Andrew Bailey, Governor of the Bank of England, has echoed JPMorgan Chase CEO Jamie Dimon’s earlier comments that the collapse of two US companies could be a sign of wider problems in the financial system.
Speaking before a House of Lords committee that it was important to take the failure of car parts supplier First Brands and subprime car lender Tricolor “very seriously,”—drawing comparisons with the 2008 financial crisis.
Historical Precedent?
The bankruptcies have raised questions about the quality of deals in the private credit market—where companies arrange loans from non-bank lenders. The first inklings of the 2008 crisis in the mortgage market started with subprime loan issues, then problems started appearing with Alt-A loans before extending further .
Bailey noted that before the 2008 collapse hit the crisis stage, there had been a belief that sub-prime mortgages were “too small to be systematic” but that this had been “the wrong call”.
So whether the bankruptcies were one-off issues, or as Dimon had said, a case of “the canary in the coal mine,” were unclear, Bailey added, saying that the Bank of England planned to run a “stress test” of private equity and credit firms.
“I think the big question… is: are these cases idiosyncratic, or are they what I call the canary in the coal mine?,” Bailey said. “Are they telling us something more fundamental about the private finance and private assets sector? “I think that’s still a very open question in the US. I think it’s a question we have to take very seriously.”
He added that there was starting to be “what used to be called sort of slicing and dicing and tranching of loan structures”.
Also appearing before the House of Lords’ financial services regulation committee, Sarah Breeden, the Bank’s deputy governor for financial stability, said the Bank would be examining the private finance sector.
“We can see the vulnerabilities here,” she said. “We can see parallels with the global financial crisis.”
The bankruptcies aren’t isolated incidents, but rather a harbinger of a larger, more profound credit rebalancing that has actually been afoot since the second quarter, according to Matt Schwartz , mortgage broker at the VA Loan Network. “This recent string of failures has had nothing to do with a lack of liquidity, but rather a misunderstanding of both duration risk and a naivety with regards to warehouse risk as purchase volume dries up.
“Many of these second- or third-tier lenders are still carrying MSRC pools that were properly marked at a 2021 level but merely hide troubled balance sheets. It’s not a defaults problem, but rather a margin problem, as with your 6.75% cost of long-funded money selling at a decreasing customer base, that spread could decimate a year’s profits in a single quarter. They who know are reducing warehouse facility exposure, selling non-strategic branches, and pursuing purchase-reno gameplans, while others are awaiting a January miracle in the fourth quarter. They won’t get it.”
