Lynn Tilton’s Patriarch Faces Off With MBIA in Zohar Auction

  • Bids are due in sale of Zohar distressed-loan portfolio
  • Outcome is crucial to MBIA unit that guaranteed parts of CDO

Lynn Tilton’s Patriarch Partners has been fighting with a unit of bond insurer MBIA Inc. since at least 2009 over securities they created together starting in 2003. On Wednesday, a key question may be answered: What value does the market place on their assets?

Patriarch bundled loans to troubled companies into a series of complicated securities known as collateralized debt obligations totaling more than $2.5 billion, only to see one of the instruments default last year. That CDO, known as Zohar I, is selling its assets with some $400 million of face value in an out-of-court liquidation auction on Wednesday.

The outcome is crucial to MBIA Insurance Corp., the unit that guaranteed portions of two of the three Zohar CDOs. Valuations for assets in Zohar I will give a sense of MBIA’s possible losses from Zohar II, which comes due in January and for which the insurer guaranteed $770 million of securities. Zohar III, which MBIA has no involvement in, matures in 2018.

The MBIA unit is owed $149 million for insurance payments it made on notes that Zohar I defaulted on. If bids total more than that, MBIA will get paid back, and whatever is left will flow down to holders of other lower-priority notes, including Patriarch Partners. If the bids for Zohar I tally up to less than $149 million, the bond insurer is entitled to take possession of the entire pool of assets in a credit bid.

Choosing Assets

The auction will allow bidders to pick and choose assets, meaning they could snap up all types of debt in one or more companies rather than bidding for the entire portfolio. Some of the companies in Zohar I are also in Zohar III, giving investors in the last Zohar CDO a potential motivation to bid, a person familiar with the funds said. 

Zohar I owns more than 90 loans and 40 equity stakes in U.S. companies including MD Helicopters Inc., a business once owned by movie producer and entrepreneur Howard Hughes; Petry Media Corp., an affiliate of iHeart Communications Inc.; American LaFrance, a firetruck manufacturer, and NetVersant Acquisition LLC, an infrastructure provider.

Tilton’s firm also has an option to bid for the assets itself -- up to three days after other bids come in. Patriarch declined to comment for this story.

The Zohar CDOs have proven a headache for MBIA Insurance Corp. The company in general has had to make higher-than-expected payouts on its bond insurance policies, and while it expects to have the resources it needs to meet its obligations this year, there is the risk that the regulator New York Department of Financial Services will be forced to effectively restructure it, or to liquidate its assets to pay claims, it said in a filing last month. A spokesman for the DFS declined to comment.

It said in the same filing that it is particularly focused on the second CDO, Zohar II. As with Zohar I, MBIA will have the right to recoup insurance payment through an auction of the CLO’s assets.

Removing ‘Overhang’

Since that filing, MBIA Insurance Corp. has agreed to borrow $325 million from holders of its own debt and to sell a U.K. subsidiary to help cover payments it will owe when the Zohar II notes come due in January. It is also receiving $38 million of subordinate financing from MBIA Inc. Those arrangements, along with $60 million of its own resources, should enable MBIA Insurance Corp. to cover the default.

The financing removed a “significant overhang” from MBIA’s stock, BTIG analyst Mark Palmer said in a research note after the announcement.

Patriarch and MBIA have a long history of conflict. The two parties have sued each other in multiple courts. The dispute dates back to at least 2009, when the insurer alleged the asset manager failed to transfer debt securities into the structured finance vehicles it had created. Patriarch counter-sued in 2011, and disputes have continued over issues including breach of contract and transparency. In one case, Patriarch tried -- and failed-- to force the Zohar I CDO into bankruptcy.

SEC Suit

Patriarch is also sparring with the U.S. Securities and Exchange Commission, which in March 2015 accused it of misstating the value of loans backing the Zohar CDOs. The loans’ value was recorded as having remained unchanged even though many of the borrowers had skimped on interest payments for years, or skipped them entirely, the SEC said

Tilton has challenged the fairness of the agency’s process. An SEC judge has yet to rule on whether Tilton will be forced to return more than $200 million fees that the agency said she improperly collected.

More information about the Zohar funds could be forthcoming through separate litigation in Manhattan bankruptcy court. A Halcyon Capital Management LP affiliate recently began a fight to unseal court records in the failed 2015 bankruptcy petition for Zohar I. If Halcyon succeeds, it could reveal estimated values for the portfolio companies, Zohar’s governance structure, and Patriarch’s investment strategies.

Patriarch has fought to keep the information under wraps, accusing Halcyon, which has a stake in Zohar III, from wanting to use the information for its own advantage as a competitor that issues similar vehicles, or a prospective bidder in Zohar I’s auction. Halcyon has no intention to bid, it replied in court papers. A court hearing is slated for Jan. 13.

The failed bankruptcy petition is Zohar CDO 2003-1, 15-23681, U.S. Bankruptcy Court, Southern District of New York (White Plains).

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