Rising Interest Rates Put the Squeeze on Fintech Lenders

Rising interest rates have brought highflying consumer lenders back to earth.

Finance companies such as

Upstart Holdings Inc.

UPST -9.01%

and Mosaic lend money to people for purchases such as cars, solar panels and home electronics. But they have to borrow the money they lend out to consumers—and that is becoming increasingly expensive as the Federal Reserve continues to raise interest rates aggressively. 

As borrowing costs for the companies rise, bad loans are going up too. With red-hot inflation pushing up prices for food and rent, more customers are starting to fall behind on payments.

The lenders’ use of artificial intelligence to find and approve large numbers of borrowers quickly made them popular among stock and bond buyers when markets soared last year. Now they are falling out of favor.

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Investors have been selling out of asset-backed bonds issued by the finance companies, and some banks and credit unions have stopped buying the loans they make. That has pushed funding costs even higher. Shares of

Upstart

UPST -9.01%

and

Carvana Co.

, the online used-car dealer that also makes auto loans, are down nearly 80% this year. 

The financing squeeze is another example of how the Fed’s rate-hiking campaign is affecting all corners of the economy. While these lenders don’t have the size or name recognition of a

JPMorgan Chase & Co.

or a

Bank of America Corp.

, they are an important part of the consumer ecosystem, often lending to borrowers who might not qualify for loans from traditional lenders. Because they aren’t banks, they can’t fund themselves with deposits.

Tighter financing conditions forced the consumer-loan originator Upstart to slow lending in the second quarter, helping to push the company into a quarterly loss. Upstart plans to start using cash reserves to buy some of its own asset-backed bonds, company executives said on an earnings call last week.

“Our mission is to try and bring people who might not seem optically creditworthy through the traditional banking lens into the system,” Chief Financial Officer Sanjay Datta said in an interview. “We’re on a journey of convincing the markets that they can rely on our technology, and we are comfortable stepping in with our balance sheet to provide financing to do it.”

The company typically acts as an intermediary, identifying less-affluent borrowers through artificial intelligence and matching them with banks and credit unions for a fee. Upstart began parking some loans it made on its balance sheet early this year after banks reduced their buying, but reversed course when stock investors reacted poorly.

Upstart also arranges loans to be bundled into asset-backed bonds and sold to investors. But demand for the bonds has weakened, and the extra yield, or spread, that investors demand to buy them rather than U.S. Treasurys almost doubled since March to about 3 percentage points, according to the data provider Finsight.

Loans the company currently makes are projected to deliver investor returns of 11% compared with 7% before interest rates started rising, Mr. Datta said. Upstart says it beats competitors at finding borrowers with low credit scores who won’t default because its artificial intelligence includes nontraditional criteria such as education and employment histories.

Ashley Portillo, a 29-year-old human-resources manager in San Francisco, took out a $7,600 Upstart loan in September to repay defaulted family debts that had dragged her credit score down to about 500. Ms. Portillo used her annual bonus in April to pay off the new loan, which charged a 25.83% interest rate, and her credit score has jumped to more than 600, she said

“It was a very high interest rate…but I don’t have good credit, so there weren’t a lot of options,” said Ms. Portillo, whose parents immigrated to the U.S. from El Salvador. “At some point I’m going to want to own a house, and I want to get on a path to building my credit back up.”

Mosaic, which lends to homeowners buying solar panels, cut the interest rates on its loans in February to spur growth. It worked: Funded loans surged by about one-third this year to $8 billion. 

But the Fed started raising rates in March, and Mosaic has started ratcheting up its interest rates in recent months, said

Billy Parish,

the company’s founder.

“Everyone’s cost of borrowing has gone up, and everybody has increased rates,” Mr. Parish said. 

GoodLeap LLC, another solar-panel lender, issued its largest ever asset-backed bond this month, raising $493 million. The spread on the new bonds was about 18% higher than what GoodLeap paid for a similar deal earlier this year, according to Finsight.

Mosaic sold a $200 million minority stake in itself this summer to Affinity Partners, the private-equity firm launched by Jared Kushner, and the Swiss bank J. Safra Sarasin. Mosaic sold the shares at a lower price than they would have fetched last year, reflecting the broad stock selloff since then. Axios reported the deal in July.

“We’re growing rapidly, and in this market environment it’s good to be well-capitalized,” Mr. Parish said. “Growth-stage companies usually fail because they run out of cash.”

Carvana has had to pass along rising rates to its customers, sending down demand for the loans. Like Upstart, the company depends on asset-backed bonds and is grappling with rising costs in that market.

Carvana this month reported a second-quarter net loss. It also said it cut costs and would focus on selling loans individually rather than repackaging them into bonds. The company’s recently issued $3.275 billion bond traded up to 88 cents on the dollar this week from around 78 cents a month earlier, according to MarketAxess.

A Carvana spokeswoman said the second-quarter results “demonstrate the robustness of our business and the strength and flexibility of our customer lending program.”

Carvana’s share price skyrocketed in 2021, but less than a year later it dropped by 95%. WSJ’s Ben Foldy explains the factors that helped drive the online car dealer’s growth and why investors are now questioning its future. Illustration: Preston Jessee

Write to Matt Wirz at [email protected]

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