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First, private credit came for corporate finance. Consumer lending is now the latest frontier. In recent weeks, the likes of Elliott, Carlyle, Fortress and Blue Owl have collectively agreed to purchase tens of billions of dollars’ worth of loans, for consumers, automobiles and home equity. The sellers are once high-flying fintechs such as Klarna, SoFi and Upstart.
This latter group has been hammered by higher interest rates, heavy expenses and limited profits. More generally, these companies have decided they would rather emphasise sleek Silicon Valley brands and make algorithmic underwriting decisions instead of holding the balance sheet risk of loans that they make.
Getting into the moving business and out of the storage business is supposed to help grease even more loan origination. The merry-go-round route only continues to get longer. Until there is an actual recession and a surge in defaults, the consequences of this endless money-spinning on the financial system will not become clear.
Upstart was founded just over a decade ago by Google engineers who believed they could create a better underwriting model (which it now says is AI-powered and features 1,600 variables). For its funding, Upstart relies on so-called “warehouse” lines of credit from banks as well as then packaging and securitising loans to sell on to institutional investors. And while a bulk of revenue comes from fees, the balance sheet risk from loan charge-offs and interest rate movements on retained loans is substantial. In 2023, “fair value adjustments” of $180mn exceeded what Upstart earned in interest revenue, leading to a $250mn operating loss.
A private asset manager purchasing loans likely cares less about accounting adjustments. They are instead thinking about the cash from borrower interest payments that generate yields well into the double-digits. After Blue Owl — itself using private debt financing from Apollo — agreed to purchase up to $2bn in Upstart consumer loans over the next 18 months, Upstart shares jumped nearly a fifth, adding $700mn of equity value. Shares of SoFi rose a tenth when it recently announced its own $2bn loan sale agreement with Fortress Investment Group.
Fintechs arose from the beliefs that the basic function of banks could be upended with technology, nimbleness and regulatory arbitrage. But they have yet to usurp the big banks or master the economics without the advantage of taking cheap deposits. Private credit is now taking its best shot.