“Credit cockroaches” swarm; investment risks surface

“Credit cockroaches” in segments of the U.S. economy are crawling into the spotlight. The old adage — “see one cockroach, more are lurking”— rings true as sporadic bankruptcies and credit events pile up, revealing cracks in the economy. Prolonged high interest rates and slowing growth are exposing vulnerabilities, particularly in the high-yield bond market, where risks are surfacing. While not yet systemic, these warning signs demand sharper scrutiny.

Where are the “credit cockroaches”?

Tricolor, a U.S. subprime auto lender targeting undocumented immigrants, collapsed into Chapter 7 liquidation on 10 September, sparking a fraud scandal. The Department of Justice (DOJ)’s probe into double-pledged collateral on securitised loans triggered massive write-offs by not only regional banks but also major banks. Days later, auto parts giant First Brands filed for Chapter 11, saddled with up to USD50bn in liabilities against less than USD10bn worth of asset value. Creditors uncovered fraudulent off-balance-sheet factoring schemes, with USD2.3bn allegedly vanished, now under DOJ scrutiny. A USD1.1bn debtor-in-possession loan keeps it afloat, but the fallout shook bond markets, fuelling fears of wider defaults in a fragile credit landscape.

Likely triggers and common traits

Added to these corporate failures were recent disclosures of charge-offs by several regional banks due to fraudulent commercial loans. What is common across these incidents was fraudulent or opaque accounting practice adopted by the borrowers. All this seemed to have gone unnoticed when the economy was booming, given a lack of due diligence in the underwriting process, until economic headwinds turned those loans toxic.

U.S. bank equities underperformed on credit concerns

In our October 2025 Global Market Outlook published in September, we took profit on U.S. major banks, bracing for market volatility as a softened job market forced the Fed back into rate cuts. Stock price reaction after the recent Q3 bank earnings proved us right. Despite positive earnings surprises, pockets of asset quality concerns emerged. This has caused bank equities to lag the broader U.S. equity index by over 470 basis points since the start of October.

Add in tranches to U.S. sectors with structural and defensive growth

We take note that the above are isolated fraudulent incidents, with the loans to U.S. non-depository financial institutions (NDFI), which are more exposed to these risks, making up only less than 10% of the total US bank loans. Though this is not a systemic risk for the U.S. banking system, we are mindful that the ratio has already more than doubled in a decade. We urge caution on the U.S. banking sectors with heavy NDFI exposure. While we stay positive on U.S. equities, we see it prudent to pivot to the technology, communications and healthcare sectors, which have stronger earnings growth prospects.

Bond market implications

We have a similar focus on quality in bonds, with a preference towards investment grade corporate bonds. The recent rise in yield premiums have opened up an opportunity for tactical investors, given overall U.S. corporate default rates remain well below historical average. With the U.S. dollar expected to soften longer term, we also recommend UK government bonds (gilts) and Emerging Market local currency bonds, which we believe have better upside potential.

Ways to combat “cockroaches” in our investments

“Credit cockroaches” reveal cracks in specific U.S. high-leverage sectors, signalling idiosyncratic risks. They are not a systemic threat. That said, we need to exercise preventative “pest control” and scrutinise investment portfolios for exposure to shaky loans. All in all, diversification functions as a powerful shield — build an all-weather portfolio spanning sectors, regions, and asset classes, while prioritising quality and defensive growth to navigate any turbulent times ahead.

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