Paramount's Melrose on shaky ground

Moody's hands equity-backed slate a rating downgrade

One of the first slate financings backed by hedge-fund money now looks like a certain loser -- even for its most senior bank lenders.

Paramount's so-called Melrose I financing, whose senior debt component was led by Merrill Lynch, has been socked with a big rating downgrade by Moody's Investor Service. The downgrade -- in which Moody's chopped its rating on Melrose I from an investment grade "Baa2" to the speculative "B3" rating, or six ratings grades -- has largely gone unnoticed for the past week.

Yet the move offers rare public evidence of what's long been suspected: At least some of the equity-backed film financings of the past several years have proved to be wobbly investments. The downgrade could trigger higher interest payments to lenders and will surely lower the value of debtholders' bonds.

The 2004 financing is backed by a partial ownership stake in 26 Paramount films released during 2004-05. So, Merrill and other senior debtholders will maintain a minority hold on those assets until they can secure full repayment on their loans or Paramount buys out their equity positions.

The scope of Melrose I losses also are hinted in the ratings downgrade. For if banks are still chasing full recoupment on the financing's senior debt, that means less-secure lenders in the financing's mezzanine level will likely lose even more on their investments, and hedge funds participating in Melrose's equity tier are further still under water.

Melrose I was crafted during the management regime of former Paramount topper Sherry Lansing, whose reign atop the studio ended in 2004 amid criticism about a spate of underperforming films. The '04 film slate featured iffy releases including "The Stepford Wives," "Sky Captain and the World of Tomorrow" and "Alfie," though Par has never acknowledged publicly which of its pics were funded by Melrose I.

The titles long ago ran through theatrical, home entertainment and TV release windows, so any hope of further revenue recoupment for lenders lies strictly in the films' longer-term exploitation.

Slate misfires quickly put equity investors in Melrose I in jeopardy. But Moody's took longer to assess the danger and adjust its ratings because it rates only senior debt.

"Most of the money at the senior level will be paid back -- just not all of it," Moody's analyst Neil Begley said. "So you really didn't know until the last year or so what wouldn't be covered."

Moody's put the financing into ratings review in the summer. It posted the downgrade Oct. 21.

Despite the shaky nature of Melrose I, Paramount later arranged another asset-backed financing -- Melrose II, featuring tweaked deal terms -- to fund a slate of films released through 2007. Sony, Fox, Warner Bros. and Universal also have slate financings backed by private equity.