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), opens new tab has disclosed, opens new tab 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), opens new tab. 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, opens new tab 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, opens new tab the ⁠founder of sub-prime auto lender Tricolor on similar claims. Jefferies, meanwhile, also lent to now-teetering real-estate lender Market Financial Solutions.

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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, opens new tab 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.

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Editing by Jonathan Guilford; Production by Maya Nandhini

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Stephen Gandel

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Stephen Gandel is an award-winning journalist who has covered banking and financial markets for more than two decades. Prior to joining Reuters Breakingviews, Gandel had been the U.S. banking correspondent at the Financial Times for the past two years.

He previously worked at The New York Times as the U.S.-based news editor of DealBook, the Times’ daily business newsletter, and was on a team of reporters who won an Emmy for live interviews. He was also a senior reporter for CBS News and a markets columnist for Bloomberg.

Gandel spent 14 years at Time, working for Money, Time and Fortune magazines, where he was the only reporter to ever win the company’s Luce award four years in a row. His work was also recognized with a SABEW Best in Business award, and an Excellence in Journalism award from the NYSCPA. He is a graduate of Washington University in St. Louis, and lives in Brooklyn with his wife and two children.

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