Private Credit Firms Build Cash Hoards to Gain Share of $5.2 Trillion Consumer Debt Market

Carmen Arroyo and John Sage
Wed, August 9, 2023 




(Bloomberg) -- Private credit firms are raising billions of dollars to grab a share of the $5.2 trillion market that includes US consumer debt, seizing on a growth opportunity while the industry’s traditional lenders are in disarray.

Direct lenders such as Ares Management, BC Partners, KKR & Co., and Medalist Partners in recent months raised the money for funds designed to lend to consumer financing companies. Providers of auto and consumer loans have been unable or unwilling to tap their usual funding sources, namely regional banks and securities sales backed by assets like loan portfolios.

The private credit firms see a chance to increase returns for their investors and to diversify their offerings, lessening the focus on increasingly competitive corporate loans without adding an unmanageable amount of risk. While the more-opaque consumer debt market is vulnerable to a downturn in the economy and a given sector can be hit by defaults, loans backed by assets like real estate or autos can be attractive.

“Institutional funds may not want to increase their exposure to venture debt or corporate buyouts in an uncertain macroeconomic environment,” said Evan Carruthers, co-chief executive officer at asset-based private lender Castlelake. “But we believe they view asset-based private credit as offering similar returns to corporate debt with potentially less risk,” he said, adding this debt tends to be investment grade but with higher yields.

Direct lenders already are deploying some of the money raised to buy consumer loan portfolios from regional banks. The banks and credit unions, once among the biggest buyers of consumer debt, now are selling it to shore up liquidity after a crisis of confidence among some depositors and shareholders in March.

Loan Sales

Since then, California-based PacWest Bancorp and Georgia’s Synovus Bank are among the institutions that have sold portfolios including auto and consumer loans to private lenders.

KKR, Varde Partners and others bought the debt.

And Truist Financial Corp. unloaded a $5 billion student loan portfolio that it described as “non-core” in late June, while Western Alliance Bancorp sold roughly $3.5 billion in loans tied to commercial real estate, residential and commercial and industrial lending, as well as mortgage servicing rights and a slug of securities that were primarily collateralized loan obligations.

“The regional bank pullback has put this asset class at the forefront, with many lenders wanting to take advantage of the less crowded playing field,” T.J. Durkin, head of structured credit at Angelo Gordon & Co., said in an interview. “But we are still in the first innings of banks deleveraging, this has just started.”

Angelo Gordon raised over $1 billion for consumer loan strategies and other asset-based credits, more than its $800 million target. In Ares’ most recent earnings call, CEO Michael Arougheti said his company raised $1.8 billion during the second quarter in its latest alternative credit fund, which may include financings backed by assets like consumer or student loans. The firm to date has raised $4.4 billion in total for that fund.

And Blackstone Inc. is working on several deals with banks and other originators totaling $6 billion in this sector, according to a transcript from the firm’s latest earnings call. Jonathan Gray, Blackstone’s president and chief operating officer, said on the call the firm plans to “continue to serve their customers in areas like home improvement, auto finance, and renewables.”

ABS Inaccessible

Direct lenders are taking advantage of a breakdown elsewhere in the credit markets to enlarge their $1.5 trillion industry, and may ultimately gain greater pricing power on consumer debt.

Traditionally, banks and consumer finance companies could raise funds when needed in the asset-backed securities market by repackaging a portfolio of loans into bonds. But that market remains hostile to any but the most straightforward of offerings after the cost of borrowing shot up late last year.

Sales of ABS securities are down by 4.5% compared to this time last year, according to data compiled by Bloomberg News, after rate volatility in 2022 caused a slew of firms to pull transactions.

Consumer finance firms such as Upstart Holdings Inc. and PayPal Holdings Inc. instead struck deals with private lenders to raise capital. Castlelake LP recently agreed to buy up to $4 billion of loans from fintech lender Upstart, while KKR agreed to purchase as much as €40 billion ($43.8 billion) of buy-now-pay-later loan receivables from PayPal.

Financial technology consumer lender Oportun Financial Corp. agreed to sell $700 million of loans to a private lender duo, Bloomberg reported Tuesday.

“We believe banks are going to keep getting out of consumer credit, leaving a lot of room for non-banks,” Durkin of Angelo Gordon said. “Eventually, it will make it more expensive for Main Street to borrow money.”

To be sure, direct lenders may find out that the asset-based finance market has unique risks in assessing the quality of vast portfolios of various types of loans. “A lot of people know how to underwrite a company, but few know how to do the same with consumer credit receivables, aircraft or royalties,” Castlelake’s Carruthers said.

Private credit managers say the opportunity is too big to ignore.

“We believe specialty finance lenders are well-positioned to capture even more of this market in the coming period, which opens up the door for private ABS origination,” according to a paper from Atalaya Capital Management last month.

(Updates with details on Ares fund in 10th paragraph)

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