Private credit lenders are taking very different approaches to fraud risk in the wake of recent blow-ups on both sides of the Atlantic, with some firms running enhanced due diligence on every new deal and others treating the failures as one-offs that do not warrant a change in underwriting practice.
In the US, BlackRock’s private credit arm HPS Investment Partners is among the lenders pursuing more than $500m (£373m) of losses tied to telecom entrepreneur Bankim Brahmbhatt. Brahmbhatt’s companies, Broadband Telecom and Bridgevoice, filed for Chapter 11 in August.
Lenders allege in court filings that the businesses pledged receivables that did not exist, supported by forged invoices and fake customer correspondence. The scheme is reported to have come to light only after an HPS employee flagged an irregularity in a customer email address.
In the UK, specialist bridging lender Market Financial Solutions was placed into administration in late February following allegations of fraud and the pledging of the same property collateral against multiple loans. Lenders facing exposure include Barclays, HSBC, Santander, Apollo’s Atlas SP Partners, Jefferies and Elliott, with combined potential losses running into hundreds of millions.
Read more: HSBC’s profits drop amid exposure to collapsed UK lender
Differing approaches
Commenting more broadly on fraud detection in private credit, Nathan Hein, who leads FTI Consulting’s Risk & Investigations team, said client reactions have ranged from business-as-usual to wholesale portfolio reviews.
Some have continued with their usual underwriting on the basis that the recent failures are isolated, he said, while others have told the firm that “on a hundred percent of new deals, we’re at least kicking the tires or doing enhanced due diligence to consider fraud risks”.
That includes deeper dives on financial processes, looking at day-to-day operations outside the financials and also work on understanding related party transactions, as well as diving into the cash flows of the business.
And it is not just new deals. Some managers are taking a look at their existing portfolios as well.
“I think everyone we’ve talked to has done some sort of internal review on some level of their portfolios,” he said, noting that most are looking on a company-by-company basis as they typically understand where the risk in their portfolio lies.
In Hein’s view, it is really important for creditors to start thinking about how to assess fraud risk from day one, rather than waiting for late-stage red flags. He urged managers to formalise their approach.
“Once you assess the risk you have a formal playbook for how you address it during the diligence,” he said.
The structured framework is increasingly a regulatory hedge as well as a risk tool, with the US Securities and Exchange Commission having signalled it is looking at certain private credit firms. A documented programme is “incredibly helpful from a defence and risk mitigation approach,” Hein said.
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One expert, who helps firms address regulatory risks said the competitive pressure to deploy capital has gradually eroded standards, with lenders chasing higher-yielding borrowers without commensurate physical verification of what sits behind the loan.
Audit rights, they noted, are written into virtually every credit agreement but are rarely exercised, even on the riskier credits, where on-the-ground checks of collateral, office space and headcount would be most likely to surface a problem.
Read more: Can AI address private credit fraud?
