First Brands’ fallout sparks alarm in USD 2 tn leveraged loan market

The recent fallout of US-based autoparts maker First Brands Group has sent alarm bells ringing across the USD 2 tn leveraged loan market, the Financial Times reported on Friday. Investors warn that the sudden fallout is part of a broader pattern of stress, marking an early warning sign for a market where hasty dealmaking and rushed due diligence have become the norm.

The shockwaves have spread well beyond the loan market. Investment bank Jefferies saw its share drop by nearly 20% after disclosing losses tied to First Brands, while hedge fund Millennium is also said to have suffered losses of around USD 100 mn from financing the company’s inventory, The Economist reports. The fallout illustrates how risk tied to a single borrower has reached across banks, hedge funds, and trade-finance lenders alike.

Jefferies’ CEO Rich Handler told investors the bank “believes it was defrauded” by First Brands, joining a chorus of firms alleging misconduct, Reuters reports. Jefferies said its exposure — about USD 715 mn in receivables — is largely contained, with estimated losses of under USD 100 mn after recoveries, Morningstar analyst Sean Dunlop said. Handler’s remarks reflect rising friction between banks and private lenders — each blaming the other for letting risky credit swell unchecked.

The problem stems from the “almost unquenchable demand” for collateralized loan obligations (CLO) — investment vehicles that buy and bundle hundreds of risky corporate loans, according to the salmon-colored paper. These loans are sliced into tranches and sold to major investors such as ins. companies and pension funds, which bet on diversification as a safeguard against defaults in individual companies.

The strong demand seems to have eroded the incentive to conduct proper credit checks. With CLO investors eager to fill their portfolios, transactions have often been pushed through in days rather than weeks, leaving little time to assess borrowers’ financial health. “You’re not paid to do due diligence in this market,” an executive at a former lender to First Brands told the FT.

The episode also exposes how difficult it has become to track risk across modern credit markets, as lending has shifted since the 2008 crisis away from banks into a web of private credit funds, business development companies, and securitized vehicles such as CLOs and collateralized fund obligations. The US Department of Justice is now investigating First Brands’ accounts to determine whether the company misrepresented its borrowing and collateral, including potential multiple pledges against the same assets, The Economist reported.

The lack of scrutiny allowed red flags to slip through. First Brands raised more than USD 750 mn in March 2024 via a loan announced on Monday and finalized by Friday, according to the salmon-colored paper. Investors who avoided the debt said the company’s “adjusted” earnings were nearly impossible to tie back to its actual cashflow, raising doubts about the business’s true financial strength.

First Brands had issued more than USD 5 bn in loans, which are now trading at cents on the USD, implying losses of roughly USD 4 bn. Most CLOs managed by major asset firms — including PGIM, Franklin Templeton, Blackstone, CIFC, Oaktree, and Wellington — had exposure to First Brand’s debt, according to an analysis by Morgan Stanley. These losses are set to wipe out the CLO equity tranches, the high-risk cushions meant to absorb the first wave of defaults.

Back-to-back bankruptcies: The bankruptcies of First Brands and subprime lender Tricolor — the latter amid fraud allegations — have triggered a sell-off in corporate debt that is now weighing on the broader leveraged loan market, which is on track for its biggest monthly loss since 2022, the FT cites data from PitchBook LCD.

MARKETS THIS MORNING-

Hong Kong’s Hang Seng is leading the gains among Asian markets this morning, rising 2.1% in early trading after China held lending rates steady. The Shanghai Composite is up 0.6%, while Japan’s Nikkei remains unchanged. Meanwhile, Wall Street futures are in the green as investors await a busy earnings week ahead.

THE CLOSING BELL-

The EGX30 rose 0.6% at yesterday’s close on turnover of EGP 5.2 bn (14.9% above the 90-day average). Regional investors were the sole net sellers. The index is up 27.5% YTD.

In the green: Egypt Aluminum (+5.1%), Mopco (+3.7%), and Palm Hills Developments (+3.1%).

In the red: Arabian Cement (-1.1%), Misr Cement (-0.8%), and Juhayna (-0.4%).