The bankruptcies of auto companies First Brands and Tricolor, along with potential losses at banks and investment funds, are raising fresh concerns about hidden risks in parts of the credit market, prompting investors to take a closer look at risky debt.
Auto parts supplier First Brands and subprime lender and dealer Tricolor filed for bankruptcy protection last month. The two collapses have rattled some stakeholders in Wall Street’s multi-trillion-dollar lending machine, from leveraged loans and collateralized loan obligations (CLOs) to trade finance funds and subprime auto loans, raising questions about the exposure levels of several Wall Street money managers, who raise capital from investors to make loans. to companies.
“This would serve as a strong precedent for LPs (investors) to question risky offerings,” said Zain Bukhari, associate director of risk and valuations at S&P Global. LPs, which refer to limited partners, are passive investors who provide capital to a fund.
Some investors may request audited statements or earnings quality from independent auditing firms before investing in unsecured assets, Bukhari added. First Brands had approximately $800 million in unsecured supply chain financing liabilities.
A sign of such scrutiny appeared in July when First Brands was trying to raise a $6 billion loan to refinance its debt. In August, however, it became clear that potential lenders would require more diligence, including an earnings quality report, according to a filing by the auto parts company’s chief restructuring officer in bankruptcy court.
Investors and analysts are now assessing the consequences for individual companies exposed, as well as the broader market. They hope to get some clarity during the third quarter earnings season, which begins this week.
“Third-quarter earnings become a very interesting litmus test for how this plays out — people will be watching bank reports very closely,” said Andrew Sheets, global head of corporate credit research at Morgan Stanley. “There will be big questions about where the auto loan trends are, (and) other consumer credit payoff trends.”
First Brands filed for bankruptcy on September 29, listing more than $10 billion in liabilities. Some of the financial industry’s biggest names, including Jefferies and UBS Group, have since disclosed more than $1 billion in exposure linked to the collapse of the Ohio-based company. In early October, Jefferies said a fund in its asset management division, Leucadia Asset Management, has about $715 million in accounts receivable tied to First Brands. UBS is evaluating more than $500 million of exposure in certain funds.
Some investors have asked the Jefferies-linked Point Bonita Capital fund to return money invested in the fund, a source familiar with the matter told Reuters. On Sunday, Jefferies said its exposure to First Brands Group is limited and that any potential losses would be “easily absorbable.” When Jefferies was asked if it will face pressure from investors for greater scrutiny over risky investments, a spokesperson for the firm declined to comment Monday.
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Auto Bankruptcies Prompt New Scrutiny of Wall Street Credit Risks
Other banks exposed include SouthState Bank and CIT Group, which is now owned by First Citizens. A wide range of funds, including Sound Point Capital Management, Benefit Street Partners and Palmer Square Capital Management, hold CLOs, which collectively own hundreds of millions of First Brands’ $4 billion of first lien term loans, according to court documents. Investment firms with more than $100 million of CLO exposure include AGL Credit and PGIM, according to recent court filings.
The funds and banks either declined to comment or did not respond to requests for comment. A UBS spokesperson said the bank was “working to determine the potential impact on the performance of the small number of our affected funds.”
Meanwhile, Tricolor listed more than $1 billion in liabilities, with more than 25,000 creditors, according to its bankruptcy petition. Lenders such as JPMorgan have nearly $200 million of exposure to Tricolor, Reuters previously reported.
The credit rebound, which got off to a strong start in early October, has hit a bump in recent days as investors reduced exposure to certain sectors on concerns about weakness in consumer and auto lending, experts said.
“It now appears we have a catalyst large enough to cast a shadow of fear,” Neha Khoda, head of U.S. credit strategy at Bank of America, said in a note dated Oct. 10. “Credit investors are wondering if they need to bet on super tight spreads, and they won’t get a pushback from us.”
To be sure, the collapse of First Brands is unlikely to trigger a widespread global meltdown in credit markets, some experts said.
“On a deal-by-deal basis, we do not see conditions in leveraged financial markets being materially different from historical norms,” said Logan Nicholson, senior managing director at asset manager Blue Owl Capital.
In the United States, the overall CLO exposure to First Brands currently stands at 0.21%, according to Morgan Stanley estimates in a note dated September 26. For CLO funds that currently hold loans from First Brands, exposure levels range from 0.001% to 1.8%.
Some experts said a divergence has emerged in the CLO industry between senior and junior loan holders, as a cohort of companies with weaker credit ratings have been hit by slower macroeconomic growth and headwinds from the Trump administration’s tariff policy.
“Probably the biggest impact on the markets has been on the lending side,” said Morgan Stanley’s Sheets, adding that the ripple effect of bankruptcies could affect smaller parts of a CLO’s capital structure.
With information from Reuters.
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