De Facto Double-Pledging on the Rise... Warning Lights Flashing for Private Lending
Hana Securities: "Private Credit and CLOs Use Triple Collateralization of a Single Asset"
If Underlying Assets Falter, Chain Reactions Could Follow
Lack of Regulation Raises the Risk of a 'Liquidity Snowball'
Recently, the U.S. subprime used car loan company Tricolor and auto parts wholesaler First Brands both filed for bankruptcy. Both companies share a commonality: they attracted greater liquidity than they actually possessed by illegally using a single asset as overlapping collateral. For example, Tricolor securitized subprime loan receivables as ABS (Asset-Backed Securities) and sold them to investors, then illegally pledged the same receivables as collateral for bank credit.
In the case of these two companies, they clearly engaged in the illegal practice of "double-pledging" collateral. However, the liquidity creation structure they used is quite similar to the private credit and CLO (Collateralized Loan Obligation) structures that numerous domestic and international asset management companies and private equity fund managers have utilized in recent years. Notably, domestic pension funds and mutual aid associations have also increased their investments in private credit funds over the past several years. On October 23, Hana Securities pointed out in its report "Shadow Banking: Could It Become a Snowball Someday?" that private credit and CLO structures could become a risk factor for the capital market in the future, describing them as "double-pledging dressed in legality."
Overlapping Collateral Dressed in Legality: The Shadow of Private Credit and CLO Structures
Typically, a private credit fund lends to a company and then raises a NAV loan (Net Asset Value Loan) from a bank or another fund using the loan receivable as collateral. At the same time, the same receivable is included as an underlying asset in a CLO (Collateralized Loan Obligation) and sold to investors. In effect, a single loan receivable is split into different rights-collateral rights, income rights, etc.-among the fund, the bank, and CLO investors.
Lee Youngjoo, an analyst at Hana Securities, explained, "Legally, the fund maintains ownership of the asset, so it is legitimate. However, economically, the same cash flow passes through multiple contracts, creating three layers of leverage, which in turn leads to an excessive expansion of credit supply." If the value of the underlying asset falters, the shock will be transmitted in order: first to the NAV loan lender (senior collateral rights), then to the fund equity holders (ownership and dividend rights), and finally to the CLO investors (income claim rights). The moment the underlying asset is transferred to an external collateral holder, the internal rating structure of the CLO becomes meaningless. In summary, the current legal private credit and CLO structures allow a single underlying asset to be repeatedly used in multiple financial contracts, rapidly increasing liquidity while weakening the system's shock absorption capacity.
Regulatory Focus: Can the Double-Pledging Issue Really Be Solved?
As JP Morgan's Jamie Dimon pointed out, a single incident suggests the possibility of more similar cases. Ultimately, as seen in the Tricolor case, the double-pledging issue is not confined to a single institution. Accordingly, the U.S. Securities and Exchange Commission (SEC) and the Office of the Comptroller of the Currency (OCC) are currently reviewing measures to enhance transparency in the private lending market. In particular, they are discussing the need to strengthen disclosure and clarify collateral priority (intercreditor agreement) regarding the overlapping of NAV loan collateral and CLO underlying assets.
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The core of regulation is not to distinguish between illegal and legal acts, but to make transparent how much of the market is stacked on the same collateral. Analyst Lee Youngjoo warned, "The Tricolor incident is not just a simple corporate bankruptcy, but a microcosm showing how quickly the financial market can inflate with illusion when the speed of liquidity and asset duplication combine. The private credit and CLO markets have expanded this into a larger and more sophisticated institutional version. We need to transparently know how many times a single collateral has been traded and what rights are overlapping. If we fail to see this reality, such liquidity illusions will eventually snowball and return to the market."
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