11/06/2009

Marathon Raises Eyebrows With CLO Re-Buy

Marathon Asset Management pocketed millions of dollars over the past few months by buying back securities from a collateralized debt obligation it issued in 2005 and then retiring them at higher prices.

The move has rankled market players. They say the tactic is untoward at best - and illegal at worst - as it was based on allegedly concealed information and could result in losses for junior bondholders.

The deal in question is Marathon CLO 1, which had an original balance of $330.1 million spread among several senior and junior classes. At some point this year, Marathon repurchased most or all of the issue's triple-A-rated senior notes from Bank of America at prices that industry participants peg at 85 cents on the dollar.

At the end of September, the New York firm, in its capacity as the CLO manager, started liquidating the transaction's underlying leveraged loans with the intention of using the proceeds to retire the repurchased senior classes at par. That money started flowing to Marathon on Oct. 26.

The CLO had two senior classes with a total face value of about $245 million, little of which had previously been paid off. The quick turnaround netted Marathon more than $40 million, by some estimates.

Where does that leave junior investors? According to a report issued by trustee Bank of New York on Oct. 16, Marathon liquidated about two-thirds of the remaining collateral for the deal - assets with a face value of almost $219.2 million - from the end of September to the middle of October. The sales brought in almost $200.7 million.

That means other bondholders could wind up eating the difference of roughly $18.5 million, at a time when asset-performance troubles have already cut into the deal's credit cushions. As of Oct. 16, loans with a face value of almost $102 million remained in the collateral pool.

The deal still has $73.2 million of outstanding junior and mezzanine obligations.

To orchestrate an asset sale as large as the one Marathon pulled off, a CLO's manager has to justify its actions. According to the Bank of New York report, Marathon referred to one of three justifications for most of its moves: credit risk, improved credit profiles or manager discretion.

However, one market player said the maneuvers could result in accusations of insider trading, as Marathon knew it was going to retire the deal's collateral before it bought back the senior notes. "This smells bad," he said.

Others said insider-trading charges are unlikely, but that the firm could be held accountable for shirking its responsibility as manager to act in the interest of all noteholders. "It means they screwed all the junior guys," another source said, adding that it wouldn't be surprising to see lawsuits from some investors.

The theory is that if Marathon hadn't accelerated payments on the senior securities, lower classes would have a better chance of getting all their money back.

A source close to Marathon said the firm acted appropriately and with the full permission of its legal department. The firm, known as a savvy debt investor with $10 billion under management through a variety of vehicles, has issued seven collateralized debt obligations overall. Those deals, all completed in 2005 and 2006, had a combined face value of $3.2 billion, according to Asset-Backed Alert's ABS Database.

Marathon CLO 1 priced on March 31, 2005, with Merrill Lynch serving as bookrunner.

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