Early on Oct. 10, London daily The Guardian went public with its fears that that the issues involved in the Sept. 29 bankruptcy filing of First Brands are sufficient to trigger a run on the banking system. Later in the day, Bloomberg followed with an extensive story on some of the gory details.
First Brands is known for off-brand auto parts, a supplier to Walmart, AutoZone, NAPA and Advance Auto Parts. But it’s not the off-brand auto parts that are the immediate problem; rather, it’s the off-the-balance-sheet financing of its aggressive buyouts of companies in a world of deregulation. Private investors were lured by the image of an expanding company and high interest rates. But in the world of opaque financing, the big unknown is how far major banks are at risk.
According to The Guardian: “Brett House, an economics professor at Columbia Business School, says concerns are primarily about unregulated private debt markets and the assets they hold.... When these assets become impaired, it’s a surprise to markets, because ... we don’t have great transparency on the location and concentration of where these assets are being held.” The concern about “impaired assets” is about re-hypothecation—where private financiers speculated on First Brand’s invoices, paying off First Brand’s suppliers with the promise of high returns when First Brand paid up. Now, there’s an investigation of the same assets in effect being promised to various investors. So, the “musical chairs” scramble is on.
Ben Lourie, professor of accounting at the University of California, Irvine, explained: “My guess is the companies went into bankruptcy because the market is not great and they started doing things they should not be doing. So they went into financial innovation with invoice financing. The fear is that the private debt market has been too hot, and [has been] giving out money, at high interest rates, to companies that just can’t pay it back, and especially to companies in the auto market.... But there isn’t as much disclosure as there is in the public markets. So there is a disclosure issue because we don’t really know what’s going on. When there isn’t as much disclosure, there’s more risk, and there’s a fear of contagion, because somebody is going to have to take on these losses, and eventually it will reach up into the banks.”
A midsized Wall Street lender, Jefferies, is known to be involved via a “a specialist invoice-finance fund it manages, Point Bonita Capital,” which places “billions of dollars of loans” with unknown investors. Jefferies is now facing redemption requests, and they admit to $715 million in exposure to First Brands, but it is likely the tip of the proverbial iceberg. According to Bloomberg, UBS, via its O’Conner hedge fund, and Millennium are also known to be exposed.
The Guardian noted that “private debt or ‘shadow banking’ to borrow against invoices, in effect keeping debt off its balance-sheet disclosures,” turned “a company with 26,000 employees into a finance company more than the supplier of auto parts.” Now, “Raistone, which arranged some off-balance sheet financing, claimed that as much as $2.3 billion had ‘simply vanished’ as part of the bankrupt auto supplier’s failure.” While Raistone has found “new religion,” they had derived 80% of its revenue from First Brands. And while The Guardian cited the collapses of “the U.K. fintech Greensill Capital in 2021, and London-listed firm Carillion in 2018” for similar reasons, they are quiet as to why that possible chain-reaction was contained, but this present one may not be.
Brett House summed up: “And that can often have knock-on effects that are unanticipated.... The risk may sit in the balance sheets of funds and other asset managers that may create counterparty risk for large financial institutions that can cause reverberations from relatively obscure small funds hitting problems and creating a cascading effect through the financial system that gets amplified by the structure of different asset classes and is unanticipated because of a lack of transparency. It effectively means that unregulated parts of the debt and asset management market may hold risks that have implications for the entire financial system.”
As Bloomberg put it: “The rushed bankruptcy is the latest sign that cracks may be developing in the facade of this rapidly expanding corner of the financial industry. These risks are no longer confined to Wall Street.”
The Sept. 29 bankruptcy lit a fuse not likely to end with Jefferies, and the two articles from Oct. 10 may only indicate the pace of the escalation—one that has the elements to pick up its pace rapidly.
