The "key-man" covenants in Asset Allocation & Management Co.'s (AAM) Diversified Asset Allocation Holdings (DASH) SF CDOs have allegedly been breached after the founders of AAM's CDO business left the firm. JPMorgan Chase, the trustee on DASH I and DASH II, received notice that key-men covenant breaches had occurred on June 4 and June 10, respectively.

The three key persons to leave were principal Patrick Livney, ABS head trader and portfolio manager Larry Zeno, and portfolio manager Kathy Lang. Instead of jumping ship to another firm, the three are starting a new company, Meritus Asset Management, which will focus on structured finance, collateral management, and CDO issuance.

Reportedly, the three expatriates won a lawsuit last week filed by AAM against them and an investor. The decision will allow the former team to compete for management of the three DASH CDOs. The DASH CDO investors now have approximately one month to approve the replacement of the new ABS portfolio management team that AAM has recruited from .

As of press time, one CIO at an asset management firm holding DASH II bonds reported that his firm hasn't yet received notice of a vote. If two-thirds of the investors in any of the DASH CDOs do not approve the new key-person team, a second vote will go to the equity investors to select a new team, or at the extreme, a replacement collateral manager - an uncommon event. If the vote to replace AAM goes to the equity holders, Zeno and Livney will be able to participate since they own some of the equity in the deals.

Zeno's replacement as lead structured finance portfolio manager is Scott Edwards, who helped to bring approximately 12 people over from Skudder. Interestingly, Edwards' Bloomberg message screen reads: "Have you hugged your portfolio manager/trader today?"

But not all investors are ready to give out hugs. One investor said that he - among others - feel that the AAM CDO management team's ABS experience is heavily weighted toward the triple-A end of the capital structure. This could be a concern, considering that between the three DASH CDOs there are 200 various ABS issues - the vast majority of which are triple-B and some of which are distressed. One $7.8 million franchise ABS position in Global Franchise Trust within DASH I has experienced a technical default due to an approximate $1.2 million write down of principal.

DASH I, however, is not on ratings watch. Each of the DASH deals had a 12.5% limit on each asset class. Another frustration expressed is that that information on who the other investors are in the deal has not been made available to bond holders (which is not unusual), and that information on the developing situation has been hard to come-by.

Meanwhile, sources report that DASH bonds are offered in the secondary market, but one European investor said that there are no visible bids. Offers would be at discounts, and the older the deal the bigger the discount. However, this is not unusual for ABS CDOs, since these deals rarely trade.

While a strong desire to replace the manager may be present, doing so is extremely difficult - the decision is often fought given the lucrative management fees involved (50 basis points per annum in the DASH deals) and the reputation damage a collateral manger would sustain if they had a deal pulled from them.

Additionally, once a new team or key people are replaced, proving someone's resume is unworthy to manage a deal is difficult, and cooperation from the collateral manager is unlikely since they may not know who all the investors are and have little incentive to do so.

Rating sources said that since they are not directly involved in the transactions, they will not step-in to resolve any disputes between the investors and the collateral manager - although they will continue to monitor the performance of the outstanding CDOs. Note that none of the DASH deals are understood to be on ratings watch.

Rating sources also noted that the experience level of new CDO management teams is subjective, and that assessing the relationship between performance and management background is far from any science. To many, replacing a manager is more trouble than it is worth and is indeed a rare event, despite some horribly performing transactions.

Once a deal hits triggers and trading restrictions kick in or the reinvestment period ends, many will argue that replacing the manager would not accomplish much. Certainly from the existing collateral managers point of view, keeping the deals at an approximate 50 basis point per annum fee schedule is something worth fighting for - particularly considering that Asset Allocation has USD1.15BN in CDOs from DASH I, DASH II, DASH III.

The other principal members to leave AAM that are expected to play a role in Meritus AM are ABS portfolio mangaer David Ortiz and ABS surveillance expert Ben Safanda. Peter Mavrogenes, a founding partner and chief investment officer, also left AAM this Spring, but he was not directly involved in the CDOs.

AAM manages approximately $10 billion in assets, of which more than $5.6 billion represent structure finance securities. The firm has over 150 institutional clients, with a focus on insurance companies.

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