The collapses of First Brands and Tricolor Holdings have sparked fears that mounting bad loans could threaten the US economy’s path forward.

Tricolor, a subprime auto lending firm, dramatically collapsed amid allegations of fraud, raising alarm about the state of the US subprime auto sector more generally.

Tricolor’s business model was predicated on extending financing to customers with limited credit histories, charging them high interest rates, with higher than usual down payments.

Weeks later, automotive parts supplier First Brands Group collapsed, amid questions about its accounting and borrowing practices.  

As reported by Bloomberg, “the company had accumulated billions of dollars in debt that wasn’t reflected on its balance sheet, according to court records, raising red flags about its true financial condition.”

Are these companies the canaries in the private credit coalmine? Or simply isolated cases of corporate mismanagement?

Leveraged lending

A JP Morgan strategist points out (23^rd October) that the majority of the troubled credit originated in leveraged loans originated by banks, rather than private credit.

The note explains that private wealth investors have gained exposure to leveraged loans via Collateralised Loan Obligations (CLOs), in which “Pools of AAA tranches, perceived as lower risk, have been marketed as below-investment grade securities, leading to easier accessibility by individuals.”

As the note acknowledges, this description will likely ring alarm bells due to their close resemblance to the collateralised debt obligations (CDOs) which (as the analyst puts it with admirable restraint) “exacerbated the 2008 global financial crisis.”

Critically, though, CLOs are not concentrated in an overheated housing market and span multiple economic sectors. Investors have thus “taken the recent defaults as a signal to examine sector exposure across portfolios in the backdrop of broader economic and tariff headwinds.”

Concentration risk aside, are the defaults a sign of poor lending practices more broadly, and could private credit be implicated? While there is clearly evidence of risky lending, “many lending platforms have remained disciplined, focusing on senior-secured lending and using limited leverage”.

Macro risks

Goldman Sachs analysts agree. Spencer Rogers of Goldman Sachs Research (6^th November) acknowledges that “with each successive credit event that comes to light, it becomes harder to say that these are all totally unconnected.” However, Rogers suggests that “at this stage, we would still very much come down on the side of these being idiosyncratic events and not credit-type events”.

Rogers suggests that allegations of fraud against the affected companies is evidence that the collapse aren’t simply the result of a downturn in economic conditions and poor credit quality.

While Rogers seems broadly sanguine about credit markets, potential risks could include an unexpected acceleration of inflation, the effects of a continued deterioration in the labour market, or renewed instability linked to trade policy.

Rating the raters

It is one thing to ask whether private lenders are behaving prudently, but an equally important question is whether the rapidly expanding private credit market is being properly overseen. Concerns about oversight have grown louder in recent months. Colm Kelleher, chairman of UBS Group, has warned that many insurers are now extending large volumes of loans without the necessary expertise or the discipline of transparent, rigorous credit assessments.  (Kelleher’s contention, however, has been vociferously rejected by industry leaders.)

 At the same time, observers have noted the growing influence of smaller ratings agencies that have been issuing vast numbers of credit scores, raising questions about the consistency and reliability of those evaluations.

Whether the recent collapses prove to be isolated failures or early warnings of deeper fragilities, they underscore the need for vigilance in a market that could be growing faster than its oversight.

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