BREAKINGVIEWS-First Brands row hints at banks’ shadow exposure

By Stephen Gandel

NEW YORK, March 9 (Reuters Breakingviews) - Cockroach troubles tend to extend further than they first appear. JPMorgan boss Jamie Dimon likened high-profile credit blowups to the sneaky insects, implying that deeper problems lurk. And now, six months after heavily indebted auto-parts retailer First Brands toppled, regional lender Western Alliance WAL.N has disclosed a $126 million hit from the mess. It never lent directly to First Brands, but instead to a fund run by Wall Street financiers at Jefferies JEF.N. It’s just one of many smaller banks piling into the murky world of shadow finance.

First Brands’ surprise bankruptcy last year sent a chill through credit markets. Federal prosecutors alleged that it pledged assets multiple times over to secure billions of borrowings, largely from non‑bank lenders. It was not an isolated case, with the government also indicting the founder of sub-prime auto lender Tricolor on similar claims. Jefferies, meanwhile, also lent to now-teetering real-estate lender Market Financial Solutions.

Western Alliance claims a deliberate breach of contract, saying that Jefferies has ceased to pay $126 million outstanding on loans to special-purpose vehicles that held First Brands’ accounts receivable. Jefferies said on Monday that these are non-recourse loans, with no guarantee of payment from the SPVs’ parents, and that the suit lacks merit.

Whatever the case, shares of Western Alliance and Jefferies have tanked 11% and 14%, respectively, since Thursday. Morgan Stanley analysts downgraded their recommendation on Jefferies’ shares, citing the litigation.

Western Alliance is a relative pipsqueak, at roughly $8 billion in market value. Yet many similarly sized institutions have been swept up in the flood of lending to lightly regulated firms that the Federal Reserve labels “non-depository financial institutions.” Lending to these shadow banks has climbed to $1.9 trillion, up 180% from $680 billion in 2021, according to Fed data. This growth tracks the vertiginous rise of private credit and asset-backed lending, which have increasingly displaced traditional banks since the 2008 financial crisis. Providing leverage is a way to get a cut of the action back.

The question is how much risk this poses. Banks’ equity is a loss-absorbing buffer, taking the hit if loans go awry en masse. Yet 40 U.S. lenders with a combined $4.7 trillion in assets now have lent the equivalent of more than 100% of their total equity capital to shadow banks, up from 29 banks holding $1.1 trillion two years ago, according to data from KBRA Financial Intelligence. Nearly all borrowers are current on their payments, and much of the activity relates to the mortgage market, which enjoys effective government support. Yet the territory in which cockroaches can breed is growing.

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CONTEXT NEWS

Western Alliance on March 6 filed a suit to recover $126 million that the Phoenix bank says is owned by Point Bonita, a private credit fund managed by a division of investment bank Jefferies. The loss is tied to a loan that the credit fund made to failed auto-parts maker First Brands. Point Bonita in turn had borrowed money from Western Alliance in order to fund its investments.

Jefferies on Monday said Western Alliance loans were non-recourse, and that it plans to fight the suit.