Auto sector bankruptcies spark credit risks probe

The bankruptcies of automotive-related companies First Brands and Tricolor, along with potential losses at banks and investment funds, are raising new concerns about hidden risks in parts of the credit market, — prompting investors to take a closer look at risky debt.

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Auto parts supplier First Brands and subprime lender and dealership Tricolor both filed for bankruptcy protection last month. The two collapses have rattled some stakeholders in Wall Street’s multitrillion-dollar credit machinery, from leveraged loans and collateralized loan obligations (CLOs) to trade-finance funds and subprime auto loans, raising questions about exposure levels of a number of Wall Street fund managers, which pool capital from investors to provide loans to companies.

“This would serve as a strong precedent for LPs (investors) to question risky offerings,” said Zain Bukhari, associate director of risk and valuations at S&P Global. LPs, referring to limited partners, are passive investors that provide capital to a fund.

Some investors may ask for audited statements or quality of earnings from independent audit firms before investing in unsecured assets, Mr, Bukhari added. First Brands had roughly $800 million in unsecured supply chain financing liabilities.

A sign of such scrutiny appeared in July when First Brands was trying to raise a $6-billion loan to refinance its debt. In August, however, it became clear that potential lenders would require further diligence, including a quality-of-earnings report, according to a document filed by the auto parts company’s chief restructuring officer in bankruptcy court.

Investors and analysts are now assessing the fallout for the individual firms exposed as well as for the broader market. They hope to gain some clarity during the third-quarter earnings season, which kicks off this week.