$12bn of debt: How First Brands Group collapsed

0:00What happens next in the story of money? Nuveen has spent over 125 years helping clients answer this question. By investing in the growth of businesses, real estate, infrastructure and natural capital, we continue to deepen our expertise across income and alternatives so investors can confidently write the next chapter of their own portfolio stories. Nuveen. Invest like the future is watching. Visit nuveen.com slash future to learn more. Investing involves risk. Principal loss is possible. What does it take to inflict damage on some of the world's biggest financial institutions? Well, as it turns out, one secretive businessman with a track record of battling creditors in court.

0:45And it all starts with a tip. I was having breakfast and I got a message from a contact who said they had heard of this interesting company that was potentially having issues. That's the FT's Hortensa Alley. The tip centered around a huge auto parts company, which is a bit out of left field. She's the FT's banking editor. But lots of big financial firms had lent this company money, and now it was running into trouble. So Hortensa mentions it to our colleague Robert Smith. He's the FT's corporate finance editor, and he reaches out to some of his contacts. For a while, he doesn't hear anything back.

1:30And then in August, Rob gets a call. I was sitting there with sort of an incredibly experienced, incredible person telling me that one of the biggest companies in its sector in America was a ticking time bomb. The company we're talking about is called First Brands Group. Not exactly a household name, but it's a business with a collection of factories from Pennsylvania to California. Ones that make spark plugs, brake components, and windshield wipers. It's an auto parts supplier, basically. And it's from the Rust Belt of the United States. So not typically the kind of company that would cause the upper echelons of Wall Street to lose sleep over.

2:15Yet that's exactly what happened last month when first brands collapsed. And as Rob Hortensa and our colleagues worked together on the first brand story, they unveiled something possibly even more troubling. A form of Wall Street lending that's exposed financial markets to broader risk. Risk that's even got central bank leaders worried.

2:43I'm Michaela Tendera from the Financial Times. Today on Behind the Money, First Brands Bankruptcy has raised questions about one of Wall Street's favored forms of financial innovation. the$2 trillion private credit market. This form of lending is often opaque, and there's concern that after years of loosening lending standards, First Brand's demise could be an omen.

3:16There are many questions in this story, but let's start with one of the biggest. It concerns the founder of First Brands, a mysterious businessman called Patrick James. How did this obscure entrepreneur, based in the Midwest state of Ohio, enlist some of the biggest names in finance to lend his firm not just millions, but billions? Who is he? Well, the story begins sometime after the 2008 financial crisis, when Patrick James goes on a debt-fueled acquisition spree. Here's Rob. So Patrick James, he borrowed a lot of money to buy existing companies and sort of piece them together. So one of the early deals he did was in 2014, and he bought a windscreen wiper maker or a windshield wiper maker, as you say in the U.S., called Trico.

4:13And then sort of every year he'd announce a new deal. So, you know, buying a carburetor maker, buying a spark plug manufacturer. and each time he did it he borrowed more and more money and the group became bigger and bigger and then it was in 2020 I believe he rebranded the company First Brands Group so you know he's kind of saying we've got all the brands we're the First Brands Group if you want your Trico windscreen wipers we're there you know if you want your Michelin branded tires we're the guys and you know like a lot of schemes that go awry or like a lot of companies that blow up he had a good pitch.

4:51One of the first major Wall Street firms to latch on to the first brand's pitch is the investment bank Jeffreys. Jeffreys got involved with first brands very early, so in 2014, before it was even called first brands. And they basically were there to shepherd it into the market, to help it borrow this money from these private investment firms. And Jeffreys, it's tried to model itself on what it would describe as a pure play investment bank. So sort of like the investment banks of yore, where kind of swaggering bankers went out and won business, and they lived and died by the strength of the service they could offer their clients.

5:31Jeffries isn't the only firm to give them money. In fact, Jeffries has since pointed out that they were aware of nine other banks being involved in acquisitions or loan arrangements for first brands. And that's because, in part, as Patrick James builds up first brands in the wake of the financial crisis, a new area of finance is on the rise. Private credit. It's a form of lending that Hortensa, as the FT's banking editor, is watching closely. After the financial crisis, regulators sought to restrain banks because they'd been doing all of these risky trades that almost led to the collapse of the global economy.

6:11and one of the repercussions of this was that they would effectively make it much more onerous for banks to lend to highly levered borrowers or companies that have a lot of debt on their balance sheet which tend to be mid-sized businesses and what happened was that there were these very very smart people on Wall Street who thought well if banks can no longer lend to these businesses we could set up firms that can and that was sort of the genesis of the private credit industry. It wasn't that it hadn't existed before, but there was this kind of new borrower or new market that they could easily cater to.

6:47And so it was kind of fortunate that as Patrick James was trying to build this business of his, there was a group of lenders ready to lend to him that perhaps are more lenient in terms of scrutiny than maybe a bank would have been. So First Brands grows alongside this boom in private credit. Lots of big financial institutions from Zurich to Tokyo become tied up in this business. Along the way, Patrick James amasses the trappings of a billionaire. I think what's interesting is before the collapse of first brands, this was sort of a big immigrant success story. Patrick James, he's Malaysian. He's from like a family of Indian descent.

7:29And then he later moved to America for college with like seemingly not a lot of wealth. but he sort of stuck around in Ohio and he very quickly became involved in a lot of different industrial businesses and then at the sort of peak of first brands he amassed this very lavish sort of lifestyle he had oceanfront properties on both coasts so he had a big oceanfront property in Malibu had a big oceanfront property in the Hamptons he had almost like I'd call it almost like a compound in Ohio. So it's sort of like five houses and a tennis court. So you had a lot of trophy homes all around America. And that brings us up to this past summer and the tips we heard about earlier, the ones Hortensa and Rob received from their contacts.

8:22Now, as they're digging in, they learn something. In early August, first brands had been working to refinance its debt once again with the investment bank Jefferies. But this time, something went wrong. So this company raised debt constantly. It needed to keep accessing debt markets to survive. So they tried to do a$6 billion debt refinancing. So that's essentially when you raise new debt to pay off the old debt. It's quite a large deal. And it ran aground because lenders took a look at this and they had concerns about the financial statements. But what we discovered through our sources was that First Brands was also raising sort of a lot of less visible financing.

9:15Stuff that behaved a lot like debt, but perhaps wasn't disclosed as debt on the balance sheet. And we sort of had people saying that they believed there could be billions of dollars more of this stuff than perhaps everyone realized. Okay, so to sum it up here, this company you've just received a tip about, you have people telling you that it could have billions more dollars of debt than anyone knows about. I mean, what was going through your mind as you uncovered all this? I think the thing that really shocked us was this was a company neither of us had heard of. Yes. And we write a lot about debt markets.

9:56And as soon as we did our research, We found out this thing was a debt monster. And we kind of discovered that some of the biggest names in international finance had exposures that weren't well understood. So for us, it was kind of a, oh, my God, sort of moment. There's this sort of debt bomb lurking out there that no one really seems to know anything about. So Rob and Artensa have found a debt bomb hidden away, and supposedly it could go off at any moment. So they and two of our colleagues write about this in the FT. And the reaction to their reporting is fairly muted. No one really freaked out.

10:45And then about, I think it was just over a week later, we published a second story. This time, people sit up and take note. And in that second story, we revealed that a very big Wall Street firm called Apollo Global Management had taken a short position against first brand's debt. Now, that meant that it would make money if the company entered financial difficulties. So debt can trade like a stock can trade. And when people have concerns around a company, that debt trades down. And the company's debt immediately crashed. And from there, in a matter of weeks, it went from this kind of freak out in debt markets to the company filing for bankruptcy.

11:32September 28th this year. That's when First Brands files for bankruptcy. When we first wrote about the company, it had told investors it had$800 million of cash on its balance sheet. When it filed for bankruptcy at the end of September, it had$12 million in the bank. So something went completely wrong with this company. There was almost like a bank run on the company's cash. And it was just a complete fire sale. So some of the biggest institutions on Wall Street were just dumping their debt. I don't think it's too hyperbolic to say it was complete carnage. A couple weeks later, the U.S. Department of Justice announces it's launching an inquiry into the collapse of the firm.

12:20Days after that, First Brand CEO Patrick James steps down. And all the while, Rob Hortensa and some of our colleagues are parsing through these bankruptcy documents. That's where they learned that what their sources had told them, that First Brands had billions more of this off-balance sheet debt, that it was even more true than they had imagined. So First Brands had about$6 billion of loans. So those are like the normal sort of loans that in the past would have been made by banks. A lot of them were made by investment firms. But on top of that, it had a lot of what is called off balance sheet debt.

13:00And what that broadly means is that in the company's accounts, this wasn't disclosed as debt. Well, how does that work? How does a company accumulate debt, but then the debt doesn't appear on its balance sheet? So, you know, First Bands was borrowing money. It was borrowing money from lenders. But on top of that, it was raising this other form of financing that was tied to its invoices and tied to the little bits and bobs of metal sitting around in its warehouse. And this is all quite normal stuff in finance. The crucial point there is while you owe money to a bank, it's not classed as debt on your balance sheet.

13:43It's sort of mingled in with all the other invoices you pay suppliers. So it's a bit of a loophole where if companies abuse it, they can rack up hidden debts quite quickly. So it came out in the bankruptcy that there was a total of nearly$5.5 billion of this off-balance sheet financing in different forms. So you had people who thought, okay, there's$6 billion of debt out here. And then they wake up one morning and read the disclosure in the bankruptcy and they realize, oh my God, there's nearly$12 billion of debt here. It's almost double, basically. And it's really crucial to make the point that, and maybe it's a simple point, but it should still be made.

14:30Having a high debt load, not a crime. There's a lot of highly leveraged companies. That's fine. Having debt that your creditors don't know about can become quite a problem for you and your creditors. Big financial names like UBS's Chicago-based hedge fund unit O 'Connor, U.S. hedge fund giant Millennium, and Japan's Mitsui & Co. and Noren Chukin Bank all provided this form of financing, off-balance sheet financing to first brands. And the story of how other lenders missed all that debt? That's a story that tells us a lot about how private credit markets work and how opaque they can be.

15:32that are shaping tomorrow's economy, all while aiming to deliver the resilience and returns that portfolios seek today. Nuveen. Invest like the future is watching. Visit nuveen.com slash future to learn more. Investing involves risk. Principal loss is possible. In the course of their reporting, Rob and Ortenza found a number of red flags at first brands that Wall Street lenders either missed or chose not to be concerned about. One of their first stops was to look into the background of First Brand's CEO, that mysterious businessman, Patrick James. So usually when we're dealing with a person that we are not familiar with in the business world, what I will try to do is go through various government filings to see if they've been mentioned in anything.

16:19And I'm looking on the Securities and Exchange Commission website, which houses corporate filings, and I find a reference to Patrick James and the company First Brands Group. It's in relation to an acquisition that they made a couple of years back. And I'm sort of like, well, great, we're going to find some more details about him. But the profile of James is basically one line. And I think all it says is that he has extensive experience in the automotive aftermarket industry. So we find ourselves in this position where we really know very little about him. We can find biographies from the high school that he went to, but we don't know what this person has been doing in the corporate world for the past 30 years.

16:59Even first brands' lenders were in the dark about who Patrick James is. When we talked to the lenders, who are the people who should know the most about this company, they didn't know anything or very little about Patrick James either. And this guy was the chief executive, but he was also the 100 % owner of the company. And again, this is a man who, despite all of that, has accrued$12 billion of debt. And we can't, you know, we can't find any reference to him really, any meaningful reference to him on the internet. So it was kind of a strange moment and almost a red flag in and of itself. One of the things Rob and Hortenso were able to find out quite quickly, though, was James's colorful legal past, which included a string of failed companies behind him.

17:46And very quickly, we uncovered that there had been prior accusations of fraud against James. And the accusations were eerily similar to what we were hearing on First Brands Group. More than a decade ago, two lenders in separate cases sued Patrick James. So in one of those lawsuits, the bank that filed the claim against Patrick James, it accused him and his businesses of making, quote, misrepresentations and omissions, end quote, relating to their invoices and inventory. So that was really interesting because it seemed to be relating to the same sort of financing that was at the heart of first brands collapse.

18:32And then there was another lawsuit where James was accused of creating a, quote, web of companies, quote, to transfer out funds, quote, in an attempt to defraud, quote, creditors. So he was basically accused of creating this very complicated, shifting group of companies in which the allegation was that money was siphoned out of them. It's worth noting that Patrick James, through a spokesman, has said these allegations are, quote, categorically false. The cases were robustly defended and never tried after settlements were reached. These were civil claims where serious allegations are often made which turn out to have little substance.

19:15Certainly nothing criminal was ever brought against Patrick James. In fact, James' spokesman also told the FT about our reporting on his backstory that James hasn't been accused of any wrongdoing and is confident that the board's independent investigation will vindicate him. But beyond Patrick James' legal history, there were other issues that Rob and Hortensa learned about related to the first brand's business and its debt. So a really easy one was that First Brands Group had significantly higher margins than its peers. And the auto sector generally is quite a tight margin business, right? These guys wring out every cost they can.

19:56And they found that they just couldn't really get a good explanation of that. And that was something that made some investors not lend to the company and other lenders decide to not lend in future. Plus, there was the issue of collateral for First Brand's loans. As Rob mentioned, the company was using its inventory, the bits and bobs of metal in its warehouses, as collateral. But many lenders didn't bother to check whether that collateral even existed. Now, the classic thing you do when you lend against inventory is you go to the warehouse. You look at the stock list, you go around, you see if the things are there, you know, you kick a few boxes.

20:36and we discovered that first brands so Patrick James's brother Ed James was sort of the point man shall we say for the stuff and we talked to some lenders who you know were approached about doing inventory finance and they said okay great well we'll come down to your warehouse and we'll check it against the stock list and then they were sort of cut off that you know supposedly Ed James said no no no no we don't let lenders into the warehouse you can't do that. So you can imagine for a lot of people, that was just a non-starter. They were like, we're not going to lend against a bunch of stock in a warehouse if we haven't even seen it.

21:16Now, we should be clear that the business, First Brands, has not been charged formally with fraud. Still, it all begs the question, where was the due diligence? How did First Brands manage to keep securing more and more from lenders, with no one lifting up the hood on its business. What I think this tells you about the structure of modern finance is that it doesn't pay to do deep due diligence on the companies you're lending to. People who manage investment funds, the way they make money is by earning fees. And the way they earn fees is by lending. So a lot of these people were relying on the disclosures that were given to them by the company and by the investment bank, which was often Jefferies.

22:10And they perhaps didn't have the time to really dig into the accounts. But Hortensa says there's a big picture to consider, too. We've had 10 or 15 years of what we like to call the easy money era, where there's been this abundance of cash going into the private capital industry. So they've had to find more and more opportunities to use it. And that can lead to slightly looser lending standards. Mark Rowan, the chief executive of Apollo, who, as we've said, made a bet against first brands before the company went under, has called these late cycle accidents. Add to that a sense that someone else, another lender, was assumed to be doing their homework on first brands.

22:48Usually what these companies do when something does happen like this is they'll pass the buck. They'll say, oh, well, the company had an auditor. It's the auditor's fault. And then some will say, well, you know, we bought the debt from a bank. The bank should have done the due diligence. Then, you know, an investor in private credit say, well, private credit bought the loan. So why would we do the due diligence? So it's sort of like everyone relies on the fact that the person before them performed good due diligence on the company. And they are almost absolved of responsibility. of actually having done it themselves.

23:20So, Rob, how likely is it that we see more of these situations pop up? I was lucky enough a couple of weeks ago to talk to Jim Chanos, who's one of the most famous short sellers on Wall Street. You know, he's known as the man who spotted the Enron fraud before it unraveled, right? And he had a really interesting thing to say. He was basically saying what he calls the fraud cycle follows the financial cycle. So what he meant by that is when money rushes into an asset class, that is a fertile ground for fraud. So the way he explained it is like the longer a sort of boom goes on, the more investors' healthy skepticism starts to erode.

24:02because everyone else is making massive returns and they might not really be doing the work. So you start to think, oh, well, I don't know about this, but God, if everyone else is doing it, I've got my end investors turning around to me and saying, why aren't you investing in these companies? Why aren't you doing these loans? So it just sort of wears you down. And if there's like years and years without incident on Wall Street, you think, okay, well, yeah, it's probably safe. I don't fully understand it, but I'll just go with it. So a few weeks ago, our listeners might remember that we covered the collapse of the Texas-based subprime auto lender called Tricolore Holdings.

24:46Looking at these two stories, there are a lot of similarities. How should we think about that? Yeah, I think what's interesting here is when you have an incident like this, it obviously brightens people. So what you get is you get people taking a closer look at the sort of lending they've done. You know, Jamie Dimon, the CEO of JP Morgan, on an earnings call recently, he said there's rarely one cockroach. So, you know, the analogy there is you see a cockroach in your kitchen. There's probably a few more of the guys, right? So I think that's what everyone's trying to work out at the moment. People are looking over the asset-backed lending they've done.

25:30They're looking over the corporate loans they've done. And they're trying to see, is there another first brands? Do we know anything about how regulators are thinking about the news of these recent collapses? I think it's really caught the attention of regulators because in the financial crisis, a lot of the issues were with banks. and although it was nearly catastrophic, regulators do have a lot of insight over banks. Partly because of the rules that they introduced to stop this happening again, a lot of that lending has migrated away from banks and into investment funds. And regulators just have much less visibility on what's going on there.

26:11There's also a phenomenon where often the banks are lending to the private credit funds. So there can still be a knock-on into the banking system. And this is the area where sort of central bank governors, policymakers, those sort of people are getting worried. So Andrew Bailey, who's the governor of the Bank of England, he said earlier this month that alarm bells were sort of ringing over what's going on in private credit. And he mentioned First Brands and Tricolor by name. You also had the head of the IMF, the International Monetary Fund. She said there'd been a very significant shift in financing away from the banks to what they call non-bank lenders.

26:53And again, she mentioned Tricolor and First Brands as sort of worrying signs of what might be going on.

27:02Behind the Money is hosted by me, Michaela Tendera. This episode was produced by me and Safiya Ahmed. Our executive producer is Manuela Saragossa. Fact-checking by Simon Greaves. Sound design and mixing by Sam Giavinko Original music is by Hannes Brown Topher Forges is the FT's acting co-head of audio Thanks for listening. See you next week.

27:34The future of fixed income investing will continue to blur the lines between public and private markets. Nuveen's credit platform was built to navigate this shifting landscape, channeling capital toward the businesses, infrastructure and energy solutions that are shaping tomorrow's economy, all while aiming to deliver the resilience and returns that portfolios seek today. Nuveen. Invest like the future is watching. Visit nuveen.com slash future to learn more. Investing involves risk. Principal loss is possible.