Pagaya’s 3Q23 Letter to Shareholders

This morning we presented our record 3Q results. Here’s our letter to shareholders.

In the third quarter, we delivered another set of strong results, with record quarterly network volume and revenue. We expanded our FRLPC margin and delivered record adjusted EBITDA, now run-rating at over $100 million on an annualized basis based on the third quarter. Importantly, we achieved a step-change in the expansion of our network with two new transformational partners joining our network last month - a top five bank in the U.S. and a top four auto OEM captive. We are now integrated with 28 lenders across 5 markets, with a funding network of 90+ unique institutional investors.

Our value proposition

Our mission at Pagaya is to deliver more financial opportunity to more people, more often. To do so, we developed a two-sided network that offers lenders and investors a one-of-a-kind product suite. By integrating Pagaya’s product, lenders can expand access to credit to more borrowers, resulting in growth in originations and revenues, without incremental credit risk. At the same time, investors gain access to a continuous flow of AI-enabled consumer credit and real estate assets.

In today’s environment, our product is more relevant than ever, as we benefit from two macro tailwinds for our business. First, banks are facing increasing pressure to tighten their lending standards amidst challenging market liquidity conditions and higher regulatory capital requirements. Second, private credit has an increasing mandate to deploy significant dry powder expeditiously, with a growing allocation to U.S. consumer credit. Our product offers a solution to both sides – we can help banks originate more loans without the burden of capital requirements and offer private credit a growing flow of billions of dollars of diverse consumer credit assets at attractive yields. If these macro trends continue, we expect increased demand for our product from both lenders and investors, as we partner together to support the financial needs of American consumers.

With continued strong network expansion, improving unit economics and operating leverage at scale, Pagaya is a fundamentally transformed company, even compared to just three months ago. Our network is stronger, our product is in high demand, and we have carved a clear path to deliver sustainable, profitable growth.

Our Growth Strategy Explained

Our vision is for our product suite to be integrated with most major loan origination systems (“LOS”) in the U.S. Our growth is driven by: (1) expanding integration of our product with more lender LOS, which drives increased application volume, which in turn enables continuous refinement of our product suite to serve our lender needs, driving its stickiness; (2) an increasing flow of new data over time that, all else being equal, leads to a higher rate at which we can convert applications into loans; (3) while doing so in a cost-efficient way to create quality financial products for investors.

Advancing on this vision is reflected in our following medium-term financial goals (on an annual basis):

• $25B Network Volume

• $1B FRLPC

• $500M Adjusted EBITDA

To achieve our medium-term ambitions, we are focused on executing the following key strategic initiatives:

1. Expand our product integration to more lenders across markets: with a focus on large U.S. banks and auto captives to drive increased loan application flow;

2. Increase our conversion rate with technology: by incorporating incremental data from new, large partnerships to drive credit model enhancements;

3. Deliver quality, efficient financial products at scale: increase the efficiency and lower the cost of investors’ capital through innovative structuring, diversification and scale, which in turn drives increased investor demand.

1. Expanding our product integration

We plan to drive growth by expanding our connectivity to U.S. lenders and continuously refining our product suite to meet their evolving needs.

The depth and breadth of our connectivity across the financial ecosystem translates to a significant accumulation of knowledge about each lender’s end customer: whether it be consumers, dealerships, or merchants. We use this knowledge to develop tailor-made, distinct solutions, making our product sticky and in high demand.

For example, in personal loans, we have spent the past few years developing what we believe is a best-in-class enterprise-grade product that solves for the stringent regulatory and capital requirements of FDIC-regulated banks. In auto, we are focused on enhancing product features that improve the dealership transaction experience, and in PoS lending, we are developing merchant-forward solutions.

With our existing partners, we are focused on driving application flow through product innovation and channel expansion, such as introducing our first-look product extension, our broadening set of marketing solutions, or cross-selling our solutions for other markets (like auto or PoS). Looking at all of our existing partners as of year-end 2022, they generated an estimated $65-$75 billion in annual originations. If we apply Pagaya’s average contribution to total volumes of its most mature partners of approximately 20%, the long-term network volume potential of these partnerships could range from $12-$16 billion.

For new partner integrations, our focus is rolling out our product to our robust pipeline of large U.S. banks and auto captives. So far this year, we launched three new product integrations, in line with our target of 2-4 integrations annually.

When we onboard a new partner, the first year - the integration year - is focused on expanding across the lender’s network of branches, dealers, or merchants, ensuring our product is live and operating successfully at each point-of-sale. In year two - the ramp-up year - we are focused on growing volumes with the lender as our models learn from the new flow, enabling an increasing conversion rate, all else being equal. By year 3 - the expansion year - most partnerships are fully ramped up and the focus turns to further expansion and product innovation to drive consistent growth in volumes.

To put it into context, the partners and channels we onboarded in 2022 delivered an additional $800 million to our network volume in the first 9 months of 2023, and we expect this figure to grow to approximately $1 billion in full-year 2023. We expect that our recently announced cohort of 2023 integrations (Westlake Financial, top 5 bank, and top 4 auto captive), which are much larger in total size and volume potential compared to our 2022 cohort, has the potential to generate significantly more incremental network volume over the next 12-18 months.

For our 2024 plan, we expect that all of our network volume will be sourced from partners that are already part of our network as of today. Looking to our future pipeline, we are in discussions with 80% of the top 25 U.S. banks. We have more than 10 opportunities across banks and auto captives that are in our “deep funnel” – in the later stages of business case development and onboarding. Our latest-stage opportunities in our deep funnel (those we expect can be onboarded within the next 12-24 months) represent an opportunity of approximately $2-$3 billion in incremental annual network volume once fully ramped.

On the lender side of our network, our growth will rely on our ability to deepen our existing lending relationships and the rate at which we convert our current deep funnel opportunities. Our Growth team has a proven track record of integrating 2-4 partners every year for the past 3 years. The progress we’ve made in advancing our product to this stage, so that it can deliver for lenders across markets, customer segments and sizes, reinforces my confidence in our ability to expand our network to new, large strategic partnerships over time.

2. Increasing conversion through technology

As we receive higher application flow, we can enhance our credit decisioning capabilities through increased proprietary data, which can lead to both an improved conversion rate of applications and better returns for investors.

Our models get smarter over time as we see more data – we can detect behavioral patterns, better predict the impact of macro trends on the ability of consumers to repay or detect instances of fraud. With time, as the predictive power of our AI models improves, we can increase our conversion rate by approving more loans at similar or higher expected returns. Higher conversion rates also lead to a strengthened competitive moat with our lenders.

When we first plug into a new lender, our conversion rate tends to be lower than average as our models start to train on a new dataset. Over time, as shown in the illustration below, we expect the conversion rate for each lending partner, all else being equal, to steadily improve over time as our models learn on the incoming data flow.

3. Delivering high quality, efficient financial products at scale

On the funding side for our network, we’re focused on driving innovation in structuring and issuing at scale to effectively reduce the cost of capital while still delivering similar asset returns. This includes issuing more rated transactions, issuing consistently across all market conditions, and optimizing for structures that meet investor needs. These initiatives make our investment products more attractive, driving increased demand. We’re also exploring new funding channels – such as forward flow arrangements that enable us to originate and deliver loans to investors based on their predetermined criteria – to diversify our offering to new investor types, such as large insurance companies.

Q3 Progress on our Growth Strategy

In the third quarter, we made meaningful progress in growing both sides of our network, as we continue to advance on our medium-term goals.

1. Expanding our product integration with new enterprise partnerships

PERSONAL LOAN

In personal loan, I’m pleased to announce that in October, we integrated our product with a top 5 bank in the U.S., based on total assets. This is our largest lending partnership to date by asset size. With Pagaya, banks can deepen relationships with existing customers by offering a broader array of products, in turn increasing customer lifetime value, while also providing more consumers with more access to mainstream financial products.

AUTO

In auto, we are also excited to announce the integration of our auto product with the captive financing arm of one of the world’s largest auto manufacturers. This OEM had over 1.5 million in annual vehicle sales in the U.S. in 2022, with more than 10% market share in new vehicle sales among large U.S. OEMs. We expect this integration will generate significant incremental application flow beyond our existing auto partnerships, as it will enable Pagaya to penetrate financing for new vehicle sales in the OEM’s 2,500 franchise dealerships across the nation.

We are also excited about our recently launched partnership with Westlake Financial. Westlake is the number one subprime lender in the U.S. with independent dealerships and the number four with franchise dealerships, serving a network of approximately 50,000 total dealerships. The partnership will initially focus on franchise dealerships but is expected to expand to Westlake’s larger network of independent dealerships (complementing Pagaya’s existing presence in franchise dealerships with its other auto lending partners).

The addition of several large auto partners over the past year is a testament to the attractiveness of our auto product - transforming Pagaya into one of the auto industry’s leading providers of AI-driven credit-decisioning technology.

POS

In point-of-sale (“PoS”), we are seeing accelerated growth of our product, supported by our partnership with Klarna, the world’s leading buy-now-pay-later provider. Our total PoS application volume doubled sequentially in Q323 compared to the second quarter and grew by 6 times compared to the first quarter. Our PoS product is currently focused on the 6-month and 12-month term loan product. Given the success of our partnership to date, we are in discussions to further expand our collaboration, including exploring a program to target larger-ticket size loans as a prime opportunity to gain market share in the competitive PoS market in the U.S.

In summary, the expansion of partnerships integrated in 2022 and 2023 is expected to drive a step-change in our network growth, with the potential to drive an additional ~$100 billion or more in application volume each year.

2. Model enhancements and data-driven improvements in conversion rate

As mentioned above, to improve loan conversion, we’re continuously making enhancements to our data science and credit models. In the current environment, considering lower risk tolerance by our lending partners, we developed newer models that improve pricing by focusing on reducing delinquency rates and optimizing between channels. This translates to higher returns for every incremental unit of underwritten risk.

For example, in Q3, we introduced an updated credit model in our personal loan product. This version focuses on better utilizing our network proprietary data to predict activation sensitivity (the probability a consumer will accept a loan offer) and loan return. We expect that these enhancements can lead to up to a 50 basis points increase in annualized asset returns.

We also made critical updates to our auto underwriting technology. These updates include enriching our existing methodology with additional vehicle valuation data points, improving the predictive accuracy of asset performance over time.

3. Consistently raising capital with attractive financial products

On the funding side of our network, we are consistently innovating to deliver fit-for-market structures that optimize the cost of capital for each transaction.

In the third quarter we had a record quarter of ABS issuance, with $1.8 billion issued across four transactions. We were once again the number one personal loan ABS issuer by issuance size, solidifying our reputation as the benchmark issuer of this product. Our expertise in structuring and executing complex transactions is also reflected in the expansion of our credit union trade product - an off-the-shelf funding structure that can swiftly be deployed by any of our investors looking to be opportunistic in this market. Our growing scale has also allowed us to tap into the rated auto ABS market, including our recently rated $281 million RPM 2023-3 deal, which helps reduce the cost of capital for our auto ABS issuance.

As a result of our scale, efficiency and innovative structuring, we are seeing growing investor demand. Our deals continue to be oversubscribed, with our last four deals oversubscribed by an average of 2x. We added six new investors to the network since August 2023, two of which were in the top-tier whole-life insurance and asset management industries, each with over $400 billion in total assets under management. These partnerships underscore the ability of our product to meet the needs of prominent financial institutions.

4. New Monetization Opportunities

As we look to drive the next phase of growth at Pagaya, we’re continuously seeking opportunities to further monetize our product offering. During the past quarter, we tested and launched a new product in collaboration with select partners to offer data-driven advisory services to optimize the loan life-cycle. The successful execution of this initiative has already resulted in over $1 million in incremental EBITDA year-to-date. We believe this product has the potential to generate over $10 million of incremental EBITDA on an annualized basis.

As part of our efforts to drive innovation and revenue diversification, we hired a seasoned product leader as our new Chief Product Officer, to lead this strategy and streamline our future product roadmap. This roadmap includes exploring opportunities to innovate outside of our current product offering, including potential expansion into new markets – such as home improvement PoS financing – that we believe can benefit from our tech-enabled network.

Well Positioned for Sustainable, Profitable Growth

The future of Pagaya is bright. With strong execution enabled by a product-focused strategy, we are delivering on our mission to help consumers get access to more credit, while expanding our connectivity in the financial ecosystem. Looking ahead, we are confident in our trajectory and our plan to achieve our long-term objectives.

Gal Krubiner 

Co-founder and CEO