Wall Street is worried the private credit bubble will burst

The sudden unravelling of an American manufacturer of car parts has rung alarm bells on Wall Street about risky lending in private debt markets.

The Ohio-based business, which makes windscreen wipers, fuel pumps and spark plugs, is owned and run by Patrick James, a Malaysian-born businessman with a limited public profile. It has long used an opaque financing method known as factoring, which allowed it to borrow against future cash flows.

Yet it had managed to secure financing from dozens of the world’s biggest private investment firms, including PGIM, UBS and Invesco, as it issued loan facilities with attractive returns to fund its acquisition of auto parts brands.

Only months earlier, First Brands, like Tricolor Holdings, a subprime auto lender that also filed for bankruptcy in September, had received strong credit ratings.

The financial distress the company now finds itself in can be traced back to early August, when it was seeking to raise another $6 billion in loans. Through that process, investors started to raise questions about the numbers being presented.

In early September it was reported that Apollo Global Management had amassed a short position against the debt of First Brands Group, meaning that it stood to profit if the auto parts maker failed to continue paying its debt.

The news caused a rush for the exit and the value of its debt started collapsing, before a bankruptcy process was initiated to bring some order to what appeared to have become the equivalent of a bank run. First Brands said that its Chapter 11 cases pertain solely to US operations and it expects its global operations to continue uninterrupted.

John Bringardner, head of restructuring at New York-based Debtwire, said: “This will be a messy, expensive bankruptcy, with a lot of players involved, and a lot of people are going to be second guessing choices they’ve made in the past few months on this name.”

He expects First Brands’ troubles to lead to big Wall Street players closely reviewing their investments to reassess risk.

Bringardner said the issue for investors was one of transparency. “It’s not necessarily a liquid market, like a big public bond that you can pretty easily trade in or out of, [where] you have public reporting, you can look at the financials, you can question them … Versus these kinds of off balance sheet private debt facilities that tend to be more illiquid, there’s really little to no disclosure.”

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It comes amid concerns about the boom in lending by money managers rather than banks, known as “private credit”, which has grown significantly since the global financial crisis as increased regulations and capital requirements made it more challenging for traditional banks to issue certain types of loans.

On Monday, Fitch Ratings warned that the private credit sector is exhibiting “bubble-like” attributes, including rapid growth and financial innovation, spread compression, heightened competition, growing retail participation and rising borrower leverage.

Fitch said the risks were not yet systemic because private credit is still a relatively small portion of the overall financial system. However, the ratings agency said that in the event of a shock like interest rate volatility or rising margin calls, the private credit sector could be exposed to losses and elevated redemptions, with a broad range of investors exposed.

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Questions will include how First Brands’ complex financing structures may have hidden the extent of its leverage, the due diligence of private lenders and whether they ignored any red flags, and the impact of higher tariff-related costs.

For investors, the concern is that the troubles at the auto car parts maker may be a sign of further distress in debt markets to come.