Demystifying First Brands Group’s $ 12 Billion Bankruptcy | Robert Smith of the Financial Times
Timestamps are as accurate as they can be but may be slightly off. We encourage you to listen to the full context.
Podcast Summary
Robert Smith, Corporate Finance Editor at the Financial Times, joins Jack Farley to dissect the shocking $12 billion bankruptcy of First Brands Group, an auto parts manufacturer that grew through aggressive acquisitions and complex off-balance-sheet financing. (00:33) Smith reveals how the company used sophisticated but potentially fraudulent working capital financing techniques, including invoice factoring and inventory lending through special purpose vehicles, with allegations of doctored invoices and "double pledging" of the same assets to multiple lenders. (23:42) The discussion explores the broader implications for the private credit industry, examining whether First Brands represents an isolated fraud or signals systemic issues in the rapidly growing asset-backed lending sector that has attracted massive capital inflows in recent years.
- Main themes include the anatomy of a massive corporate fraud, the risks in private credit's expansion into asset-backed lending, and the potential for more "credit cockroaches" to emerge from inadequate due diligence practices.
Speakers
Jack Farley
Host of Monetary Matters, a podcast focused on financial markets and economic analysis. Farley conducts in-depth interviews with financial experts and journalists to unpack complex market developments and their broader implications.
Robert Smith
Corporate Finance Editor at the Financial Times, where he has extensively covered the First Brands collapse and broader private credit market developments. Smith has been instrumental in bringing to light many of the fraudulent practices at First Brands and has deep expertise in structured finance, private credit, and corporate bankruptcy proceedings.
Key Takeaways
Off-Balance Sheet Financing Can Hide Massive Liabilities
First Brands used sophisticated techniques to borrow billions without showing it as traditional debt on their balance sheet. (05:05) Through supply chain financing, invoice factoring, and inventory lending via special purpose vehicles, the company accumulated $2.3 billion in hidden obligations that most lenders were unaware of until bankruptcy. This demonstrates how companies can use legitimate financial instruments in aggressive ways to obscure their true financial condition. The lesson for investors and lenders is to dig deeper into footnotes and understand all forms of company financing, not just traditional debt metrics.
Due Diligence Failures Signal Broader Industry Problems
Many sophisticated lenders to First Brands were unaware of the company's total $12 billion in liabilities, with some learning about founder Patrick James's previous fraud allegations only when the Financial Times reported them weeks before bankruptcy. (40:21) This represents a systemic failure in due diligence practices across multiple institutions. When capital flows rapidly into asset classes like private credit, the pressure to deploy funds can lead to shortcuts in proper vetting procedures, creating conditions for fraud to flourish.
Asset-Backed Lending Isn't Always Asset-Backed
First Brands allegedly engaged in invoice fraud, creating fake invoices, doctoring amounts, and "double pledging" the same receivables to multiple lenders. (23:51) What was supposed to be "self-liquidating" asset-backed financing turned into potential zero-recovery situations for lenders when the underlying assets proved non-existent. This highlights that asset-backed lending is only as secure as the verification processes around the collateral, and that sophisticated structures can mask fundamental fraud.
Private Credit Growth Creates Systemic Risks
The rapid influx of capital into private credit, particularly asset-backed strategies, has created pressure to deploy funds quickly, potentially compromising underwriting standards. (37:30) Smith notes that when money flows into an asset class, "there's maybe fewer checks because you're not going to earn fees if you don't put money out the door." This dynamic, combined with multiple similar fraud cases emerging, suggests the First Brands situation may not be isolated but indicative of broader industry vulnerabilities.
Complex Capital Structures Enable Fraud
First Brands' web of different financing arrangements - term loans, asset-backed lending, supply chain finance, and inventory lending through multiple entities - created a structure so complex that different lenders couldn't see the full picture. (03:17) This complexity served to hide the true scale of leverage and enabled fraudulent practices like pledging the same assets to multiple parties. The takeaway is that excessive complexity in corporate financing often serves to obscure rather than optimize, and should be a red flag for investors and lenders.
Statistics & Facts
- First Brands had approximately $12 billion in total liabilities against only $1-10 billion in assets, with $9.3 billion owed across various debt instruments including $5.5 billion in term loans and $2.3 billion in off-balance-sheet obligations. (02:13)
- Onset Financial, a Utah-based equipment leasing firm with only about 20 employees, had $1.9 billion in exposure to First Brands out of their total $5 billion in lifetime lending, representing nearly 40% of their entire business. (10:42)
- Rating agency Egan Jones issued approximately 3,600 private credit ratings in a single year despite having only around 20 employees, raising concerns about the quality and thoroughness of their rating process. (59:08)
