Banks Get Picky on Asset-Based Lending After Credit Blow-Ups

(Bloomberg) — European banks are being more selective on asset-backed lending, as collapses including Tricolor Holdings and Market Financial Solutions Ltd. have made firms more cautious of the sector.

BNP Paribas SA, Deutsche Bank AG and Banco Santander SA are among banks that are being more particular about which deals they participate in, according to people with knowledge of the matter. It’s become more difficult to get deals accepted through risk committees, especially for loans to smaller borrowers, said the people, who asked not to be identified discussing private information.

Companies that tap asset-backed loans are often specialty lenders or firms with large inventories that can be used as collateral. The former typically use such borrowings to fund their own lending operations.

Banks are doing more to scrutinize credit quality and ensure risk is priced appropriately. That’s making it more difficult for smaller borrowers that rely on asset-backed loans to obtain funding, the people said.

Spokespeople for BNP and Deutsche Bank declined to comment. A spokesperson for Santander didn’t provide a comment.

In recent years, banks have ramped up asset-backed lending to reap the benefits of higher-paying loans. Such deals also come with the protection of collateral that either bears income or can be sold in the event of default.

However, the industry has come under scrutiny since the collapses of subprime auto lender Tricolor, UK mortgage lender Market Financial Solutions, known as MFS, and US auto parts firm First Brands Group, which all had some sort of asset-backed financing. Banks that weren’t exposed to the blow-ups want to ensure they don’t end up in such scenarios.

“Across the market, participants are ramping up their due diligence processes, even among the most established players,” said Michele Bisceglia, chief executive of Five Sigma Finance, which conducts due diligence on asset-backed deals. Executives from Five Sigma and others including Interpath and Kroll said they’ve seen increased interest from banks and other investors recently.

Barclays Plc, which had exposure to Tricolor and MFS, is pulling back in the sector, “constraining lending to certain structured finance counterparties who operate more vulnerable business models,” Chief Executive Officer CS Venkatakrishnan said on an earnings call this week.

Many banks are still participating in asset-backed lending, but may choose to focus on larger borrowers with institutional backing, some of the people said.

Deutsche Bank Chief Financial Officer Raja Akram said on an earnings call Wednesday that the bank would continue to take market share “prudently” if “there’s opportunity to continue growing this business within our risk appetite.”

In the current environment, Deutsche Bank is “able to be even more selective of who we choose to do business with,” he said. The bank is also tightening underwriting standards around private credit.

Increased Vigilance

With a typical asset-backed lending structure, banks hold the senior portion of the debt, which protects against losses. But it doesn’t shield a lender from fraud or a total collapse.

“Bankers have become more comfortable with relying on the representations made to them. The problem is, if the representations are wrong, the only recourse they have is against a company to whom they probably would not have loaned to on the same terms, if at all,” said Charles Whitehead, a professor of business law at Cornell University and former banker.

Due diligence advisers are often brought in to work with banking teams on site to underwrite deals and check against fraud risk. These firms are checking existence of collateral through property records, comparing cash flow projections against other borrowers and verifying the borrower’s auditor, according to market participants.

Funding Circle, a provider of loans to small and medium enterprises, is “spending more time with investors to answer queries and providing more frequent updates,” said Dipesh Mehta, its chief capital officer.

“This heightened scrutiny is unsurprising and has been driven in part by recent instances of corporate fraud,” he said. However, he said non-bank lenders have always been held to a higher standard of transparency and Funding Circle is benefitting from and well positioned to withstand this deeper scrutiny.

Banks are focused on asking potential borrowers how they can ensure collateral isn’t promised across multiple debt facilities, a practice known as double pledging. Tricolor’s founder Daniel Chu was charged with double-pledging auto loans as collateral, after the company collapsed last year. Creditors have also accused MFS of the practice.

“People want to make sure the assets are real,” said Nick Parkhouse, global head of financial services at Interpath. “Everyone is having a deep look at everything they’ve got.”

–With assistance from Arno Schütze, Laura Noonan and Rodrigo Orihuela.

(Updates with quote in 14th paragraph.)

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