Western Alliance sues Jefferies for $126M in First Brands fallout

• Key insight: The latest fallout from the collapse of auto-parts company First Brands was unexpected, since Western Alliance had previously expressed confidence in its contract with Jefferies.
• Supporting data: A Jefferies affiliate had paid off more than $211 million of the $337 million debt since Western Alliance extended the loan last fall.
• Forward look: Western Alliance believes it will win its suit against Jefferies and recover the full $126 million, but said the legal process will take time to resolve.

The high-profile bankruptcy of the auto-parts company First Brands Group has struck again.
Western Alliance Bancorp. announced Friday that it is suing Jefferies Financial Group after Jefferies' affiliates backpedaled on previous assurances that they could pay off a large commercial loan balance. The loans were collateralized by accounts receivable purchased from the now-collapsed First Brands, which has been accused of fraud.

Phoenix-based Western Alliance charged off the entire $126.4 million balance, a reversal of its prior confidence in its contract with Jefferies. 

On Friday, Western Alliance CEO Kenneth Vecchione said that Jefferies told his bank last week that it would cease making payments, which he called "shocking" and "highly unusual."

"Plainly, in my entire banking career, I have never witnessed a breach of contract that so deliberately places the reputation and operating integrity of a counterparty at risk, forcing future banks, clients and counterparties to seriously reevaluate the dependability of that organization's commitments," Vecchione said on a Friday call with analysts and investors.

Western Alliance's lawsuit, filed earlier in the day in New York state court, accuses Jefferies and several affiliates of breach of contract and fraud, alleging that the defendants "knew they did not intend to repay the loan in full."

Jefferies said in a written statement that its loan from Western Alliance entitled the bank to conduct audits of the underlying receivables. Jefferies added that its affiliate "acted in good faith and with goodwill toward the bank at all times."

"Unfortunately, First Brands and its leadership perpetrated a wide-ranging and well-concealed fraud," Jefferies said. 

Jefferies also said that it believes Western Alliance's suit is "without merit" and "will be defended vigorously."

Western Alliance's suit marks another blow to banks from the private-credit industry. A series of credit hits last fall began to sow concerns about traditional financial institutions' exposures to nonbank lenders. While banks' private credit-related assets have largely seemed to perform, moves like Western Alliance's can give credence to investor doubts.

First Brands first stirred panic when it filed for bankruptcy in September amid allegations of fraud. Jefferies, through its affiliate Point Bonita Capital, a division of Leucadia Asset Management, had invested in the company's receivables.

The fallout from First Brands' collapse also cost First Citizens BancShares in North Carolina and SouthState Bank in Florida, which in October reported related charge-offs of $82 million and $32 million, respectively.

In October, Western Alliance agreed to extend a loan it had made to a Point Bonita Capital fund that had exposure to the car-parts company.

"Jefferies has publicly stated they feel confident in Point Bonita's near-term ability to pay off all debt, due to the diverse set of assets apart from the First Brands related receivables," Vecchione said during the company's third-quarter earnings call in October. "Jefferies remains confident and so do we."

Jefferies had remained current on the agreement until last month, Vecchione said Friday, and had paid off more than $211 million of the debt.

Western Alliance also announced Friday that it is making moves to offset the $126 million credit hit. The bank said it is pursuing $50 million of securities gains, plus $50 million of "expenses initiatives throughout the year that do not impair growth or operational capacity," Vecchione said. 

The remaining $26 million shortfall is still under review, Vecchione said, but he expects to make up the amount "either through growth, pricing initiatives, future stock repurchases and other fee and expense programs." He said the bank will have more details to report on its first-quarter earnings call.

Mike Mayo, an analyst at Wells Fargo Securities, called Western Alliance's loss a "headscratcher" in a Friday note, given the timing and the bank's prior upbeat disclosures.

The Phoenix bank's stock was down as much as 15% on Friday, though it recovered some ground later in the day.

Truist Securities analyst David Smith wrote in a note that the $126 million hit was "big but manageable." 

"The loss is still a black eye for a bank that is already dealing with sizable valuation discounts for perceptions of complexity and credit risk," he wrote. "Losing $1.2 billion of market cap on a $126 million loss clearly reflects fears that there is more to come."

Western Alliance has an additional $330 million of asset-based lending exposure, excluding the First Brands-related debt, Vecchione said Friday.

Still, the bank on Friday stuck to its prior guidance on credit quality for the year.

This incident isn't the first credit-related snafu at Western Alliance in recent months. In August, the bank sued entities affiliated with real estate firm Cantor Group to recover $100 million, alleging the borrowers fraudulently violated their loan agreements with the bank. Western Alliance took a $30 million reserve in the third quarter to manage potential losses on the debt.

Vecchione said Friday that there's a key difference between First Brands and Cantor. Jefferies explicitly said it wouldn't make the loan payments, and the collateral behind the First Brands exposure is worthless, he said. The Cantor case, by contrast, is tied to existing properties that are currently being reappraised.

Western Alliance believes it will win its suit against Jefferies and recover the full $126 million, Vecchione said. But he noted that because of the legal process, "anything that we will recover will come down the road."