Post-Tricolor: Three pathways to ABS defaults and lessons learned

Contributed piece by Nicole Byrns, partner at Dumar Capital Partners These days, everyone is talking about the benefits of investing in asset-based finance so much that, despite some recent bumps in the road, newcomers may think that ABF is only sunshine and rainbows. But those of us who have been around a while know that not all that glitters is gold. Recent failures like Tricolor Auto Group and Market Financial Solutions show that things may not go as planned, and that downside scenario suddenly comes to life. I am not here to rain on the parade, but I do want to explore a few situations when events did not unfold as expected — where lenders found themselves facing defaults on debt secured by ABF assets including consumer loans or equipment leases, or where asset purchasers saw their investments plummet in value. What led to this distress? Were any steps taken to turn things around? How did it all play out? And, most importantly, were any lessons learned? Rather than focusing on recent events that the market has widely discussed, I want to examine some situations not only from my career but also from industry veterans to hear their perspectives. From these conversations, three situations consistently emerged as the most common pathways to default: Performance : assets are under-performing compared to original expectations; Capital mismanagement : limited liquidity or insufficient capital to fund operations; and Fraud : someone is doing something shady Performance pays, usually Deteriorating asset performance is the most frequent pathway to default and the one we are typically best prepared to manage. Regardless of the underlying cause — economic shocks , poor underwriting or overly aggressive projections — the result is the same: the loans or leases are performing drastically worse than expected. Experience has shown that sometimes the best response is the least instinctive one: do nothing. Exercising patience and allowing the remaining performing assets to service the debt can sometimes be the most effective approach. In ABS securitizations, this is often the only option available to bondholders. In private ABF , however, a well-structured transaction has mechanics such as rapid amortization, cash trapping and over-collateralization that facilitate full repayment from the remaining cashflows. This scenario played out during the pandemic, when ABS and private debt facilities financing small business loans faced heightened risk of non-payment as obligors shut down. KBRA Performance Insight: According to the rating agency KBRA, six small business loan ABS transactions breached their delinquency trigger in the second quarter of 2020, triggering an early amortization event. Of these six, five were fully repaid within one year thanks to continued cash flowing into the transaction structure due to modified loan payments negotiated by active servicing. Two transactions remained outstanding for a longer period of time but were eventually fully repaid in 2022-2023 through asset sale processes, the proceeds of which were sufficient to fully repay the most junior bonds. -- KBRA, “US Small Business Lending ABS Performance in the COVID-19 Era”, March 2021 All the lenders and bondholders — even the junior lenders — eventually (and I mean very eventually) were repaid. In these cases, patience quite literally paid off in the long run. While sometimes it pays to be patient, there are times when cutting losses early is the smarter move. Two key factors drive this decision. One is the belief that performance will never stabilize. The other is the capital’s time horizon. Can investors afford to wait out the distress or is their timeline too short? In either case, selling the exposure – even at a deep discount - may be the better option, rather than holding out for an uncertain recovery. Capital management: saving the crown jewel Sometimes a company has aggressive growth projections that fail to materialize, or is hit by an economic shock without sufficient liquidity to weather the storm. In these situations, the assets are often still performing. Value exists – whether in the assets themselves, the company’s origination strategy, its product offerings or its market share — leading investors to see a case for restructuring operations rather than liquidation. Here, ABF providers hold the company’s crown jewel: existing, paying assets. If the company is expected to survive, it will likely file for Chapter 11 bankruptcy protection , and, if not already done, the ABF lenders will activate structural protections while they wait for their white knight — the debtor-in-possession (DIP) lenders — to step in. Any post-filing financing will typically be structured to repay the ABF lenders, freeing up the company’s most valuable assets for the DIP providers. I have experienced a few of these bankruptcy situations, and while the uncertainty was tense (and, at times, nail-biting), we took it one day at a time and focused on what we could control. The ABF restructuring playbook under Chapter 11: Accelerated cash settlements: We increased the cash settlement frequency from monthly to weekly and eventually to daily, enabling real-time tracking of our over-collateralization position while also releasing excess cashflows to a company desperate for liquidity; Decreased leverage: We implemented additional protections, including reducing our advance rate; and Collateral and data verification: We conducted an asset audit to confirm reported balances. In short, everyone’s focus was on ensuring that asset performance (discussed above) did not become yet another problem in an already troubled situation. Fraud: The warning signs were there Most veterans I spoke with agreed with my theory: when fraud is behind the default , investors usually suffer significant losses with little hope of recovery. Fraud in ABF can take many forms: origination of non-existent assets, intentionally manipulated data or double (even triple) pledging of collateral , just to name a few. History has shown that when fraud is involved, once it is discovered, asset and enterprise values are either already gone or, if some value remains, it is quickly wiped out by investor panic. Not only do investors lose their capital, but the company itself typically disappears, leaving behind a skeletal operation to wind things down. Many ABF investors believe that their systems, oversight and judgement make their portfolios impervious to fraud. However, the industry received a wake-up call this year – fraud and operational risk are real. The sudden demise of Tricolor in September 2025 , with claims of double-pledging and duplication of vehicle identification numbers, and, in March 2026, MFS, a UK-based real estate bridge lender accused of double-pledging and multiple loans secured by the same properties — not to mention First Brands and Bankim Brahmbhatt/Broadband Telecom/Bridgevoice — showed that fraud and operational risk have not disappeared as the market has matured. As the industry mulls over what went wrong, I repeatedly hear the same rationalization: “Fraud can’t be completely prevented. If someone wants to commit fraud, they’re going to find a way.” At the same time, I heard of several market participants who gave themselves a “pat-on-the-back” because they looked at these platforms but walked away. Believing fraud is unpreventable is partially true, and sometimes we don’t give luck as much credit as it deserves. Fraud doesn’t happen in a vacuum, and early warning signals create an environment where it can breed. But realistically, it takes a sharp eye and deep diligence to connect these early warning signs with potential or actual fraud. Most often, actors intend to limit fraudulent activities to one-offs as a quick fix to an immediate and acute problem. However, once it’s started, it’s hard to stop out of fear of being discovered or maintaining the new status quo. My own “Tricolor situation” (how industry veterans now refer to their fraud-related restructurings) had many of these early warning signals that went unnoticed until it was too late. Our borrower had a small “Other liabilities” item on its balance sheet that was not material during our pre-close diligence. Over the course of a year, however, this item increased to a significant amount. After multiple inquiries, the company eventually admitted that it had been extending its payables’ terms and were now classified as long-term “Other liabilities” rather than short-term “Accounts payable.” We also learned that the sub-servicer’s unpaid fees were included in this balance, which meant that the company was retaining the waterfall’s servicing fees, and the sub-servicer had not been paid in months. Things quickly went downhill after that. In retrospect, the warning signals — which are always easier to see in hindsight — were the existence of an ambiguous liability category combined with its rapid growth. Safeguards designed to prevent fraud — pre-funding verification, audits and diligence meetings — have been developed over the years, but ABF’s rapid growth and new entrants without their own Tricolor experience have pushed operational risk oversight to the backburner. Recent events served as an unfortunate reality check on the extent to which operational risk management has been deprioritized. My concern is that this focus will abate given the competition for origination and the need to deploy capital. In today’s frothy market, lenders may relax protection to win deals. However, veterans of work-outs and restructurings know that no transaction is worth sacrificing the safeguards that preserve long-term value. Lessons learned: What the scars taught us Hindsight makes it easy to categorize these defaults and pinpoint missteps. But in the moment, the right course of action is not always obvious. From these experiences, my colleagues and I have taken away several critical lessons that we now prioritize when we face these situations: Move quickly and decisively . Once a situation unfolds, don’t waste time debating what to do, just do something. Whether it is sending a default notice or implementing a rapid amortization, delaying these actions will erode asset value. You will not regret taking decisive steps, but you will regret waiting too long. Find the cash. If you do not know or do not control your cash collections, then figure it out - immediately. Without access to cash collections, incoming payments cannot be used to reduce exposure, and there is a real risk that the funds will be claimed by another party. Any payment, regardless of who receives it, reduces the asset’s balance, diminishing its value without corresponding funds to offset this reduction. And once these funds are gone, it is impossible to recoup them. Additionally, do not be surprised if cash moves in unexpected directions. In one case, I learned, too late, that a third party controlled a failed originator’s payment website and collected funds that I was unable to redirect into my account. In another, back when obligors paid by check before ACH payments were the norm, I discovered, again, too late, that funds in my collection account were combined with other parties’ money (known as “commingling”), and any cash distributions from the account were prohibited for some time. Find the cash, stop the leakage and get it into your system fast. Is the back-up servicer ready? If the assets have a servicing component, ensure the back-up servicer is truly prepared to assume servicing and make this determination well before you must remove the existing servicer. Servicing transfers always take longer than expected, especially when servicing agreements still need to be negotiated, data tapes are outdated and ACH files are not regularly delivered. Worse, you may be working without the existing servicer’s cooperation, which adds more delays and complications to the process. If the back-up servicer has a real call center, an active loan management system and collectors ready to go, you’re already ahead of the game. Vervent , the back-up servicer for the Tricolor facilities, was fully prepared with the systems, staff and data to assume customer communications within days of Tricolor’s shutdown and keep the payment channels open. Additionally, because of its experience and resources, it was able to on-board Tricolor’s accounts to its systems within 17 days of transfer, an especially fast timeline for a portfolio of that size. In the end, everyone I spoke with agreed that these workout situations were some of the greatest learning experiences of our careers. But I wouldn’t wish these events on anyone just for the sake of professional growth. The uncertainty, tough decisions and tense moments, none of them are easy in the moment. That said, despite the bruises and scrapes, those of us who have navigated these crises have lived to tell another tale. And the one thing we all agree on is that in ABF, there’s almost always a yellow brick road leading you out of the fog. Byrns has a track record of more than 20 years of private investing and financing experience at funds and financial institutions and is an accomplished asset-backed finance investor. The article originally appeared in The Credit Practitioner and is published with permission from the author. Auto Finance Summit, the premier industry event for auto lending and leasing, returns October 5-7 at Caesars Las Vegas. To learn more about the 2026 event and register for early-bird pricing through Aug. 21, visit www.AutoFinance.live/AFS .

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