Fed Rate Increases Are Squeezing Consumer-Finance Companies

The financial squeeze that started about six months ago for companies that lend to ordinary Americans is getting worse, contrasting sharply with recent rallies in stocks and corporate bonds. The main reason: These finance companies have lost access to easy money.

Widespread economic uncertainty has made debt investors less willing to buy the bonds these nontraditional lenders issue. Higher interest rates, courtesy of the Federal Reserve, have given investors other attractive options.

Now, these finance companies are paying as much as four times what they paid in January to borrow in bond markets the cash they lend to customers. Plenty of them are struggling to make that math work. Once-highflying consumer-finance companies such as Pagaya Technologies have flipped from profit to loss. Some smaller outfits are shutting down altogether.

Many of the nontraditional lenders launched within the past decade, which means they have never weathered a sustained period of high interest rates.

“All of these fintech firms talk about their data science and machine learning capabilities, but the truth is, their models have not been battle tested through a recession yet,” said Reggie Smith, JPMorgan Chase & Co.’s lead fintech stock analyst.

Office supplies at the Athas Capital Group, which announced its closure because of the poor outlook for selling loans to Wall Street firms.

Photo: Maggie Shannon for The Wall Street Journal

Pagaya and other startups such as Affirm Holdings Inc. and Carvana Co. aren’t banks, which means they can’t take deposits for funding. For borrowers with imperfect credit, these alternative lenders are sometimes the only way to get an auto loan, mortgage or buy-now-pay-later offer.

The companies are now lending less or charging more for loans they do make, adding to concerns already swirling about the health of the economy.

Athas Capital Group, an alternative mortgage lender in Calabasas Hills, Calif., announced its closure in November, citing the poor outlook for selling its loans to Wall Street firms.

“Do I set a bunch of cash on fire to stick around or do I close shop?” asked Brian O’Shaughnessy, co-chief executive officer. “We chose, right or wrong, to close up shop.”

He is now trying to help his roughly 265 employees find jobs at competing firms.

The average price of bonds backed by private-label mortgages recently fell to about 82 cents on the dollar, their lowest level since at least 2011, according to a Wall Street Journal analysis of data from the Financial Industry Regulatory Authority. Bond prices typically fall when interest rates rise and investors demand higher yields to lend money.

Sales of the bonds made from private-label mortgages, which don’t benefit from federal guarantees, boomed last year when Treasury bonds were paying peanuts.

Normally, loans from alternative lenders are bundled into securities that Wall Street firms sell to pension funds, insurers and other investors. These bonds are known as asset-backed securities, or ABS, and they are typically sold to investors in multiple slices that have different yields based on their risk.

The securitization process is integral to keeping many consumer-finance companies in business, but it can amplify market gyrations in unexpected ways. Prices of collateralized loan obligations, or CLOs—a type of ABS—gapped below fair value in October when U.K. insurers and pensions responded to rising interest rates by dumping CLO bonds.

Some investors have stopped buying ABS, which they still associate with the 2008 financial crisis, to reduce risk. Others are selling out of fear that the loans backing the bonds might go bad. Home prices are already falling in many U.S. cities, and delinquencies are creeping up on auto and other consumer loans.

The biggest change, though, is that insurance companies and pension funds have scaled back their interest in ABS, said Rich Barnett, a partner at investing firm Castlelake LP. Rising interest rates have lifted the yields on corporate bonds and Treasury bonds, making them attractive for the first time in years.


Do you think the turmoil in ABS bonds will spread to other markets? Why or why not? Join the conversation below.

Prudential Financial Inc. has slowed once-brisk purchases of ABS and CLOs in its approximately $400 billion insurance account. Instead, it is snapping up high-rated corporate bonds because their yields have risen, socking them away in preparation for when the Fed starts cutting rates again, chief investment officer Timothy Schmidt said.

Investment-grade corporate bond yields doubled this year to a 13-year high of about 5%, which is close to the roughly 7% return many pensions and insurers shoot for. Another benefit: Corporate bonds have longer terms than most ABS, making them better matches to offset the payout schedules of insurance and pension liabilities.

“We will look back at the assets we’re buying now as pretty attractive,” Mr. Schmidt said. “I don’t think anyone expected rates to move this far this quickly.”

Investors still willing to buy the bonds are making borrowers pay up. Affirm, a buy-now-pay-later company, abandoned plans to issue a $350 million bond in November when investors demanded higher yields than it was willing to pay, people familiar with the matter said. The company also finances loans through bank credit lines and direct sales to investors such as the Canada Pension Plan Investment Board.

Americans have racked up more credit-card debt than ever. WSJ’s Dion Rabouin explains the contributing factors and why this could spell trouble ahead for the U.S. economy. Photo: Keith Srakocic/Associated Press

Pagaya, a technology-driven consumer finance company, went ahead with a $543 million bond last month but had to pay investors an 8.1% interest rate on its best-quality bonds to get the deal done, according to data from Finsight. That marks a steep increase from the 6.1% rate it got on comparable bonds sold in August and 2% on a deal in January.

Issuance of consumer-loan ABS declined slightly this year, but Pagaya has nearly doubled bond sales to about $3 billion, according to Finsight. Fees from bond sales account for much of the company’s revenue, according to its financial filings.

At the same time, delinquencies have risen on loans bundled into ABS that Pagaya sold. A bond the company issued in January at 100 cents on the dollar traded in mid-November at around 88 cents, according to data from Empirasign.

Pagaya has been buying loans with tighter underwriting standards this year, and its November bond issuance shows that bond investors trust the company’s artificial-intelligence methodology, its 34-year-old co-founder Gal Krubiner said. The U.S. and Israeli firm uses AI to identify attractive loans that other lenders would turn down, Mr. Krubiner said.

“We saw the uncertainty and volatility coming,” he added.

Pagaya’s stock is trading below $1, down from about $10 three months ago.

Carvana, an online auto dealer, is facing a cash crunch. Its shares, which soared in the pandemic, have lost 98% of their value this year. The company recently hired restructuring advisers.

Asset-backed bonds of companies that go bankrupt typically avoid default, but their prices can fluctuate wildly. A bond backed by auto loans that Carvana issued for 100 cents on the dollar in September 2021 traded around 75 this month, according to data from Empirasign. Part of that decline also reflects the rise in overall interest rates.

For the shrinking pool of investors in the market, the yields have rarely been higher.

Subprime auto lender Flagship Credit Acceptance LLC did a roughly $400 million bond deal in late October. The riskiest chunk of its bonds, which had a double-B rating from some agencies, had a spread of 9 percentage points over going rates.

No comparable subprime auto bond had ever priced with such a wide spread since at least the last financial crisis, according to John Kerschner, U.S. head of securitized products at Janus Henderson Investors. Investors who bought the debt received a yield of over 13%, according to Finsight.

“It very much feels like you’re getting paid for the risk right now—and then some, quite frankly,” said Mr. Kerschner, who has been investing broadly in ABS.

Write to Matt Wirz at, Ben Eisen at and Tom McGinty at

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Donovan Larsen

Donovan is a columnist and associate editor at the Dark News. He has written on everything from the politics to diversity issues in the workplace.

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