Orb Group negotiations to sell off the U.K. hotels backing its HOTELoC deal are underway. A spokesman at Morgan Stanley confirmed that the deal should reach due diligence by next week at the earliest.

Moody's Investors Services placed the HOTELoC deal under credit watch in early March following a fraud investigation concerning the Orb Group. An investigation by Ernst & Young and Morgan Stanley found an £11 million shortfall in the cash flows. The company also signaled at the time its plans to exit the hotel business.

Concerns expressed by Moody's at the time concentrated on how the new owner would make use of the Hotel properties. The agency's initial ratings on the class D and class E notes were based on the ownership potential of three of the largest properties included in the portfolio located in London. The properties were originally slated for conversion into high-end apartments.

With ownership change, Moody's said that it would have to monitor future plans. The agency also expressed concerns over the £11 million shortfall and said that the cash would have to be repaid higher up in the waterfall. Moody's added that if these missing funds were not accounted for in a timely fashion, the borrower would be considered in breach of its obligations under its operating credit agreement with Thistle Hotels.

At press time, the spokesman at Morgan Stanley said the group was close to a deal with Andrew Ruhan, the chairman of PSINet. According to market sources, the sale price is at £652 million, and it's understood that Ruhan would assume the outstanding securitization debt. Ruhan would also replace the GBP11 million in funds gone missing. Dresdner Kleinwort Wasserstein reported that the transaction would involve Ruhan's assumption of £531 million of debt from Orb and payment of overdue obligations. Ruhan would also pay Morgan Stanley the £17 million the bank is owed for a bridge loan that has been in default since last year.

"The current situation is that we have to wait and see," said one market source. "[Orb Group] has almost reached a deal several times already, and it makes sense that this would take time - no one will spend that kind of money without due diligence. It's safe to assume though that whoever emerges as the buyer will be less fraudulent than the old owners." Orb had previously stated that it had agreed to sell the hotels to Alan Rankin, a nightclub entrepreneur.

The Hotels involved in the deal are still performing, said one analyst, but the question remains as to the new buyer's future plans for the properties. According to one market source, all redevelopment plans have been put on hold for the time being due to the buying process. "The redevelopment plans for the three London hotels might not happen as soon as we would like, but the new owner is likely to make [redevelopment] a priority," the source said. "The success of this deal depends on the profits generated from these would be high-end properties."

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