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Tug boats with barge goes through the locks near Seattle.
- The two investment giants are among the largest holders of the senior notes issued by Harley Marine, a Seattle-based operator of tug boats and barges.
- About two months after the deal was sold last May, the company had exhausted most of its working capital and investors were locked in a legal spat over allegations of embezzling and misusing corporate funds.
- The $405 million in senior bonds have lost about $50 million based on current market prices. The debt trades at about 88 cents on the dollar, the lowest level since the deal was sold, according to bond prices kept by Finra.
- The deal is a type of bond deal known as a whole business securitization, part of a growing but potentially risky part of the asset-backed securities market.
Two of the world's most savvy bond investors have seen an investment in the sometimes murky world of a niche fixed income market run aground.
Pimco and DoubleLine Capital are among the largest investors in a deal sold last May by a Seattle-based tug boat and barge company known as Harley Marine. The investment has taken a hit after expenses rose faster than expected, according to people with knowledge of the deal. A legal spat over $2.6 million in alleged embezzled or misappropriated funds has contributed to the deal's underperformance.
Pimco's flagship Income Fund, run by co-chief investment officer Daniel Ivascyn, is one of the largest holders of the $405 million in senior notes sold last May by Harley Marine, according to data compiled by Bloomberg. DoubleLine ranks fourth, the data shows. Another $50 million in junior notes was also issued.
Last week, $2 million in senior bonds traded hands at 88.5 cents on the dollar, suggesting that bondholders have lost about $50 million. That's down from 92 cents on the dollar in November and the lowest they've ever traded, according to Trace, an industry bond-price reporting service. Harley Marine has also stopped paying principal to junior noteholders, according to Kroll Bond Rating Agency.
The deal has, for some, become a symbol of the "late cycle" froth that's developed in parts of the bond market as investors grasp for yield in riskier securities. It's a type of deal known as a whole business securitization, transactions that take entire companies and package them into bonds for sale to investors. It's one subsector in a broader category known as the esoteric ABS market that has nearly doubled in the last four years.
Spokespeople for Pimco and DoubleLine Capital declined to comment.
Late cycle froth
The way whole business deals work is this: a company looking to raise money takes most or all of its corporate assets, often including intellectual property, brand trademarks or physical property, and places them into a separate legal structure created for the purpose. That legal entity then issues debt to investors, who get the income generated by the operating assets. They also have recourse to seize the assets in the event of a default and other provisions thought to better protect them.
Pioneered in the 1990s among UK pub operators and popularized the next decade with US franchise restaurant companies like Taco Bell, the transaction machinery has been applied to other industries in the last few years. It's a trend that's been driven by risky borrowers looking for cheaper financing, eager bankers looking for deal fees, and hungry investors in search of yield.
Critics contend that despite the additional protections meant to protect bondholders, investors are still subject to the underlying credit of the company that issued the securities. Few whole business securitization structures have been tested in bankruptcy court.
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Guggenheim Securities, one of the most active banks in this part of the market, prides itself on introducing new issuers to the market. Over the last five years, it's helped 50 companies sell this kind of debt for the first time, according to a person with knowledge of the bank's business.
Guggenheim led the Harley Marine deal. In May 2018, the investment bank helped the 31-year old company that operates more than 120 vessels on inland rivers and nine ports from Alaska to the Gulf of Mexico tap the bond market for the first time.
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Privately held, Harley Marine offers services such as bunkering (refueling vessels when they call at port), transporting fuel, escorting larger ships, and offering rescue tows, with a majority of revenue coming from oil and gas firms, according to Kroll.
Guggenheim underwrote $455 million in bonds spread across two classes of debt. Kroll assigned a BBB, or investment grade, rating to the senior notes and a BB, or junk, rating to the junior notes.
Some investors who balked at the deal criticized how it was marketed, according to two of them who asked for anonymity to discuss the process. One said Guggenheim was tight with information and only gave investors about a week to review the deal. That's roughly the same amount of time investors might get to review a bond backed by auto loans originated by a Ford Motor Credit, a much more common transaction with more easily understood collateral.
"Barges was not something that I'd thought about, frankly," said another investor who declined to invest in the Harley Marine deal. "I don't know anything about the underlying rates, the competitiveness, how much a 20-year old or 40-year old barge is worth, maritime rights. It's just very complicated."
Guggenheim declined repeated requests for comment.
The formal marketing period for whole business securitizations is 10 days, and the Harley Marine deal was no different, according to a source familiar with Guggenheim's process. An initial pre-marketing process began as early as September 2017 for some investors, the person said.
Problems start to emerge
Pimco owns $83 million, or 20%, of the $405 million in senior bonds sold by Harley Marine, according to data collected by Bloomberg. DoubleLine, Vanguard and Thompson Investment Management also own the debt, the data shows. Thompson's $14.7 million investment had fallen 31% through yearend, according to its fund disclosures.
Almost as soon as the deal closed, problems emerged. Harley Marine quickly depleted most of its working capital, withdrawing more than 90% of the $10 million account in the first two months, Kroll wrote in an October report that placed the notes on watch for downgrade. When it downgraded the deal the next month, unpaid operating expenses had climbed to more than $12 million.
The problem was with the company's articulated tug barges, vessels that have a hinged connection between the tug and the barge rather than one that's fixed, according to Kroll.
Details are hard to come by, but at one point the company saw more demand for the barges and added vessels, which increased revenue and expenses, one of the people said. When demand fell again, the company didn't cut its capacity quickly enough and ran up additional costs, the person said.
"The offering included due diligence by several major accounting and financial firms, none of whom identified any issues," Greg Hollon, attorney for founder and CEO Harley Franco, said in a statement, adding that bondholders didn't raise concerns about inadequate disclosures. "Indeed, Mr. Franco understood that the HMS offering included full disclosure of all material facts. Of course, these types of transactions always involve unavoidable risk, which the bondholders accept when they invest."
At about the same time it ran out of money in the working capital account, Harley Marine was plunged into chaos. A unit of Macquarie Group, which owns 47% of Harley Marine, sued Franco, alleging that he "diverted, misappropriated, and/or embezzled" more than $2.6 million from the company, according to the civil suit.
Franco disputed the allegations and countersued. A board vote to relive him of his CEO duties failed in court.
"Industry insiders likened the false allegations to dropping a nuclear bomb on the company," Franco's attorney said in the statement. "Mr. Franco is deeply saddened by Macquarie's actions and their impact on the company which he built over the last three decades."
Macquarie declined to comment.
Last month, Franco finally relented and agreed to give up day-to-day responsibilities, according to Maritime Executive. And with Franco ceding control, Macquarie dropped its lawsuit against the former CEO, according to a person with knowledge of the matter, who added that the firm may pursue future legal action to recover some of the lost money. Matt Godden, the chief operating officer, was named interim president and handed operating control.
Higher yields, higher risks
A ratcheting down of the legal spat hasn't helped the company's underlying financial position. It's now in talks to line up financing to cover operating and capital costs. An initial $10 million loan discussed by Kroll in its October and November reports is apparently still on the table, as are bigger financing options, according to a person with knowledge of the talks. The $10 million is the smallest of those being discussed, the person said.
The additional debt "would likely cause" a breach of the deal's debt caps and may trigger a rapid amortization of the bonds if not fixed within 90 days, according to Kroll. The breach can be waived by the bondholders' representative, Kroll said. Late last month, Pimco won the right to act as that representative, according to January 25 letter from US Bank, the trustee for the deal.
For Pimco and the other investors, losses are possible if they want to sell the bonds in the secondary market, while legal and third-party consultant fees eat into deal proceeds. That's not to mention the opportunity lost on hours spent working out the deal. Investors may get their money back if the company's situation turns around or until the deal matures. In 2043.