Private Credit Firms Capitalize on Banks Dumping Consumer Loans

The landscape of consumer lending in the United States is undergoing a significant shift as regional banks and finance companies sell off consumer loans at discounted prices. Funding challenges and rising costs are driving this trend, leading private credit firms and hedge funds to seize the opportunity.

Canyon Partners, Castlelake, and Hyland Hill are among the prominent players in this market, significantly increasing their loan purchases compared to the previous year. As banks reduce their consumer lending activities, hedge funds and other investors stand to profit, while consumers may face higher borrowing costs.

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Regional banks, once major purchasers of consumer debt, are now offloading these loans to streamline their balance sheets and reduce capital requirements. PacWest Bancorp recently sold a $3.5 billion consumer credit and timeshare receivables portfolio to Ares Management Corp.

This strategic move by regional banks is in response to funding cost increases caused by individuals and companies transferring their funds from smaller banks to higher-yielding money market funds, subsequently raising lenders' funding expenses. These banks, which cater to consumers and small businesses, heavily rely on deposits.

Bonding loans and selling them as asset-backed securities have become more expensive. The average yield on asset-backed instruments, as indicated by the Bloomberg index, reached 5.5%—near its highest level since the financial crisis—compared to 1.13% at the end of 2021.

Additionally, US asset-backed sales have witnessed a 6% decline since 2022. Lenders now face higher borrowing fees, with personal loan-backed asset-backed securities yielding 2.5% more than the benchmark in 2020. An April 2023 trade yielded as much as 7.7%, highlighting the mounting pressure on lenders.

Private credit firms such as Hyland Hill have also witnessed an upsurge in consumer lender transactions since 2022. Some lenders have lost purchasers or securitization financing, compelling them to sell their loan portfolios to sustain their operations. Investors are cautiously waiting for higher returns before making purchases. Portfolios have been sold at discounts ranging from 97 to 99 cents on the dollar, considerably below the initial debt values.

Notwithstanding the risks associated with consumer loans, investors are capitalizing on the current market conditions. KKR & Co. recently acquired €40 billion ($44 billion) in buy-now-pay-later loan receivables from PayPal Holdings Inc., enabling PayPal to pursue further acquisitions. Similarly, Castlelake also made a substantial purchase, buying $4 billion in installment loans from Upstart Holdings Inc. Investors are being selective, curating portfolios of loans that offer favorable risk-return profiles.

Private credit firms are actively entering the asset-backed securities (ABS) and consumer lending sectors. However, this shift may lead to higher borrowing costs for consumers. Investors are exercising caution but seizing opportunities to acquire portfolios with favorable risk profiles.

As the consumer lending landscape evolves, the market will continue to see developments driven by the need for liquidity, capital optimization, and evolving consumer demands.