Just weeks before its bankruptcy, First Brands Group was being pitched to investors as a $6 billion loan opportunity. Jefferies was marketing the deal. The company was said to have nearly $1 billion in cash. Then it imploded - proof, once again, that “due diligence” is sometimes just a phrase in a pitch deck.

Tricolor Holdings collapsed even faster. Tricolor operated as both a used car dealership and a subprime lender, offering high-interest loans to borrowers with limited or no credit history—many of them undocumented. It packaged those loans into AAA-rated securities and sold them to investors. When repayments faltered, the whole structure unraveled. Fifth Third Bank, one of its creditors, is accusing Tricolor of fraud, alleging that the company pledged the same collateral to multiple creditors. Investigators are now combing through what may be a corrupted loan database, and banks have begun repossessing vehicles from dealership lots across the Southwest.

The speed of these collapses caught investors off guard. Just months ago, First Brands’ debt was marked near par by private credit funds—some even marked above 100 cents on the dollar. Tricolor’s AAA-rated securities were trading at full value before the bankruptcy. Today, First Brands’ top-tier loans fetch just over 33 cents on the dollar and Tricolor’s lower-ranking bonds have plunged to 12 cents on the dollar. These weren’t supposed to be crazy investments. They sat in the portfolios of pension funds, insurers, and asset managers—institutions that aim to avoid volatility, not absorb it.

Kroll – a bond rating agency cut its bond rating on some Tricolor bonds from AAA - 19 levels to double C. According to Bloomberg - the rating agency wasn’t able to contact Tricolor and couldn’t confirm even basic facts about the business.

These defaults have exposed weaknesses in the credit markets, are leading investors to question lending standards, and the structure of private debt markets. They’ve also raised questions about how much risk is hiding in supposedly safe securities—and whether more surprises are waiting in the wings.

First Brands revealed a twelve-billion-dollar web of liabilities when it collapsed - and investigators are working to unveil whether the firm pledged the same assets to different lenders several times over – in order to borrow these huge sums of money. Jefferies - the investment bank, and Millennium Management – one of the biggest hedge funds in the world, are said to be amongst those facing losses.

Tricolor and First Brands operated in different corners of the auto sector. Tricolor sold used cars to subprime borrowers, many of whom were undocumented workers in the Southwestern United States. First Brands imported and distributed car parts—things like brake pads, spark plugs and windshield wipers—which were sold to major retailers like AutoZone and O’Reilly.

Both companies were privately owned and both relied heavily on debt. Tricolor – Like many dealerships, earned more from the loans it made to its customers than from the cars themselves. According to Bloomberg – they regularly charged interest rates above 20%. Those loans were bundled into asset-backed securities and sold-on to investors. First Brands was built up through acquisitions – which were financed by borrowing. Its owner, Patrick James, expanded the company by stitching together smaller manufacturers - he then layered on further leverage by borrowing against invoices and inventory—tapping private credit funds and specialist lenders.

Their business models weren’t inherently flawed. Tricolor served a niche market with limited access to traditional credit. First Brands built scale through acquisitions and supply chain finance. But each was exposed to pressures that have intensified in recent years: immigration enforcement, rising tariffs, inflation, and a consumer base stretched by higher interest rates and elevated vehicle costs.

AutoZone and O’Reilly autoparts – two customers of First Brands - have continued to report strong earnings. This makes First Brands’ collapse even more striking. The problem wasn’t demand—it was the structure of the company’s financing.

CarMax, the country’s largest used car retailer, missed earnings expectations by more than 37% last week, sending its stock to a five-year low. Unit sales fell sharply, and management described the quarter as “challenging,” citing weaker consumer demand and pricing missteps. Carmax caters to middle-income buyers. If this group are cutting their spending, it might be a sign that broader spending is under pressure.

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The US consumer economy appears to be splitting – we discussed this idea recently in my video on the great Mortgage divide. Wealthier American households are feeling quite rich, many bought homes before the pandemic with low-interest rate loans and house prices are now up significantly. This group are also up on their investments – with the stock market sitting near all-time highs.

Poorer households – on the other hand - are falling behind. Inflation – which refuses to go away - has pushed up the cost of everyday essentials. Interest rates on poorer Americans loans are high and things like used car prices, though off their peak, are still high relative to pre-pandemic levels.

Other expenses like insurance premiums and car maintenance costs – which make up a larger percentage of low-income Americans spending - have outpaced headline inflation too.

While prime auto loans seem fine – at present – according to Fitch - 6.6% of subprime auto loans are at least 60 days past due – this is the highest level seen - since the agency began collecting data on them. Credit card defaults and student loan defaults have risen sharply too.

Tricolor’s collapse reflects some of this pressure. The company specialized in lending to borrowers with limited access to traditional credit—many were undocumented workers who live paycheck to paycheck. Some analysts have pointed to immigration enforcement as a contributing factor. Deportation fears and labor force exits may have disrupted repayment patterns, though the extent of the impact remains unclear.

First Brands was exposed to a similar consumer base, but indirectly. Its parts were sold through retailers that cater to budget-conscious drivers. AutoZone and O’Reilly have reported strong earnings, suggesting auto part demand remains intact. The problem in this case may not have been the customer base— it appears instead to have been the capital structure of the business. First Brands had borrowed heavily to fund acquisitions, then borrowed again against invoices and inventory. Rising tariffs added further strain to their business model, increasing costs on imported components and squeezing margins.

There are other signs of general weaknesses in the business sector too. Sales of semi-trucks – which can indicate to investors how busy businesses expect to be in the coming months and years - have fallen 24% since May 2023, to the lowest level seen in five years. Medium duty truck sales are down almost 30% too.

Labor market data adds another layer of uncertainty. ADP’s private payroll report showed a loss of 32,000 jobs in the most recent period. Now this number may not be accurate – but it is all we have right now as The Bureau of Labor Statistics has paused its reporting due to the US government shutdown. Unemployment affects credit markets both as a leading indicator and as a trigger – as obviously - when jobs disappear, repayment risk rises.

This all comes at a time when the reward for taking risk in markets has collapsed. The spread between yields on corporate bonds and the equivalent expiration treasury bonds has fallen to its lowest level since 2007. The Economist pointed out this week that junk bonds are now offering spreads of just 2.8 percent – which is well below the 4.5-percent average of the last twenty years.

The collapse of these companies has drawn attention to the near two trillion-dollar private credit market that has fueled Wall Street’s recent boom.

The short seller Jim Chanos who earned his reputation from exposing fraud at Enron in the late 1990’s – a firm that used off-balance sheet financing to hide substantial losses - told the Financial Times yesterday that First Brands Group’s chaotic bankruptcy could augur a new wave of corporate collapses.

Policymakers have spent the past decade shifting risk away from banks and into the hands of non-bank lenders. That strategy will have reduced systemic exposure, but it‘s also made it harder to track where the pressure in the economy is building.

Private credit ballooned when banks – faced with higher regulation - withdrew from riskier lending the wake of the global financial crisis; these new – private lenders sought to capture high returns in opaque markets, and were willing to put up with the risk doing so entailed. This has led to extraordinarily complex financial arrangements, many beyond the sight of regulators and even the institutions involved.

Private credit was supposed to be smarter. Lenders wrote bespoke contracts, tailored to each borrower. They avoided public disclosures, sidestepped mark-to-market volatility, and operated in bilateral relationships that promised flexibility in a downturn. The model was pitched as safer than bank lending and more disciplined than public debt markets.

First Brands shows how that model can break. The company had multiple layers of financing—some syndicated, some private, some off-balance sheet. Lenders didn’t have a full picture of the overall capital structure. Some may have thought they held senior claims, only to discover they were exposed to collateral that had been pledged more than once.

The fallout from First Brands and Tricolor has reached deep into Wall Street and the FT wrote an excellent piece on the winners and losers. Jefferies, which had been marketing First Brands’ debt just weeks before the collapse, now faces reputational damage. Its investment unit was also exposed to the company’s invoice financing—an arrangement that may not have been adequately disclosed to other lenders.

Millennium Management, one of the world’s largest hedge funds, is among those facing losses. Other asset managers, including PGIM and CIFC, held First Brands debt through collateralized loan obligations. Some of these CLOs bought the debt near face value. It now trades at just over 33 cents on the dollar.

Tricolor’s collapse has hit banks directly. JPMorgan, Barclays, and Fifth Third provided warehouse lines of credit to the company, expecting to be repaid once the auto loans were securitized. That repayment never came. Fifth Third has accused Tricolor of fraud, alleging the company pledged the same collateral to multiple lenders. The bank has warned of a $200 million impairment.

Bondholders are now scrambling to protect their claims. Clear Haven Capital has been calling other investors, urging them to coordinate legal strategies. Triumph Financial – a Dallas based bank - reportedly sent employees to Tricolor dealerships to repossess vehicles that were pledged as collateral. It’s unclear – based on the news reports if they sent lawyers or tow trucks drivers. Possibly both – you would probably need both…

Auditors are also coming under scrutiny. BDO gave First Brands a clean audit earlier this year and the company collapsed just months later, revealing a $12 billion web of liabilities. Deloitte was hired to produce a quality-of-earnings report, but the bankruptcy beat them to it. Timing, as ever, is everything.

Some investors saw the trouble coming. Apollo Global Management and Diameter Capital shorted First Brands debt before the collapse. Others moved in after the fact, buying distressed loans at steep discounts. Goldman Sachs reported that nearly $1 billion of First Brands debt changed hands in a single day.

Private credit is often described as being outside the banking system. That’s not quite true. Non-bank lenders—private credit funds, hedge funds, specialist finance firms—borrow from banks. They rely on revolving credit lines, warehouse facilities, and bridge loans. These arrangements don’t show up in public filings, but they matter.

Bank lending to non-bank financial institutions (NBFIs) has surged. It now accounts for all of the growth in bank lending this year. One regional bank reportedly has $62 billion in loans to shadow lenders—roughly a fifth of its loan book. Most of it is categorized as “business,” “private equity,” or “other.” which is finance-speak for “don’t ask.”

The risk isn’t just that these lenders might fail. It’s that they might draw down their credit lines at the worst possible moment. A non-bank financial institution under pressure is most likely to tap its bank credit just as the value of its collateral is falling. That’s what bankers call “wrong-way risk.”

Regulators can see the exposures, but investors can’t. Quarterly filings don’t break out NBFI lending in useful ways. The system is opaque by design. That opacity is part of what makes it fragile.

Wall Street doesn’t seem rattled. The leveraged buyout of Electronic Arts—a mature gaming company with flat revenue—was announced just days after First Brands collapsed. If there’s fear in the market, it’s wearing noise-cancelling headphones. The deal, valued at $55 billion dollars, is the biggest leveraged buyout in history - topping in dollar value the $45bn buyout of Texas utility group TXU in 2007- which later filed for bankruptcy. The deal includes twenty billion dollars in debt and is described by the FT as “a huge bet that AI can significantly cut the companies operating costs, allowing the equity investors to manage a large debt load on a company that historically carried limited net debt. If there’s fear in the private credit market, it’s not showing up in the deal flow.

There’s no sign of a crisis - but there’s no real sign of caution either.

The most revealing work on First Brands didn’t come from rating agencies or investor decks. It came from Robert Smith at the Financial Times. Smith and his team uncovered prior fraud allegations against Patrick James, the company’s founder by digging through court records—work that – it would appear - many lenders failed to do. The cases Smith found came out of losses during the financial crisis in 2008 and were for millions of dollars – not billions. These cases were settled - not dismissed.

Smith has spent years covering credit markets and has written about numerous scandals in the past. He recognized the warning signs: related-party complexity, off-balance-sheet debt, and lenders unaware of what other lenders were doing.

The FT’s coverage of First Brands was built on public records and financial statements. Smith has pointed out on LinkedIn that all of the factoring expenses were disclosed. The spreads were visible. Some investors saw the problem and walked away. Others didn’t bother to look. Smith’s reporting filled a gap that investor due diligence should have covered.

Credit markets aren’t exactly melting down. But they are not really compensating investors for the risks they’re taking either.

First Brands and Tricolor are not systemically important, and their failures didn’t trigger panic. But they possibly reveal how fragile some corners of the credit market have become, especially where opacity meets leverage. These weren’t exotic instruments held by speculative traders. They were AAA-rated securities, backed by collateral, sold to institutions that prize stability.

The structure of risk has changed a lot since the global financial crisis. Much of today’s subprime and corporate debt sits with investment managers, insurers, and pension funds—entities funded by longer-term liabilities. That’s a far cry from the asset-backed commercial paper and bank deposits that once underpinned the last crisis. But the funding model isn’t the only variable worth watching.

Private credit has grown rapidly and so has its reliance on bank financing. Robert Armstrong pointed out in a recent FT column that shadow banks now account for all of the growth in U.S. bank lending this year. At $1.7 trillion dollars – he points out that – Shadow Bank lending now represents 13 percent of total bank loans—and far more at the largest institutions.

There’s no sign of fear in markets – other than the dollar being down about 10% year to date. Credit spreads are tight. Equity markets are buoyant and the largest leveraged buyout in history was announced – just days after First Brands collapsed. If investors are worried, they’re certainly not showing it.

But the question isn’t whether the market will unravel. It’s whether investors are being adequately compensated to take the risks they’re assuming. When spreads are thin and structures are opaque, even a stable system can produce nasty surprises.

Some people in the comments have been saying that this channel has drifted from its stated focus on rap news – [Ted] you can forget about icey tea and scoopy scoopy dog dog. In Rap News - Bloomberg reported this week that a Canadian Hedge fund manager and meme stock investor has been standing outside the rapper Drakes House in Toronto - trying to convince Drake to say something about some stock. Many are arguing that Canadian regulators should crack down on this sort of thing - as if it actually works out – Other Canadian investors like The Plain Bagel – are likely to start harassing the Barenaked Ladies to write a song about Berkshire Hathaway. Who knows where this could all end.

In other news, the FT reports that a convicted Chinese fraudster doing time with Sean John Combs (also known as Diddy, Puff Daddy, Puffy, P Diddy, Brother Love and Frank Black (not to be mistaken with Black Francis – from the Pixies) has been teaching a self help course in prison called “Free Game with Diddy” Guo – the Chinese fraudster (also known as Guo Wengui and Ho Wan Kwok) – describes Sean John Combs (also known as Diddy, Puff Daddy, Puffy, P Diddy, Brother Love and Frank Black (not to be confused with Black Francis – from the Pixies) as being very organized – he went on to say that he and Sean John Combs (who has a variety of aliases) had discussed creating an artificial intelligence platform together when they are released from jail – so we have that to look forward to.

If you enjoyed this video – you should watch my video on Chinese meme stocks next. Don’t forget to check out our sponsor Saily using the link in the description. Have a great day and talk to you in the next video – bye.