Recent headlines surrounding corporate credit stress, particularly involving companies like First Brands and Tricolor, coupled with soured commercial loans among US regional banks Zions and Western Alliance, have drawn investor attention and raised questions about whether there are broader systemic risks akin to historic periods of credit stress. The developments are emblematic of an environment characterized by frothy valuations, increased volatility, loose underwriting standards, and questionable corporate governance. Such conditions evoke memories of past scandals—Enron, WorldCom, LeNature, HealthSouth, and Wirecard—names that should instill concern in the hearts of investors, and specifically, research analysts.
While familiar themes are emerging, we believe that these events are not systemic and, more importantly, a reflection of why deep credit analysis and security selection is even more crucial in this part of the credit cycle. However, we are mindful of the recent development in credit markets: the growth of private credit and the blurring of lines between public and private sectors, including direct lending and asset-backed finance. The interconnected nature of these markets makes it increasingly important for credit analysis to encompass both public and private markets to obtain a comprehensive view of a borrower.
First Brands, a manufacturer of auto parts formed through a series of acquisitions, has aggressively utilized receivables factoring—selling receivables at a discount to third-party buyers—while providing limited disclosure of outstanding liabilities. In a similar vein, Tricolor, a used-car dealer and lender targeting borrowers with little-to-no credit history, allegedly pledged customer loans as collateral multiple times over. Both companies capitalized on a market awash in capital chasing outsized returns, despite evident warning flags.
This is a good example of the role our credit research team plays in properly vetting borrowers. We rely on the extensive experience of our analysts, honed over multiple credit cycles and enriched by sector expertise, to evaluate known and unknown risk factors. This collective knowledge underpins each investment decision we make. We cultivate relationships with management teams and industry participants to gain insights that extend beyond financial reports. Our fundamental analysis encompasses business operations, competitive positioning, prospects, and capital structure, but equally considers the managers and owners—assessing their reputations and past performance.
Our team's initial interaction with First Brands and its management team occurred about five years ago, as they were rapidly acquiring auto parts manufacturing businesses. As investors in the sector, we closely monitored the company's acquisitions and the questionable valuations attached to them. When First Brands sought funding through the high-yield market, our analyst expressed skepticism regarding the significant add-backs to EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) and the related assumptions for growth and deleveraging. Given our wariness of the equity owner, coupled with a critical review of the company’s offering documents and financials, we ultimately decided to pass.
Similarly, in the case of Tricolor, the integrated business model linking dealerships and financing, along with their specific demographic focus, informed our analysis and led us to limit our exposure while maintaining a more senior position in the capital structure.
Meanwhile, recent disclosures of fraud losses at US regional banks Zions and Western Alliance have heightened scrutiny on lending to non-depository financial institutions (NDFIs), a rapidly growing segment. Our analysts have reviewed NDFI exposure across all nine US regional banks under our coverage. It is important to note that NDFI is a broad category that includes multiple loan types and borrower profiles, many of which have historically demonstrated low loss rates. We reiterate that higher NDFI exposure does not necessarily indicate higher credit risk, and we conclude that exposure to NDFIs is manageable, even in stressed loss scenarios.
Our preference among US regional banks is for the larger institutions with assets ranging from $100 billion to $250 billion, with minimal exposure to banks with less than $100 billion in total assets. Loan growth among these banks has remained disciplined, with NDFI loans representing 12% of total loans on an aggregate basis.
At J.P. Morgan Asset Management, rigorous due diligence forms the cornerstone of our investment process. Our analysts conduct deep, proprietary research to uncover attractive investment opportunities for our clients and, perhaps more importantly, to identify risks that may be mispriced or overlooked by others. We question, probe, and challenge assumptions, continually reviewing our investment decisions to ensure that anticipated returns align with identified risks. While we believe these situations are idiosyncratic, we remain vigilant and view these events as a reminder of the importance of deep credit research.