Rhymes with 2008
So there’s this holding company named First Brands, which owns several well-known brands of auto parts. Should be a relatively boring, stable business, given the ongoing resilience of the US auto industry and America’s ongoing love affair with cars.
Except that the owner is a recluse, who doesn’t like to have his camera on in video calls with investors, the company has a history being late on operational and debt payments, and its growth is mostly due to acquisitions rather than y’know selling more products at a profit. And then, to fund the acquisitions, they turn to vendor finance, the process whereby the company sells forward its invoices at a discount, with the expectation that those invoices will be paid in full in 30 or 60 days, and the buyer of those invoices gets a nice return.
Vendor finance has been in use for centuries: it’s how Goldman Sachs got its start (mostly with shipping invoices, not parts and labour invoices, mind you). When Migrations.ml was alive, I would get a few emails a month from small investment banks offering to buy or “factor” our receivables. It can work, and credit risk is quite low, as most people who receive an invoice, such as for your motor oil or exhaust system, pay it when it’s due.
BUT, when the vendor that issues the invoices is in trouble and declares bankruptcy, then people stop paying the invoices. And the company that bought those invoices is screwed. And then people start suing the asset manager that structured the invoice purchases. And then the other clients of that asset manager look sideways at the asset manager, and ask for all of their deposits and investments back. And lenders to the asset manager start worrying about credit risk, which the whole thing was supposed to avoid in the first place.
And that is where we are now: First Brands not only overleveraged, but they sold the same invoices more than once. The renowned investment bank Jefferies owns the asset manager that funds the deals (Leucadia Asset Management), and Leucadia is now losing big name clients like Blackrock and Morgan Stanley, and the companies that were supposed to have done the due diligence when the deals were structured, are cutting staff as they face an 80% reduction in their revenues.
And now enter a regional bank, Western Alliance Bancorp, which decided to lend into Leucadia and take the receivables as collateral. Now the collateral is worth $0, driving up the credit risk of the loan. Western could force Leucadia to pledge other assets, or lawyer up, but the real risk is to Western Alliance’s reputation: if their depositors decide that their money is at risk, put on your Nikes and get set for a bank run.
It all could have been avoided with proper due diligence, but when there is a lot of capital chasing yield, then the DD get relaxed, to the point of making really dumb decisions that a normal person would avoid.