Lessons from Tricolor and First Brands

Two recent high-profile private-credit failures — subprime auto lender Tricolor and autoparts supplier First Brands (Chapter 11) — exposed fraud and off‑balance-sheet double‑pledging that left lenders with far higher leverage than underwritten, prompting scrutiny of private credit underwriting, ratings and transparency. The asset class remains large (BlackRock cited ~$2.1tn) with trailing default rates modest (S&P ~4.55% end-Q3 2025; Fitch US private credit ~5.2% July 2025), fundraising softened (188 funds closed in 2024) but 57% of LPs plan to increase allocations; regulators (notably EU rules) are tightening liquidity and leverage oversight, while refinancing needs (Goldman: ~24% of leveraged loans maturing this year) are keeping deal flow in pockets of the market.

Analysis

Market structure: Large, credible service providers and advisors (SPGI, MCO, GS, JPM) are likely beneficiaries as demand for independent due diligence and restructuring/advisory rises; opaque specialist private-credit shops and any manager with hidden leverage (examples: parts of BLK’s HPS exposure) are losers. Demand for private credit remains strong (dry powder high, 24% of leveraged loans maturing by year-end), but supply will tighten if regulators cap fund leverage or banks retrench, driving higher yields in lower-mid market and stretched credit segments.

Risk assessment: Tail risks include a regulatory shock (EU leverage/liquidity rules forcing 10–30% forced sales) or multi-fund fraud cascade that pushes realized private-credit write-downs into double digits within 6–18 months. Immediate (days): headline-driven spread widening and equity volatility; short-term (weeks–months): fund flows and covenant repricing; long-term (years): structural growth to ~$4tn by 2030 but with higher compliance costs. Hidden dependencies: bank-funded warehouse lines, private letters from small ratings shops, and continuation-vehicle liquidity mismatches are potential contagion channels.

Trade implications: Favor long positions in high-quality information providers and advisers—buy SPGI and GS exposure—and hedge reputational/operational risk in diversified asset managers (BLK) via puts. Use BKLN (leveraged-loan ETF) put spreads or buy senior IG CDS protection to shield credit exposure; rotate out of illiquid private-credit allocations into liquid HY and senior secured loans in the next 30–90 days to capture repricing. Entry window: initiate within 30 days, scale through 90 days, re-assess after regulatory announcements (30–60 day cadence).

Contrarian angles: Consensus inflation of systemic risk may be overdone—actual private-credit trailing defaults sit ~4.5–5.2%, not crisis levels, so top-quartile managers will likely see inflows and spread compression recovery. The market may underprice the franchise value of dominant rating/advisory firms (SPGI, MCO) and over-penalize diversified asset managers; risk: heavy-handed regulation could unintentionally push lending back into opaque bank balance sheets, increasing systemic concentration rather than reducing it.

Key Decisions for Investors

• Establish a 2–3% long position in S&P Global (SPGI) shares or buy a 6–9 month 5–10% OTM call spread to capture higher fee demand from re-rating and increased third‑party diligence; target +8–15% upside over 6–12 months.
• Initiate a 1–2% long position in Goldman Sachs (GS) equity or buy 9–12 month calls (10% OTM) to play increased refinancing/advisory flow from the 24% leveraged‑loan maturity wall; add if M&A/refinancing volumes rise >10% QoQ.
• Hedge reputational/operational exposure in large managers by buying 6–9 month puts on BlackRock (BLK) equal to 0.5–1% notional of portfolio value (10% OTM) or short BLK vs long SPGI as a 1:1 pair to capture dispersion risk.
• Protect liquid credit exposure by buying BKLN (leveraged‑loan ETF) 3–6 month put spreads (5–15% OTM) sized to cover 2–3% of AUM, or purchase 1–2% notional senior IG CDS protection if available; act within 30 days and scale if leveraged‑loan spreads widen >100bps.
• Reduce new commitments to blind‑pool private‑credit funds by 20–30% over the next 60 days; redeploy into top‑quartile direct lending managers with covenants or into liquid senior loan/HY ETFs until regulatory clarity (EU fund approvals, leverage caps) is achieved within 60–90 days.