Is First Brands implosion a new subprime crisis?

The collapse of First Brands Group, a private Ohio-based auto parts conglomerate, has sent ripples through the private credit sector, exposing vulnerabilities in a market that has ballooned to nearly $2 trillion. The fallout is forcing finance professionals and institutional investors to re-examine the risks embedded in opaque lending structures that have flourished outside traditional banking channels.

First Brands, once a fast-growing supplier of spark plugs and wiper blades, filed for bankruptcy in late September, revealing a staggering $12 billion in liabilities, much of it hidden in off-balance sheet vehicles and unconventional financing arrangements. The company’s aggressive expansion was underpinned by a blend of leveraged loans, supply chain finance, and special purpose entities (SPEs) that left even seasoned Wall Street professionals struggling to untangle the true extent of its obligations.

Major financial institutions have been caught in the crossfire. Jefferies’ Leucadia Asset Management unit faces a $715 million exposure through its Point Bonita Capital Fund, while UBS O’Connor’s private markets arm has more than $500 million at risk. These exposures are tied to receivables from major retailers and to fintech platforms like Raistone, whose fortunes were closely tied to First Brands.

Jefferies has stated it is working with advisors to assess the impact on its Point Bonita strategy, which has held First Brands-linked assets since 2019. Meanwhile, Millennium, a multi-strategy hedge fund, has already written down $100 million due to its exposure.

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‘Layers of risk’

The First Brands bankruptcy has drawn sharp warnings from industry veterans. Jim Chanos, renowned for his prescient short position against Enron two decades ago, has been particularly outspoken. “I suspect we’re going to see more of these things, like First Brands and others, when the cycle ultimately reverses,” Chanos told the Financial Times, emphasizing that private credit “has put another layer between the actual lenders and the borrowers.”

Chanos likened the current private credit boom to the pre-2008 mortgage market, where risk was obscured by multiple intermediaries. “With the advent of private credit . . . institutions [are] putting money into this magical machine that gives you equity rates of return for senior debt exposure,” he said, warning that such high yields for supposedly low-risk investments “should be the first red flag.”

However, Sean Beznicki, Director of Investments at VLP, told InvestmentNews: “Unlike the SVB collapse, which was a systemic liquidity shock that rattled the banking system, the First Brands bankruptcy is an isolated credit event. It’s part of a credit cycle, not a sign of structural weakness.

“While it may create some short-term noise in spreads, the broader credit market remains well-supported by strong bank capital, diversified lenders, and ample liquidity. SVB tested the system’s plumbing - First Brands is testing investors’ credit discipline.”

The bankruptcy probe into First Brands is now investigating whether the company pledged the same invoices to multiple lenders and whether collateral was improperly mixed between entities—a scenario that could deepen losses for creditors.

Opaqueness: A feature, not a bug

Unlike public companies, First Brands’ financials were not widely available. Only managers of collateralized loan obligations (CLOs) who signed strict non-disclosure agreements could access its books. Even many sophisticated credit specialists were unaware of the SPEs backing the company’s inventory financing until just before the collapse. As Chanos observed, “The opaqueness is part of the process. That’s a feature not a bug.”

Goldman Sachs traders reportedly only discovered the high-cost borrowing from these SPEs hours before they too filed for bankruptcy. The tangled ownership structure—where founder Patrick James controlled both the operating company and its financing vehicles—has been described by Chanos as a “huge red flag.”

Orlando Gemes, CIO at Fourier Asset Management, told CNBC that the market has become “very aggressive in offering covenant-lite loans, but also a higher percentage of loans with a Payment-in-Kind structure, creating even more risk.” He added, “Lending standards in the leveraged finance market are the weakest they’ve ever been.”

Tony Tutrone, head of alternatives at Neuberger Berman, cautioned that asset managers must avoid taking in more capital than they can prudently deploy. “Managers need to be disciplined and not take money if they’re getting too much money and they don’t have enough deal flow,” he said.

Despite the size of the collapse, most analysts believe systemic risk is limited, thanks to post-2008 reforms and enhanced protections in CLOs. Still, the episode has exposed the difficulty of performing due diligence in private markets, where transparency is often lacking and risk can be hard to measure.

Patrick Ghali, managing partner at Sussex Partners, told CNBC: “In public markets, you can look on your screen and see where a company trades — you can see what the liquidity is, what the volumes are, you can stress-test it. In private markets you don’t have that.” He added, “There are a lot of people who probably don’t remember 2008 as it was almost 20 years ago, but there are lessons to be learned from it.”