had written to Tilton in April.
A spokesperson for MBIA stated that the firm was “disappointed by Ms. Tilton’s effort to deflect blame and attention from her own performance and legal issues,” arguing that this complaint filed is “littered with false statements.” MBIA did acknowledge though that it would honor any payment obligations associated with the upcoming maturity of the Zohar I.
The SEC also brought fraud charges against Tilton and Patriarch on March 30 over the firm’s valuation of its portfolio companies loans. “Nearly all valuations of loan assets have been reported to investors as unchanged from the time they were acquired despite many of the companies making partial or no interest payments to the funds for several years,” the charges from the SEC allege.
MBIA currently insures $151 million in Zohar I and $808 million in Zohar II as of June 30, according to Moody’s analysts on October 9. Moody’s analysts however believe that MBIA would benefit from the Zohar I and II CLOs defaulting and taking control of the assets. “A default would trigger MBIA gaining certain rights and authority over the notes, which would see them in a better position to take steps to mitigate their losses,” the analysts wrote. Moody’s had previously placed MBIA on negative watch outlook due to its exposure to the Zohar CLOs on March 2015.
While losses from a default on the Zohar I are expected to be “manageable,” according to Moody’s, the larger liability from a default on Zohar II could greatly hurt its capital position. This also comes as the insurer is set to deal with other distressed issues in its municipal bond portfolio related to Puerto Rico.
While little to no public information exisst on the underlying loans of the Zohar CLOs, the notes still trade in the secondary. The third Zohar CLO issued in 2007 is the most actively traded, and the senior-most A1 tranche has been quoted around the low 60s with yields varying wildly between the mid-teens to above 30% depending on timing of payments, according to estimates from dealers. But a number of investors were wary as those implied yields assume that the CLOs would not get extended. The A2 tranche on the wrapped Zohar II had recently been quoted around the 81 area.
A spokesperson for the plaintiff Patriarch Partners declined to comment further. — Andrew Park
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