Management overhaul fails to quash downgrade risk for Harley Marine

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A whole-business securitization sponsored by Harley Marine Services could be downgraded for a third time, despite the resolution (at least for now) of a power struggle inside the Seattle barge services firm.

Kroll Bond Rating Agency said this week it will maintain the downgrade watch it has for Harley Marine Financing LLC Series 2018-1 even though a new controlling ownership entity sponsored by Macquarie Capital and Arclight Capital Partners has installed new senior management and a new board of directors.

The original $436.5 million deal that closed in May 2018 has already been downgraded twice primarily because of a yearlong legal fight between founder and former Chief Executive Harvey Franco and Australia-based Macquarie.

The barge services firm remains mired in costly multiple lawsuits, according to Kroll, including those with Franco as well as a shipbuilder who claimed in a lawsuit filed in 2017 the company reneged on the purchase of two tugboats. The company has also taken on additional debt that puts more stress on the trust’s ability to repay the full principal and interest of the outstanding securities.

“In the event the elevated operating expenses experienced during the management litigation and transition manager periods continue, further rating action could be taken,” Kroll’s report stated, spelling out conditions for a possible downgrade.

The clash over control of Harley Marine occupied the company during the second half of last year. In a July 2018 civil lawsuit, minority shareholder Macquarie had accused Franco of misappropriating company funds and charging personal expenses to the firm, while Franco alleged in a countersuit that then-minority stakeholder Macquarie and another management executive of trying to oust him over his opposition to selling the company.

Efforts by Macquarie to remove Franco failed in 2018, but in January this year Franco announced he had voluntarily relinquished operational control of the firm to Chief Operating Officer Matthew Godden, who had supported efforts by Macquarie to boot Franco. Four months later, Harley Marine issued a release stating Franco had been terminated as CEO and that Godden would succeed him.

Franco has subsequently filed suit for wrongful termination, according to Kroll, adding to the stack of legal actions affecting Harley Marine.

The notes under watch involve two tranches of Class A-2 senior notes and Class B subordinate notes totaling $436.5 million, close to the original $455 million notional value of the bonds sold in May 2018.

Kroll has previously downgraded the outstanding notes twice. The Class A-2 notes issued with a BBB rating at closing were revised to a lower BB rating in November 2018, and in March were further downgraded to BB-. The Class B notes fell from the original BB rating to a current B-.

Kroll has indicated in past reports it does not consider the notes in jeopardy of default, but did caution that publicity from the management dispute could lead to cancelled contracts or other business-related issues that would affect cash flow needed to pay down the notes. Last November, Kroll reported the agency did not “view this as a likely outcome.”

The bonds remain secured by all of the assets of Harley Marine, including all income from the company’s lease, freight and leasing agreements, intellectual property and ownership of the original 122-tugboat fleet placed into the master trust. The trust pays Harley Marine to operate and manage the fleet, similar to a sale-and-leaseback agreement, but the deal is structured as a whole-business securitization more typical of highly leveraged franchised companies.

Kroll’s report stated the new management will be looking to continue reducing operating expenses, which totaled an unpaid balance of $13.89 million as of the September servicer report. While revenues have been sufficient to cover interest payments on both tranches as well as scheduled principal on the Class A-2 notes, “the operating expenses continue to be high due to cashflow timing at the Manager level as it relates to outstanding payables,” the report said.

But “the instability at the management level has subsided, and there is a working corporate governance structure in place,” the Kroll report stated. “If the new management structure in place can at least maintain the revenue levels experienced, as well as return operating expenses to levels where the Class B Notes begin amortizing, it is likely no further rating action will be taken."

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