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

Ladies and gentlemen, greetings, and welcome to the Pagaya Technologies Fourth Quarter and Full Year 2024 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Josh Fagen, Head of Investor Relations. Please go ahead.

Thank you, and welcome to Pagaya's Fourth Quarter and Full Year 2024 Earnings Conference Call. Joining me today to talk about our business and results are Gal Krubiner, Chief Executive Officer of Pagaya; Sanjiv Das, President; and Evangelos Perros, Chief Financial Officer. You could find the materials that accompany our prepared remarks 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 with respect to, among other things, our operations and financial performance, including our financial outlook for the first quarter and full year of 2025. Our actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially from our expectations include, but are not limited to, those risks described in today's press release and our filings with the U.S. Securities and Exchange Commission. We undertake no obligation to update any forward-looking statements as a result of new information or future events. Please refer to the documents we file from time to time with the SEC, including our 10-K, 10-Q, and other reports for a more detailed discussion of these factors. Additionally, non-GAAP financial measures, including adjusted EBITDA, adjusted EBITDA margin, adjusted net income, fee revenue less production costs or FRLPC. FRLPC as a percent of network volume and core operating expenses will be discussed on the call. Reconciliations to the most directly comparable GAAP financial measures are available to the extent available without unreasonable efforts in our earnings release and other materials, which are posted to our Investor Relations website. We encourage you to review the shareholder letter, which was furnished with the SEC on Form 8-K today for detailed commentary on our business and performance in conjunction with the accompanying earnings supplement and press release. With that, let me turn the call over to Gal.

Thank you for joining us today for a discussion of our Fourth Quarter and Full Year 2024 results as well as an update on our business as we enter 2025 on the strongest overall footing in our company's history. You will see from our press release this morning that we closed out 2024 with an annual revenue of more than $1 billion, up 27% year-over-year, FRLPC of $407 million, up 54% year-over-year and adjusted EBITDA of $210 million, up 156% year-over-year. All of our key reported metrics were at record levels and beat our prior guidance. As we close out 2024 and as part of our regular quarterly process, we have updated the fair market values for our risk retention securities tied to 2021, 2022, and 2023 loan vintages. We noted during the third quarter 2024 earnings that we expected to have taken the vast majority of expected impairment charges associated with our 2022 vintages, along with prior vintages by year-end 2024. The 2023 risk retention securities, which totaled at $275 million at the end of the third quarter were marked down by $145 million this quarter, which impacted our P&L. Even with the vast improvement in credit performance, the values of these securities, as mentioned in the past, were extremely sensitive to even small changes in underlying credit and prepayment assumptions because of the challenging funding environment that existed during 2023. We believe that we are now poised to generate consistent growth going forward that is profitable. And as such, we are providing our first-ever GAAP net income profit guidance as part of our 2025 outlook. It will provide more detail on our financial results later in the call. I want to take a step back and revisit where Pagaya is in its evolution, while it sets our product and company apart and underscore the value that we bring across our network, our ecosystem, and to our shareholders. We created Pagaya to enable lenders to provide more credit products and services to more customers, customers who have traditionally been excluded from the financial ecosystem. These are good borrowers, hard-working mainstream Americans. And the country's biggest lenders are increasingly leveraging Pagaya's differentiated product value proposition to do exactly that, offering more credit products and services to more customers. And when they do, they retain and add more customers and more valuable depositor accounts, they maintain and enhance customer lifetime value, and they boost return on marketing spend, all without bearing the balance sheet costs. Recently, several lending partners have expanded the use of our unique solution to further engage existing customers to boost cross-sell and further solidify relationships. As important as the unique value proposition our product offer is the deep level of integration within our partners' internal lending funnel. This enables Pagaya to seamlessly add and service customers on behalf of these lending partners. The best evidence of our solution is the industry demand and usage, with over $2.6 trillion of loan applications running through across our network, resulting in $28 billion of loans originated and provided to 2 million people. To put things in perspective, that's nearly 1% of all adult Americans. With this demand and success, the flywheel is only getting stronger. Each application across our network provides Pagaya with more valuable data, which is used to make our underwriting technology even stronger. This, in return, enhances the value we provide to our partners, and when our partners thrive, Pagaya thrives. The timing has never been better for Pagaya to help our 31 lending partners in this fast-changing environment. Momentum on the funding side of our network is just as robust and truly underscores the support from several of the largest institutional investors in the financial investment world. Look no further than our recently announced forward flow agreement with funds managed by Blue Owl Capital to purchase up to $2.4 billion in consumer loans through the Pagaya network over 24 months. This is the second large forward flow agreement announced in just less than 6 months, a testament to the demand for the high-quality consumer loans originated on our network. In addition to that, we have raised $27 billion in our ABS program across 66 transactions with over 130 institutional funding partners. We closed our sixth AAA-rated ABS transaction in the fourth quarter and executed our third pass-through securitization of the year in December for $100 million. We expect that all of our funding programs will continue to experience strong, growing, and oversubscribed demand as Pagaya becomes a one-stop shop for big institutional investors looking to get exposure to the space in the form of personal loans, auto loans, or point-of-sale loans. Our current management team is highly experienced, having navigated challenging credit businesses through various cycles. This management's job has been to drive the maturity of our operating model and financial structure to amplify and maximize the value we can provide not only to our partners but to our shareholders as well. Over the last year, we have built the strongest and most efficient funding mechanism in Pagaya's history. We have restructured our balance sheet, enhanced our liquidity profile, and that means we are now fully self-funded. Investors may wonder if we need to raise equity capital to support the business given the quarter's outsized GAAP net loss. The answer is simple: no. We do not expect to need any equity capital moving forward. Our certainty is derived from the optimizations our team achieved on our funding and operating model in 2024. We worked tirelessly to increase our net fees, reflected in FRLPC, by 55% year-over-year to 4.5% of our volume, while at the same time reducing our net cash requirement to fund our volume from 3% to almost 1.5%. Along with high-quality liquid securities on our balance sheet, this paves the way to positive cash flow, eliminating any need for an equity raise. We believe that we now have the operational and financial momentum, balance sheet strength, maturity, and deep institutional credit skills to manage through various environments. We expect that our growth will be disciplined. While credit impairment will always be part of any credit-related business, for Pagaya, its impact is expected to be far smaller. This is reflected in our inaugural GAAP net income guidance, which we will discuss later in the call. We are entering 2025 at a pivotal point, where we believe that we have achieved the scale, operating, and structural efficiency to be GAAP net income positive by the second quarter of 2025. In closing, I could not be more excited standing here today in front of you, ahead of what Pagaya will deliver to the investment community and partners throughout this year and going forward. This inflection point is an important one. We will continue our mission to boost financial inclusion, bridge Main Street and Wall Street, and at the same time, showcase our ability to generate powerful and consistent EPS growth for our shareholders. We look forward to demonstrating the benefits of all of our hard work and investment to maximize the value of one of the country's most unique and in-demand lending networks. With that, let me turn the call over to our President, Sanjiv Das, to provide an update on our product and growth strategy.

Thank you, Gal. I'd like to start where Gal left off by reiterating that we believe our business is now the strongest it has ever been. Our solutions have never been as in demand as they are currently, and our business has never been as well-positioned to service that demand while sustainably maximizing the impact for our shareholders. In terms of our lending partners, growth from existing partners and our new partner pipeline remain extremely robust. We expect that we will continue to boost monetization among leading institutional partners, adding new products to better penetrate their existing customer bases while seeing the ramp from more recently added relationships. In fact, we anticipate at least 8 lending partners will each generate $500 million or more of network volume during 2025. I want to take a moment to review our momentum across our 3 core products: personal loans, auto and point-of-sale loans. These 3 product lines are at different stages of maturity and monetization within our business, which drives a mix of strong, stable growth from longer-standing products along with more rapid growth trends from newer products, fueling consistent long-term growth from both volume and monetization. Starting with our most mature product, personal loans, partner demand remains robust as we look into 2025. Growth here is disciplined as we continue to see strong and stable consumer performance among loan vintages that have seasoned over the last 12 to 18 months. In terms of monetization, personal loan FRLPC is robust at 6.3% versus 4.5% overall. Despite the relative maturity of this product on our network, volumes this quarter grew by 24% on an organic basis to $1.6 billion. Turning to auto lending. Here too, we are focusing on disciplined and judicious growth as we ramp back up to leverage improving sector trends. Here, too, we have seen strong and stable credit performance with 2023 vintages markedly better than 2022 peaks. EP will discuss these trends in detail later in the call. After an uncertain macroeconomic backdrop, we focused our efforts during 2024 on improved credit underwriting and are positioned to benefit from substantially improving funding efficiency and notable improvement in returns and margins. We completed the onboarding of OneMain Financial and expect to start generating more volume from recently onboarded partners. Our year-end auto volume annualized run rate was nearly $1 billion with fourth quarter sequential growth of just under 40%. Our POS product, the newest and fastest-growing vertical, is set to be the most powerful contributor to medium-term growth, leveraging very strong demand for our product. Here, we are pushing forward with existing partners, Klarna and U.S. Banks Elavon, while discussions continue with many major center banks and global payment brands. Already, we are seeing robust growth in this vertical with over 170% sequential growth in our POS volumes in fourth quarter. Our year-end exit rate represents a run rate of more than $1 billion in network volume with strong returns. Turning to our new partner pipeline. Demand remains extremely robust. Among our potential new partners, I'd like to highlight several late-stage discussions among U.S. regional banking institutions and look forward to sharing more progress through 2025. As we gain more traction with new and existing partners, we have evolved our product strategy to help partners serve their customers' needs outside of the second look product. Our prescreen product, for instance, which is in testing with 3 existing partners, has enabled lenders to drive engagement with substantially lower customer acquisition costs, and we believe that over time, will drive increased conversion. As a reminder, the Prescreen product is truly innovative. It leverages our access to lending partners' customer data, combined with our own data to provide recommendations for additional lending products to customers who deserve them and who would benefit from them. By helping our partners to offer additional products and opportunities to engage with qualified customers, the Prescreen product enables our partners to drive further growth without additional marketing costs, not only boosting return on investment but retention. We look to scale this product further through 2025. We are also focused on helping our partners leverage customer acquisition products across asset classes outside their traditional channels. For instance, we are testing affiliate expansion with several existing partners and see promising customer acquisition trends, which is another avenue to help our partners drive customer and revenue growth, engagement and returns on investment. We believe that the best way we can measure the value we provide our partners is through the FRLPC we generate on network volume. After all, as our partners benefit, so do we. In fact, our FRLPC grew by 55% in the fourth quarter of 2024, resulting in a record 4.5% of network volumes, the top of our guidance range. Our quarterly application volume of $197 billion helps illustrate our deep integration across many large lending institutions. And the fact that we have funded under 1% of those loans speaks to our extremely prudent underwriting standards. As I turn over to EP to discuss our financials in more detail, I want to leave you with the understanding that we expect our growth will be as balanced and disciplined as ever. We have extremely robust demand trends from both new and existing partners and opportunities to expand the ways in which we help them engage and monetize their customers across their enterprise offerings. With that, I will now pass it over to EP.

Thank you, Sanjeev. 2024 was a solid year for Pagaya from a financial perspective as we turn the corner to a new chapter in our company's history. In the beginning of 2024, we set out 2 aspirational goals: to become cash flow positive and to set ourselves up to become GAAP net income positive in 2025. And while the journey to get there has been very challenging, the team readily embraced it and successfully executed towards achieving these goals. We are ready to leverage all of the hard work, tough decisions, instructive learnings from our disappointing past performance, and deep management experience to truly demonstrate the earnings power of our business in 2025 and beyond. Throughout 2024, we are enlightened by our experience dealing with legacy issues and the adverse impact from our 2021 to 2023 performance but still remain laser-focused on building a disruptive business that can withstand all cycles and create long-term shareholder value. Pagaya has been tested as has our sector, U.S. consumers, and our lending partners, and we have persevered and emerged from a series of macro and other factors with a strong fee-generating engine, improved capital structure and liquidity profile, and significant operating leverage. I'm very pleased to be here today and provide our inaugural launch of positive GAAP profitability guidance, which we expect in the second quarter of this year while executing a business plan that is self-funded. This is no small fit for a company of our size and short history. Our results for the fourth quarter were better than our guidance, demonstrating strong monetization of robust network volume and continued operating leverage, leading to 88% EBITDA growth. We are publicly guiding to GAAP net income profitability for the first time, which I will discuss in more detail later. Before turning to detailed results, I'd like to highlight several achievements, which reflect the consistent execution of our financial strategy. FRNPC as a percent of volume at a record 4.5% increased 25 basis points quarter-over-quarter and 130 basis points year-over-year, the truest measure of the value we provide to our network partners. Core operating expenses were 49% of our FRLPC, the lowest in our public history, a testament to the operating leverage in our model and the trend that will persist going forward. Our funding program has been further optimized with diverse funding sources such as the recent forward flow from Blue Owl and improvement within our ABS program. Net cash required to fund our volume has declined from 2% to 3% for personal loans and 1.5% to 2.5% for our network volume. This is a step function improvement in our risk exposure in absolute terms as well as cash flow characteristics. Our interest expense and access to liquidity have improved meaningfully as we completed our previously announced balance sheet restructuring and refinancing. Lastly and importantly, we no longer expect to face material headwinds to profitability from securities on our balance sheet associated with 2021 through 2023 vintages. This allows us to demonstrate the true earnings power of our operating model as stable recurring growth in revenue is expected to drive profitability. Turning to network volume. We saw 9% growth in the fourth quarter to $2.6 billion, of which we funded under 1% of the flow through our network, relatively in line with the trend over the last several quarters. Part of the increase was attributable to CRM and higher-than-expected conversion versus what we expected with our previous guidance. Personal loans remain the largest contributor to the volume, up 24% year-over-year organically at approximately 60% of the total. Total revenue and other income of $279 million grew by 28% from the year-ago quarter with fee revenue up 31%, primarily due to personal loans. FRLPC grew 55% to a record $117 million in the quarter and was a record 4.5% of network volume. This was at the high end of the 3.5% to 4.5% range we provided for the second half of 2024 and was up 130 basis points from the year-ago quarter. Once again, lending product fees made up the majority or 71% of total FRLPC, up from 63% 1 year ago and 32% 2 years ago. This is an important and purposeful shift towards more sustainable and predictable revenue growth through the cycle. Our adjusted EBITDA grew 88% year-over-year to a record $64 million, with margins up 730 basis points to 23%. Incremental margins of 49% in the quarter reflected strong operating leverage, a trend we expect to continue going forward. Net income attributable to Pagaya was a loss of $238 million and was primarily impacted by fair value adjustments, a risk that we had highlighted during our third-quarter earnings. The losses ended up higher than we expected. Overall, fair value adjustments net in our overall portfolio were a loss of $156 million versus $101 million in the prior quarter. Approximately 90% was attributable to 2023 vintages. In addition, previously recorded market-driven losses of $79 million in other comprehensive income on our balance sheet were reversed and reported as other expenses net on our P&L. This reversal is attributable to our fair value estimate, assuming we will exercise our optional redemption rights on several of our investments as the most likely scenario compares with prior estimates. We believe we have taken the majority of our losses related to historical vintages in the last quarter, and we do not expect them to have a material impact, if any, to our performance in the future. I want to highlight a few things and emphasize what I mentioned before. Losses in any consumer lending business are to be expected, but the outcome of our execution over the challenging 2021 to 2023 period is still deeply disappointing. Throughout 2024, we have taken significant actions to effectively navigate similar outcomes in the future. Select examples include our scale and expanded flow access, improved credit underwriting and risk management overlay, funding optimization and diversification, and cost of capital improvement, all of which have been validated by third parties such as rating agencies, corporate funding partners, and institutional investors looking to gain access to our production. Cost of capital improvement, all of which have been validated by third parties such as rating agencies, corporate funding partners, and institutional investors looking to gain access to our production. In addition, introducing GAP net income guidance is one step towards driving visibility and accountability. Continuing with our results, interest expense was $26 million in the quarter while share-based compensation expense of $16 million was toward the lower end of our expected range of $15 million to $20 million per quarter. Adjusted net income was positive for the sixth consecutive quarter at $13 million, excluding share-based compensation and other non-cash items such as fair value adjustments. Our credit performance remains strong with continued improvement over the past 2 years driven by enhancement of our underwriting models. Our personal loan cumulative net losses for first- and third-quarter 2023 vintages are 20 to 35% lower than peak losses in late 2021 at the same month on book. Other cumulative net losses for first- and third-quarter 2023 vintages are trending approximately 30 to 50% lower than peak 2022 vintages at the same month on book. Turning to funding, the team has driven meaningful improvements in diversification and efficiency of our funding channels. In our APS program, as of the end of 2024, we have issued $26 billion across 64 transactions with more than 130 partners, including our 6th AAA-rated transaction, which closed in the fourth quarter. We expect net risk retention levels in our personal loan paid APS program to remain in the 4 to 5% range of notional size of the deals. Last week, we announced our second large forward flow agreement with funds managed by Blue Owl Capital to purchase up to $2.4 billion in consumer loans through the Pagaya network over a 24-month period. This is a clear testament to the attractiveness and demand of consumer credit originated across Pagaya's platform and our focus on funding loan origination in a capital-efficient manner. We have further diversified on the back of our third partial securitization of the year in December for $100 million. As a reminder, partial transactions not only help to diversify our funding sources, but the net risk retention requirement is at a minimum 1 percent of the notional size of the deal. We will continue to leverage strong demand from investors for this product. We currently expect all non-AVS funding channels to represent 25 to 50% of our 2025 funding sources. This will lead to continued reduction in required risk retention, and we will continue to consider holding more securities when and if it makes economic sense. Before turning to guidance, I want to review our balance sheet and provide more details on fair value adjustments for the quarter. We ended the year with $227 million in cash and cash equivalents and $764 million in investments in loan and securities. In the fourth quarter, the fair value of the overall investment portfolio net of non-controlling interest and prior to any new additions in the quarter was adjusted downward by $156 million versus $101 million last quarter. 90% of those adjustments were driven by the 2023 vintages as a result of the meaningfully higher cost of capital at which these transactions were executed, leaving minimal to no cushion against changes in initial loss assumptions, which still ended up being higher than expected at the time of pricing. Additionally, we reversed the previous loss of $79 million in other comprehensive income in our shareholders' equity, which was a reclassification to other expense, as I explained earlier. Our 2025 guidance, which includes positive gap profitability in 2025, reflects multiple illustrative scenarios related to future impairments, if any, as laid out in our earnings supplement. In the fourth quarter, we also added $17 million of new investments in loan and securities, net of paydowns from prior investments, inclusive of an $8 million gain on sale. As of year-end, the mix of our investments was 31% notes and 68 percent certificates versus 13% notes and 87% certificates a year ago. The improvement in mix and quality of our assets is an additional source of potential liquidity for Pagaya as we head into 2025. Turning to our outlook, our full year 2025 and Q1 2025 outlook reflect the current momentum and resilience in our business, and while we see improvement in the macro environment, we remain cautious. The focus remains on profitable growth, and we expect to generate positive gap net income profitability in the second quarter of the year. We expect continued growth across personal loan, auto and POS products, while FRLPC reflects the full year impact of the improvement in fees in 2024 and the change in funding mix. Given the investments to date in operating efficiencies, we do not expect any material investment in the business in 2025. GAP net income profitability will be driven by these factors along with lower fair value adjustments, if any, as well as lower interest expense, all the results of our relentless execution in 2024 to get the company to be cash low and gap net income positive. For the first quarter of 2025, we expect net worth volume in the range of 2.5 to 2.7 billion. Total revenue and other income in the range of 280 to 295 million, and adjusted EBITDA in the range of 65 to 75 million. We expect first quarter GAP net income in the range of negative 20 million to break even. For the full year, we expect net worth volume in the range of 10.25 to 11.75 billion. Total revenue and other income of 1.15 to 1.275 billion, and adjusted EBITDA in the range of 265 to 315 million. We are guiding to GAP net income for the year in the range of negative 10 million to positive 40 million. With that, let me turn it back to the operator for Q&A.

[Operator Instructions] The first question comes from the line of John Hecht from Jefferies.

I guess my question is, you've given us some details around the fair value marks in the quarter. The marks were a little bit bigger than prior quarters. Maybe can you give us a little bit more detail on kind of what framework you use to make the fair value marks? What's baked into them now? And what gives you confidence that there won't be ongoing fair value marks as we go through 2025?

Sure, John. It's Gal here. Thank you so much. So I will take the first piece, and then we'll hand it over to EP to speak more specific about the framework and where the loss is coming from and Sanjiv to speak about what it means for the business. So first, let me say that. As we think about the impairment, and as you mentioned out, the last 3 quarters were an outsized losses versus what we used to have in the past and what we expect to have in the future. Most of them are the things that are driving for 2023. If you recall, in our last earnings call that we stood here in November, we actually said that we are going to have another quarter of losses coming through. Most of the losses, and it will speak specific numbers are related to the 2023 vintages that throughout the year got seasoned and therefore, versus where they are marked on the balance sheet, where the actual data coming in took the fair market value hit. And all of that in 2023 was because the funding conditions were so challenging that in order to support the network, the funds and the investors, et cetera, we needed to put up these things that we knew could have some potential losses in the form of the level of sensitivity to it. But really, the bigger question that you're asking is, how should we feel comfortable that this will not be happening again. So first and foremost, let me share that the guidance that we provided for 2025 is including any potential credit-related impairments. We have built in the last 2, 3 quarters a very robust infrastructure and capabilities to be much more predictive about this type of outcome as it relates to the losses and the different parts. And if you remember, we repeatedly said that as we think about the 2024 deals and transactions that we have on the balance sheet because of the different environment that were produced in, plus how we know the performance of the credit is performing and it's performing well we are in the very strong belief, and we have the visibility to know that a meaningful or a magnitude like that of losses is out of the question. That comes to the last piece, which is when we are thinking and speaking about the 2024 trends and where we are standing today as the business and what the business is underwriting today is a very strong production that is consistent both on the credit on the income side, but a lower cost of capital and a better structures on the other side that is translated into normal future losses meaningful on the 2024 and the future. And when we did the full fair market value as in our regular process to bring this down, the prior '24 vintages should not have any material drag on our performance. And hence, we are today having the ability to provide a GAAP net income guidance inclusive of any potential credit-related impairments. I will hand it over now to EP to speak a little bit more about the specific of the numbers and the things behind, and then Sanjiv will close it out with the understanding of the business impact.

Thanks, Gal. John, thank you for your question. Just wanted to give a little bit more context as well, a little bit more details and more importantly, highlight what we have done to mitigate such outcomes in the future. In the last quarter, we did highlight that we expected more losses on the 2023 vintages where were the challenging vintages. We had indicated that we had a mark on those of $275 million, and we did take a $144 million impairment against those this quarter out of the total of $156 million. Overall, credit-related impairments were at $229 million net of noncontrolling interest, which included a $79 million reversal of previously accumulated losses on our balance sheet that were moved into other expense. 90% of those losses I pointed out are driven by the 2023 and the rest from the '21 and '22 vintages. As a reminder, these were executed during very challenging funding environment where the cost of capital was higher than the actual expected return. So even small changes in credit was exposing us to potentially large losses. I still want to highlight that despite that, the credit performance of the 2023 vintages are significantly better and improved relative to the '21 and '22 peaks in the range of 20% to 50% relative to those, and you can see a lot more of that detail in our supplement. And the second piece I want to highlight is that based on what the market we currently have on the 2023 and the prior vintages, we do not expect any material impact on our performance relative to those vintages. All of us giving us confidence [indiscernible]. We are providing more visibility in our supplement on what we are assuming in terms of potential impairments, if any, for 2025. In our supplement, I encourage you to look at that for more details. Now to your question around the approach on the valuation for those. As you know, fair value is effectively based on a range of all different relevant assumptions that drive the changes in projected cash flows. These securities are now seasoned -- if you think about the 2023, right, they're seasoned 12 to 18 months now approximately, which is basically the point where we can really start being predictive about end state losses and assumptions that we have to make 3 to 4 years out. So while we had some trends from the earlier vintages in 2023, we did warn about this in 3Q, but we had to go through the full process and get significant more data at the end of the year to conduct the full testing assessment. What's more important, I think, is here to highlight the actions that we have taken to basically mitigate similar outcomes in the future. And those are driven by 3 things: the optimization of our ABS structures, the diversification of our funding sources and obviously, some improvement in the macro environment. On the ABS structure, the structural improvements that we have validated by AAA rating in our PL portfolio and AA in our auto, all of that has lowered the cost of capital, and that's a permanent improvement in these structures. In addition, 25% to 50% of our funding is expected to come by non-ABS vehicles and therefore, that require basically no capital to be put at risk. All of that lowers the absolute amount of capital that we put to use to fund our volume, which is significantly lower than it would have been relative to the 2023. And obviously, the macro environment has improved, has been a tailwind, even though we do remain cautious about that. And interest rates are still at a very high level relative to historical levels. But all of that allows us to have a buffer in terms of the cost of capital that we're currently seeing relative to the expected return of the assets. All of that gives us very strong confidence, and this is why we're here today guiding to positive GAAP net income as it relates to our 2025 performance. I will pass it over to Sanjiv for maybe some additional remarks.

Yes. I mean, basically, AP and, just to close it out briefly, but very importantly, the way I think about this, John, is the benefits of having leaned in to grow and develop a really solid operating business through a challenging funding period are quite clear. We see that we stood by our lending and our funding partners through the cycle with very good returns. We've now grown our FRLPC to very, very strong levels, as you saw at 4.3%. We gained our AAA rating through this process. Significantly improved our ABS structure. We've strengthened the pipeline of potential partners. You've heard about U.S. Bank, [ Lara ], OneMain. All of this was done as a result of leaning in, entered new asset classes with significant payoff like POS, as we noted last quarter and this quarter. And finally, diversified our funding sources beyond ABS to forward flows and pass-throughs with huge institutional partners on both sides in Blue Owl and Castlelake. And of course, net-net, what this has done to the operating business that we are generating today is very strong. And so now we are able to focus on growing it through '25 and '26.

The next question comes from the line of David Scharf from Citizens JMP.

Obviously, demand in the pipeline remains very strong. So I'll just follow up with a couple of follow-on credit questions. First is, I guess, for EP, I just want to make sure I understand the guidance correctly because I'm looking at the slide that has the -- Slide 21, which has the scenarios about write-downs and impairments in the loan portfolio. It looks like scenario A is sort of driving your guidance. Am I led to believe that if expected cash flows actually perform in line with your forecast, that you're -- that we'll have $100 million to $150 million more pretax income and then tax affected for GAAP. Is that how we're supposed to interpret Slide 21 that -- inherent in the GAAP guidance is some very conservative assumptions around expected cash flows?

Thank you for the question. No, I think let me provide more clarity. If we expected any more losses on our existing portfolio, we would have obviously taken that. So the base case is what drives effectively our expectation for 2024. What we are doing is in our guidance together with everything else. We're just using that scenario A, which provides an additional $100 million to $150 million potential impairment, if any, and that's what's basically driving our guidance. And that's -- just to be clear, it's on the full year guidance for 2025, not 2Q.

The next question comes from the line of Sanjay Sakhrani from KBW.

This is actually Steven Clark filling in for Sanjay. I just wanted to follow up around the network volume growth. It seems like there's a pretty wide range across what you're guiding to for 2025. Could you just talk about what the current operating environment looks like? And what are the factors that we should consider in terms of how you get to either end of the range?

Sure. So I think, I would like to take your question to a little bit of a bigger question, I think that will frame exactly what you're trying to ask. I think the question is how are we thinking about growth, and there is a very important piece that led me to that, that is actually building the budget or the guidance as you see now, and giving us the north star of what we're solving for over the cycle. So the long story short of it is that we perceive ourselves as a network. When you perceive yourself as a network and not an originator, what we're actually providing or the way we grow is either to get more customers, our lending partners, or to sell to our lending partners more products, such as the pre-stream that Sanjiv has shared over the phone call and there are many more. When you take these top of the funnel type of growth activities, which are not driven by changes so much in macro, we are trying to build an over the cycle business that would provide products and services that are relevant to lenders in any environment. And that, we think about it as a steady state of growth of a 20% caregiver over the cycle regardless of the different pieces and will not bore you on this phone call, but there are many other factors that in different environments are balancing themselves out to make sure that only the relevant piece is the increase of the top of the funnel, which is how much we are solving for our partners and the different products to our partners. Inside of that, the levers of the way you can think about it, or the pulls and the push, are how good our models are and therefore we are collecting them, how good are the products and how much we can sell of them, how good the team is executing into getting more partners, how cheap our cost of capital is so we can actually later sell the loans in a more profitable way or in the same time could approve more loans because our cost of capital is lower. But I think the more interesting piece, and that I would love Sanjiv to take, is how our customers' needs have changed that is really talking to the maturity of the company and the stages. Sanjiv, you want to take it?

Sure. I'll just say a couple of things, I'll pretty much address it, but I'll just say a couple of additional things. Number one, our partners today are large public companies. We are a large proportion of what they do on the PL side. Purity to our partners is extremely important to our partners, so instead of going all in and showing spikes and troughs in growth, we show predictability in our growth, and that has been one of the reasons why we have given the outlook that we have, that's number one. Number 2, I would say just from an operating environment standpoint, you asked about the operating environment and wider range, we see that consumer FICOs are relatively stable in 2024 compared to 2023, and 2025 seems to be pretty stable as well, our personal loan delinquencies are down, our auto delinquencies are largely stable, and so we've taken all that into consideration, including the fact that we have not accounted for any rate drops, and so we've been, in our opinion, somewhat conservative, but extremely responsible. Thank you.

The next question comes from the line of Pete Christiansen from Citi, please go ahead.

E.P., I think you mentioned in your prepared remarks, I was just hoping you could reiterate it, I think you were able to overcome some redemption issues that you've had, potentially with these marks, and then as a quick follow-up, just curious how you see the mix of network volume evolving this year, I would assume, you know, a higher degree of point of sale could translate to lower risk on the risk retention side, just some thoughts there would be helpful.Thank you.

Sure, just to clarify a little bit on your first point, what I was highlighting is that in the evaluation that we did for our fair value for Q4, some of that is coming through early redemption rights that we have on some of those securities. We didn't have any issues or anything, so just provide some clarity, but moving on to the important question, as we think about the volume guidance, again, as we have been doing in the past, you need to appreciate the fundamentals of our model. We don't grow by chasing credit growth or trading conversion, we grow by adding more partners to the network. So when you think about the high range of our range on the volume side, effectively, that would imply that some of the newer partners that we have announced will accelerate more than we would versus the lower end of the range, which means we would take a little bit more time for those relationships to mature. That's a little bit hard to think about, the volume growth. And then in terms of areas of investment, as you think about the different asset classes, personal loan will continue to grow, but most of the investments and call it higher ROI and growth potential that we see is in our auto platform and POS, and maybe Sanjiv can add a little bit more color to those.

Sure. I mean, in the last quarter, we gave some indication of how much we would grow our POS business. Obviously, we've delivered that. The exit rate on our POS, you know, 24% year-on-year growth and 176% sequential growth demonstrates the fact that we will deliver on POS what we are seeing. And right now, we are talking to a bunch of large POS players, both amongst regional banks as well as leading POS lenders. I should emphasize that we have also got Elavon in addition to Klarna, and frankly, we've been very, very conservative on the Elavon numbers in 2025. We will grow with them. They're a very successful partner, and so we've been somewhat conservative on our numbers but extremely bullish on POS.

The next question comes from the line of Joseph Vafi from Canaccord Genuity. Please go ahead. Joseph, if you can please unmute your line from your end and ask your question.

Sorry about that. Thanks, guys, and for all the color, and nice to see the outlook for 2025. Just wondering if it's too early to have, you know, maybe kind of a more normalized fair value adjustment kind of margin or, you know, percentage of FRLPC or network volume, you know, as we move forward and maybe if we've gotten past, you know, some of these rough bumps, how to think about that, you know, on a normalized basis, you know, over the medium term.

So, Joe, it's Gal here. I think within the numbers, there is some big assumptions that are relatively stable numbers that you saw in the past. We are not yet in the place to, you know, characterize it in a percent, et cetera. We are walking through that, but you should assume that in the GAAP net income full year guidance, there is some part of it and post the call, we can take it to the different places to see where it stands.

Ladies and gentlemen, that was the last question. I will now hand the conference over to Gal Krubiner for his closing comments.

So thank you, everyone, for coming. I want to hand it over to E.P. to say a few closing remarks for this session.

Thanks, Gal, and allow me a little bit to take you a little bit through a longer journey that we have delivered this year. If this was a very challenging road with a lot of surprises, tough decisions, and highly instructive learnings, we delivered major accomplishments throughout the year. And with a new management team in place, but the same vision of building a disruptive business that can deliver sustainable growth through the cycle. Let me walk you through what we have accomplished this year and what we have delivered. In Q4, we did warn about the impairments. We said these 20, 20, 30 will be behind us with no future expected material, and we strongly believe we are delivering that today. In the beginning of the year, we set 2 goals, cash flow positive and gap net income positive. And the pillars for that were through higher fees, more operating leverage, and capital efficiency. We delivered 130 base points improvement in FRLPC. That is $130 million more profit on our $10 billion of volume. On operating leverage in 2Q, we took action and delivered $25 million of annualized savings, with core operating expenses as a percent of FRLPC coming down from 67% to 49% a year ago. In 2Q earnings, we indicated that there is room for improvement on our interest expense, and we delivered, again, $30 million in savings through refinancing transactions that we actually executed in 3Q. On the capital efficiency and diversification in 1Q, we said we will get forward flows and pass-throughs, and we delivered over $3 billion in forward flow programs and a robust pass-through program as well. In addition, we optimized our ABS structure. All of that basically led to cash required to fund our volume down by 200 base points versus 4Q 2023. That is a $200 million less cash required per $10 billion of volume, and still with a buffer. On the business side, we said we're going to add new lending partners, and we delivered the relationship with OneMain and Elavon. We also launched new products. We expanded existing relationships into new asset classes. All of that, coupled with our strong pipeline of new partners, we delivered the seed for future sustainable growth. We delivered positive cash flows. We improved our balance sheet and created more access to liquidity to eliminate concerns for future equity raise needs. Now we're giving you guidance on the up net income positive, and we're here again to deliver.

Thank you very much for joining us today. Ladies and Chairman, the Conference of Pagaya Technologies has now concluded. Thank you for your participation. You may now disconnect your lines.