The asset-based finance market is feeling shockwaves from the collapse of Market Financial Solutions, the UK residential mortgage bridging lender, in February. Banks and asset managers which had funded MFS are deeply embarrassed, and may tighten their policies to prevent themselves being exposed to other specialist lenders whose reliability they are not confident of.
It is right for lenders in this awkward position to review their underwriting and make sure they are performing all the right checks to avoid fraud and credit problems. It is also only natural that they want to try and find a solution as quickly as possible — partly to ease any concerns among their shareholders or members.
However, if lenders' intention is to prevent a similar situation from happening again, any changes they make to underwriting practices should be directly related to the reasons why MFS fell.
The problem is it is still not entirely clear why MFS collapsed, and therefore what measures could have been taken to prevent it from happening.
There have been allegations that MFS had double-pledged assets to different funders. A representative for Paresh Raja, founder and CEO of Market Financial Solutions, declined to comment.
The truth is still not clear, so banks should not rush to change their lending rules too sweepingly.
Hold or fold
Evidence on how banks are reacting is slight, but there are bound to be serious reviews of policies, if not changes.
Bloomberg reported in late March that Barclays was scaling back its asset-based lending to smaller lenders after being stung by MFS and Tricolor, the US car finance lender that went bankrupt in September.
Barclays declined to comment on this when asked by GlobalCapital.
At Morgan Stanley's European Financials Conference in London on March 18, Barclays' chief executive CS Venkatakrishnan was asked about Barclays' exposure to MFS and Tricolor.
He said: "They are both examples of fairly deep and sophisticated fraud", and added that Barclays' losses from MFS would be "materially lower" than its exposure, which had been reported to be about £500m.
Venkatakrishnan did not say Barclays was making a wholesale change to its lending to securitized assets, but he said "risk management is an evergreen exercise. It's like mowing your lawn. You do it over and over and over again."
If Barclays does pull back from financing other non-bank lenders, it could be a blow to start-up finance companies seeking warehouse funding lines or forward flow agreements to fund their lending books.
Wells Fargo, another lender to MFS, was reported by 9fin to have launched a comprehensive review of warehouse lending from its European securitized products business by US-based compliance officers, which would include site visits to specialist lenders, questionnaires and examining collateral.
Wells Fargo has not confirmed whether this review is happening and declined to comment when asked by GlobalCapital.
Jefferies is one of the few banks with exposures to MFS to have put out a formal statement, in the form of a letter to “clients, stakeholders and friends of Jefferies,” setting out the size of its exposure.
It has £103m of exposure to a warehouse facility but said the hit to net earnings was likely to be less than $20m.
“It now appears that some of the collateral underlying that facility may have been double-pledged,” said the letter from Rich Handler, Jefferies’ chief executive, and Brian Friedman, the bank’s president. “At this time, we have already recovered approximately 25% of our facility in cash, and believe that a further approximately 40% is secured by valid loans, while we are continuing to review the remainder of the portfolio.”
In wording that has been much commented on, Handler and Friedman said: “The [MFS] facility was sized at a level that was within our risk appetite and the amount of the net loss is well within our tolerance. We realise meaningful profit from our activities in ABS, including CLOs, and while our involvement in MFS was disappointing, it is within our risk appetite.”
Jefferies has not clarified whether it will be changing its ABF underwriting practices, but the statement certainly does not imply a large pullback.
Much at stake
So far, banks are being understandably cagey about how their risk appetite and criteria have changed in light of MFS and Tricolor.
More care and due diligence would certainly be advisable. But the risk is that banks over-react hastily, swinging to being over-cautious.
Banks becoming wary of asset finance might save them from getting burned by any more specialist lenders, but it could also result in them no longer helping structurally sound lenders.
In the short term, this might not be the worst thing for the UK residential bridging loan sector, as the industry has been due some consolidation.
However, it would be a great shame if funding dried up for finance companies that lend to small and medium-sized companies, especially if it turns out that the collapse of MFS had idiosyncratic causes which will not bleed into SME lending.
As Mark Twain said, a cat that sits on a hot stove will not sit on a hot stove again, but it will also never sit on a cold stove either.
Stoves can do without cats. But the innovative finance market would be much poorer without funding from banks.