Pagaya Technologies Ltd. (PGY) Earnings Call Transcript & Summary

Good day, and welcome to the Pagaya First Quarter 2023 Earnings Call. Today's call is being recorded. At this time, I would like to turn the call over to Jency John, Head of Investor Relations. Please go ahead.

Thank you, and welcome to Pagaya's First Quarter 2023 Earnings Conference Call. Joining me today to talk about our business and results are Gal Krubiner, Chief Executive Officer of Pagaya; and Michael Kurlander, Chief Financial Officer. You can find the presentation that accompanies our prepared remarks, our earnings release and a replay of today's webcast on the Investor Relations section of our website at investor.pagaya.com. Our remarks today will include forward-looking statements that are based on our current expectations and forecasts and involve risks and uncertainties. These statements include, but are not limited to, our competitive advantages and strategy, macroeconomic conditions and outlook, future products and services and future business and financial performance. Our actual results may differ from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are described in today's press release and in our Form 20-F filed on April 20, 2023, as furnished with the U.S. Securities and Exchange Commission as well as our subsequent filings made with the SEC. Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. Additionally, non-GAAP financial measures will be discussed on the call. Reconciliations to the most directly comparable GAAP financial measures are available in the earnings release and in the appendix to the earnings presentation, which are posted on our Investor Relations website. With that, let me turn the call over to Gal.

Thank you, Jency. This quarter was another proof point of our ability to execute through volatility and progress on our long-term strategy. I will start with a performance update, then an overview of our plan to achieve our medium-term growth ambition. Before I pass it over to Mike to discuss this quarter's financial and outlook for the remainder of the year. Let me take you through the financial highlights for the quarter. We beat guidance on all of our key metrics this quarter: network volume, revenue and adjusted EBITDA. Where return to profitability on adjusted EBITDA basis is ahead of our outlook and are increasing our adjusted EBITDA guidance for the full year, reflecting our focus on driving sustainable profitable growth. Network volume in the quarter was $1.85 billion, 12% higher than last year. This drove total revenue and other income of $187 million, 9% higher than last year and adjusted EBITDA of $2 million. As a reminder, we closed our acquisition of Darwin in January, an investment we made to take our SFR platform to the next level. If we exclude the impact of Darwin, adjusted EBITDA would have been approximately $5 million, a like-for-like improvement of $14 million sequentially versus the fourth quarter of 2022. Now I will discuss operational highlights that drove these results. On the partner side, 20% of our network volume came from our partners and products that were onboarded in 2022. As our network grows, we see increased monetization opportunities with AI integration fees growing by 230 basis points from 5.5% to 7.8% of network volume. On the funding side, we were the top issuer of personal loan ABS in the U.S. in Q1, continuing that ranking from 2022 with over 30% share of market. We onboarded 2 major asset managers to our network and strengthened our relationship with some of our long-term funding investors such as GAC. Our funding capabilities remain robust as our AI technology enabled us to outperform the market. With these achievements in mind, we are confident we are well positioned for future growth. We remain focus on what we can control, although the timing and pace of our growth can be somewhat influenced by market conditions. Now stepping back for a second. We want to talk about Pagaya mission. Pagaya's mission is to empower our partners to deliver more financial opportunities to more people more often. We do this by leveraging AI technology and data science. We partner with financial institutions like Ally, SoFi and Klarna, who originate loans with our network. Institutional investors purchased these loans through our networks too. Today, over 1 million U.S. consumers currently have active loans that were originated with the Pagaya technology. We have a unique business model that we believe is inherently less volatile than other comparable fintechs in consumer lending space. On Slide 13 of our earnings presentations, we compelled Pagaya's volume and revenue versus the market benchmark, which shows that we have been able to deliver more consistent and stable performance over time. Looking ahead, our medium-term financial ambition is to reach $25 billion in network volume and $1 billion in fee revenue less production costs or FRLPC. We plan to do this by: one, bringing more value to existing partners; two, adding new partners, including large banks; and finally, by driving a 3% to 4% FRLPC margin. This brings us to what I believe is an inflection point in our company's journey. We already have the tools we need to reach our medium-term ambition. We have become meaningful contributors to the growth of some of our most mature partners. Looking at our top 3 personal loan partners, approximately 26% of the total origination volume are being created using our network. That compares to only 10% of their origination volumes in the first quarter of 2021. As our value grows, we see improving economics. AI integration fees, which are fees earned for the creation of assets on our network are growing, helping to offset the impact of financial market volatility. New partners and products such as Auto are also growing rapidly. Application volume for our Auto business grew by 51% year-over-year supported by increasing application flow of the large bank we onboarded in 2022. We grew network volume for that partner by 4x since its first quarter on our network with significant runway to scale further in the near future. The combination of increasing scale of mature partners and the addition of new partners and products has resulted in substantial growth over the past few years. 2022 network volume was nearly 5x larger than network volume in 2020. We have significant runway for future growth with our network as it stands today. We show an illustration of this on Slide 21 and 22. We believe we can reach our medium-term ambition of $25 billion (sic) [ $27 billion ] of network volume and $1 billion of FRLPC with just the existing partners and products on our network. Let me dive into this in a bit further. In 2022, we onboarded 6 new partners with an estimated combined annual origination volume of over $65 billion. We have already demonstrated that for some of our mature partners, we can drive growth equivalent to nearly 30% of the partner's total originations. If we assume that, we eventually reached 30% of 2022 origination volume for just the 6 partners we onboarded last year. This is an additional $20 billion of net worth volume. On top of the $7 billion we already delivered in 2022, gives us a total of around $27 billion in annual network volume. That assumes zero growth from other partners on our network and zero new partners. While we will, of course, continue to drive growth from existing partners and adding new ones, we have the ability to reach our financial goals even without doing so. If we apply our target FRLPC margin of 3% to 4% to the $27 billion of network volume, that translates to nearly $1 billion of FRLPC. Now let me discuss our focus on growing and diversifying our funding network. We offer institutional investors one-stop shop access to 5 different markets at scale with outperformance enabled by AI. We have raised over $16 billion in funding across all of our financial vehicles since 2020, and we have been able to do so consistently even in severe market dislocations. Our ABS, these are typically oversubscribed by 2x to 3x, enabling us to become the top personal loan ABS issuer in the U.S., reaching this rank in just 4 years. As our Auto business grows, we are increasing issuance to fund new partners origination. We issued $1.1 billion in 2022, ramping up to nearly $800 million in May 2023 year-to-date. Our investor base is growing. Our order book for our ABS vehicles has around 80 unique investors, and is becoming more diversified over time with a mix of large asset managers, sovereign wealth funds, hedge funds and insurance companies. We have seen a significant step-up over time in repeat investment from existing investors, as you can see on Slide 30, speaking to the strength of our performance track record. As we announced last month, we extended our funding relationship with GIC through 2028. We also welcomed new top-tier institutional investors to our funding network. As we announced yesterday, we are partnering with Angelo Gordon, Värde Partners and ATLAS to provide funding for a multibillion-dollar credit union. We believe that growing investor demand is a reflection of our ability to consistently deliver asset outperforming with AI technology. While application volume from partners tend to grow over time as our network expands, our conversion rate is our level to optimize as a performance as macro conditions evolve. Backed by AI-driven insights, we have been exercising underwriting prudent in the current environment, reducing our approval rate by nearly 50%, as you can see on Slide 32. As liquidity conditions will improve, we can dial the rate back up and increase network volume. In fact, if we applied our peak third quarter in 2021 conversion rate to full year 2022 application volume, network volume in 2022 would have been over $10 billion, doubled what it was in 2021. With a faster reaction time enabled by our AI, our personal loan portfolio has consistently outperformed the market benchmark. 30 days past due at months on book 3, for Q4 2022 vintages are 55% lower than Q4 2021 vintages, which were some of the worst-performing vintages market-wide. With recent vintages returning to Q1 2021 performance levels, we are comfortable with our target ROA range of 8% to 12% return. Before I turn things over to Mike, let me recap. I believe that our business is at inflection points. First, our network is expanding with significant runway ahead of us. As the network expands, our AI technology gets stronger with more training data points and increased model accuracy. As our data mode grows, we have an increasing ability to monetize our network. Increasing scale and monetization combined with a focus of operational efficiency, give us an achievable path forward to delivering sustainable, profitable growth. Let me pass it over to Mike to discuss this as well as our 2023 outlook in more detail.

Thanks, Gal. The inflection point Gal just spoke to is also starting to be reflected in our financial performance. We believe that the path forward to delivering sustainable profitability will primarily be a function of 3 factors: number one, significant runway for future growth, which Gal spoke to; number two, a resilient business model that enables consistent delivery of our targeted 3% to 4% FRLPC margin; and number three, a continued focus on operating efficiency. As a reminder, in 2022, we made significant discretionary investments, resulting in near breakeven adjusted EBITDA of negative $5 million. In the first quarter of 2023, we returned to positive adjusted EBITDA, excluding the impact of Darwin, a $14 million sequential improvement versus Q4 2022. Our Q1 2023 results reflected a focus on higher-margin generating volumes, further monetizing our network and executing on cost savings initiatives while also optimizing for asset returns as the market conditions remain volatile. Network volume grew by 12% year-over-year to $1.85 billion, primarily from the acceleration of new partnerships, balanced by continued low conversion rate of application volume. Total revenue and other income grew 9% to $187 million. Revenue from fees, which makes up 95% of total revenues, grew by 11% year-over-year. Our take rate defined as revenue from fees as a percentage of network volume remained stable versus the prior year at 9.5%. This reflects an evolving composition of our fee revenue, as you can see on Slides 40 and 41. While capital markets fees are lower in the current macro environment, we've increased AI integration fees and contract fees. We believe our ability to effectively hedge the impact of financial markets with multiple revenue streams speaks to the resiliency of our business model and the future potential to monetize the network as we grow. After factoring in production costs, our FRLPC margin declined to 2.7% in Q1. While this is below our target of 3% to 4% of network volume, we view this as a transitory period where capital market fees are pressured by current market conditions and AI integration fees are on the rise. We expect our FRLPC margin to increase above 3% in the second quarter and on a full year basis in 2023 as we realized a full quarter's impact of improving economics. Turning to operating expenses. Last quarter, we spoke about cost savings initiatives that we planned to implement in 2023 to deliver gross annualized savings of $50 million. We accelerated the bulk of those initiatives in Q1. Operating expenses, less stock-based compensation, depreciation and onetime expenses in the first quarter declined $10 million sequentially versus the fourth quarter of 2022, excluding the impact of our recent Darwin acquisition. Our operating expense ratio declined by 3 percentage points sequentially versus 4Q '22 to 29% of total revenue. GAAP net loss was $61 million, impacted by non-cash items such as share-based compensation and our election to a shift to available for sale accounting for our risk retention assets. GAAP net loss in the quarter reflected the cumulative impact of the shift. Adjusted net loss in the quarter was $11 million, excluding these items. In summary, let me reiterate that we remain committed to delivering sustainable profitability on an adjusted EBITDA basis. With another quarter of strong execution behind us, we are entering Q2 with significant momentum. As a result, we are raising our adjusted EBITDA guidance to now range between $15 million and $30 million on the year. Our outlook for second quarter and fiscal year '23 reflects a few factors. First, continued prudence in underwriting standards as the environment remains uncertain; second, delivering our target 3% to 4% FRLPC margin; and third, a continued focus on cost management. It's important to note, with limited visibility, we are not factoring in any material improvements in capital markets into our outlook. In the second quarter, we expect network volume to range between $1.8 billion and $1.9 billion. Total revenue and other income to range between $180 million and $190 million and adjusted EBITDA to range between $5 million and $10 million. For the full year 2023, we expect network volume to range between $7.5 billion and $8 billion. Total revenue and other income to range between $775 million and $825 million and adjusted EBITDA to range between $15 million and $30 million. With that, let me turn it back to the operator for Q&A.

Excuse me. We will now be conduct a question and answer session. [Operator Instructions] Our first question comes from Joseph Vafi with Canaccord.

Nice to see the progress in the business and nice to see the fine tune up on the EBITDA line. Just at a high level, maybe some of the top of the funnel metrics we could dive into. I know you disclosed a really nice increase in application volume in Auto, just wondering what you're seeing in some of the other verticals and related to that appetite from new lenders becoming partners? And then I have a follow-up.

Sure, Joe. It's Gal here. Thanks for the question. So as you pointed out, definitely Auto was the application that we grew the most, that then over 50%, because it's like very good partnership we landed. That's the part where we're growing the most. Second to that, I would say that we are seeing a strong demand for application from our existing partners continue to grow up, both on the personal loan and some other new partners, as you know, like Klarna and Auto, they just onboarded. I mean, working very diligently to increase the amount of application flow and to ramp up this type of partnership. From a new partner perspective, we do expect to have 1 or 2 more at the other half of the quarter, hopefully, big names that we've been working a lot on and will show the importance and the progress of the lending partners and such. From the way we think about conversion of these things, obviously, it's important to say that we are staying very prudent in this environment, and we are shifting to more resilience borrowers, conversion rate and taking down 50% from 3Q '21. And that actually means 2 things. It means that like we have already embedded growth in our systems, lenders, et cetera, that as soon as the environment improves, we can tweak in that up and create a lot of growth based on what we have already. And the other piece is, in these days, it's bringing us better quality of volumes, that are actually having higher FICO, higher income, because of other funding partners are closing their credit box more and more. And maybe the last point to add, just like on the funding side of that, which is another top of the funnel metric, we have raised over $2.5 billion today to support that growth.

Great. And then maybe 1 on conversion rate. I know it's down as you're remaining prudent and cautious on underwriting, but it looks like it's kind of stabilized here for a couple of quarters. How should we feel about that conversion rate trajectory? Or basically, do you think we're at the bottom of where conversion rate is? Or would there be something that would take it lower other than perhaps another macro leg downturn?

I think you are on point. We are in the field today that we have bottomed out, like we're up to the bottom from a conversion perspective. I will say that these things are coming from where we see the funding costs and where we see the ROA of the assets that we are producing. From an ROA perspective, we believe that we are in the 8% to 12%, which is our target and therefore, we don't need to reduce the conversion rate further. I think the next thing you will see in the coming quarter is the conversion will start to go up. It's how to predict exactly when and how, but definitely the trend, the day of action is for that. And that's what we believe is the power of the situation were outstanding and honestly by the inflection point of Pagaya from that perspective.

Our next question comes from Michael Legg with Benchmark.

Just kind of want to follow up on Joe's question on the verticals. Can you talk a little bit more about the geographic dispersion of where you're seeing straight weakness throughout the different regions a little bit?

Sure. So from regions perspective, it's rather diversified across the U.S. So like the big states, such as the California, Texas, et cetera, you will assume they are higher percentage. But if you do it by population, it's kind of like more or less the same.

Okay. Great. And then just a follow-up. You mentioned AI integration fees growing up. Can you talk about how you're able to pass those through?

Thanks for the question, Michael. It's Mike. Absolutely, we see in these times, the value proposition of Pagaya is really enabling our partners to continue to grow. And as Gal touched on, in this environment, you see credit tightening, you see funding more scarce. And in that sort of environment, we're able to help our partners grow using the Pagaya network. And as we do that, we've been able to -- it's part of that value proposition, increase fees. And so as our partners win, we've been winning alongside and that's allowed us to grow our integration fees by approximately 230 basis points over last year.

And just following on that, does that mean that you have a host of people who want to use your API and that your -- by increasing the cost that's almost limiting the expansion in the near term just based upon availability or your capacity, I should say?

Yes, I think, this is Gal again. I think that Michael, if you think about API in economics and environments like that, you are prioritizing places where you have a higher margin or higher fees. And as the environment and the market is becoming more stable, you will move more to grow even in the lower margin type of products, and you would be less prudent on that side, too. So I think that you can think about it that notice, it make it slower of growth in that environment, and that's part of the way it's influencing us. But as we move to a positive EBITDA being stronger in the fundamentals of the business as such, and then as these things will move on, we'll continue to grow because we have all the fundamentals to be able to do so.

Great. Congratulations on a great quarter.

Our next question comes from Moshe Orenbuch with Credit Suisse.

Gal and Mike, great quarter. Maybe following up on that a little bit. I think Pagaya had some unique advantages during that difficult funding environment because you kind of prefunded and you were able to sort of get compensated for that. Could you talk a little bit about how you -- if the financial markets normalize, how do you kind of protect the advantage that you were able to get in this environment?

Definitely. And Moshe, nice to hear you, and thanks a lot for the question. So it may be a little bit less intuitive. But like in times like that, as you mentioned, our value proposition actually becoming more apparent. So let me talk about it both on the partner side, as you mentioned, and on the funding side. So for the first side, the partner side, like we are a real part of the ability to fund it. And we're enjoying doing that. This is our duty. That's why we are here to support our partner to be able to bring more credit to our consumers. And you see that in a few places in the presentation that our wallet share, so to speak, with many of our partners is increasing as the day goes by, especially in these environments. On the funding side, it's -- and for that, like it obviously creates for us a lower cyclicality volatility versus others because we are becoming a bigger part of that lending ecosystem in these days. So like in normal days, the environment is growing, and we are keeping our fair share. But in days maybe that the environment maybe is not growing, but we are increasing our session. And that is a little bit of the less volatility more consistently that we are speaking. And historically, we sell with a positive volatile market, partner very much appreciate the stability. They rate for them top #1, kind of like metric in the stability of the network and in strengthening their value proposition, their ability to bid for the consumers and therefore, increasing our value proposition with them. So I think that the stability is something that like the partners very much appreciated, and we are working day in, day out to make sure what we are going to be for that through the time, and as such, getting compensated to that and rewarded. On the funding side, in days like that, investors want to be more prudent. They want a high-quality source of assets that is coming with a very strong underwriting capabilities. And again to that, just yesterday, we announced a very unique partnership that we need together with Angelo Gordon and Värde to be able to foresee the things, some kind of a portion of the portfolio, sellout through a credit union, through our technology. So being there next to our funders, next to our funding partners and to be able to foresee the things and use the network AI capabilities in order to issue to make sure that performance is going to be in line anytime is the thing that we are flipping and making sure we're doing in this environment. And as I said about the [indiscernible] that goes a long way and becoming a strong relationships that are able to stay out of the market situations and are the basic building of our ability to deliver the future growth in the $27 billion [indiscernible].

Great. And maybe as a follow-up, the idea of being able to charge AI fees versus capital markets fees. I would imagine it's generally when the capital markets environments were more robust, it was easier for your customers to pay you in those capital markets fees. But can you just talk a little bit about how you see that mix evolving over time?

Sure. Yes, Mike, do you want to take it?

Absolutely. Really, I think good demonstration of the resiliency of the business model because there's actually a slide, I think it's 41 in the deck that shows this [indiscernible] different range. You've got those 2 different types of fees that you refer to. On the capital market side, you've seen the trend actually decrease as market liquidity has dried up overall. And we actually think that's now really hitting a bottoming out point. And on the other side, you've got the AI integration fees, which is everything Gal just spoke to around the value add from a partner perspective and from overall ability to grow. And so those 2 things will ebb and flow depending on the overall market, our goal is to deliver consistent results of FRLPC in the 3% to 4%. And we think we can get there through multiple ways, which is a unique structure of our business model that's resilient.