First the private credit firms came for the banking industry’s lucrative corporate loan business. Now they’re grabbing a chunk of their consumer-lending work. The pressing question for this thriving multitrillion dollar industry is whether it has timed its latest incursion badly.
The likes of Fortress Investment Group, KKR & Co. and Carlyle Group have all been hoovering up packages of consumer loans in Europe and the U.S. over the past year. With unemployment spiking unexpectedly in some of the world’s biggest economies, the bet looks riskier than it did a few months back.
Private credit rose to prominence over the past decade by gobbling up much of the company financing traditionally provided by Wall Street, but its success has attracted a horde of new market entrants and the extra competition has pushed down its once stellar returns. As a result, firms have been foraging in new areas to try to put their vast pots of client cash to profitable use.
Debt taken on by squeezed Europeans and Americans — through everything from “buy now pay later” to old-fashioned credit cards — has become the latest hot property for private credit funds looking to diversify as banks retrench.
“The consumer-loan trade really started to happen in force since the regional banking crisis” in the U.S. last year, says Patrick Lo, partner and co-chief investment officer at Waterfall Asset Management.
New York-based Fortress inked a deal this summer to provide £750 million ($956 million) for a British provider of dental loans. Fellow U.S. asset manager Castlelake last week agreed to buy up to $1 billion in consumer loans initially created by Pagaya Technologies, whose business model is to use artificial intelligence to help vet consumer borrowers. It’s done similar with Upstart Holdings, another AI-based fintech.
KKR launched a €40 billion vehicle last year to buy current and future BNPL loans originated in Europe by PayPal Holdings. Rivals such as Blue Owl Capital are looking to expand into consumer finance via acquisitions. It’s all part of a plan to build so-called asset-based finance businesses, which provide funding to both companies and consumers.
Fund managers at these firms say they’re only interested in higher-quality consumer lending, but some concede they need to be vigilant about becoming exposed to struggling borrowers when deciding where to invest. Rougher economic times mean people need to borrow more — an opportunity for cash-rich private credit funds — but also make it harder for them to honor debts.
Buy now, pay later
“Even if you have some deterioration driven by the higher unemployment rate, we think we have enough of a cushion in the structure to absorb this,” says Dominick Ruggiero, co-CIO of Fortress Lending Funds. “That said, we need to constantly reevaluate our assumptions. Higher unemployment is going to drive more volatility, especially on the subprime consumer.”
Others point out that although asset-based finance is usually secured by real things such as property when lending to companies, it often isn’t secured against anything when used to fund consumer lending, adding to the dangers.
Credit card delinquencies in the U.S. have risen to their most elevated levels in more than a decade by some measures and the impact of a higher-rate environment hasn’t been fully felt yet, experts warn. According to a Bloomberg News survey done by Harris Poll, some 43% of those who owe money to BNPL services said they were behind on payments. More than a quarter of respondents said they were delinquent on other debt because of their BNPL spending.
A senior manager at one of the largest private-market firms, who asked to remain anonymous when discussing commercial matters, says the risk from subprime consumer loans has increased as pandemic monetary stimulus fades. His firm is doubling down on backing loans to consumers who have equity in their homes, he adds, rather than exposing itself to unsecured lending.
Some of this also explains why traditional lenders have been vacating the space that private credit is starting to fill. “I think most banks don’t find consumer debt sufficiently attractive given the risk it bears,” says Marco Folpmers, a partner for Deloitte’s financial risk management team. “BNPL platforms in particular are struggling to make a profit.”
