The Hidden Dangers of Off-Balance-Sheet Financing in Leveraged Buyouts: Lessons from First Brands' Collapse

The rapid expansion of private credit markets and leveraged buyout (LBO) activity has created both opportunities and systemic vulnerabilities, as evidenced by the recent collapse of First Brands Group. This case study underscores the risks inherent in opaque off-balance-sheet financing structures and the role of predatory lending practices in amplifying corporate fragility. For creditors and investors, the fallout from First Brands serves as a stark reminder of the need for rigorous risk management in an increasingly complex credit landscape.

The First Brands Collapse: A Case of Structural Weakness

First Brands' demise was not an isolated failure but a systemic breakdown rooted in unsustainable debt accumulation and financial engineering. The company's aggressive acquisition strategy-bolstered by $10 billion to $50 billion in debt-relied heavily on off-balance-sheet financing arrangements. These structures, often facilitated by non-bank lenders like Onset Financial Inc., allowed First Brands to obscure its true liabilities while securing capital for its portfolio of over 25 automotive brands.

A critical flaw in these arrangements was the prevalence of covenant-lite loans, which lacked maintenance covenants that could have triggered early interventions as financial distress emerged. According to a report by Bloomberg, founder Patrick James accused these lenders of engaging in "commercial payday loan" practices, with fees and structures that masked the usurious nature of the debt. Compounding the issue, First Brands allegedly submitted fraudulent invoices-such as inflating a $179.84 invoice to $9,271.25-to secure financing. These practices created a false sense of stability, delaying corrective actions until liquidity collapsed entirely.

The founder's alleged diversion of hundreds of millions of dollars to personal accounts further exacerbated the crisis, raising questions about governance and fraud. By September 2025, First Brands filed for Chapter 11 bankruptcy, unable to meet its obligations.

Systemic Risks in Off-Balance-Sheet Financing

The First Brands case is emblematic of broader vulnerabilities in leveraged buyout environments. Private credit, now a $1.7 trillion market, has become a dominant source of financing for middle-market and larger companies, often bypassing traditional banks. While these arrangements offer flexibility and higher returns, they also concentrate risk in the hands of a few large fund managers and lack the liquidity of public markets.

Off-balance-sheet financing, in particular, introduces opacity that can obscure a borrower's true financial health. As noted by PennantPark, covenant-lite loans-common in private credit-reduce lenders' ability to monitor and respond to deteriorating conditions. This dynamic is amplified in high-leverage environments, where borrowers are especially sensitive to interest rate hikes and economic downturns.

The systemic risks are further compounded by the growing reliance on asset-backed lending. First Brands' collapse has already prompted lenders to tighten verification protocols and reduce advance rates on receivables and inventory. Yet, with U.S. corporate default risk hitting a post-financial crisis high of 9.2% in 2025, the need for proactive risk mitigation has never been greater.

Risk-Mitigation Strategies for Creditors and Investors

Addressing these vulnerabilities requires a multifaceted approach. Traditional tools like Credit Default Swaps (CDS) remain relevant but are insufficient on their own. Recent market trends highlight the growing importance of tailored solutions such as amend-and-extend transactions, liability management exercises (LMEs), and equity injections. These strategies allow investors to restructure capital stacks and provide breathing room for distressed borrowers without triggering defaults.

For creditors, enhanced due diligence is critical. This includes rigorous verification of collateral and receivables, as well as stress-testing borrowers against interest rate shocks and revenue declines. Investors, meanwhile, should diversify across asset classes and geographies to avoid overexposure to concentrated private credit funds.

Regulatory scrutiny may also play a role. The withdrawal of leveraged lending guidance by the OCC and FDIC in 2025 has created a regulatory vacuum, underscoring the need for clearer standards to prevent future crises.

Conclusion: Lessons for a High-Risk Era

The collapse of First Brands is a cautionary tale for an era of aggressive LBOs and opaque financing. It highlights the perils of conflating complexity with sophistication and the dangers of underestimating the interdependence between borrower behavior and lender incentives. For creditors and investors, the path forward lies in balancing innovation with transparency, and yield-seeking with prudence. As private credit markets continue to evolve, the lessons from First Brands will be pivotal in shaping a more resilient financial system.