Two Bankruptcies That Changed How Lenders Look at Collateral
The collapses of an auto-parts supplier and a subprime auto lender exposed how little visibility creditors had into the financing structures behind their loans — and set the tone for a nervous year in credit.
Two bankruptcies in the autumn did more to change lending behavior than any supervisory guidance issued this year.
The first was First Brands, an auto-parts supplier whose failure left creditors examining a capital structure that had layered supplier financing, factoring arrangements and off-balance-sheet obligations in ways that were difficult to reconstruct even after the filing.
The second was Tricolor, a subprime auto lender whose collapse raised questions about the quality of the receivables backing its securitizations.
The common thread
Neither company was large enough to threaten the financial system. What made them significant was what they revealed about the information available to lenders.
In both cases, creditors discovered after the fact that the collateral supporting their exposure was less clean, or less exclusively theirs, than they had understood. In a market where lending against pools of assets has grown enormously — through private credit funds, business development companies and specialty finance vehicles — that is a structural warning rather than a company-specific one.
What followed
Within weeks, two regional banks disclosed that they were pursuing recovery of a combined $160 million from lending arrangements tied to distressed mortgage funds, alleging that the collateral was not what had been represented. Bank stocks had their worst day in months.
By spring, global regulators were publishing reports on vulnerabilities in private credit, and default rates in the sector were reaching records.
The lending changes that stuck
Credit committees have responded in ways that are visible in loan documentation rather than in headlines. Verification requirements on borrowing-base certificates have tightened. Field exams that had become annual formalities are being conducted more often. Cross-collateralization language is being scrutinized. And lenders are asking, more insistently than they have in years, who else holds a claim on the same assets.
None of that prevents fraud. What it does is shorten the time between when a problem starts and when a lender finds out about it — which, in credit, is usually the difference between a loss and a catastrophe.
