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

All right, everybody. Last session of the day for me is Pagaya. Before we get started, I'm going to read some quick disclosures. For important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. The taking of photographs and use of recording devices is also not allowed. If you have any questions, please reach out to your Morgan Stanley sales representative. So with that, I'm delighted to welcome Gal Krubiner, CEO and Co-Founder of Pagaya, joined by -- joining him is also EP, CFO of Pagaya. Welcome. First time at the conference, I believe.

Yes.

So pleasure to have you guys here.

Thank you so much.

Thank you for having us.

Maybe we could just, for those in the room who don't really know the story that well, Pagaya, could you talk about the mission of the company, the path from founding to where you are today?

Yes, definitely. So let me start. First of all, thank you very much for having us. We're excited to be here and to share the Pagaya story. We've been on a long execution time coming to finally get net income positive. So great time to meet and to speak about what Pagaya does, the mission, the vision, et cetera. So when you think about what Pagaya is trying to accomplish, we are a key player inside the financial ecosystem in consumer credit, which is helping different bank and lenders to extend their ability to provide credit to consumers in the U.S. And when we think about that, we have found, as many others have found, that there is still a very big lack of ability to provide credit for consumers in the U.S. We're talking about numbers that are staggering as high as 42% that our people are actually getting declined when they are asking for a loan in the U.S. And Pagaya is actually trying to solve that but in a very differentiated way. We have decided that in order to solve that, we will partner with the banks and the lenders rather than to compete with them. So by that, we're actually connecting to the loan origination systems that the applications are running through them. And in the moment of offering, when there is a person in the branch or online asking for a loan and is automatically getting declined by the bank because they might have lower FICO or other things, we are providing an approval to that bank to actually show an application approval to that customer and helping the bank to accept that customer to their ecosystem. And to summarize all of that, I think it's to summarize with the value proposition to the lenders, which they tend to keep the customers, they tend to make revenue fee without any balance sheet in that transaction that is happening, and they do not need to put any capital in work because when we speak about it later, we have a very vast majority of investors behind us on the other side of the network and allowing that transaction to happen.

Makes sense. So you're providing banks and institutions with key white-labeling service to retain that customer. Can you talk about who these typical lending partners are for Pagaya? How has that changed over time? Maybe you can give us some key examples of names we're all familiar with in the room?

So the first wave of lenders, as we call them, that adopted our solution and we partnered up with are actually what we call the FinTech 1.0, the Prosper back in the days. We started as early as 2019, Best Egg and many other lenders. They were the first wave of adopters to our solution. They were monoline personal loan lenders that needed to improve their ability to convert consumers, and therefore, partnering up with Pagaya was a no-brainer for them. The second wave of partners were actually the auto bank lenders. So think about -- they are in the U.S., mainly for used car. Many lenders that are providing to the dealerships the ability to finance the purchases of the different consumers that are coming through their doors. We are speaking about companies like Exeter, Flagship, Westlake, which is very known one and is a big one. And the last one that is actually the most known one is Ally Bank, which is our partner. The third wave of partners that we managed to onboard over time are banks, as I started to mention, and buy now, pay later companies. They're the ones that you are most familiar with, I guess, is SoFi Bank, Klarna, which is a bank, U.S. Bank that are using our services, any FICO below 720 on personal loan and their Avvance, which is their buy now, pay later solution on the Elavon rails, which is the payment processor from them. So we had in Pagaya, I would say, 3 waves of partners. They are all lenders. They are all massive lenders that are putting out there anywhere from a $5 billion a year to a $40 billion, to a $50 billion, to a $100 billion. And it ranges from fintech players to auto loan lenders and up until the biggest partner that we have, which is the fifth biggest bank in the U.S., which is U.S. Bank.

And I think just to add to that, if you put it all together, we're talking about 31 different partners today, again, ranging from banks, all the way to fintechs across multiple asset classes. And when you think about that, that's a key differentiator from a data perspective and flow that we get relative to some of the other lending partners or lending institutions out there.

That's great. And what sets you apart from some of the tech-enabled lenders that many in the audience may be more familiar with? Is it the AI? Is it your data? And maybe why can't another company just do this? Is it that hard?

Yes. So I would say the key differentiator is the data when you think about it from the AI. Like AI is a little bit of a buzzword. A lot of people are using the technology. Technology solution is very critical in these types of loans because we're talking about multi-kit items, and you need to actually have a -- in order to have a continuous flow, you need a technology solution. What really sets us apart is what I said previously. It's the data that we see across the entire credit spectrum of consumers, from people that work with banks, all the way to fintechs across multiple asset classes. To put some numbers in perspective, we look at almost $1 trillion of applications a year. And all of that data fits into our model. And that's what really differentiates us relative to some other lending institutions that can be just servicing a certain consumer base and may be limited in terms of their scope and application flow.

And you talked about, I think, the $1 trillion applications a year, if I have it right. So how does that -- like does that give you a unique perspective on the consumer today? And in light of that, can you talk about how you would characterize the state of the consumer today, what any concerns you're hearing from any partners on that? And how has Pagaya been able to navigate maybe some of the more tougher environments you've encountered out there?

Yes. So I would say it's definitely a unique advantage. Even if I take you back in history, back in 2021 when we're much smaller, we still managed to be some of the first ones to react to some of the macro environment that we're facing then. And obviously, as we continue to add more partners to get more flow, that data continues to accelerate the efficiency and the productivity of what we do. What I would say is on the consumer, 2 things. One is we don't see anything in the data coming through that's pointing to consumer-facing challenges in paying their debt. But we do see a little bit because of the uncertainty, because of the macro, a little bit less maybe willingness on their end to take on more loans. We're monitoring that very closely. Again, the benefit of the data is that we see that real time and we can react to it. The other thing I would say as well is that from our perspective, because we're different in the way we go to market and the way we grow, we're actually very well positioned for potentially challenges on the line. Even in Q1 when we came out with the first quarter profitability in the guidance, we -- when we talk about the guidance that we gave, we were positioned for increased uncertainty. And that's how we sort of manage the current environment.

And just to double down on that point because it's obviously a question we get from many investors that are actually curious in what's the state of the U.S. There was so much noise, especially around April. And I think there is a very strong statement to be said that the U.S. consumer is holding and holding well. When we are saying that, we're obviously saying that from a debt perspective and the ability to pay. To EP's point, we saw a few softening part on the ability to spend, which is something that is less important from us. But from a lender point of view, from a consumer health financial instability, I think there were a few doom scenarios that came up in April about how is that going to look like and the tariff's impact, et cetera. As for now, the consumer is very stable. And from our perspective, that we are actually looking to have stability, this is an important thing when you're trying to build over the cycle long-term companies. The year has progressed to be, I would say, strong in that regard. So the ability to actually continue to propel the value proposition of Pagaya to the lenders and a lot of things that we're going to touch about later about the private credit that we saw so many companies today speaking about it, and specifically, the ABS side, the asset-backed funding into this is definitely a strong tailwind that we are getting for people who are looking to find places to have good investments for their capital.

And you touched on the consumer health a little bit. Some people out there think second look means low quality borrowers. Is this purely second look? And what does your typical borrower look like? And could you maybe layer in some bifurcation of like what you're seeing by cohort? You understand the consumer is strong, but like what are you noticing by low income, high income, or low FICO, high FICO?

Yes. So we start with just characterizing what is the typical borrower of Pagaya. So it's sad to say, but they are very strong borrowers. What I'm saying it's sad to say because the 42% decline number that I just quoted is for the everyday American. We are talking about people that have $110,000, $113,000 of an income. To put that in perspective, it's the first, second and third tiers from an income perspective across the U.S. We're talking about people that have 17 years of credit history. We're talking about people, that their average FICO is 690. So by all means and all of these numbers I'm quoting are for the personal loan, on the auto, is a little bit lower but in the same vein. So the point being is that a second-look solution for different part of banks could still be very strong financially borrowers. And that's really the core heart of the solution that we are serving because the one most important thing for the lenders that we work with is to continue to have the relationship with these consumers. These consumers have deposits. They have mortgages. They have -- are consumer in other financial instruments. So to make sure you're actually meeting their credit demand, to make sure they are staying in your ecosystem is a very beneficial outcome. And to your question, throughout the '21 and '22, which was one of the toughest years for consumer credit, call it the people that are earning $50,000, $60,000 or below are actually being squeezed out of the system, both with the interest rate going higher 2 years back and with inflation sometimes hitting the ability to maintain that. The lower incomes are harder time to find real credit solution in our spaces. And I think the full industry has shifted up in quality. And today, we're seeing very strong results, not just for the last quarter, but like I would say, anywhere from middle to late 2023. Consumer credit early delinquencies or cumulative net losses are rather stable.

I would want to also not lose sight of the fact that while the secondary program obviously is a key product for Pagaya in how we go to market, we actually have developed and commercialized other products that are not secondary in nature. It's like a first look, like a prescreen product. And this is in our ability to basically monetize the relationship with our existing partners. So while we start with secondary product, we now have the ability to offer other products that are most like a first-look type of product.

Okay. And just curious, so you're sitting here, the consumer looks pretty good. What are the top few reasons why some of these banks or financial institutions are maybe declining and bringing them to you?

One word.

Just FICO, that's it?

Bingo, regulation, that's it and the different pieces of what it costs to have a lower FICO, which again, lower could be 720 is the regulatory regime that exists. And by the way, not to say it's good or bad. There are very many strong reasons why depositories should stay super safe without the ability to endure any losses. And you have many accounting regimes from CECL to regulatory different type of policies from Basel to others that are actually making that very hard for banks to be competitive in the areas where we are operating, which just to put the things to it, the capital for that places are coming from pension funds, are coming from insurance capital. So it's not to say that there is an avoidance in the world of that. It's just that instead of the balance sheet of the banks are funding it, it's moving to other balance sheets that usually tend to be longer by nature and not showed by nature like depository institutions as such.

Okay. Makes sense. Can we talk a little bit about the operating models and the operating leverage you're able to generate? How do you monetize the advantage you have? And how do you use that to actually generate the operating leverage?

Yes. So the operating leverage is a major differentiator of Pagaya relative to any of the other typical lending institutions. We don't have any customer acquisition costs. Those are borne by our lending partners directly. And therefore, we have none of the marketing costs. So if you think about it from a numbers perspective, if you look at, let's say, Q1 2025, we had an 89% adjusted EBITDA flow-through for that specific quarter year-over-year. What that means is that any incremental dollar that comes through in the form of fees that we generate for every transaction, effectively, substantially all of that goes straight to the bottom line and drives profitability. If you compare that to any other players in the space, as I said before, you would have significant marketing costs that would not allow them to have that significant benefit. That's how to think about it. And then ultimately, that's how we manage to get to our GAAP net income profitability in this quarter. And when you think about the year -- the next few quarters and years, if you think of us as a 20% growth company type of year-over-year, effectively all that incremental growth will go straight to the bottom line.

And the way I like to characterize it is think about it as a software margin business because in a consumer credit business, you have a very high correlation between marketing spend to the ability to originate. When you're breaking these two, and to EP's point, most of the costs are constant and let's explain why, because we are mainly putting cost into the connectivity to these lenders. Once you have done that, the growth with a specific partner has 0 relevancy to the volume that you are creating through them. So by the nature of going after more partners from the 31, hopefully to the 40 to the 50 and from expanding with each partner from one product to second to third, for sure, there are a few things you need to add, but they are nothing compared to the correlation that you will need to have if you're with few consumer business that is just driving growth through marketing costs. And that is the biggest differentiator from the top line to the bottom line of Pagaya that will stay a strong differentiating factor over the next few years as we build the company more.

Makes sense. And how do you think about the funding for the company? How do you secure capital? Who are your typical counterparties? How do you retain risk? Maybe you could speak to some of the fervor that private credit has had in recent years.

Yes. So we're now at, I guess, the best point that we have been in our history, both from a diversification perspective and optimization. So today, think about Pagaya linking directly private credit to the loan originating system of the lenders. And it comes in 2 basic forms, through ABS securitization as well as non-ABS structures like forward flows, pass-through programs and other privately managed funds. In terms of the breakdown, think about it approximately 50%-50%., 50% coming from non-ABS and 50% coming from the ABS side. The other key differentiator is that on the ABS specifically, it's not traditional ABS. It's what we call prefunding ABS. Effectively, what that means is we go out, raise the capital from our investors and then feel that these ABS deals, which actually comes in at a slightly higher cost, but a significant way for us to mitigate and manage liquidity risk. So when you put that all in perspective, we feel very good about where we are today. The demand is extremely strong from the funding side and the private credit who is looking to deploy capital to these types of assets and are in need of a technology solution that we can provide to them in order for -- to get continuous access to that flow. We're the largest ABS issuer on the personal loan side. We're a AAA issuer across all our products, personal loan, auto and POS in ABS. So we're probably at the best time we have been from a diversification perspective, optimization and overall cost of capital.

And the one thing I want to mention on, which I think is important and sometimes people are losing sight of it, on that side, too, we are a service provider. When you think about a private credit fund as big as $200 billion and smaller than $3 billion. And when they are trying to open a sleeve and to focus on private credit that goes into consumer credit assets, they don't have the technology capabilities to underwrite $10,000, $20,000 loans. It's impossible. So they need in their cost structure and their 3-year plan goal to rely on partners like us. We have positioned ourselves and invested a lot of time and effort to understand what is meaningful for them and what are the right structure to be able to provide market feeds purpose type of a solution. And when you think about it, again, the ability to work with and we announced a $2.4 billion forward flow with Blue Owl on in the personal loan ABS -- sorry, in the personal loan market. When they will start looking on other sectors and on the buy now, pay later or the auto loan, it's a very obvious transition. So building that in a way that is speaking in the biggest investors in the world language and we have 130-plus of them is allowing us to get the tailwind that I just described before that is helping us to be the technology partner for the private credit people to enter into consumer credit at all.

And have you noticed that those conversations are picking up more recently and...

Massively.

Okay.

I will say that the last -- it's -- I think you can characterize the moment of breakthrough to the ecosystem, call it, 18 months ago, actually with a great partner of us, ours, which is the Castlelake, together with Upstart that announced forward flow in scale. And there -- from there, I would say, later last year to the start of this year, we saw many transactions that are mainly in between Upstart, ourselves and SoFi, the 3 leading categories and maybe a firm that have captured most of that show.

So then what does this mean for your growth trajectory and your profitability profile over the next few years? What are the key drivers of the growth? And talk about the operating leverage you have. I know you already spoke about that, but maybe just layer that in again.

Yes. So maybe I will speak about the growth engines and then EP will take out the impact to financials, et cetera. From a growth perspective, there are 3 nature plays to bring growth with. First one, we have 31 partners. To EP's point before, they have 60 million customers. To ask the question of what is the credit of their customers, we'll need to have and to be proactive about it rather than just passive about it, which is the decline product. To be able to offer a preapproved offer for this part of the 60 million customers is a huge potential growth for the future. And next to that, building more of our models, tuning more of the staff, collecting more of the data, deploying that into the existing network that Pagaya has right now could easily be a very strong growth engine over the next few years. The second growth engine is bringing more lenders. So we have now landed a top 5 bank, which is U.S. Bank. We have landed Ally Bank. We are in discussion with 80% of the top 25 banks in the U.S. The U.S. banks are recognizing that their ability to partner with Pagaya and to keep their customers happy and to keep deposits inside their banks is a very powerful tool, and more likely, they're not easier than many other initiatives that they could do. So pushing that hard and being able to showcase to many CEOs of the consumer banks that Pagaya is a must solution and not just a nice-to-have solution, that's our next frontier of growth and we are working very hard on that with very good success so far. The third piece is making everything more efficient on the funding side to reduce the cost of capital, on the models to improve the activation, on the ability to drive applications and approval on -- without the need to do verification and stipulation. There are many inefficiencies still lying in the system. And when you reduce them and you shrink them, your ability to approve many more customers is just the nature of the beast. So we have 3 major growth of engines or vectors of growth. And maybe the next one I would put as the full is even when we have 31 partners, we have it with 1 specific product and we have 3. So the ability to cross-sell to each is a very big opportunity. And maybe you want to share a little bit how it's going to look on the financials and the funding side?

Yes. So the way to think about it, what you just heard is basically that we can grow in a way where we don't have to take on more risk. We're growing by adding more partners to the network, getting more application flow. And if you think about that, without doing that with any risk, if you'd say we grow top line volume, call it, or revenues by 20% because of the operating leverage that we discussed before, effectively, today, we're underwriting $460-or-so million of fees, 20% growth of that will effectively go straight to the bottom line. If you see that even 12 months out, that's $1 per share on an EPS basis, and that's the earnings power of the network. And we have hit that inflection point. We demonstrated that in Q1, and we're now at the point where, because of the scale and breadth, we can actually continue to deliver that without, again, taking on more risk.

And you did regionally just achieve GAAP profitability. It's been volatile on the way there. You raised some equity capital as well. Where are you today and being able not only to self-fund, but grew that profit more consistently? I know you just touched on some of the numbers there, but how do you keep that more consistent and stable?

Yes. So what we have done over the last 12 months is we set out a financial strategy almost 18 months ago now to be GAAP net income profitable and cash flow positive, and we have achieved both those things. So now as we generate more cash flow, we can actually start building up reserves or use that effectively to fund the business without the need to raise any capital. We don't have any need of that. On top of that, what we did in the last year, we optimized the balance sheet. So setting aside the growth and how we fund that, we have now access to, let's say, immediate liquidity from some of the securities that we hold on our balance sheet. And that, by itself, think about it as a buffer for a rainy day. If we need to do that, we can monetize those types of investments. So -- and from here on, as we continue to grow, as I was saying before, any incremental growth and incremental growth on the top line goes straight to the bottom line, both in terms of profitability as well as cash flow generation.

Makes sense. And your stock has been also pretty volatile this year as well. It was under pressure in March and April. Since rebounded, you've been able to grow revenues to cheap profitability. What do you think is driving this volatility in -- is there a different way you think investors should be valuing your stock?

Yes. So let me start, and EP, feel free to add. I think that actually, the last quarter was a very strong turning point. I think people mixed back in the days between a working business model to a wrong cycle for the consumer credit. So people, losses that are happening across the industry, but specifically in Pagaya and said, "Wait, maybe the business model works or not. And there was a question mark around that. And obviously, we knew the business model is the right business model and has this operational leverage, and we were focused throughout the last 18 months, 24 months to drive the long-term value of Pagaya, even if there are some headwinds in the consumer credit space to that. And in the first quarter this year, I think more than anything, we showcased that the ability of Pagaya to be able to actually drive profits. But more importantly, has a very clear sight for meaningful profits and earning power, as EP pointed out, about earning power and the ability to drive valuation higher was very well received. And you start to see many investors that are getting deeper into the model and asking the right questions and understanding the beauty about that very lean business model, combined with a very simple achievable growth targets to build something very, very powerful into the connectivity point between the private credit needs to deploy capital and the bank balance sheets that are pulling back. And as we believe that we are going to show continuous growth in the GAAP net income and the earning power of the company, we believe that the valuation of the company will fix itself and will come to a very interesting investment thesis for the next few years.

Yes. I would say we definitely hit that turning point, and I think it's very obvious now to the marketplace. Last year, we're talking about operating leverage and the path to profitability. We delivered that in 1Q as a result of that. We were talking about the optimization and diversification of funding. We have delivered that. When you look about how we have grown, you look at how much of the loans -- applications for that comes in that we convert into actual funded volume. That has been very stable. We did not open the headworks, credit books in order to get to that point. So all of this is coming now together. And I think people are seeing that. So I do feel we've passed that sort of turning point after Q1. Obviously, a lot more work to do. but that consistent sort of disciplined execution is what will set us apart.

Great. So sounds great, but what call keeps you up at night? You talked about how you've engaged in a lot of conversations with bank partners. What maybe happens if credit starts going the wrong way, you pull back? Does that upset their customer base? You mentioned regulatory is getting easier for a lot of the banks maybe on the capital front, CFPBs a little bit out of the picture right now. Does that keep you up at night? Or is there anything...

So actually on the regulation front, I think it was so tight on the banks that I think there is a welcoming act to reduce that a little bit and will actually make the banks that we work with more open to partnering up. So that's not the case. I think there are 2 main pieces to point out, call it, as a fintech leader. I think when we looked on the '21 and there was obviously very cheap money and a lot of money coming to the space and there was big promise, et cetera, and as a founder and a CEO of a company, it all looked so well for the industry. In hindsight, the overall volatility is not good. How much money was pulled in? People were not rationale and then pulled back and then you need to face. I think the one1 thing that keeps me up at night is the asymmetrical potential volatility that we cannot expect. So it's less about a recession or not in a second that will react to how we do it or not. But it's something that I'm going to get all of us again, chasing our tails and a lot of growth companies expanded very good years instead of looking on the long-term growth rather than looking on a very short term. And the second piece is, look, we have a very unique opportunity to become a powerhouse. It feels like we can do it. And it feels like with a few more partners, a few more support from our funding. We can create an ecosystem that was not here before and to be a category leader of something that was not done and providing a lot of value for consumers, for banks, for investors, which is very exciting. The thing that keeps me at night awake from that perspective is to make sure we're going to keep the eye on the ball and we're going to execute as we should. We had a tremendous one accomplished so much. If you can just replicate that to the future, I think we're all going to be satisfied hitting that milestone and looking on the long-term vision of Pagaya.

Maybe just in the last 1.5 minutes we have here, you recently had some management change. Can you talk about the current team? And maybe taking a full circle, has that driven a shift in the mission statement or the mission of Pagaya? Or has it strengthened it?

On management, I will need to discuss. But EP is a newly appointed CFO for the last 18 months. He was obviously an amazing pleasure to work with him in the details, very hands on. That's the new Pagaya. I had the luck and the pleasure to work with Sanjiv Das, which is our President, and he's here in the audience. We announced him as a cofounder, too. He's coming with a very strong consumer credit background of understanding what is risk, what is enterprise risk, what is risk management. And part of the things where we are so confident in our ability to drive value in the future without taking asymmetrical risk is because of him. And next to him, he brought an amazing team of our Chief Risk Officer, which is Raj, that came from many very deep knowledge, institutions and city, alumina and many others. So I think the big statement from us is we have a world-class team that is thinking risk, that is financial driven, that is willing and ready to take Pagaya to new heights, but in the right profitable growth. And we leave the audience with that.

Well, on that note, it sounds great, but thanks for coming, guys. Gal, EP, appreciate it.

Thank you.

Thank you for having us.