Marathon Asset Management is returning to the CRE CLO market for the first time since 2006. Its new transaction has some features that have fallen out of favor since the financial crisis.

The $470 million Marathon 2018-FL1 is initially backed by 16 loans with an aggregate balance of $333.9 million. The sponsor has 120 days to put the additional $136.1 million it is raising to work, and to date it has only identified three of the assets it plans to acquire totaling $43.1 million, according to rating agency presale reports.

In other words, investors aren’t sure exactly what they are signing on for.

In addition, the CRE CLO has relatively broad leeway to use proceeds from the return of principal on its existing assets to acquire new, as-yet unidentified assets over the first two years of the transaction, subject to certain eligibility criteria.

Both of those features, known as “blind ramp” and “blind reinvestment,” have become rare. The majority of CRE CLO issued after the financial crisis are not actively managed.

The initial mortgage assets consist of 15 pari passu participations (66.4%) and four whole loans (33.6%). Each pari passu participation has a related companion participation that represents an unfunded future advance obligation. The future advance obligations have an aggregate balance of $72.8 million and are held outside the trust by the seller. One of these assets ( the fourth largest, at 8% of the collateral pool) also has a funded companion pari passu participation held outside the trust by an affiliate of the seller.

The related loan proceeds were used to refinance existing debt (eight loans, 48.5%), property acquisitions (10 loans, 35.1%) and recapitalization (one loan, 16.4%).

Still, the new deal is a far cry from the $1 billion that Marathon issued in 2006, which was called a CRE CDO (for collateralized debt obligation) because it contained a far broader range of assets, including senior and subordinate commercial real estate loan, subordinate commercial mortgage bonds, the debt of real estate investment trusts, and “other non-CRE collateral,” according to Kroll Bond Rating Agency.

The rating agency doesn’t indicate how Marathon’s earlier deal performed – many pre-crisis CRE CDOs sustained big losses – except to say that the preferred shares issued in the deal are still outstanding. The notes have all been repaid.

“Despite its limited CRE CLO management experience, the firm is an experienced CRE lender and Marathon’s senior real estate team members have an average of over 22 years of industry experience and 12 years at Marathon,” the presale report states.

Kroll notes that both the ramp and reinvestment features “can lead to negative credit migration, as well as increased concentration and the presence of subordinate debt over the term of the securitization.” It said this risk is “partially mitigated” by the eligibility criteria, which include minimum loan-to-value and debt service coverage ratios and property type and geographic concentration limitations.

Kroll also sees a potential upside t ongoing, pro-active management of the assets, particularly in times of distress. The CRE CLO can sell defaulted assets throughout the life of the deal to itself, its affiliates or third parties. It can also exchange defaulted assets for assets owned by its affiliates, provided the exchange asset satisfies the eligibility criteria.

The presale report does not state whether Marathon is obliged to do so, however.

Kroll considers the initial collateral to be “highly leveraged” with a weighted average in-trust LTV, as measured by Kroll, of 121.7%. However, this is “modestly below” the average (122.5%) of the 14 prior CRE CLO transactions rated by KBRA over the past 12 months.

Another potential red flag is the transaction’s relatively high exposure to lodging exposure represents 30.2% of the initial pool balance. That’s well above the average of 12.3% for the comparable set. Kroll generally views hospitality properties unfavorably, as these assets tend to have more volatile cash flows than other property types due to their dependence on nightly room rates. The pool’s current lodging exposure consists of four full-service hotels (30.2%), only one of which is national brand-affiliated. Two of these (21.4%), Freehand New York (largest, 16.4%) and Freehand Miami (8th largest, 5.7%), contain “non-traditional bunk style sleeping arrangements targeting a specific travel demographic.”

Both Kroll and Moody's Investors Service expect to assign triple-A ratings to the senior tranche of notes to be issued; Kroll alone is rating the subordinate tranches.

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