7 lessons from the First Brands bankruptcy: Cracks in the private credit boom
Originally published on LinkedIn in Jan Brzeski’s Observations newsletter. Republished here with permission.
First Brands, an Ohio-based auto parts company built through a series of acquisitions, recently declared bankruptcy, casting an uncomfortable spotlight on the often-opaque world of private credit (see NYT article). The company had borrowed billions of dollars from a mix of credit funds and nonbank lenders, many of whom now face significant losses.
As someone who believes deeply in the potential of private credit, especially my own niche of senior loans secured by real estate, I also think it’s critical that investors understand the realities and risks embedded in this fast-growing market. Below are my top seven observations related to First Brands and the issues exposed by its bankruptcy:
1. Private credit has become too big to ignore
Private credit has grown into a $1 trillion industry in the U.S., according to the Federal Reserve. Some estimates of its full extent are much higher. It is now a major profit driver for some of the largest Wall Street firms, including Blackstone, Apollo, Ares and BlackRock. What happens in private credit increasingly affects a wide range of investor portfolios, from institutional investors to retirement accounts.
2. Every boom breeds a bubble
Financial markets are prone to overexuberance, and private credit is no exception. The abrupt failure of First Brands may be an early sign that parts of the market became too optimistic and allowed risk discipline to erode.
Because most private credit managers earn revenue based on assets under management and loan origination volume, they have an incentive to “say yes” to new loans and to postpone uncomfortable conversations and decisions when early warning signs appear. As in every cycle, the seeds of the next downturn are often planted during the most optimistic phase of expansion.
3. Losses are inevitable — even without systemic risk
Private credit may not threaten the financial system the way bank failures do, but many investors will likely experience losses in the coming years — whether through reduced income or permanent impairment of principal.
No market delivers consistently high returns forever. Private credit has enjoyed a remarkably long stretch of strong performance with few setbacks. A period of retrenchment or repricing seems both natural and overdue.
4. A clubby market can create hidden risks
The industry’s power is concentrated among a group of elite firms. The same companies that built enormous private equity portfolios over the past two decades — firms that reaped extraordinary profits from leveraged buyouts — have now become the dominant players in private credit. In many cases, they are lending to the very companies owned by their peers’ private equity funds.
This circular structure fosters a “clubby” dynamic that can mute honest risk assessment. Investment firm X may hesitate to push hard on a struggling borrower owned by firm Y, knowing that firm Y would return the favor when the roles are reversed. Everyone wants the party to continue — and no one wants to be blamed for being the first to turn off the lights.
5. Don’t count on auditors to catch problems early
Auditors tend to miss the early signs of trouble in every financial boom. The large accounting firms simply cannot analyze every loan in sprawling portfolios or independently verify each valuation. They rely heavily on the representations of fund managers, often giving little scrutiny to loans deemed “performing.”
In private credit, managers also have wide latitude to amend or restructure loans. Sometimes this flexibility helps preserve capital, but it can also delay the recognition of losses — or even compound losses — and obscure the true health of a portfolio.
6. Beware the PIK uptick
One red flag worth watching is the increasing use of payment-in-kind (PIK) interest. PIK allows a borrower to pay interest by increasing the loan balance instead of using cash. While this can buy time for a company facing temporary liquidity pressure, it can also serve as a way to avoid classifying a loan as nonperforming, thereby postponing bad news. When PIK shows up late in the life of a loan to a stressed borrower, it’s often a yellow light turning red. By all accounts, the use of PIK is increasing, and a good portion of that is likely “bad PIK,” meaning PIK designed to avoid a default.
7. Deferred pain IS still pain
The expansion of private credit isn’t inherently negative. It fills an important gap left by banks and provides capital to many companies that might otherwise struggle to obtain financing. But the very success of private credit and its decade-plus run of steady returns may be masking deferred problems.
There are legitimate reasons for managers to work through troubled loans quietly and gradually. Yet discretion can also be abused. Investors should be wary of assuming that every private credit strategy is sound or that every manager will handle adversity well.
In summary: private credit remains a powerful and dynamic corner of modern finance. But as First Brands reminds us, rapid growth and abundant optimism can conceal risk and complacency. Not all private credit investments are created equal — and while the largest players sometimes weather volatility better than smaller peers, even the biggest lenders are not immune.
Adding to this risk is the growing push to funnel retirement money into these same funds. Recent federal guidance has opened the door for 401(k) plans to allocate capital to private equity and private credit. Some observers, including Wall Street Journal columnists, have questioned whether such illiquid, opaque assets belong in retirement portfolios. If the sector experiences sharp losses, regulatory scrutiny is likely to follow.
Can you think of another recent case that revealed similar cracks in private credit or in another fast-growing financial market?
