Whole business securitizations are supposed to insulate investors from corporate mismanagement. They hold bonds issued by a bankruptcy-remote trust that purchases the company's assets, rather than debt issued by the company itself.

A fight for control of Harley Marine Services, which closed a $455 million whole-business securitization less than two months ago, is putting this idea to the test — and spooking bondholders in the process.

The legal fight over the petroleum transport and bunker service specialty firm pits founder Harley Franco against the Seattle-based company’s minority private equity investor Macquarie Group. In a lawsuit filed on July 2 in Delaware, the Australian-based financial giant accused Franco of embezzlement and fraud — and Harley Marine successfully gained the support of the firm’s chief operating officer in voting to unseat and remove Franco in order to sell the company.

Franco countersued in Washington state, accusing Macquarie and COO Mark Godden of breaching their fiduciary duties in trying to oust Franco. Franco won a temporary restraining order in the Washington court that restored him to his role as chairman and CEO.

Harley Marine

Franco argued in his lawsuit that the courtroom tussle has threatened to disrupt customer and banker relationships for the company. It already has impacted the two classes of notes that were offered in a securitization that priced in May.

Some investors have taken flight, unloading their bond holdings, which are now trading at a discount to face value as a result, according to Kroll Bond Rating Agency, which issued a statement Thursday meant to reassure investors. The Class A senior notes, which have a weighted average life of 3.8 years and are rated BBB by Kroll initially priced at 101 of face value and pay N + 275 basis points (for an initial yield of 5.75%). They are now trading at 384 basis points over the benchmark.

Likewise, the Class B notes, which are rated BB and have a weighted average life of 2.0 years, initially priced at 102 of face value and pay 394 over the benchmark; they have fallen to 97 cents on the dollar, resulting in an effective spread of 703 basis points.

“[A]t this point, nothing indicates that credit risk in the transaction has increased,” Kroll stated in its report. It said the company is operating “as usual” and the latest servicer report showed a “robust” securitization cash flow that provided an interest coverage ratio of 2.44 x — “well above” the 1.75x trigger that would require proceeds to be diverted toward paying down the notes early.

“It is possible that the negative headlines and/or change in management could cause some clients to cancel their contracts with HMS or employees to leave the company,” the report states. However, “currently, we do not view this as a likely outcome.”

A management change and sale by Macquarie could trigger a change-of-control event that would set in motion early amortization if Franco’s holdings fall below 20% after his ouster and Godden remains as a director or officer, according to Kroll. (Also, if a new management team of at least four executives is in place with or without Godden on board, the early payoff requirement could occur after six months.)

A rapid amortization would bring some reinvestment risk for original bondholders, Kroll noted, “but should not otherwise affect returns. However, for those investors who purchased the bonds in the secondary market at a discount or premium, returns could be greatly enhanced or reduced.”

Kroll stated it expected “further clarity” by the end of the week on how the lawsuit would proceed due to the two different jurisdictions involved in the dispute.

In Macquarie’s original lawsuit, the PE firm alleged it found through an audit that Franco had misappropriated over $3.6 million of assets and funds to pay personal expenses. According to the Seattle Times, Franco’s response argued that “contrary to Macquarie’s allegations, Harley Marine 'is highly profitable and Franco is not at all in a strained financial position. In fact, Franco has a net worth of over $200 million.’ ”

Harley Marine’s whole-business securitization involved the proceeds from contracts on the operation of 122 vessels owned or leased by Harley (61 barges and 61 tugboats) that maneuver between nine ports in Alaska, the East and West Coasts and the Gulf of Mexico. The company had $189 million in revenue in 2017 and $45 million in earnings, according to a securitization presale report from Kroll. (Earnings declined for two consecutive years from a peak $50 million in 2015.)

Franco founded the company in 1987 as a full-service marine logistics company involved in bunkering, fuel terminal transportation, ship assist and escort, harbor and contract services and terminal services.

Harley’s long-term customers include major petroleum firms such as Phillips 66, Andeavor (formerly Tesoro), Chevron, Shell and BP. Most of its contracts are one-to-five-year “time charter” contracts in which the company pays for costs of operations except for moorage and fuel expenditures.

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