Wall Street Blood Friday! MFS Crisis Involves Billions in Exposure for Major Banks, Are Credit "Cockroaches" Emerging in Swarms?

On Friday, Wall Street lenders were hit hard by the bankruptcy of a little-known UK mortgage provider—MFS. This move heightened market fears of larger losses for banks and once again raised warnings about more “cockroaches” emerging in the booming private credit industry.

MFS’s bankruptcy accelerated a broad sell-off of financial stocks and alternative asset management firms in the U.S. stock market on Friday. Concerns about loan standards within the industry are prompting markets to brace for the potential spread of credit contagion.

Similar to last year’s collapse of the American auto loan company Tricolor Holdings, MFS is a non-bank financial firm aiming to fill market gaps ignored or avoided by large banks, while lending funds to these Wall Street giants to conduct business. Its dramatic fall closely resembles that of last year’s auto parts supplier First Brands—banks initially felt confident in tangible collateral, only to have that confidence shaken by allegations of “double pledging.”

Even some of the involved Wall Street institutions share similar names: Santander Bank and Jefferies Financial Group are once again in trouble, trying to recover as much funds as possible from this sinking company—both banks had been impacted by the First Brands case in recent months.

This time, alongside them, entities like Atlas SP Partners under Apollo Global Management, Barclays, Wells Fargo, Castlelake LP, and TPG Inc. are also caught in the turmoil.

“We’re seeing these kinds of incidents crop up more and more, which is definitely concerning,” said Joe Saluzzi, Co-Head of Equity Trading at Themis Trading. He added that he’s now starting to worry about the severity of the issues.

Nicole Byrns, founder of Dumar Capital Partners, a collateralized asset finance fund, also said, “Over the past six months, the market has been continuously discussing how to prevent fraud. Dedicated working groups have been established, and new anti-fraud products have been developed. However, this incident shows there may still be gaps in our ability to detect fraud.”

MFS’s “double pledging” scheme?

London-based MFS specializes in complex real estate mortgages, claiming to be a dedicated “buy-to-let” mortgage and bridging finance provider.

According to court documents, the company has been forced into bankruptcy proceedings after falling into trouble. Creditors who successfully petitioned to place the company into administration on Wednesday accused it of financial misconduct and mismanagement.

Representatives of the creditors submitted documents to the High Court in London this week stating they received support from “major international financial institutions and their legal advisors” for MFS’s bankruptcy. MFS may have engaged in “double pledging”—using the same collateral to secure multiple loans without proper disclosure to lenders, with the collateral gap possibly reaching £930 million ($1.25 billion).

It is reported that for the total £1.16 billion in loans to MFS, only £230 million of “real value” is available in the collateral accounts. The practice of double pledging could have caused an unexplained gap of over 80% on the nearly £1.2 billion debt.

According to recent filings, as of December 31, 2024, MFS’s net assets stood at £15.9 million, with 149 employees. Its loan book totals £2.4 billion.

While many questions remain about what exactly went wrong with MFS, Zircon Bridging Ltd. and Amber Bridging Ltd.—two MFS creditors pushing for its placement into bankruptcy—said that December last year may have been a turning point. At that time, MFS was accused of beginning to transfer most or all of its income from certain transactions. The destinations of these funds are currently unknown, according to court documents.

Both entities say the whereabouts of the missing income and the reasons for the transfers remain unclear.

Although it is too early to determine the final losses for creditors (if any), in transactions like those arranged by MFS, collateral values typically range from 105% to 120% of the loan amount.

Impact on Wall Street with hundreds of millions at risk

MFS’s collapse is undoubtedly another blow to Jefferies, which had already attracted attention for its significant role in the First Brands case. Sources say Jefferies’s exposure to MFS loans is about £100 million.

In addition to Jefferies, court documents show that lenders like Barclays, Santander, Wells Fargo, and Apollo-backed Atlas have also extended loans to MFS, totaling over £2 billion ($185 billion RMB).

At a hearing, a judge noted that Barclays alone has about £600 million tied up with MFS. Barclays is one of the banks that arranged loans for MFS.

Atlas estimates its risk exposure at around £400 million. A spokesperson for Atlas said that due to MFS violating contractual terms, the firm proactively declared two related loans in default last week and is pursuing all legal avenues to maximize recovery.

Additionally, a TPG spokesperson said the firm has a total exposure of £44 million—less than 2% of MFS’s loan portfolio, based on publicly available figures.

Citi analysts noted that since banks often sell off part or all of their risk exposure when arranging such loans, these figures should be viewed with caution. They stated, “Loan arrangements are very different from holding that risk on the balance sheet. It’s also unclear whether provisions have been made for this, and if so, how much.”

Market data shows Jefferies’s stock plunged nearly 10% on Friday, continuing Thursday’s 3.5% decline, amid reports that the New York-based bank has risk exposure to MFS, unsettling investors. Barclays shares fell 4.2% in London, underperforming the FTSE 100’s 0.6% gain. Santander’s stock dropped nearly 5%.

This panic also broadly impacted bank stocks, with the S&P 500 Banking Index falling sharply by 4% on Friday.

The proliferation of credit “cockroaches”

Just months before MFS’s “exposure” was exposed this week, Jamie Dimon, CEO of JPMorgan Chase and a Wall Street heavyweight, warned that the $trillions of credit mechanisms on Wall Street could see more “cockroaches” after the bankruptcies of First Brands and Tricolor.

Coincidentally, earlier this week, Dimon issued a new warning, saying he is beginning to see similarities between today’s markets and those before the 2008 financial crisis.

“Unfortunately, we saw this situation in 2005, 2006, and 2007—almost identical—rising tide, everyone making big money,” Dimon told investors on Monday. “I see some people doing stupid things.”

Clearly, investors are highly alert to any signs of deteriorating lending standards and cracks in the credit markets, with some concerns centered on the overexuberance in the private credit sector—where specialized funds lend directly to companies. While traditional banks are the largest risk bearers, the collapses of First Brands and Tricolor last year have intensified these worries.

According to Jefferies’ disclosures last year, its Leucadia Asset Management division held about $715 million in receivables related to First Brands through its credit fund Point Bonita, though the firm later claimed its risk exposure was limited.

This week, major financial players have also engaged in verbal sparring over the broader health of corporate sectors, especially in private credit. Blue Owl Capital Inc. decided to halt quarterly redemptions for one of its retail funds, unsettling investors and triggering a sell-off in asset management stocks. An Apollo-backed commercial development firm also cut quarterly dividends and marked about 3% of its portfolio to reduce risk.

While some large private credit players still argue that many recent high-profile defaults involve bank loans rather than private debt, others believe market unease is justified—Bruce Richards, chairman of Marathon Asset Management, compared the risks faced by software companies to “a train coming down the tracks that can be seen from afar.” These software firms have accumulated hundreds of billions in debt in recent years, even as AI threatens to eat into much of their business.

“It’s not a question of ‘if,’ but ‘when,’” he said. “The market has just begun to wake up.”