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. With that, I'm delighted to welcome Gal Krubiner, CEO and Co-founder of Pagaya. Joining him is also EP, CFO of Pagaya. Welcome. First time at the conference, I believe.
Yes.
Pleasure to have you guys here.
Thank you so much. Thank you for having us.
Maybe we could just, you know, 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?
Yeah, 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. Great time to meet and to speak about what Pagaya does, the mission, the vision, etc. 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 banks and lenders to extend their ability to provide credit to consumers, to consumers in the U.S. 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.. 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. By that, we're actually connecting to the loan origination systems that the applications are running through them.
In the moment of offering, when there is a person in the branch or online asking for a loan and he is automatically getting declined by the bank because they might have a lower FICO or other thing, 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. 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 that are allowing that transaction to happen.
Makes sense. 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's that changed over time? Maybe you can give us some key examples of names we're all familiar with in the room.
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. 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. Think about that, 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, Flagstar, Westlake, which is a very known one and is a big one. 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. The ones that you are most familiar with, I guess, are SoFi, 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. We had in Pagaya, I would say, three 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 $100 billion. 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.
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. 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. 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? Maybe why can't another company just do this? Is it that hard?
Yeah. I would say the key differentiator is the data, when you think about it from the AI. Like AI is, you know, a little bit of a buzzword. A lot of people are using the technology. A technology solution is very critical in these types of loans because we're talking about small ticket items, and you need to, actually have a conti, 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 feeds 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.
You talked about, I think, the trillion applications a year, if I have it right. Does that give you a unique perspective on the consumer today? 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?
Yeah. What I would say, it's definitely a unique advantage. Even if I take you back in history, back in 2021, when we were much smaller, we still managed to be some of the first ones to react to some of the macro environment that we were facing then. Obviously, as we continue to add more partners and 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, two 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 down the line. Even in Q1, when we came out with the first quarter profitability and the guidance, we, when we talk about the guidance that we gave, we were positioned for increased uncertainty. And, you know, that's how we sort of managed the current environment.
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. 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 point, we saw a few softening parts on the ability to spend, which is something that is less important for us. 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's that gonna look like and the tariffs impact, etc. As for now, the consumer is very stable.
From our perspective, we are actually looking to have stability. This is an important thing when you are trying to build over the cycle long-term companies. The year has progressed to be, I would say, strong in that regard. The ability to actually continue to propel the value proposition of Pagaya to the lenders, and a lot of things that we are going to touch about later about the private credit that we saw so many companies today speaking about it, and specifically 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.
You know, you touched on the consumer health a little bit. You know, some people out there think second look means low-quality borrowers. Is this purely second look, and what does your typical borrower look like? Could you maybe layer in, some bifurcation of, like, what you're seeing by cohort? You know, you're saying the consumer's strong, but, like, what are you noticing by low income, high income, or, you know, low FICO, high FICO?
Yeah. We start with just characterizing what is the typical borrower of Pagaya. It's sad to say, but they are very strong borrowers. Why 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. By all means, all of these numbers I'm quoting are for the personal loan. On the auto, it's a little bit lower, but in the same vein.
The point being is that a second look solution for different parts of banks could still be very strong financially borrowers. That is 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 are consuming other financial instruments. To make sure you are actually meeting their credit demand, to make sure they are staying in your ecosystem, is a very beneficial outcome. To your question, throughout 2021 and 2022, 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 two years back and with inflation sometimes hitting the ability to maintain that, the lower incomes are having a harder time to find real credit solution in our spaces. I think the full industry has shifted up in quality. Today we're seeing very strong results, not just for the last quarter, but, like, I would say anywhere from middle to late 2023. The consumer credit early delinquencies or cumulative net losses are rather stable.
I would wanna also not lose sight of the fact that while the secondary program obviously is a key product for Pagaya and 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 pre-screen product. This is in our ability to basically monetize the relationship that we have with existing partners. While we start with secondary product, we now have the ability to offer other products that are most like, like a first look type of product.
Okay. Just curious, you know, 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? Like what.
One word.
Just FICO? That's it?
Bigo. Regulation.
Okay.
That's it. The different pieces of what it costs to have a lower FICO, which again, lower could be 720, is the regulatory regime that exists. By the way, not to say it's good or bad. There are very many strong reasons why depositaries should stay super safe without the ability to endure any losses. 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. 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 short by nature like depositary institutions and 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, how do you use that to actually generate the operating leverage?
Yeah. So the operating leverage is a major differentiator of Pagaya relative to any of the other, typical, lending institutions. We do not 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, you know, 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, so 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. Ultimately, that's what made we how we managed to get to GAAP net income and profitability in this quarter. When you think about the year, you know, 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.
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 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 zero relevancy to the volume that you are creating through them.
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 there are nothing compared to the correlation that you will need to have if you were a consumer business that is just driving growth through marketing cost. That is the biggest differentiator from the top line to the bottom line of Pagaya that will stay a strong differentiator factor over the next few years as we build the company more.
Makes sense. 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, you know, fervor that private credit has had in recent years.
Yeah. We're now at, I guess, the best point that we have been in our history, both from a diversification perspective and optimization. Today, think about Pagaya, linking directly private credit to the loan originating system of the lenders. It comes in two 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 pre-funding ABS. Effectively, what that means is we go out, raise the capital from our investors, and then fill these ABS deals, which actually comes in at a slightly higher cost, but a significant way for us to mitigate and manage liquidity risk.
When you put that all in perspective, you know, 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 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. We're probably at the best time we have been from a diversification perspective, optimization, and overall cost of capital.
The one thing I wanna mention on that, 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, as small as $3 billion, and when they are trying to open a sleeve and to focus on private credit that goes into consumer credit assets, they do not have the technology capabilities to underwrite $10,000-$20,000 loans. It is impossible. They need, in their cost structure and their three-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 structures to be able to provide a market fits purpose type of a solution.
When you think about it, again, the ability to work with, and we announced a $2.4 billion forward flow with Blue Owl in the personal loan ABS, in, 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. 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 as a whole.
Have you noticed that, you know, those conversations are picking up more recently?
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 ours, which is Castlelake, together with Upstart that announced forward flow in scale. From there, I would say later last year to the start of this year, we saw many transactions that are mainly in between, you know, Upstart, ourself, and SoFi are the three leading categories and maybe Affirm, that have captured most of that share work.
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? You already spoke about that, but maybe just layer that in again.
Yeah. Maybe I will speak about the growth engines and then if you will take out the impact financials, etc. From a growth perspective, there are three major 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 that their customers will 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 pre-approved offer for this part of the 60 million customers is a huge potential growth for the future.
Next to that, building more of our models, tuning more of the stuff, 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, more lenders. We have now lended a top five bank, which is U.S. Bank. We have lended 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 than not, easier than many other initiatives that they could do.
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 that when you reduce them and you shrink them, your ability to approve many more customers is just the nature of the beast. We have three major growth engines or vectors of growth.
And maybe the last one I would put as the full is even when we have 31 partners, we have it with one specific product, and we have three. The ability to cross-sell to each is a very big opportunity. And maybe you wanna share a little bit how it's going to look on the financials and the funding side.
Yeah. The way to think about it, what you just heard is basically that we can grow in a way where we do not have to take on more risk. We are growing by adding more partners to the network, getting more application flow. If you think about that, without doing that with any risk, if you say, you know, we grow top line volume, call it, or revenues by 20% because of the operating leverage that we discussed before, effectively, today we are unrating $460 million or so of fees. 20% growth of that will effectively go straight to the bottom line. If you see that even 12 months out, that is a dollar per share on an EPS basis, and that is the power, the earnings power of the network. 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.
You know, you did recently just achieve GAAP profitability. It's been volatile on the way there. You raised some equity capital as well. Where are you today in being able to not only just self-fund but grow that profit more consistently? I know you just touched on some of the numbers there, but like, how do you keep that more consistent and stable?
Yeah. What we have done over the last 12 months is how we set out a financial strategy almost 18 months ago now to be GAAP netting and profitable and cash flow positive. We have achieved both of those things. 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 equity capital. We do not have any need of that. On top of that, what we did in the last year, we optimized the balance sheet. 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. 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. From here on, as we continue to grow, as I was saying before, any incremental growth, any 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. You know, it was under pressure in March and April. It's since rebounded. You've been able to grow revenues, achieve profitability. What do you think is driving this volatility? And is there a different way you think investors should be valuing your stock?
Yeah. Let me start an EPP for you, guys. 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. People saw losses that are happening across the industry, but specifically in Pagaya too, and said, "Wait, maybe the business model works or not." There was a question mark around that. Obviously, we knew that the business model is the right business model and has this operational leverage. 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.
In the first quarter of 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. 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 target to build something very, very powerful into the connectivity point between the private credit needs to deploy capital and the bank balance sheet that are pulling back.
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.
Yeah. I would say we definitely hit that turning point, and I think it's very obvious now to the marketplace. Last year, we were talking about operating leverage and the path to profitability. We delivered that in Q1 as a result of that. We were talking about the optimization and diversification of funding. We have delivered that. When you look at how we have grown, you look at how much of the loans, the application flow that comes in that we convert into actual funded volume, that has been very stable. We did not open up the credit box in order to get to that point. All of this is coming now together, and I think people are seeing that. I do feel, you know, we've passed that sort of turning point after Q1.
Obviously, a lot more work to do, but that consistent sort of discipline execution is what will set us apart.
Great. This all sounds great, but what, Gal, keeps you up at night? You know, 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. It's getting easier for a lot of the banks, maybe on the capital front. CFPB is a little bit, you know, out of the picture right now. Does that keep you up at night, or is there anything else you think?
Yeah. 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. That's not the case. I think there are two main pieces to point out. Call it as a fintech leader. I think when we looked on the 2021 and there was obviously very cheap money and a lot of money coming to the space, and there was big promise, etc. As a founder and a CEO of a company, it all looked so well for the industry. In hindsight, the over-volatility is not good. How much money was pulled in, people were not rational, and then pulled back, and then you need to face.
I think the one thing that keeps me up at night is the asymmetrical, potential volatility that we cannot expect. It is less about a recession or not in a second that will react to how we do it or not, but it is something that is gonna get all of us again chasing our tails and a lot of growth companies that spend very good years instead of looking on the long-term growth rather than looking on the very short term. The second piece is, look, we have a very unique opportunity to become a powerhouse.
It feels like we can, 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 gonna keep the eye on the ball and we're gonna execute as we should. We had a tremendous 18 months that we accomplished so much. If you can just replicate that to the future, I think we're all gonna be satisfied hitting that milestone and looking, on the long-term vision of Pagaya.
Maybe just in the last minute and a half we have here, you recently had some management change. Can you talk about the current team and maybe taking it 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. It 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 is here in the audience. We announced him as a co-founder too. He's coming with a very strong consumer credit background of understanding what is risk, what is enterprise risk, what is risk management. 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.
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 Citi alumni and many others. 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. We leave the audience with that.
Hey, on that note, sounds great, but thanks for coming, guys. Gal, EP, appreciate it.
Thank you so much.
Thank you for having us.