Private Debt Exposure in LBOs: Unraveling Risk Contagion and Valuation Mispricing Post-First Brands Collapse

The collapse of First Brands Group in late September 2025 has exposed critical vulnerabilities in private debt markets and leveraged buyout (LBO) activity, particularly through its use of opaque financing structures and aggressive debt accumulation. With liabilities estimated at $10–$50 billion, the automotive parts supplier's bankruptcy has triggered a cascade of losses for asset managers, banks, and private credit funds, underscoring systemic risks in leveraged finance, in a Financial Times analysis. This case study reveals how risk contagion and valuation mispricing can amplify distress in highly leveraged firms, with broader implications for the private debt ecosystem.

Risk Contagion: A Systemic Threat

First Brands' reliance on off-balance-sheet financing-such as invoice factoring, supply chain finance, and inventory-backed deals-masked its true debt burden, creating a false sense of stability, according to MYCPE ONE Insights. These structures left multiple stakeholders exposed, including Business Development Companies (BDCs) like Prospect Capital (PSEC) and Great Elm (GECC), which collectively faced $224 million in losses from first and second lien debt, the MYCPE ONE Insights piece reports. Collateralized Loan Obligations (CLOs), which held approximately $2 billion in exposure to First Brands, further illustrate the interconnectedness of risk. A PitchBook report notes that 69 CLO manager platforms had an average exposure of 0.24% to the firm's debt, amplifying concerns about portfolio-level contagion.

The fallout has also exposed legal and regulatory gaps. For instance, Apollo Global Management and Diameter Capital Partners circumvented First Brands' disqualified lender list to short its debt, highlighting the complexity of distressed debt trading, as Bloomberg reported. Such maneuvers underscore how opaque financing can create asymmetric information, enabling opportunistic strategies while deepening systemic instability.

Valuation Mispricing: Market Sentiment vs. Fundamentals

The sharp devaluation of First Brands' debt-trading at 33–50 cents on the dollar-reflects a significant mispricing driven by market sentiment and capital constraints. Fitch's downgrade of the firm to 'B' and subsequent placement of its debt on negative watch exacerbated this divergence, after Fitch downgraded the firm, as investors rushed to offload risk. Academic literature on mispricing emphasizes that such gaps between market prices and intrinsic value often arise during periods of distress, particularly when capital flows are restricted or interfirm relationships amplify panic, as the contagion network paper explains.

This mispricing is further compounded by the lack of transparency in First Brands' collateral structures. For example, its $866 million in supply chain finance claims involved entities like Wafra (a Kuwaiti fund) and Pemberton Capital Advisors, creating a web of dependencies that obscured true risk exposure, according to the MYCPE ONE Insights piece. As a result, even high-quality assets within the firm's portfolio-such as its automotive brands-face discounted valuations during restructuring, despite their standalone viability.

Broader Implications for LBO Activity

First Brands' collapse serves as a cautionary tale for the private equity and leveraged finance sectors. Its debt-to-EBITDA ratio exceeded 10x, far above investment-grade thresholds, illustrating the dangers of overleveraging in pursuit of aggressive growth, Bloomberg reported. The event has already prompted tighter scrutiny of LBO models, with analysts warning of a potential wave of distress if high interest rates and regulatory pressures persist (Bloomberg coverage).

Moreover, the bankruptcy has drawn parallels to the recent failure of Tricolor Holdings, another subprime auto lender, raising alarms about sector-specific vulnerabilities, the MYCPE ONE Insights article observed. This clustering of distress highlights the need for enhanced due diligence, particularly in evaluating off-balance-sheet liabilities and collateral quality.

Conclusion: Lessons for Investors

The First Brands case underscores the fragility of private debt markets when leveraged firms employ opaque financing. Investors must now grapple with heightened risk contagion and valuation mispricing, which could ripple through CLOs, BDCs, and Wall Street institutions. As the firm navigates Chapter 11 restructuring, the focus will remain on asset sales and debt haircuts, with distressed debt funds poised to capitalize on discounted opportunities. However, the broader lesson is clear: in an era of rising leverage and complex financing, transparency and rigorous risk management are no longer optional-they are existential imperatives.