Imagine a financial world where the roar of engines in the auto industry suddenly turns into the screech of brakes on Wall Street— that's the startling reality unfolding right now as recent bankruptcies in the automotive sector are forcing investors and experts to question the hidden dangers lurking in the credit markets. It's a wake-up call that could shake the very foundations of how we think about investing, and it begs the question: are we overlooking risks that could derail our portfolios? Stick around because this story is just heating up, and there's more to uncover than meets the eye.
Summary
The recent collapses of companies tied to the automotive world are igniting a wave of fresh worries about concealed perils in various corners of the credit landscape, pushing financiers to scrutinize high-risk debts with unprecedented intensity.
Companies
Let's dive into the details. The bankruptcies of First Brands, a key auto parts supplier, and Tricolor, a player in subprime lending and dealerships, have both occurred in September, sparking alarm bells. These failures are prompting stakeholders to reevaluate the entire ecosystem of Wall Street's massive credit operations, encompassing everything from leveraged loans and collateralized loan obligations (CLOs)—think of CLOs as bundles of loans packaged together for investment—to trade-finance funds and loans for subprime auto buyers. This scrutiny is particularly directed at a range of Wall Street fund managers who gather money from investors to lend to businesses, raising eyebrows about just how exposed these managers might be.
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Investors Demanding Greater Caution on Risky Assets
As Zain Bukhari, an associate director of risk and valuations at S&P Global, points out, this situation sets a powerful example that could encourage limited partners—those are the passive investors who put up capital for funds—to challenge offerings that seem too dicey. Limited partners might now insist on audited financial statements or independent quality-of-earnings reports before dipping their toes into unsecured assets. For context, unsecured assets are loans or debts not backed by specific collateral, making them riskier because if something goes wrong, there's no tangible security to fall back on. First Brands, for instance, carried about $800 million in such liabilities tied to its supply chain financing.
A clear sign of this heightened vigilance emerged back in July when First Brands sought a massive $6 billion loan to restructure its debts. By August, though, potential lenders demanded extra checks, including a detailed quality-of-earnings report, as revealed in a court filing by the company's chief restructuring officer during bankruptcy proceedings.
Assessing the Impact and Looking Ahead
Right now, investors and analysts are busy evaluating the consequences not just for the directly affected firms, but for the wider market too. They're pinning their hopes on the upcoming third-quarter earnings reports, which begin this week, to shed some light.
"The earnings from Q3 will act as a crucial indicator of how this turmoil unfolds," explained Andrew Sheets, the global head of corporate credit research at Morgan Stanley. "Everyone's eyes will be glued to the banks' disclosures, with big questions swirling around trends in auto loans and other areas of consumer credit, like charge-offs—those are when lenders write off bad debts as losses."
Delving deeper, First Brands sought bankruptcy protection on September 29, with over $10 billion in debts listed. Prominent financial players, including Jefferies and UBS Group (UBSG.S), have disclosed exposures exceeding $1 billion linked to this Ohio-based company's downfall. Jefferies, through its asset management arm Leucadia Asset Management, reported around $715 million in receivables connected to First Brands. UBS is evaluating over $500 million in potential exposure across select funds.
In a related twist, some investors have pressured a Jefferies-affiliated fund managed by Point Bonita Capital to return their invested capital, as a source close to the matter shared with Reuters. Jefferies responded on Sunday by downplaying the impact, stating any losses from First Brands would be "easily manageable." When queried about whether investors might push for stricter scrutiny of high-risk investments, a Jefferies spokesperson chose not to comment on Monday.
Other banks with stakes include SouthState Bank and CIT Group, now under First Citizens. A variety of funds, such as Sound Point Capital Management, Benefit Street Partners, and Palmer Square Capital Management, hold CLOs that include hundreds of millions from First Brands' $4 billion in first-lien term loans—these are senior loans with priority claims on assets in case of default. Investment outfits with over $100 million each in CLO exposure encompass AGL Credit and PGIM, based on recent court documents.
Most of these funds and banks either chose silence or didn't reply to comment requests. A UBS representative noted they were "actively assessing the possible effects on a limited number of our funds."
Meanwhile, Tricolor reported liabilities surpassing $1 billion, impacting more than 25,000 creditors in its bankruptcy filing. Lenders like JPMorgan (JPM.N) face nearly $200 million in exposure, as previously covered by Reuters.
The Credit Rally Hits a Rough Patch
What started as a strong credit market rebound in early October has stumbled in recent days, with investors pulling back from certain areas due to fears about vulnerabilities in consumer spending and auto financing, according to specialists.
"We've hit upon a significant trigger that's sown a bit of apprehension," remarked Neha Khoda, head of U.S. credit strategy at Bank of America, in a note from October 10. "Credit market participants are rethinking whether they should commit fully to deals with extremely narrow spreads, and we wouldn't advise against that caution."
That said, not everyone believes First Brands' collapse will trigger a massive, worldwide credit crisis. Some experts argue it's contained.
"Looking at individual deals, the leveraged finance markets don't appear all that different from past patterns," said Logan Nicholson, senior managing director at Blue Owl Capital, an asset management firm.
In the U.S., CLOs as a whole have just 0.21% exposure to First Brands, per Morgan Stanley's estimates from September 26. For the specific CLO funds involved, exposures vary from a tiny 0.001% up to 1.8%.
Experts also note a growing split in the CLO world between those holding senior loans (higher up in the repayment priority) and junior ones (lower, riskier tier), exacerbated by sluggish economic growth and trade policies under the Trump administration, like tariffs.
"The more pronounced effects are likely on the loan market side," Sheets from Morgan Stanley added, suggesting the bankruptcies' fallout might disproportionately hit the junior tranches of CLO structures—those riskier layers that absorb losses first.
But here's where it gets controversial: Is this just a blip, or a harbinger of deeper systemic issues? Some might argue that over-reliance on risky assets in a booming market sets us up for bigger falls, while others could counter that the financial system's resilience has proven stronger time and again. And this is the part most people miss—the potential for policy changes or even government interventions to mitigate such risks. What do you think? Could stricter regulations on subprime auto lending prevent future meltdowns, or would that stifle innovation in financing for everyday consumers? Share your thoughts in the comments—do you side with the cautious investors demanding more transparency, or believe the market will self-correct without overhauling how funds operate?
Reporting by Anirban Sen and Saaed Azhar in New York; Additional reporting by Matt Tracy and Davide Barbuscia; Editing by Megan Davies and Matthew Lewis.
Our Standards: The Thomson Reuters Trust Principles.
Anirban Sen is the Editor in Charge of Market Structure at Reuters in New York, where he oversees coverage of stock exchanges and market-making firms like Jane Street and Citadel Securities. He previously served as M&A Editor at Reuters, leading teams that broke stories on major deals, such as Mars' $36 billion acquisition of Kellanova, Synopsys' $35 billion buyout of Ansys, and GTCR’s $18.5 billion takeover of Worldpay. In 2023, he contributed to a Reuters team that earned a Gerald Loeb Award for coverage of the FTX collapse. Starting with Reuters in Bangalore in 2009, he later worked as a technology deals reporter for outlets like The Economic Times and Mint in India before returning to Reuters in 2019 as Editor in Charge, Finance, to guide reporting on investment banking and venture capital.
Saeed Azhar is a Reuters financial journalist on the U.S. banking team, with a focus on major players like Goldman Sachs and Bank of America, plus regional banks. He relocated to New York in July 2022 after leading finance coverage in the Middle East from Dubai and working in Singapore on Southeast Asia finance.
Matt Tracy reports on U.S. credit market activities, including corporate debt, credit ratings, U.S. Treasuries, commercial mortgages, and the tug-of-war between public and private financing. He collaborates on other topics with Reuters teams and previously covered regulatory probes into mergers, such as antitrust, national security, FCC, and state reviews of big deals since 2016. His reporting broke news on investigations into AT&T's Time Warner merger, T-Mobile's Sprint acquisition, Bayer's Monsanto deal, and numerous other high-stakes combinations.
