Transcription
Markets are priced for perfection. Stretch valuations, sky-high earnings expectations, and almost no volatility. But markets rarely fall without a catalyst. And one may have just appeared.
A little known auto parts maker, First Brands Group, has gone bankrupt, and that's exposed billions in hidden debt, and it's also dragged major lenders into the mess. It's part of the $3 trillion private credit market, one of the biggest and riskiest sources of corporate funding. In this video, we'll explore how private credit works, what's going wrong, and also why cracks here could be the spark that finally rerates equities back to reality. Remember, if you do enjoy our content, then why not like this video and subscribe to our channel.
The canary in the credit coal mine was First Brands. Now, First Brands built its empire on cheap debt, but also financial engineering. CEO Patrick James spent a decade building up car parts companies with borrowed money, creating a $5 billion revenue group. Behind the scenes sat over $8 billion dollars of debt, much of it hidden through invoice factoring and supply chain finance, pulling future cash into the present. By mid-2025, the cash ran out, lenders pulled back, and payments stopped. When the firm filed for bankruptcy, just $12 million remained in the bank and billions were unaccounted for. This was a textbook case of opacity, leverage, and wishful accounting.
The first cracks appeared on September the 15th, 2025 when First Brand stopped forwarding customer payments owed to Jeffrey's Point Bonita Capital Fund. Roughly $715 million in receivables from major auto parts retailers. Now, this wasn't a direct loan default. Instead, it was a breakdown in the company's role as payment servicer under its factoring arrangements. Now, this lapse left about a quarter of Point Bonita's $3 billion trade finance portfolio at risk. And by the end of September, First Brands had filed for bankruptcy. As much as $2.3 billion had, in the words of one creditor, simply vanished.
We did cover the First Brand's default in our weekly market roundup. We tried to keep it topical, short, punchy, but also humorous. And this allows you to keep abreast of what's going on in the macroeconomic world, but also what it means for your investments. Now, remember, it's completely free of charge. You can sign up for it very easily. Just go to our website, pensioncraft.com/newsletter, to learn more. And you'll also find a link to that in the description below.
Tariffs also played their part. In 2025, sweeping import duties, 10% across the board, 55% on China, 25% on Mexico, slammed the auto parts industry. First Brands relied heavily on global sourcing. As a result, costs surged, margins vanished, and refinancing became almost impossible. The tariffs didn't cause the bankruptcy, but they turned a fragile business into a failing one.
So why does a bankruptcy matter? It's because it exposed the shadow system that funded it, private credit. So, here's how it works. Instead of borrowing money from banks or issuing bonds in public markets, companies instead get loans from private funds. And these are managed by firms like Apollo, Blackstone, Ares Management, and KKR. These funds raise capital from pension funds, insurance companies, endowments, and increasingly retail investors such as you and I.
Now, why did this market explode in size? Well, after the 2008 financial crisis, banks faced stricter regulations that limited their ability to make risky loans. Private credit funds stepped in to fill the gap. They offered companies several advantages: faster approvals, more flexible terms, and confidential arrangements without public disclosure requirements. The markets ballooned from $200 billion in 2010 to over $3 trillion today, and it now rivals the US high yield bond market in size. But unlike public bonds, private loans don't trade or mark to market. Their valuations are whatever their fund managers say they're worth.
One of the biggest problems with private credit is that it has multiple layers of leverage and this amplifies risk. The private equity firm might use borrowed money. The private credit fund uses borrowed money. The borrowing company uses borrowed money and of course the fund's investors like pension funds might also themselves use borrowed money. Now when one link in this chain breaks, losses could cascade through the entire system.
Now, other companies could be at risk. Credit markets often witness periods of calm followed by clusters of problems that materialize at the same time. Just before the collapse of First Brand in September, subprime auto lender Tricolor Holdings collapsed amidst allegations of fraud and also mismanagement and this triggered losses for banks and investors. Now, it turns out that private credit managers had little direct exposure to Tricolor Holdings. Just 14 business development companies held about $230 million or about 4% of First Brand's term loans. So, Tricolor's downfall was ultimately a bank credit issue rooted in fraudulent warehouse lending. And this wasn't a specific private credit crisis. But what it did do was rattle confidence in credit quality and underwriting standards generally. And this had consequences.
If you look at shares of US regional banks, they tumbled in October after several lenders revealed potential fraud-related losses. Disclosures from Zions Bank and Western Alliance following the collapse of Tricolor and First Brands rattled lots of investors and it sent the KBW regional banking index down more than 6% and that was its sharpest drop since April of 2025. And the sell-off reflected growing unease that rising credit risk and isolated fraud cases may signal broader weaknesses across smaller bank balance sheets. Even as analysts stressed that the direct exposures remain limited. As one analyst put it, "When credit risk is rising, you just sell off the entire group and you get answers to your questions later."
And if we look at the exposed sectors, it tells the story of where stress is quietly building. Commercial real estate is the really big one. There we can see that roughly $1.5 trillion in loans mature by the end of 2026. And yet at the same time, office occupancy is still 20 or 30% below pre-pandemic levels. Buildings once financed at 3% now face refinancing at 7 or 8%. Many landlords may not be able to roll over their debt without investing fresh capital, which few of them have. That's already leading to handbacks to lenders, especially in the US and European city centers.
Auto suppliers are next in line. Tariffs, high energy costs, and rising wages have squeezed already razor-thin margins. And firms that survived on short-term financing now face a double blow: higher costs and also tighter credit. So, First Brands wasn't unique. It was simply the first to break. Healthcare and retail tell a similar story. Private equity-backed rapid expansion, but now costs are climbing. Staff shortages are persistent. And at the same time, margins are eroding. Retailers at the same time are stuck with post-COVID debt just as consumers tighten their belts.
So how would a private credit crisis spread to the wider economy? Let's walk through the contagion pathways. I think there are six key channels. Let's start with banks. These have lent about $300 billion to private credit funds. And if those funds face withdrawals, they draw credit lines simultaneously. This tightens bank liquidity, especially for those smaller regional banks where we saw the big sell-off earlier.
Second, insurance companies. If these are private equity-owned, they may hold riskier assets. And as a result of losses, they'd have to sell what's liquid, which is treasuries, and this would spread contagion from the private equity market and the private credit market into the broader US Treasury market.
Third, pension funds. So if we look at schemes like CalPERS, which is the largest US pension fund, they and many other pension funds have significant private credit allocations. Now if returns falter in private credit, that would widen funding gaps and that would mean higher contributions would be required into those pensions and that would mean less real economy spending. So that could potentially put a break on growth in the wider economy.
Fourth, collateralized loan obligations or CLOs, which are bundled packages of loans and hundreds of those CLO funds held First Brand's debt. Now if defaults rise together in that space, then the lower-rated tranches, because these CLOs are often sliced up into different levels of risk, those lower-level tranches could take losses and it could trigger forced selling and we could get a fire sale. This is reminiscent of what happened during the global financial crisis, for example.
Fifth, business development companies or BDCs. Public and non-traded BDCs hold over $120 billion in private loans, and rising defaults could push these companies also into fire sales.
So, I think the bigger risk here is a good old-fashioned credit crunch. And the biggest risk in these credit crunches is fear itself. Now this is perhaps the most dangerous pathway because if lenders become uncertain about which borrowers are hiding off-balance sheet liabilities like First Brands, they could pull back from lending altogether. This credit crunch would affect healthy companies too and it would force them to cut investment but also employment and small and medium-sized businesses which depend heavily on private credit would be hit the hardest. The real economy effects would cascade. Companies unable to refinance would file for bankruptcy. Unemployment would rise as companies cut costs. Consumer spending would decline. Banks would tighten lending standards further. And the Federal Reserve would face a dilemma: Should they cut rates to support the economy? But then that could potentially encourage more risky lending, or should they maintain higher rates and risk deeper recession? But opinions here diverge sharply.
Industry insiders in private credit argue that First Brands was primarily a broadly syndicated loan failure, not a private credit problem. Syndicated loans, remember, when banks pull together to lend to companies. So people in the private credit space would point to patient capital, buy and hold strategies, and relatively low default rates as evidence that the private credit market is fundamentally sound. Whereas critics would counter that we simply don't know the true risk because the market lacks transparency without mark-to-market pricing, comprehensive data, or stress test history. We're just flying blind. The fact that approximately $2.3 billion could simply vanish from First Brand's balance sheet without lenders noticing until it was too late suggests due diligence failures.
So, is private credit the next financial crisis? Here's my take on it. Firstly, the sector is now easily large enough to be systemically important, $3 trillion globally. The interconnections with banks, insurers, and pension funds create contagion pathways, as we've seen, and the opacity prevents accurate risk assessment. If we get a maturity wall in debt, where multiple loans come due at the same time when risk appetite is low, and then you combine that with higher interest rates, that could really test the system. However, leverage appears to be lower than pre-2008 levels. And if we look at long-term locked-up capital, that does reduce run risk. Bank capital buffers are now stronger, and the current stress in the market appears manageable for now. The honest answer is we just don't know yet. The private credit market's never been tested by a severe recession when it's been at its current scale. What happens when defaults spike, valuations plummet, and investors demand their money back simultaneously is uncharted territory. So, First Brands, I think, was a warning shot. Whether it's an isolated cockroach, in the words of Jamie Dimon, or the first of many remains to be seen, but one thing is certain: the financial system's built another massive, opaque, interconnected structure, and we won't know how stable it is until the storm hits.
So, tell me in the comments below what you think about private credit. Do you invest in it yourself? Do you think it's going to be the trigger of the next credit crisis? Remember, you can sign up for our free weekly market roundup to keep abreast of issues like the private credit market, but also others. And you can also join our membership very easily. Just go to pensioncraft.com/membership to learn more. And as always, thank you for listening.