Fraud, Collateral Damage, and Liquidity: Assessing the Investment Risks in the First Brands Bankruptcy Saga

The collapse of First Brands Group in September 2025 has sent shockwaves through the private credit and factoring markets, exposing vulnerabilities that extend far beyond the company's own financial missteps. What began as a liquidity crisis for a once-dominant auto parts supplier has evolved into a broader reckoning with systemic risks in opaque financing structures, regulatory oversight, and the interconnectedness of financial institutions. As investors and regulators grapple with the fallout, the case underscores the need for a reevaluation of risk management practices in private credit markets.

The Unraveling of First Brands: Fraud and Liquidity Collapse

First Brands' Chapter 11 filing was precipitated by a liquidity crisis rooted in aggressive off-balance-sheet financing and alleged fraud. According to a Reuters report, the company allegedly sold the same invoices multiple times or fabricated them entirely, creating undisclosed liabilities estimated between $10 billion and $50 billion. These practices, which masked the true extent of its debt, left First Brands unable to meet its obligations as cash reserves dwindled. The founder, Patrick James, and his brother Edward James, now face legal scrutiny for their alleged roles in orchestrating the scheme.

The company's reliance on opaque financing structures-such as factoring arrangements and supply chain finance-highlighted a critical blind spot in financial reporting. Under U.S. GAAP, such transactions are often recorded as trade payables rather than debt, misleading investors about leverage levels. As K2 Partners noted, what appeared to be a leverage ratio of 4x was, in reality, closer to 20x when hidden liabilities were revealed. This distortion of financial health underscores the risks of relying on non-transparent accounting practices in private credit.

Systemic Risks in Private Credit: Leverage, Interconnectedness, and Regulatory Gaps

The First Brands case has amplified concerns about systemic risks in private credit markets. The firm's failure triggered a cascade of losses across its financial counterparties, including a UBS fund (30% exposure), a Jeffries fund ($715 million), and a joint venture between Norinchukin Bank and Mitsui & Co. ($1.75 billion). These connections reveal how financial distress can propagate through the system, particularly as private credit becomes increasingly intertwined with traditional banking. For instance, Western Alliance Bank's exposure through a leverage facility provided to Jeffries illustrates the layered risks in a highly interconnected market.

Regulatory scrutiny has intensified in response. While private credit is often touted for its rigorous due diligence, the First Brands bankruptcy has raised questions about whether opaque structures pose broader financial stability risks. The International Monetary Fund has warned that the links between traditional banks and private credit could create ripple effects during downturns, especially if collateral values decline or downgrades occur. Meanwhile, U.S. lawmakers have called for stronger capital requirements and limits on executive compensation to address these vulnerabilities.

Collateral Damage and Investor Reactions

The fallout from First Brands' collapse has extended beyond its immediate creditors. JPMorgan Chase and Fifth Third Bank recorded losses exceeding $170 million each due to their exposure to Tricolor, another firm implicated in fraudulent practices. Similarly, the Cantor Group controversy involving Zions Bancorporation and Western Alliance Bank has exposed risks in commercial real estate lending tied to forged collateral claims. These cases highlight the fragility of asset-backed lending when due diligence is insufficient.

Investor confidence in private credit has also wavered. While some analysts argue that the failures of First Brands and Tricolor are idiosyncratic rather than systemic, others warn of deeper issues. The rapid growth of non-bank lenders and covenant-lite loans has increased market opacity, raising concerns about lending standards and borrower monitoring. As Jamie Dimon and others have noted, the incidents underscore the need for improved risk management practices across the credit ecosystem.

The Path Forward: Transparency and Regulatory Reforms

The First Brands saga has catalyzed calls for enhanced transparency and regulatory oversight. The Federal Reserve's October 2025 FOMC meeting minutes acknowledged the risks posed by nonbank credit activity, though Chair Jerome Powell downplayed systemic concerns. Meanwhile, the appointment of an independent examiner in the First Brands case has intensified scrutiny of off-balance-sheet financing and asset valuation disputes.

For private credit markets to regain stability, stakeholders must address the root causes of these failures. This includes stricter disclosure requirements for off-balance-sheet liabilities, enhanced due diligence for asset-backed transactions, and clearer guidelines for collateral management. As the sector evolves, investors must balance the search for yield with a renewed focus on risk mitigation-a lesson that First Brands' collapse has made painfully clear.