Yahoo Finance Pagaya Technologies Ltd. (NASDAQ:PGY) Q1 2024 Earnings Call Transcript
Pagaya Technologies Ltd. (NASDAQ:PGY) Q1 2024 Earnings Call Transcript May 9, 2024
Pagaya Technologies Ltd. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good day, and welcome to the Pagaya 1Q 2024 Earnings Conference Call. All participants will be in the listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Jency John, Head of Investor Relations. Please go ahead.
Jency John: Thank you, and welcome to Pagaya’s first quarter 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 can 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 and involve certain 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, including our financial outlook for the second quarter and full year of 2024.
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 filings and in our Form 10-K filed on April 25, 2024, 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, including adjusted EBITDA, adjusted EBITDA margin, adjusted net income, fee revenue less production costs or FRLPC, FRLPC margin 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 on 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.
Gal Krubiner: Thanks, Jency, and good morning, everyone. I’m actually very pleased with our first quarter results. At Pagaya, we are always striving to build the future where more Americans have access to the financial products they deserve through our technology. Our operating performance was strong. We grew fees with our lending partners and raised a record of $2 billion in funding. I’m very proud to announce that this month we added Elavon to our network, a top five global payment company and 18 new funding investors. Our network is now connected to 30 lenders and 116 funding partners. This accomplishment speaks to the power of our business, but I’m especially proud of the progress we are making on our bank enterprise sales strategy.
Let’s go back to 2022 for one second. When we reported earnings for the very first time as a public company, I spoke about one of the key reasons why we decided to go public, which was to execute our enterprise bank sales strategy, partnering with the largest banks in the country. Now fast forward two years, we now have three of the country’s top banks using the Pagaya product and many more in the pipeline. And as I shared, we also added Elavon, U.S. Bank’s Merchant Services and Payment Solutions to our POS vertical. Just one quarter after announcing the addition of U.S. Bank to our personal loan vertical. That speaks to the value of our products. On the financial side, we once again delivered record-breaking financial results, exceeding our outlook with network volume of $2.4 billion, total revenues of $245 million and adjusted EBITDA of $40 million.
Fee revenue less production costs was up 84% year-over-year to $92 million, and our FRLPC margin extended 109 basis points year-over-year to 3.8%. That’s the highest level we have seen since the beginning of the rate hike cycle in early 2022. This is obviously a clear proof that our strategy is working and that there are more room to increase our unit economics going forward. We delivered a fifth back-to-back quarter of improvement in adjusted EBITDA and positive quarterly GAAP operating income for a third time of $8 million. We reported our third quarter of positive and growing operating cash flow in a row, delivering $20 million of operating cash flow this quarter. We continue to manage credit performance very closely to deliver strong and consistent asset return to our funding partners.
We are seeing continued strong performance on our 2023 vintages with delinquencies trending at their lowest level since early 2021. Sanjiv will speak to this in more details in just a moment. As I look ahead, Pagaya is on a path to be connecting infrastructure between all major U.S. loan originating systems and public and private capital markets. Since we started back in 2016, our teams have been working day-in and day-out building the right infrastructure and capabilities to put us on this path. The connectivity we built thus far, 30 of the country’s largest loan origination and over 100 of the country’s largest funding providers is the foundation of the enterprise value of our business. We got here faster than I thought possible. Just three years ago, our business was connected to 10 lending partners and around 20 investors.
As you can imagine, each new partner we onboard is adding to our institutional knowledge and capabilities to build better and smarter products for lenders across the country. As we build our product ecosystem, we’re making our relationships with our lending partners stickier and increasing the overall pool of economics we can share in. And we are growing new enterprise-grade lenders to the network from top five consumer bank to the world’s largest payment providers. Now let’s talk strategy. From a strategy perspective, we’re focused on two simple priorities. First, operating in a smart way to optimize for the current environment; and second, setting the stage for long-term growth. On near-term operational execution, our priorities are maximizing the profitability potential of the business and doing so with efficient use of our capital.
We are seeing an increasing ability to earn more fees as we scale. Now on the capital side, our focus is to become more capital-efficient as we grow. That means reducing how much upfront capital we use to fund new network volume. In order to achieve this, we are diversifying our funding and financing mechanisms to reduce net risk retention. We landed a $100 million secured borrowing facility in the quarter to finance our risk retention needs and a new whole loan sale structure transaction that resulted in a low 1% net risk retention on that deal. We are in advanced conversations now with several counterparties to execute forward flow and whole loan sale arrangements. This could exceed $1 billion in total size. Based on our ongoing conversation with new funding and financing counterparties, we can meaningfully reduce net risk retention over the next few quarters.
These initiatives are key to our strategy to reach cash flow positive in early 2025. EP will speak more to this in a moment. Thinking about our long-term growth plan; we’re not taking our foot off the gas in lending new enterprise-grade lending partners. That has been and remain our North Star for our future growth and company potential. That will ensure that we have the raise in place to achieve our ambition to become the lending tech partner of choice for the largest banks in the country. Adding Elavon, as I mentioned this quarter, in our point-of-sale vertical is a great example and speaks to the power of enterprise sales with large banks, the ability to expand our product across multiple consumer divisions within a single enterprise. Let me spend a minute on point-of-sale.
This is what we believe an excellent tier of growth for Pagaya. Point-of-sale is a fastest-growing consumer credit market, far outpacing the growth of total consumer credits. Pagaya is a leading white-label point-of-sale solution provider in the market today, allowing payments businesses and banks to offer point-of-sale financing under their own brands. Now this is a super important point. The value prop is very strong. Why give your customer away when you can partner with Pagaya? The power of that value prop is creating momentum for our future pipeline. And as such, we are in discussions with several large payment businesses that we aim to integrate over the next 12 months to 18 months. Additionally, discussions with banks in our pipeline are increasingly turning to how Pagaya can help them break into point-of-sale.
As we expand the offering to more industry leaders, we believe we can be a truly disruptive solution in the traditional buy now, pay later universe. The top line opportunity is also huge. We believe our point-of-sale vertical has the potential to generate billions of dollars in incremental network volume to our business at scale. Now, looking at our broader pipeline of prospective lending partners, we are currently in late stage discussions with six large lenders across our main verticals of personal loan, auto and point-of-sale. We are advancing our bank pipeline and expect to integrate three new point-of-sale providers or banks in our point-of-sale vertical over the next 12 months to 18 months. On our existing lending partners, we continue to deepen our relationship with them, which is leading to better unit economics.
Our 2023 cohort ramp up is tracking according to plan while we continue to prioritize our most profitable personal loan partnerships in a continued constrained funding environment. These actions are adding to our bottom line. Our average personal loan FRLPC margin more than doubled year-over-year to 6%. We are also in late stage talks to expand our personal loan product with an existing bank partner. More to come on that later this year. With that, let me pass it over to Sanjiv to discuss our bank enterprise strategy and other operational updates.
Sanjiv Das: Thanks, Gal. In Q1, we reorganized the operating business to increase capital efficiency and enhance our margin profile while still continuing to grow the business. We refocused the operations of Pagaya into two distinct areas, growth and monetization. Our growth team is focused on adding new partners across banks, fintechs, auto, captives and POS lenders, and we put a new product organization in place that is designed to extend the Pagaya solution to our existing network of 30 partners. On the monetization side, the team is laser focused on Pagaya’s economic disciplines of maximizing partner revenue opportunities and efficiently allocating capital to volumes that deliver the highest IRR. The benefit of this transformation is a highly disciplined approach in our core operating business both in the growth of our network volume as well as enhanced economic returns through more efficient capital allocation.
So the outcomes are clear. Because of this operating discipline, the benefits of higher margin are already evidenced in the growth of our FRLPC to the highest level in eight quarters. As a result of this more deliberate and disciplined capital allocation process towards partner flow, we not only deliver a higher FRLPC for Pagaya, but also a higher IRR for our funding investors. Additionally, in our credit underwriting discipline, we are making methodical flow decisions that are demonstrating an improvement in our performance. Based on MOB 30 DPD [ph] it’s fair to say that in both PL and auto, Pagaya is already outperforming the market. 30-day delinquencies for six, nine and 12-month seasoned personal loans are at their lowest levels since April 2021, on average 30% to 40% lower than peak levels in 2021, and have been in continuous steady decline since then.
Our most recent personal loan vintages from later 2023 are showing similar performance with early stage delinquencies at their lowest levels since January 2021. We continue to be encouraged by these trends even as we are carefully monitoring consumer trends in the industry. Our vision is for Pagaya to be the lending technology partner of choice for banks and other large financial institutions. Despite being an eight-year old company, we’ve already built up an extensive network of 30 lending partners of diverse size and scale. What we’ve learned from our enterprise bank partnerships is that there is a massive opportunity for Pagaya’s product solution. Expanding from one bank consumer division to another consumer business in a bank is significantly easier as we demonstrate the value our product can create.
As you would expect, this enterprise strategy significantly shortens our average sales and onboarding cycle. Landing Elavon at U.S. Bank is a great example of this. In just one quarter after announcing our U.S. Bank personal loans partnership, we are now in the process of offering our solution to Elavon, which is another business within U.S. Bank. Deployment of our product across the banking ecosystem also demonstrates the industrial strength of Pagaya’s offering in the face of the highest regulatory and compliance standards that banks have to comply with. I take great pride in what the teams and leaders have achieved in just one quarter of focus on discipline and operational efficiency. I do believe there is more to be done. As we stay focused on this, I believe that we will have the opportunity to further reduce expenses and improve our operating efficiency, which will set us up to invest in the key strategic needs of the business.
With that, let me hand it over to EP to discuss our financials in more depth.
Evangelos Perros: Thank you, Sanjiv, and good morning, everyone. We delivered another record quarter across our key metrics. While we continue to operate in a higher for longer rate environment, we remain focused on profitability and capital efficiency. Network volumes reached the record $2.4 billion in the quarter, up 31% year-over-year and up for the fifth consecutive quarter. Application flow grew year-over-year. Our conversion rate remains low as we optimize for our most profitable lending channels and returns for our funding partners. As a result, personal loans, our most scaled and highest margin product continue to be the largest driver of network volume at 55%. Total revenue and other income grew 31% to a record $245 million compared to the same quarter in 2023 driven by a 35% increase in fee revenue.
We continue to improve our unit economics. Fee revenues less production costs once again outpaced network volume growth by a significant margin. FRLPC grew by 84% to a record $92 million compared to network volume growth of 31%. Sequentially, this equated to FRLPC growth of $16 million, the largest quarterly increase in our history. Fees from our lending partnerships amounted to 63% of total FRLPC in the quarter compared to 43% in the prior year. This is a testament to the growing fee generating power of our business, making us increasingly less reliant on network volume expansion to drive bottom line growth. FRLPC margin increased 109 basis points year-over-year to 3.8%, the highest level since early 2022. Our personal loan business generated an average FRLPC margin of 6%, over 200 basis points above the blended average and up 300 basis points compared to the same quarter last year.
We grew fee rates across almost all of our personal loan lending partners in the quarter. Additionally, in the first few weeks of the second quarter, we further improved unit economics with some of our lending partners as we scaled these channels. Higher FRLPC is translating directly to our bottom line. We delivered record adjusted EBITDA of $40 million with an adjusted EBITDA margin of 16.2%. We also delivered our third consecutive quarter of positive GAAP operating income, which was $8 million in the quarter. Core operating expenses, which exclude stock-based compensation, depreciation, and one-time expenses, increased $4 million year-over-year and $10 million sequentially. Record funding of $1.9 billion led to elevated ABS setup costs sequentially, which we expect to normalize in the second quarter given the excess dry powder we raised to fund network volume.
Additionally, we’re lapping a one-time compensation benefit from the fourth quarter. Net loss attributable to Pagaya was $21 million, an improvement of $40 million from the prior year. Share-based compensation expense amounted to $15 million. Higher interest expense of $15 million reflects the addition of our new term loan facility in the first quarter. Credit impairments of $19 million after accounting for non-controlling interest on our investments in loan and securities represented less than 3% of our portfolio. We reported our fourth consecutive quarter of positive adjusted net income of $13 million, an improvement of $24 million compared to the prior year. Shifting now to discuss our approach to capital efficiency. First, let me discuss our funding in the quarter.
Overall, funding markets are on a stronger footing than in 2023. We are seeing spreads in our 2024 deals reduced by 150 basis points to 200 basis points compared to the peak in 2023. We took advantage of more favorable market conditions at the start of the year to raise $1.9 billion in funding, giving us excess dry powder of approximately $ billion at the start of Q2. We added another 18 funding partners in the quarter. The tailwind of private credit deployment in consumer credit markets continues to work in our favor, with alternative asset managers being the majority of new funding partners we added in the quarter. Capital efficiency is a key enabler as we march toward our next financial milestone of reaching cash flow positive. Our strategy is focused on minimizing the amount of upfront capital we utilize to fund new network volume.
We plan to do this in two ways. First, by diversifying our funding model with structures like whole loan sales or forward flow, and second, by executing more efficient ABS structures and financing arrangements. On diversifying our funding strategy, we executed a $50 million securitization in March that was uniquely structured to mimic a whole loan sale to investors. With this deal, we retained a net 1% vertical slice of the transaction. We have strong confidence we can scale programs like this one to reduce our upfront capital needs. We are in the midst of advanced discussions with several large asset managers to execute new forward flow and whole loan sale arrangements, which we believe could exceed $1 billion in total size. In our core ABS funding model, we’re solving for two things, lowering net risk retention and improving the quality of assets retained.
We’re accomplishing this by taking a larger gross portion of our deals with a higher quality mix of both debt and equity securities. This enables more efficient financing, which results in single digit net risk retention. While we will dynamically adapt our funding strategy based on market conditions, our aim is to target an average net risk retention rate of 2% to 3% of network volume with a diverse mix of funding sources. This is a key driver of our strategy to get positive net cash flow by early 2025. Moving on to our balance sheet and cash flow. As of March 31, our investments in loan and securities, net of non-controlling interest was $804 million. As a result of excess funding issuance, we added gross new investments in loan and securities of $262 million, offset by proceeds from securities of $36 million.
We recorded net fair value adjustments which reduced the carrying value of the portfolio of $40 million in the quarter. Cash and cash equivalents amounted to $310 million. We delivered our third consecutive quarter of positive cash flow from operating activities of $20 million, driven by FRLPC growth and continued operating leverage. Combined cash flow from investing and financing activities was $68 million, driven by our debt and equity capital raises in the quarter offset by excess funding issuance. We expect additional financing on these issuance to be executed in the second quarter. To close, our fee generating business continues to deliver. We see a significant opportunity for further FRLPC expansion as we bring our newer lending partners to the similar economics as our mature partners.
We’ve demonstrated the operating leverage inherent in our B2B business and we see opportunities to be more cost efficient and plan to execute on some of those initiatives over the next few months. On the capital side, we’re entering 2024 in a stronger position to execute on our funding strategy, already proving our ability to do so in the first quarter even in a continued challenging market environment. As we expand our fee generation and drive capital efficiency, we remain confident we can reach cash flow positive next year. Now let me switch gears to our second quarter and 2024 financial outlook. Our key priorities this year are enhancing profitability and capital efficiency. Our guidance for the second quarter and the full year reflects a few key assumptions.
First, we expect to continue to drive improved unit economics with our lending partnerships. We are focused on dynamically managing our portfolio as market conditions evolve to direct capital to our more profitable lending channels. Second, we expect to significantly scale our whole loan sale funding program and execute other structures like forward flow, along with raising additional secured borrowing to drive our net risk retention lower over the remainder of the year. In the second quarter of 2024, we expect network volume to range between $2.2 billion and $2.4 billion, total revenue and other income to range between $235 million and $245 million, and adjusted EBITDA to range between $40 million and $45 million. We are reiterating our full year 2024 outlook, we expect network volume to range between $9 billion and $10.5 billion, total revenue and other income to range between $925 million and $1.05 billion, and adjusted EBITDA to range between $150 million and $190 million.
With that, let me turn it back to the operator for Q&A.
See also
20 Largest Banks in the US by Customers and
20 Countries with the Highest Literacy Rate in the World.
To continue reading the Q&A session, please click here.
