Middle Market Debt Weekly: First Brands Fraud Revelations Deepen as Private Credit Markets Stumble into 2026

The week ending January 18, 2026, saw the middle market debt ecosystem grappling with the fallout of the largest asset-based lending fraud in recent history, as First Brands Group’s restructuring advisors confirmed $2.3 billion in “fabricated” receivables during the launch of a court-supervised sale process.^¹ Simultaneously, the broader private credit sector faced its first significant test of the year, with business development company (BDC) equity prices experiencing pressure amid shifting expectations for Federal Reserve policy and lingering liquidity concerns following the Blue Owl merger termination in late 2025.^²

First Brands Launches Sale Process Amid “Widespread Irregularities”

The defining narrative of the week emerged from the Southern District of Texas, where First Brands Group formally launched a marketing process to sell its business on January 7, seeking to salvage operations from a capital structure riddled with fraud.^³ Court filings from restructuring advisors at Alvarez & Marsal revealed the staggering scale of the alleged deception. The investigation confirmed that approximately $2.5 billion in factored invoices could not be matched to actual inventory sales, with the company allegedly using “fabricated” and “significantly inflated” invoices to secure financing from multiple lenders simultaneously.^⁴

The chaos has left customers freezing payments, trapping roughly $250 million in cash that is critical for the debtor-in-possession (DIP) budget.^⁴ Creditor attorney Robert Stark summarized the lender dilemma during a January 7 hearing, stating, “We don’t know whether this case is a business with fraud attached or a fraud with a business attached.”^³

The official committee of unsecured creditors filed explosive allegations on January 6, claiming that Utah-based equipment financier Onset Financial provided short-duration financing agreements secured by First Brands’ inventory in exchange for average internal rates of return of 300%.^⁵ According to the creditors, Onset used former First Brands executive Edward James—the brother of founder Patrick James—for negotiations while allowing him to personally invest in the financings, generating hundreds of millions of dollars for James and outsize returns for Onset.

The committee labeled Onset a “net winner” from the alleged fraud, noting that it collected about $2.9 billion in repayments from First Brands after providing $2.5 billion in financing—yet Onset claims it is still owed a further $1.9 billion. Court papers revealed that First Brands employees “knew the company was being fleeced,” including a 2022 message thread where one employee remarked that the Onset employee who persuaded First Brands to take an inventory loan returning 179% would be the “employee of the year,” adding later, “3 months from now…. ‘who signed this f’n agreement???’ LOL.”^⁵

A spokesperson for Onset characterized the creditor committee’s claims as “unsupported and baseless,” adding that Onset is a “victim of the shocking fraud committed by Patrick James and his cohorts.” Asset manager Silver Point Capital recently purchased a controlling interest in Onset’s bankruptcy claim for undisclosed terms.^⁵

The week brought additional developments as U.S. Bankruptcy Judge Christopher Lopez approved the appointment of Martin De Luca of Boies Schiller Flexner as examiner on January 9, with a $7 million budget to investigate the multi-billion dollar fraud claims that have dominated the reorganization effort.^⁶ The appointment came as First Brands warned that unless it gets new financing, it will run out of cash around the end of January, potentially forcing the case into Chapter 7 liquidation. The company’s latest cash flow forecast, from January 3, projects that First Brands will run out of cash by the first week of February unless it secures more financing.

On January 9, First Brands filed a lawsuit against Edward James and Onset Financial, alleging they conspired “to defraud creditors out of billions of dollars and property.”^⁷ According to the lawsuit, Edward James “would work against the company as Onset’s secret partner” through sale and leaseback transactions with “outrageous terms.” Federal prosecutors have also opened a criminal probe into the company.^⁵

“Launching the marketing process represents a decisive step toward positioning our brands for long-term stability under new ownership,” said Charles Moore, interim CEO at First Brands Group.^⁸ The company’s portfolio includes leading automotive and commercial vehicle aftermarket brands such as FRAM, Luber-finer, Raybestos, Trico, Autolite, and ANCO. First Brands is also in discussions with an Ad Hoc Group of lenders regarding an agreement to provide additional debtor-in-possession financing and serve as the stalking horse bidder for certain business segments in the sale process, with the company targeting completion in the first quarter of 2026.

For asset-based lenders, the case has become a cautionary tale regarding the limitations of traditional borrowing base certificates. The investigation found that First Brands had sold the same invoices to different factors, creating competing claims that now threaten to derail recovery efforts.^⁴ Legal observers note that bankruptcy-remote structures designed to isolate specific assets have been tested as secured lenders filed motions to dismiss certain special purpose vehicle filings, asserting they were filed in contravention of bankruptcy-remote governance provisions.^⁹

BDC Sector Faces Redemption Pressures and Liquidity Concerns

The broader private credit ecosystem confronted its first significant test of the year as major non-traded business development companies faced a spike in redemption requests. According to Robert A. Stanger & Co., investors in BDCs holding more than $1 billion asked to pull a total of more than $2.9 billion in the fourth quarter, up 200% from the prior period.^¹⁰

In an unprecedented move, Blue Owl Technology Income Corp. allowed investors to withdraw as much as 17% of its net assets, worth about $685 million, well in excess of the 5% quarterly limit the firm had previously set.^¹¹ The firm also amended the deadline for investors to redeem their shares to January 8 from December 31. Redemption requests for Ares’ non-traded BDC also reached more than 5% of the vehicle’s net assets in the fourth quarter, according to Goldman Sachs analysts.

Blue Owl’s proposed merger of its non-traded BDC, Blue Owl Capital Corporation II (OBDC II), with its listed BDC, Blue Owl Capital Corporation (OBDC), announced in November 2025 in response to a sharp increase in redemption requests, has drawn scrutiny as OBDC was trading at approximately a 20% discount to its stated NAV.^¹² The situation highlights the challenges facing semi-liquid vehicles when stress tests the promise of smooth NAV pricing.

KBRA’s third-quarter 2025 BDC ratings compendium noted that credit performance across rated BDCs remained generally solid, although signs of late-cycle softening have begun to emerge.^¹³ Investments on non-accrual status remain low but increased year-over-year to a median of 2.5% of total investments at cost for non-perpetual life BDCs. The rating agency indicated that competitive pressures, tightening spreads, and the potential for additional rate cuts have many BDCs adjusting their dividend strategies to allow for more flexibility.

Federal Reserve Signals Extended Pause Amid Sticky Inflation

The December CPI report released on January 13 showed consumer prices rising 2.7% year-over-year, unchanged from November, with core CPI at 2.6%—both readings matching expectations.^¹⁴ While the report provided some relief with core inflation matching a four-year low, traders kept bets intact that the Fed would stand pat at its meeting later this month and likely won’t consider another cut until June.

Federal Reserve Vice Chair Philip Jefferson, speaking on January 16, characterized the outlook as “cautiously optimistic” while noting that inflation “remains somewhat elevated from our 2 percent goal.”^¹⁵ Jefferson indicated that the Committee’s rate cuts since mid-2024 have brought the federal funds rate “into a range consistent with the neutral rate—a rate that neither stimulates nor restricts economic activity.”

Kansas City Fed President Jeff Schmid offered a more hawkish perspective on January 14, noting that “inflation is running around 3 percent, which is above the Fed’s 2 percent objective.”^¹⁶ Schmid, who voted against the Committee’s October and December rate cuts, emphasized that “inflation has been above the Fed’s 2 percent objective for over four years. I don’t think we have room to be complacent.” The Fed is expected to hold rates steady in the range of 3.5%-3.75% at its January meeting, with the CME FedWatch tool showing a 95% probability of no change.^¹⁷

M&A Sentiment Reaches Six-Year High Despite Market Headwinds

Despite the challenges facing lenders, the Citizens 15th annual M&A Outlook revealed sentiment at its strongest level in six years, with 58% of respondents characterizing the current deal environment as strong.^¹⁸ Private equity executives demonstrated increased confidence, climbing from 48% in the first quarter of 2025 to 86% by year end, with 90% of PE firms anticipating that deal flow will remain steady or increase in 2026.

“Private equity firms have been sitting on dry powder for years, and 2026 may finally deliver the conditions they’ve been waiting for,” noted Jason Wallace, Citizens’ head of M&A. Nearly four in five companies view themselves as possible sellers, an increase from the prior year, while 61% say they could act as buyers. More than half of the private equity firms expect to initiate deals in the second quarter, before the U.S. midterm elections and the potential increase in uncertainty.

The Capstone Partners M&A outlook projects a gradual middle market recovery in 2026, driven by private equity deployment and eventual exit activity.^¹⁹ Private equity reemerged as a dominant force in 2025, ending a three-year lull with five consecutive quarters of platform acquisition growth and near-record participation in middle market deals.

Private Credit Faces First Real Test Since COVID

Industry observers characterized the current environment as one of the first real tests for the largely non-institutional client base of many non-traded funds since the pandemic.^¹⁰ While the headline default rate in private credit has remained below 2% for several years, once selective defaults and liability management exercises are taken into account, the “true” default rate approaches 5%, according to With Intelligence analysis.^²⁰

Payment-in-kind (PIK) usage has risen notably in private credit, with public BDCs now receiving an average of 8% of investment income via PIK. The Morgan Stanley private credit outlook noted that non-accrual rates in seasoned BDC portfolios have trended lower in recent quarters, though the firm maintains a significant underweight to healthcare, which has led all sectors in loans placed on non-accrual status over the last year.^²¹

Asset-Based Lending Market Dynamics

The ABL market experienced a dichotomy during the week, with the First Brands scandal casting a shadow over the sector while underlying fundamentals remained supportive. Industry analysis indicates that 2025 delivered favorable conditions for borrowers, with lower pricing, larger single hold levels, and extras such as accordions making the borrower experience particularly advantageous.^²²

Asset-heavy sectors such as retail and manufacturing featured frequently in transactions, with funders across the market more willing to look at retail after previous years of hesitancy. Private credit’s continued focus on the ABL market has resulted in new fund-backed asset-based lenders launching with well-known figures recruited to lead business development. The clearers have performed well in the ABL and invoice finance mid-market space, benefiting from the ability to offer competitive pricing together with the option to provide ABL alongside other banking products.

Items to Consider for Market Participants

First Brands Implications for Collateral Monitoring. The scale of fabricated invoices, double-pledged receivables, and usurious financing arrangements returning 300% IRR in the First Brands case warrants enhanced due diligence protocols for ABL and factoring portfolios. The limitations of traditional borrowing base certificates have been exposed, particularly in complex factoring arrangements involving multiple lenders and inventory financing structures.

BDC Redemption Dynamics Merit Close Observation. The 200% increase in redemption requests at major non-traded BDCs signals evolving investor sentiment toward private credit. The contrast between smooth NAV pricing and actual market liquidity conditions deserves attention, particularly as the Blue Owl merger situation unfolds.

Fed Policy Path Supports Extended Rate Stability. With inflation remaining sticky around 3% and the Fed signaling patience, market participants should prepare for rates to remain in the 3.5%-3.75% range through at least mid-2026. The implications for floating-rate borrowers and BDC net investment income warrant scenario planning.

Private Credit Quality Indicators Require Monitoring. Late-cycle softening has begun to emerge across BDC portfolios, with non-accrual rates at 2.5% at cost and rising PIK incidence. The gap between headline default rates and “true” default rates including liability management exercises merits attention.

M&A Conditions Suggest Activity Acceleration. With deal sentiment at six-year highs and PE confidence recovered, market participants should prepare for increased transaction volume in the second quarter as sponsors seek to deploy capital ahead of midterm election uncertainty.

Conclusion

The week ending January 18, 2026, crystallized the tensions facing the middle market debt ecosystem as it enters a new year. The First Brands fraud—with its billions in fabricated invoices, usurious financing arrangements returning 300%, and competing creditor claims—represents the largest test of asset-based lending risk management in recent memory, while simultaneously highlighting the vulnerability of collateral-based lending to sophisticated manipulation. The BDC sector’s first real stress test since COVID, with redemption requests surging 200% and the Blue Owl merger situation exposing gaps between stated NAV and market pricing, underscores the challenges facing semi-liquid private credit vehicles as investor sentiment shifts. Yet amidst these concerns, M&A confidence has reached multi-year highs and private equity stands ready to deploy substantial dry powder. The coming quarters will test whether the market can absorb the First Brands fallout while navigating extended Fed patience and evolving credit quality dynamics across middle market portfolios.

Footnotes

1. First Brands Group: $2.3B Fraud Triggers Chapter 11 Filing – Elevenflo
2. BDC Common Stocks Market Recap: Week Ended January 9, 2026 – BDC Reporter
3. First Brands looks to sell its business to get out of bankruptcy – Crain’s Detroit Business
4. First Brands Seeks Court Approval for Reconciliation Procedures – Shumaker Loop & Kendrick
5. First Brands Creditors Allege Utah Financier Paid Kickbacks for ‘Usurious’ Deals – Wall Street Journal
6. First Brands Judge Approves Examiner to Probe Fraud Allegations – Bloomberg
7. First Brands sues founder’s brother, largest creditor for fraud – Crain’s Cleveland Business
8. First Brands putting business up for sale – Trucks, Parts, Service
9. Bankruptcy-Remote Structures Tested in First Brands Group Cases – Covington & Burling LLP
10. Private Credit Faces Billions in Investor Withdrawals – Bloomberg/Wealth Management
11. Blue Owl BDC Allows 17% Redemptions as Investors Storm Exit – Bloomberg
12. Private Credit Outlook 2026: The Market Faces its First Big Test – With Intelligence
13. KBRA Private Credit: BDC Ratings Compendium Q3 2025 and 2026 Outlook
14. CPI inflation report December 2026: Prices rose at 2.6% annual rate – CNBC
15. Speech by Vice Chair Jefferson on the economic outlook and monetary policy – Federal Reserve
16. The Economic Outlook and Monetary Policy – Federal Reserve Bank of Kansas City
17. CPI gave Wall Street good news but not enough for Fed to cut rates soon – CNBC
18. Middle-market M&A set to expand in 2026 as deal confidence hits multi-year high – InvestmentNews
19. Merger and Acquisition Outlook 2026 – Capstone Partners
20. Private Credit Outlook 2026: The Market Faces its First Big Test – With Intelligence
21. Private Credit 2026 Outlook – Morgan Stanley Investment Management
22. Asset-based lending wrapped 2025 – Addleshaw Goddard LLP