Loose credit risks emerge as U.S. bond market sounds the alarm! Two "top-tier" companies collapse suddenly

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According to media reports, U.S. bond investors have issued a warning over relaxed lending standards in the credit market, as two companies that were considered healthy just weeks ago have suddenly run into trouble.

Earlier this month, the collapse of subprime auto loan company Tricolor Holdings, along with auto parts supplier First Brands Group starting to consider bankruptcy proceedings, caught investors off guard. Tricolor had received unanimous AAA ratings when borrowing in the credit market, and First Brands' total on- and off-balance sheet financing could be as high as $10 billion. Last month, it nearly refinanced again.

The media noted that investors originally intended to view these two events as isolated incidents, but together, they reveal cracks appearing within the credit market. Since the financial crisis, traditional banks have gradually retreated, and the credit market has become a vital source of financing for consumers and businesses.

Traders and investors told the media that they have begun to question current risk controls, as these mechanisms allowed Tricolor and First Brands to come to the brink of collapse in such a short time.

An investor who sold Tricolor bonds last week told the media that the company's collapse and the subsequent market turmoil was "one of the worst things I've seen in the asset-backed securities market."

Both companies used asset-backed debt structures (ABS): Tricolor bundled subprime auto loans into bonds, while First Brands pledged receivables to certain specialist funds to obtain credit.

The core of ABS is: using specific assets or loans as collateral for financing, including credit card debt, railcar and solar panel lease contracts, airplanes, or music copyrights, etc. Some investors said they've recently begun thoroughly investigating their portfolios to ensure they haven't invested in companies facing similar situations, and are asking more detailed questions during new underwriting deals.

Potentially dimming the luster of ABS financing

The media reported that in recent years, U.S. investment banks have invested more and more in ABS because they claim these products are much safer than the junk loans they used to issue.

But now, Tricolor is under investigation by the U.S. Department of Justice for alleged fraud, and some investors have long harbored doubts about First Brands' financials and accounts receivable financing methods. Now, lenders are concerned that they aren't clear on the scale of such off-balance-sheet financing.

Analysts believe the crises at Tricolor and First Brands may tarnish the white-hot ABS sector. ABS is not a new product, but it has grown rapidly. Wall Street giants such as Apollo Global Management and KKR are constantly developing new lending methods.

This development was once beneficial for non-bank lenders. For example, Tricolor leveraged strong market demand for auto loan-backed bonds to aggressively expand its lending business.

About $2 billion of funding was extended to Tricolor backed by auto loans, and now those lenders are in trouble. According to two sources familiar with the matter, the company failed to pay interest in September, and some lenders are reportedly trying to seize vehicles.

Major banks also affected

Several large banks have also been impacted, including JPMorgan Chase and Fifth Third Bank, facing loss risks on auto loans worth hundreds of millions of dollars.

Another investor who has sold packaged Tricolor loans told the media they never expected that banks like JPMorgan would fail to spot the underlying financial issues, especially since JPMorgan was one of the main underwriters of these debts.

"That's what is truly shocking. JPMorgan is one of the most professional lending institutions in the world; how could they not spot this problem?"

Since the financial crisis, global central bank policymakers have tried to strengthen the banking system, one approach being to shift lending from the regulated banking sector to other parts of the financial system.

The media reported that European Central Bank officials received a briefing last week, including on the rise and collapse of non-bank lenders like Tricolor.

Tomasz Piskorski, a professor at Columbia Business School, told the media that Tricolor's failure could prompt investors to "become more cautious."

"He said rating agencies would scrutinize more strictly, and credit may become harder to obtain as a result."

ABS fraught with issues, but institutions still investing

For First Brands, its underwriter Jefferies was still marketing a new $6 billion loan deal for the company a few weeks ago, assuring investors that as of March this year, the group still had nearly $1 billion on its balance sheet.

But now, First Brands is negotiating emergency rescue financing with lenders to fill an imminent funding gap, which may ultimately lead to a bankruptcy filing.

The rapid fall in the value of its debt has also shaken the $1.5 trillion U.S. leveraged loan market—First Brands' subprime bonds were trading for just "a few cents on the dollar" this week.

Lenders have almost zero transparency regarding First Brands’ use of "accounts receivable-backed financing." This type of financing is usually carried out by specialist funds, with operations completely opaque.

Previous media reports noted that hedge fund giant Millennium Management and an investment arm under Jefferies have provided such financing to First Brands.

Several experts in accounts receivable financing told the media that, even with the evident flaws in First Brands' financing plans, some lenders still put in money because these "seemingly secured" assets offered very high yields. One fund manager told the media:

"A lot of people have set up accounts receivable funds. When there’s too much money burning a hole in their pocket, they start to take risks. This company always offered the highest returns in the market—and always had more to offer, there was no limit."

Despite the rapid sell-off of First Brands bonds and Tricolor’s collapse, fund managers are still investing in new ABS deals.

Sources told the media that Goldman Sachs is preparing this week to sell a $300 million portfolio based on subprime credit card receivables issued by fintech firm Mission Lane.

Dylan Ross, head of asset-backed financing at asset manager TCW, told the media that the market’s acceptance of such deals shows there’s still confidence in securitized finance.

"Since the financial crisis, almost no investment-grade structured products have defaulted—the problem isn’t securitization."

Risk warnings and disclaimerThe market involves risks and investments require caution. This article does not constitute personal investment advice, nor does it consider the special investment objectives, financial situation, or needs of any particular user. Users should consider whether any opinions, views, or conclusions within this article apply to their specific circumstances. Investment decisions are at your own risk. ```