Investors in the $2tn leveraged loan market have warned that the abrupt collapse of First Brands Group is an early sign of trouble for a market where hasty deals and hurried due diligence have become commonplace.
First Brands was among the largest issuers of loans bought by collateralised loan obligations, investment vehicles that buy up small slices of hundreds of individual corporate loans.
CLOs have become popular with insurers and other big investors who bet that by spreading their lending across many different companies they are protected from the pain of defaults in one or two businesses.
But the rapid bankruptcy of First Brands, a maker of antifreeze, windshield wipers and brake pads, has raised concerns over the rapid growth of the CLO market, which has provided almost unquenchable demand for the leveraged loans that private equity firms often use to finance their acquisition sprees. Some fund managers worry that a spate of CLO losses could cause Wall Street’s securitisation machine to sputter.
“Inside credit markets for more than a year, there has been a grudging recognition that there was and is a series of credit problems that could be substantial and could be dangerous to the overall economy,” said Andrew Milgram, chief investment officer of Marblegate Asset Management, a distressed-debt investor.
First Brands’ downfall, just weeks after subprime auto lender Tricolor filed for bankruptcy amid allegations of fraud, has stoked concerns that the failures are unlikely to be isolated incidents.
“You’re not paid to do due diligence in this market,” an executive at a former lender to First Brands said.
First Brands had issued more than $5bn of senior and junior loans, which were bought up and held in dozens of CLOs issued by asset managers including PGIM, Franklin Templeton, Blackstone, CIFC, Oaktree and Wellington, according to a Morgan Stanley analysis.
Most of those vehicles have already realised their losses, selling out of the loans as First Brands’ problems came to light over the past two weeks. The loans are now changing hands at just cents on the dollar, with an implied loss of more than $4bn.
Those losses will principally hit the returns of CLO equity holders, which includes the managers of the structured credit vehicles themselves. CLOs are often 10 times leveraged, with $50mn of equity supporting a $500mn loan portfolio, for example. Defaults such as First Brands’ cut into that equity cushion, which exists to take the first loss and protect higher-rated investment grade tranches of the CLO.
Trading of those equity tranches is opaque, but investors said they had not yet seen money managers dumping those positions in secondary trades.
The sell-off in First Brands debt has started to weigh on the broader market, with PitchBook LCD data showing the US leveraged loan market is on pace for its biggest monthly loss since 2022.
“The two successive defaults of [First Brands] and Tricolor Auto brought into highlight potential irregularities and underwriting challenges in the credit market,” Bank of America strategist Pratik Gupta said. “The market has started to take a dim view of credit fundamentals.”
Despite the troubles at First Brands and Tricolor and pockets of weakness starting to appear in the US economy, the strong demand for higher-yielding investments such as leveraged loans has kept spreads on risky corporate debt at near-record low levels.
Leveraged loan issuance hit a record in the third quarter at $404bn, according to PitchBook LCD. However, investors say this feverish pace of issuance has meant deals — which a few years ago may have taken weeks or more to line up — are now often raced through.
When First Brands raised more than $750mn in March 2024 to fund an acquisition, it announced it was in the market for the debt financing on a Monday morning. Investors were allocated the loans before lunch on Friday of the same week. In total, more than 80 CLOs were exposed to First Brands, bankruptcy filings showed.
Demand has persisted despite some of the worst investor protections on record, according to Covenant Review. Lawyers for the industry say they have little power to push back against weak protections when willing buyers are so numerous.
First Brands debt offered attractive rates, with an interest rate 5 percentage points over the floating rate benchmark for the US dollar loans it issued in March 2024. When accounting for discounts investors received at the time of the capital raise, the loans yielded roughly 11 per cent.
Investors who have suffered losses on the loans say due diligence was not made a priority, with some investors taking comfort from the fact that larger managers with bigger teams of credit analysts had bought in.
But others saw red flags they said steered them away from the debt. The company was perpetually buying up smaller businesses and raising more debt to fund those takeovers. Investors said that made it difficult to assess how the underlying business was faring. Others pointed to the difference between the cash flows that First Brands generated and the profits it reported it was earning.
“Everything was adjusted,” one investor who decided against investing in First Brands debt said, referring to its profit statement. “Nothing tied to cash so it was virtually impossible” to analyse.
Josh Easterly, the chief investment officer of investment group Sixth Street, pointed to the fact that many CLO investment firms have just a handful of analysts covering their entire credit portfolios, which can include hundreds of different investments. Moody’s estimates roughly 2,000 companies issue debt that is bought by CLOs in the US.
“When the tide goes out . . . things are going to come out,” Easterly said, noting that investors would see “who has done their work and who hasn’t.”
While defaults in the leveraged loan market have picked up this year from 2024, the pace remains low by historical standards, according to PitchBook LCD data. But concerns about the lack of due diligence in a frothy market are starting to mount.
“With [Tricolor] and First Brands, the problems of the credit market are starting to percolate into the general Wall Street psyche,” Milgram said. “Are we entering a period where those [CLO market’s] assumptions will be tested?”
The top-rated AAA tranches in CLOs have proven their mettle during prior market sell-offs and economic downturns, given how diversified the vehicles are. Investors said defaults would need to rise dramatically to begin to impair investors in even the lower-rated portions of the vehicles.
Money managers are nonetheless keenly aware of the problem that First Brands might cause the broader market.
Asset manager Silver Point this month began the marketing of its first euro CLO by highlighting one point in investor materials seen by the FT.
It said: “Silver Point has zero First Brands exposure.”
Additional reporting by Robert Smith