By David Ruhlig, Senior Managing Director of Lender Services, and Kenneth Sechler, Director of Consumer Finance
Introduction
Recent high-profile frauds in the consumer finance space have highlighted a serious and growing risk for asset-backed lenders: the double pledging of collateral by re-lenders operating multiple special purpose vehicles (SPVs). As competitive pressure pushes senior lenders deeper into subprime consumer finance markets, many are discovering that their siloed due diligence processes are no longer sufficient. A systemic failure to coordinate has created blind spots that can be exploited.
Understanding the Double Pledging Risk
At the heart of the issue is the structure of consumer finance re-lenders, who often raise senior debt for individual SPVs, each purportedly holding a distinct pool of consumer receivables. In theory, each lender has a first-priority claim on a segregated asset pool. In practice, however, re-lenders have taken advantage of fragmented oversight to pledge the same assets across multiple facilities.
The type of fraud involved – borrowing base fraud – can be particularly insidious because it may be perpetuated by even a single bad actor within the borrower’s organization. One dishonest employee with access to collateral data and reporting systems can manipulate borrowing base certificates and documentation to present inflated or duplicated assets. This risk highlights the importance of not only internal controls for the business, but external controls for investors, lenders, or other potential stakeholders.
The risk intensifies when lenders conduct collateral examinations in isolation – with each focusing solely on the SPV backing their own pledged assets. These examinations validate cash flow, portfolio performance, and collateral documentation – but only within the silo of the single legal entity subject to the review. When this process lacks visibility into other SPVs and into the consolidated operations of the re-lender, the potential risk of asset recycling is increased, as well as the risk of duplicate pledging across multiple borrowing base certificates – something that could occur potentially even without a financial statement impact if isolated to borrowing base data only.
The Role of Lender Silos
Lenders are often reluctant to share information due to confidentiality concerns, competitive dynamics, or structural limitations. As a result, there can be little to no cross-lender validation of whether an asset appearing in one portfolio might also appear in another.
This lack of coordination, however, creates a systemic vulnerability. Fraudulent operators can manipulate reporting and asset files, creating the illusion of separate collateral bases. These weaknesses may go unnoticed until a borrower defaults or a whistleblower surfaces.
Coordinated Solution
To mitigate this growing risk, senior lenders must move beyond isolated field exams and toward a more coordinated model of oversight. A few actionable strategies include:
- Cross-SPV Audits: Require that collateral examinations review not only the subject SPV but also obtain consolidated reporting and collateral data across all affiliated entities for reconciliation.
- Shared Collateral Registries: Develop or participate in centralized registries or clearinghouses where lenders can validate the uniqueness of pledged assets in real time against a consolidated asset view.
- Syndicated Diligence Models: In deals where multiple lenders provide credit to affiliated SPVs, consider joint diligence protocols and shared third-party vendors to ensure consistency and transparency.
- Ongoing Monitoring with Triggers: Use data analytics and performance covenants to flag anomalies in portfolio behavior that may suggest recycled assets or undisclosed cross-collateralization.
- Review of Borrowing Base Controls: Include a review of the borrower’s internal controls over borrowing base preparation as part of diligence. Evaluate segregation of duties, data access restrictions, and validation procedures. Senior lenders should also consider mandating specific control procedures within the loan service agreement to ensure greater transparency and discipline in borrowing base reporting.
Conclusion
Double pledging is not just a technical risk; it is a systemic one. As asset-backed lenders deepen their exposure to consumer credit, the need for robust, coordinated oversight has never been greater. Recent industry frauds have shown that the cost of fragmented due diligence can be catastrophic. To protect their capital and uphold the integrity of the asset-backed lending market, senior lenders must work together. Only through proactive coordination and shared vigilance can they close the gaps that fraudsters exploit.
About LCG Advisors
LCG Advisors is a nationally recognized advisory firm with specialized expertise in asset-based lending, borrower due diligence, and credit risk assessment. The firm’s Financial Institutions Group is the market leader in providing risk mitigation services to capital providers active in the specialty finance segment, including consumer and commercial re-lending, distressed asset acquisitions, and subprime finance. With decades of experience conducting field examinations and portfolio reviews, LCG provides the insights and independent analysis lenders need to protect against complex risks.
For questions related to consumer finance or to schedule an engagement, contact David Ruhlig, Senior Managing Director of LCG’s Lender Services Practice and Founder of LCG’s Financial Institutions Group, or Kenneth Sechler, Director of LCG’s Financial Institutions Group and Leader of the Consumer Finance Vertical.