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The collapse of Market Financial Solutions amid fraud allegations in February ensnared some of the largest lenders on Wall Street. But one big bank with exposure to the UK mortgage provider had until Tuesday avoided the limelight: HSBC.
The $400mn “fraud-related” charge HSBC disclosed in its quarterly earnings this week marked it out as one of the lenders hardest hit by MFS’s collapse, and sent the bank’s shares down more than 6 per cent on the day.
Unlike banks such as Barclays, Santander and Jefferies, HSBC was able to maintain that it had not lent directly to MFS — and to keep its large exposure under wraps. Instead, HSBC’s ties stemmed from so-called back-leverage to a private credit unit of Apollo Global Management that was formerly part of Credit Suisse.
HSBC’s disclosure casts a spotlight on one of the key drivers of the private credit boom: bank debt.
Private credit funds have stepped in to finance mid-market companies and less creditworthy borrowers as post-2008 capital rules made it the business unappealing for banks. But as banks have pulled back from lending directly to these borrowers, they have piled in to another kind of lending: to private credit groups.
The private credit industry receives hundreds of billions of dollars in financing from traditional lenders, a mutually beneficial agreement that boosts private credit returns while providing supposedly relatively safe fee income for banks.
But the outsized HSBC loss relative to peers with direct exposure threatens to undermine a widely held belief that arm’s-length lending by banks to high-risk borrowers through private credit is safer.
Banks fund private credit in myriad ways. They lend to fund investors, extend subscription lines to funds, provide repo financing and loans backed by the value of a fund’s portfolio as well as so-called back leverage, the type of debt which linked HSBC to MFS.
HSBC lent money to Atlas SP, the securitised products unit which the private capital giant Apollo bought in early 2023 and which many inside Credit Suisse had considered its crown jewel, according to people familiar with the matter.
Atlas used those funds to make loans to MFS through an entity known as a special-purpose vehicle, part of a chain of financing which underpins the private credit model and gives banks indirect exposure to borrowers.
Atlas funds held £1bn of debt across two lending vehicles created by MFS, according to insolvency documents. But the firm has stated that its net economic exposure was £400mn. A person familiar with the exposure said the lower figure took account of risk transferred to other parties.
HSBC had funded 80 per cent of the value of the loans in the SPV tied to MFS with the rest coming from Atlas itself, according to people familiar with the matter. Lending 60 to 70 per cent of a portfolio’s loan value would be more typical in the sector, according to people familiar with the matter.
The high loan-to-value ratio explains why the bank was among the hardest hit even with indirect exposure, said one of the people. HSBC is also reliant on Atlas as the direct lender for any recoveries, they added.
In the vehicle in question, Atlas’s equity — the 20 per cent of the loans to MFS it funded itself — is already likely to have been wiped out. That situation can create problems for banks, because it reduces the incentive of the direct lender to aggressively pursue the borrower to recover the debt.
HSBC and Atlas declined to comment.
Apollo said on Wednesday that its asset-backed finance portfolio suffered investment losses of 1 per cent in the first quarter after the hit from MFS. Without the drag from the Atlas SP vehicles, its asset-backed finance business would have made a 1 per cent quarterly return.
Regulators have already raised concerns about whether banks may have been overeager to cash in on the private credit boom and really understand their exposure.
“You get leverage at the corporate level . . . there is leverage at the fund level and there is leverage at the sponsor level,” Bank of England deputy governor Sarah Breeden said at an FT conference last month, referring to the types of lending for private credit firms. “That is a layer cake and the banks don’t really add those up.”
But with MFS, there were a string of red flags which should have put lenders on notice.
MFS secured billions of pounds of loans from banks and private credit providers despite being a relatively unknown firm outside the niche world of bridging loan providers, almost exclusively controlled by one man, and funding dozens of property deals linked to a former land minister in Bangladesh.
Banks are taking action in response to the losses. Barclays said last month it would stop lending to structured finance counterparties that could not demonstrate strong financial controls after its own £228mn loss from MFS.
At HSBC, the loss cuts to the heart of a decision by chief executive Georges Elhedery to create a financing powerhouse by merging some of the bank’s businesses.
The MFS exposure stemmed from HSBC’s newly created corporate and institutional banking division, which had set out plans to boost lending to the private equity and credit industry.
HSBC has reviewed all its lending lines and is pausing certain types of lending, according to one person familiar with the bank’s position. It has insisted the loss is a one-off.
The BoE’s Breeden said last month that “idiosyncratic issues of due diligence failings or fraud are usually the things that come out first”.
If enough “lemons” appear in the private markets — examples of problematic loans to low-quality borrowers — it can become impossible for lenders to tell the difference “between good credit and bad credit”, Breeden warned. Then, a crunch in private markets can end up hitting the real economy.
