Jim Chanos slams ‘magical machine’ of private credit after First Brands collapse

Jim Chanos, one of Wall Street’s best-known short sellers, has sounded the alarm on the private debt boom, telling the Financial Times that First Brands Group’s chaotic bankruptcy could augur a wave of corporate collapses.

Some of the biggest names on Wall Street are facing the prospect of multibillion-dollar losses from the bankruptcy of First Brands, a heavily indebted maker of spark plugs and windscreen wipers based in Ohio.

First Brands has now disclosed almost $12bn in debt and off-balance sheet financing built up in the years before its Sunday bankruptcy filing, which also ensnared less well-known private lenders such as a Utah-based leasing specialist.

“I suspect we’re going to see more of these things, like First Brands and others, when the cycle ultimately reverses,” Chanos told the Financial Times, “particularly as private credit has put another layer between the actual lenders and the borrowers.”

Chanos, 67, cemented his reputation shorting energy trader Enron, which like First Brands made substantial use of off-balance sheet financing and whose $70bn collapse heralded the onset of the 2001 stock market crash.

He announced in 2023 that he was closing his main hedge funds after more than three decades, while continuing to offer bespoke advice on fundamental short ideas as well as some macro insights.

In a 2020 Lunch with the FT interview, Chanos said financial markets were in “the golden age of fraud”. On Thursday he said this phenomenon had “done nothing but gallop even higher” since he made the remark.

First Brands has not been accused of fraud. However, a bankruptcy probe into its byzantine off-balance sheet financing is examining whether the company pledged the same invoices multiple times. This investigation has also uncovered that debt collateral may have been “commingled”. 

The FT has previously reported that the group’s founder and owner, low-profile businessman Patrick James, was previously sued by two lenders that alleged that fraudulent conduct had exacerbated their losses.

James strongly denied the allegations of fraud in the two cases, which were both dismissed after settlements were reached. 

First Brands and James did not respond to a request for comment.

Chanos likened the near $2tn private credit apparatus fuelling Wall Street’s lending boom to the packaging up of subprime mortgages that preceded the 2008 financial crisis, due to the “layers of people in between the source of the money and the use of the money”.

Privately owned First Brands’ eschewed the more public bond market in favour of borrowing money through so-called leveraged loans. It also raised billions of dollars through even more opaque financing backed by its invoices and inventory, which was often provided through private credit funds.

“With the advent of private credit . . . institutions [are] putting money into this magical machine that gives you equity rates of return for senior debt exposure,” he said, adding that these high yields for seemingly safe investments “should be the first red flag”.

The FT has previously reported that some private credit fund managers had estimated returns in excess of 50 per cent on First Brands’ supposedly secured inventory debt.

Even many of the most sophisticated credit specialists on Wall Street were until recently unaware of the existence of the US auto parts maker’s special purpose entities (SPEs) backing its inventory financing.

Traders at Goldman Sachs told clients hours before these financing vehicles separately filed for bankruptcy last week that they just had discovered indications of high-cost borrowing from these entities that were “hard to reconcile”.

Chanos said: “We rarely get to see how the sausage is made.”

First Brands’ bankruptcy has revealed that James controlled both the auto parts conglomerate and some of its off-balance sheet SPEs through the same chain of limited liability corporations. Chanos described this common ownership as a “huge red flag”.

His short thesis against Enron was fuelled in part by the realisation that executives at the group were managing SPEs that engaged in complex transactions outside the purview of its corporate balance sheet.

In contrast to Enron, First Brands’ financial statements were not publicly available. While hundreds of managers of so-called collateralised loan obligations had access to its financial disclosure, they had to consent to non-disclosure agreements to receive the documents.

“The opaqueness is part of the process,” Chanos said. “That’s a feature not a bug.”

Letter in response to this article:

Data delays ought to fuel bubble worries / From Niccolo Caldararo, Department of Anthropology, San Francisco State University, San Francisco, CA, US