Private credit firms are divided over the response to the fraud as the high-profile fallout piles up
Private mortgage lenders are taking very different approaches to fraud risk after the recent explosion on both sides of the Atlantic, with some companies working with enhanced diligence on all new deals and others treating defaults as one-off exits that don’t warrant a change in underwriting practices.
In the US, BlackRock’s private equity firm HPS Investment Partners is among lenders pursuing more than $500m (£373m) in losses tied to telecoms tycoon Bankim Brahmbhatt. Brahmbhatt’s companies, Broadband Telecom and Bridgevoice, filed for Chapter 11 in August.
Lenders allege in court papers that the businesses promising the receivables were non-existent, supported by fake invoices and bogus customer documents. The scheme reportedly only came to light after an HPS employee flagged an anomaly in a customer’s email address.
In the UK, specialist lender Market Financial Solutions was placed into administration in late February following allegations of fraud and pledging collateral against multiple loans. Lenders facing exposure include Barclays, HSBC, Santander, Apollo’s Atlas SP Partners, Jefferies and Elliott, with potential combined losses running into the hundreds of millions.
Read more: HSBC’s profits fall amid exposure to failed UK lenders
Different ways
Commenting on the discovery of fraud in private debt, Nathan Hein, who leads FTI Consulting’s Risk & Investigations team, said that client reactions have varied from business-as-usual reviews to more extensive portfolio reviews.
Some continued their regular write-ups on the basis that recent failures were isolated, he said, while others told the company that “in 100 percent of new deals, we at least kick the tires or do enhanced due diligence to look for fraud risks”.
That includes delving into financial processes, looking at day-to-day operations outside of finance and working to understand group-related transactions, as well as delving into business cash flows.
And it’s not just new deals. Some managers also look at their existing portfolios.
“I think everyone we’ve talked to has done some kind of internal review at some level of their positions,” he said, noting that most look company by company as they generally understand where the risk lies in their portfolio.
In Hein’s view, it’s really important that creditors start thinking about how to assess fraud risk from day one, rather than waiting for red flags that come too late. He urged the management to legalize their operations.
“Once you’ve assessed the risk you have a formal playbook for how to deal with it during due diligence,” he said.
The structured framework is increasingly a regulatory hedge and risk-taking tool, as the US Securities and Exchange Commission has signaled that it is looking into certain private equity firms. A written plan is “very helpful in terms of prevention and risk reduction,” Hein said.
Read more: The sale of software creates fear of debt, but experts say the debt is safe
One expert, who helps firms deal with regulatory risks, said the competitive pressure to invest has eroded standards, with lenders chasing high-income borrowers without equal assurance of what’s behind the loan.
Audit rights, they note, are written into almost all credit agreements but are rarely used, even in high-risk credits, where the actual inspection of collateral, office space and credit accounting may present a problem.
Read more: Can AI tackle private credit fraud?
