Yahoo Finance

Gal Krubiner

Thank you, Jency, and good morning, everyone. I hope you had the chance to read our shareholder letter.
We delivered another very strong quarter. We beat our guidance on revenue and adjusted EBITDA with another record quarter on both metrics, and we're in line with our guidance on network volume. We're now at an annual run rate of approximately $1 billion in revenues, $400 million of FRLPC and $200 million of adjusted EBITDA. With the momentum we have delivered in the first half, we are raising our target range for FRPC percentage and our 2024 full-year outlook for revenues and EBITDA. EP will speak more to that in a moment.
I want to spend a minute now on another critical financial milestone we have achieved in the Q3. With the progress we are making on increasing profitability and getting efficient with our balance sheet, incremental volume growth is now making a positive contribution to the total cash flow. With this very important step achieved, I'm now more confident than ever that very shortly, we can self-fund future growth.
Let me turn now to our strategic priorities and how we execute on that. In short, everything we said we were going to deliver, we did. We are managing the business to deliver on our long-term ambition to be the extended credit platform for the US consumer lending industry, while being laser focused on getting cash flow and GAAP net income profitable in the near-term. We have three key priorities: number one, expanding the network to more top lenders; number two, adding additional funding capacity that limits the use of our balance sheet; and number three, improving unit economics.
Let me start with how we are growing our network with more of the largest lenders in the country. We met our target of adding two to four partners a year, five months ahead of schedule. We are building an enterprise relationship with OneMain Financial, the second largest personal loan originator in the country. The partnership is on track to go live in Q3. In addition, we have a top five bank in the onboarding process in point of sale. This will be the second top five bank partnering with Pagaya on point of sale. From my point of view, the main to join Pagaya network is accelerating compared to six months ago.
On point number two, improving capital efficiency, I'm very excited to share that we have signed our first forward flow agreement with Castlelake for $1 billion in personal loans. We are pleased to partner with one of the country's leading credit investor and expect this partnership to be a long-term and mutually beneficial one. We also got our first ever AAA rating on our personal loan ABS program. Both of these initiatives are reducing cost of capital and lowering the use of our capital to fund volume. In addition to that, last week we announced our upcoming acquisition of Theorem Capital, which will give Theorem investors access to new investment opportunities via the Pagaya network and diversify our funding sources.
Finally, on the third point, higher unit economics, our fee revenue-led production costs reached another record level with the increasing value we have delivered to our partners. And we took action to reduce operational expenses and streamline the business.
In summary, all of these actions are putting us on track to fulfill our long-term growth plan and get us to catch the positive and GAAP net income profitability by next year. I'm pleased with our performance and proud of our team execution.
With that, let me pass it to Sanjiv, who will speak on the longer term trajectory of our business, our operational priorities and our product program.

Sanjiv Das

Thanks, Gal, and good morning, everyone.
I want to spend a few minutes on how we are executing on the strategic priorities Gal just spoke about. I'll start with providing some context on our growth strategy, how we are reorganizing our business for success and provide some color on the funding and the consumer environment we are operating in. I will close with our product roadmap as we keep our eye on our future long-term vision.
We are accelerating our growth strategy by targeting enterprise lenders, where we can expand the Pagaya solution across consumer credit businesses in a single organization. We have clearly started demonstrating this with some of the largest enterprise lenders in personal loans, auto and point of sale.
For example, just this year, we expanded our enterprise relationship with U.S. Bank beyond their personal loans business to Elavon, which is their point of sale business, in literally one quarter. With LendingClub, we are now expanding our business from a secondary purchase program to our flagship personal loans program starting this quarter. And we just signed a new enterprise relationship with OneMain, which will begin with auto and move to personal loans in relatively short order.
Once the hard work of onboarding an enterprise relationship is done, extending it to other businesses within that enterprise becomes significantly easier and faster. We expect to replicate this strategy with the top five bank currently being onboarded in POS and with all other enterprise partners we bring onboard.
As we think about the key markets for future growth, point of sale is at the top of that list. Almost every conversation we've had with a big bank in the last 12 months has turned to POS and how Pagaya can help as a go-to-market enabler. We've already built the foundation of our point of sale product. As you know, we have a rapidly growing partnership with Klarna that we are in talks to expand.
We already mentioned Elavon, expected to go live by the Q4. We are onboarding yet another major bank in POS. And Pagaya has been selected to join Mastercard's Engage program as the only POS and credit partner. And we're already in initial conversations with bank and fintech lenders on the Mastercard network to partner on POS.
The growth potential in auto is also getting more apparent. The demand is strong, and our pipeline is growing. Auto market conditions are improving, and we are driving continued efficiency in our auto funding structures. The building blocks are in place to scale auto up more meaningfully over the next few quarters. We have signed several multi-year mutually beneficial exclusivity agreements with our partners, which extends and protects our fee arrangements.
At the same time, on the operational side, as you saw in June, we announced actions to streamline our organization. These actions are already delivering significant cost savings, and we are executing faster and creating more value for our partners.
Now, turning to the funding environment, as Gal mentioned, we delivered some major wins in our funding strategy, including signing our first forward flow agreement and getting a AAA rating on our personal loan ABS program. We added 22 new funding partners this year with strengthening demand. Private credit, insurance and pension funds are increasing deployment in consumer assets.
Consumer loan performance continues to show stable to improving trends. Personal loans 30 day plus delinquencies in our second half of 2023 vintages are down 40% to 50% versus peak levels in 2021. The positive trend is accelerating with delinquencies for early 2024 vintages down nearly 60% from 2021 peak levels.
On the auto side, 60-day-plus delinquencies for the first half of 2023 vintages are down 40% from peak 2021 levels. We see further improvement in second half of 2023 auto vintages with delinquencies down nearly 50% from peak 2022 levels. Despite this improving performance, we continue to keep a close eye on consumer health.
Finally, as we set the stage for future growth, we are building a product road map that will serve millions of our lending partner's customers. One example is our new pre-screen product. We are now in the process of testing pre-screen products with our partners that will provide firm offers of credit and deepen relationships on behalf of our partners with their existing consumers. Early results of these tests are extremely encouraging in terms of the high response rates. We expect new products we are developing to be a significant portion of our business in future quarters.
To close, given the strength of our pipeline and the momentum in our business, Pagaya is in a very strong position to deliver great results. I'm excited for what the future holds.
Let me now hand it over to EP to discuss our financial results.

Evangelos Perros

Thank you, Sanjiv, and good morning, everyone.
We spoke about our key financial priorities at the start of the year. Increasing unit economics, enhancing operating leverage and improving capital efficiency. I'm pleased to say we delivered on every single one of them. We grew FRLPC and adjusted EBITDA to record levels, reduced core operating expenses, signed the forward flow agreement and got our first AAA rating on our personal loan ABS program. All of these actions get us closer to reaching cash flow positive in 2025.
As Gal mentioned, we achieved a new milestone on this path. The most important step for Pagaya to become a cash generating business is to earn more fees on network volume than the capital we use to fund it. We reached that point in the third quarter. As we scale our volume the incremental cash we generate will offset operating costs to get us to total cash flow positive. And it's important to remember the capital we use for risk retention will come back as future cash flows as the security is mature.
Turning now to 2Q results, total revenue FRLPC and adjusted EBITDA hit record levels. FRLPC grew 49% far outpacing network volume growth of 19%. FRLPC as a percent of volume was above 4% for the first time in our history as a public company. We now expect FRLPC to be 3.5% to 4.5% of network volume for the remainder of 2024. While this number may fluctuate quarter to quarter with product, partner, and funding mix, this range is sustainable over time. FRLPC growth is translating directly to bottom line expansion as we stay focused on cost discipline to drive operating leverage.
Core operating expenses were 22% of total revenue in the second quarter compared to 28% in the prior year. We also executed $25 million of cost savings initiatives with a full-year impact to be recognized in 2025. We see room to drive even further efficiencies, especially in third party vendor and consultant spend.
Adjusted EBITDA is now run rating at $200 million on an annual basis with adjusted EBITDA margin above 20% for the first time since we went public. We reported operating income of $5 million. Net loss attributable to Pagaya was $75 million, impacted primarily by share-based comp and fair value adjustments.
Adjusted net income, which excludes the impact of these items was $7 million in the quarter. Share-based compensation expense amounted to $18 million. Interest expense of $22 million reflects both higher secured borrowings and the addition of our term loan facility in the first quarter. We see opportunities to lower interest expense in the coming quarters.
Net credit impairments of $58 million reflect two drivers: fair value adjustment on our risk retention assets and losses on whole loans from past deals. Both were related to older advantages in our portfolio. Operating cash flow was $15 million in the quarter, our fourth consecutive quarter of positive operating cash flow. Excluding the impact of whole loan losses, recognized in our G&A, operating cash flow would have been approximately $29 million.
I'm especially proud of our accomplishments to improve capital efficiency. Our new $1 billion forward flow agreement is expected to fund over 15% of our annual personal loan volumes. We expect to scale programs like forward flow and structured pass throughs to account for a more meaningful portion of our total funding over time. In our flagship ABS program, we've been delivering strong consistent performance, optimizing deal structures and increasing scale that led to our first AAA rating on our personal loan ABS program, which lowers both the cost of capital for investors as well as our risk retention requirements.
Now, let me close with our third-quarter and full-year financial outlook. Our outlook reflects a few key assumptions. We expect to remain prudent with our conversion rate, while continuing to expand our SFR platform. We will continue to manage our portfolio to direct capital to our most profitable lending channels. FRLPC is expected to range between 3.5% and 4.5% of network volume in the second half of the year. Our recent cost savings actions will continue to drive operating leverage with lower expected core operating expenses in the second half of the year. Finally, our outlook assumes no material change in the macroeconomic environment from where we stand today.
In the third quarter of 2024, we expect network volume to range between $2.3 billion and $2.5 billion. Total revenue and other income is expected to range between $250 million and $260 million and adjusted EBITDA to range between $50 million and $60 million. For full year 2024, we are narrowing our network volume outlook to range between $9.25 billion and $10.25 billion. We are raising the low end of our total revenue and other income range by $50 million to range between $975 million and $1.05 billion. After raising our adjusted EBITDA outlook range in June, we are raising the range by another $20 million on the low end to $180 million and by $10 million on the high end to $210 million to close.
We are proud of our performance in the second quarter as we deliver on our financial strategy, putting us in a strong position to achieve positive net cash flow and GAAP net income in 2025.
With that, let me turn it back to the operator for Q&A.

Question and Answer Session

Operator

(Operator Instructions) Sanjay Sakhrani, KBW.

Sanjay Sakhrani

So congratulations on getting to this important milestone of being able to self-fund your growth. Can you just elaborate a little bit more in terms of how you expect to utilize that? Do you feel like it takes care of all the opportunities in front of you? Or do you feel like you might still need to tap the markets from time to time?

Evangelos Perros

This is EP. Yes, we're very excited about the milestone we just hit where basically all our incremental volume is currently contributing positively to cash flow. In very simple terms, what that means is that the fees that we earn right now are higher than the capital that we're putting to work. So all what we need to do from now on is effectively cover operating expenses to get us to total cash flow positive.
And we have demonstrated that basically cost discipline is a core convenience of ours. We will continue to maintain very reasonable focus on expense discipline. And as volume grows from here on, that's the path to get us to total cash flow positive. Once we get to that point, everything all the growth going forward is going to be self-funded.

Gal Krubiner

And Sanjiv, it's Gal here. Just one point to add. And yes, this is taking into the consideration of all the things that we think we need to invest in, so new markets that we are building or other places that we are -- we'll need to lay more heavily. So this is a total number that you see on the full company level, if that makes sense.

Sanjay Sakhrani

Yes, it does. And then I wanted to just get more color on the Castlelake relationship. I think it's a good strategic partner. Maybe you could talk about the pipeline and how this specific funding commitment sort of factors into your expectations. I mean, is this incremental to what you were thinking or is it supplemental? Just trying to get a sense of that and sort of what the pipeline for additional partnerships are.

Gal Krubiner

Yes, sure. So this is obviously we're very excited about this agreement. And as we have said out, if we step back, one of the key pillars of our financial strategy is to drive capital efficiency. And by successfully executing transactions like this, we're on track to get to our capital needs to 2% or 3% over time that we have committed to.
And as we have said, I think deals like this forward flow or other structural pastures, which basically require minimal or no capital upfront is the path to get us to cash flow positive, which is significant demand from other parties as well to get into agreements like that and effectively gives us the ability to scale this program. And we also have the opportunity to expand this relationship going forward.

Sanjay Sakhrani

Let me ask one more question. I'm so sorry. Just we're hearing a lot about the choppiness in the macro backdrop and the state of the consumer. I'm just curious to get your views on what you're seeing.

Sanjiv Das

This is Sanjiv Das. So I would say that our experience in terms of the consumer performance has been -- that it's been quite stable. I think it's quite consistent with what we are seeing across the fintech closed loan environment. It all seems to be very consistent. We are, obviously, quite pleased with the performance of our own recent fintechs. They've done quite well -- in fact, improved in the case of auto quite significantly and stabilized in the case of personal loans.
Our broad thesis which has been validated is that while there is some softening in the consumer spend, their ability to repay seems to be relatively strong. And as we saw in the last quarter, as I said, our credit performance both in PL and auto is pretty much back on track. In fact, our delinquencies on auto in the recent fintechs has come down to its lowest level since 2022. We believe that rates or reducing rates will be a tailwind.
Having said that just broadly watching the consumer firmament, we are watching it very carefully and all the macro trends. And I know that we will adapt very quickly based on the depth of data that we get across all our asset classes, across our 30 partners. So we have a pretty good read on the consumer and can act pretty quickly.

Operator

Joseph Vafi, Canaccord Genuity.

Joseph Vafi

Great progress in the business here this quarter. Congratulations. Just wanted to maybe drill down a little on your forward flow agreement announcement. Just trying to get an idea first, maybe differences positives or negatives in FRLPC margin coming from funding via ABS versus forward flow? And then, just trying to figure out how you kind of orchestrate, which funding vehicles are funding, which loan volumes, how you kind a traffic cop all of that now that you've got different agreements in place? And I have a quick follow-up.

Evangelos Perros

So obviously, we're excited about this new agreement because it's aligned very much with our goal to drive capital efficiency, we have said that before there are two ways to achieve that one diversified our funding, as well as optimize our currents ABS program. When you think about this forward flow agreement and other funding mechanisms that we have, we basically that would cover call it, 20% or so of our current volume.
And this is in the form of funding that requires basically minimum or no capital requirements. And we expect to scale that program going forward to increasingly become more capital efficient. And that's basically the way we can also take the path to get to cash flow positive.
Overall, the forward flow agreement that we put in place is basically sort of based on market standards. The pricing will be reflected in FRLPC and our current direction of 3.5% to 4.5% of FRLPC going forward, already reflects those arrangements going forward.

Joseph Vafi

And then just, I mean, I guess it's the forward flow agreement is still relatively small compared to your ABS vehicles. Is there -- is it focused on funding specific loan categories or specific lending partners or is it just kind of broad based across your lending volume?

Evangelos Perros

Yes. This current agreement is across all our personal loan portfolio, but we do expect to grow as I said this program within the personal loan and also chase opportunities for some of the other asset classes as well.

Gal Krubiner

Maybe a word from the market. We do see a lot of demand for that type of assets. So it can be in a forward flow format or it can be in a pass through, as E.P. mentioned. But the reality is that the major credit shops post 2021 2022, while seeing the performance very much stabilizing and going to the right direction and actually very stabilized for over a year is bringing a lot of demand for that discussions.
We had conversations with many. Obviously, you want to land the right partners and the right programs that suit for that. But we see the same amount of interest from personal loan, on auto loans and on point of sale that this is a market that obviously we are growing a lot. So think about it as another way to fund the business with much lower upfront capital need that gives us flexibility in between the world of ABS, forward flow and few others.

Operator

Peter Christiansen, Citi.

Peter Christiansen

Glad to be the part of the roster here. Nice stuff on the partner expansion. One of the things that caught my attention was the pre-screening tool. Just curious if you could dig into that a little bit and if you can give us a sense you see that use case potentially expanding to other partners.

Sanjiv Das

This is Sanjiv. I'll take it. The way the pre-screen product works is it's essentially a firm offer of credit that we offer to our partners, existing customers on a programmatic basis. So today, if you really think about Pagaya's flagship product, we offer it to new consumers that come into our partners. Pre-screen is to the massive existing customer base that our partners have. And basically, what we do is effectively provide the Pagaya model for them to be able to expand that and offer that to their existing customers. So that distinction between new and existing is extremely important.
As you know, existing customers form the large part of our partners' portfolios. That has demonstrated huge results in some of the early work that we've done in terms of very strong response rates and very low acquisition cost. That allows us to basically offer an extended product to all of our partners. And so I would say pretty much the next phase of how Pagaya grows.
With all our 30 partner relationships, we will deepen these relationships in a very significant and programmatic basis. We have now been testing this with about three partners. Our ability to take it across the board to all of our partners is relatively straightforward and is turning out to be one of the most promising things in our businesses as we look forward to it.

Peter Christiansen

Then on the ABS issuance that you had where you achieved the AAA rating, how should we think about risk retention when you're trying to get issuance at this level of quality and the co-investment that's required?

Gal Krubiner

We're very pleased, obviously, with that outcome as we continue to optimize our ABS structure. Again, as a path for us to get to cash flow positive, I think what the AAA rating does very simply, it lowers the cost of capital for our investors and as a result, lowers the risk retention requirements that we have to put into these deals.
Now the way to think about it is on one side, you have an optimized ABS structure that calls for 5% or less risk retention combined with other structures on the floor and other pass-throughs. That's the path to get to a very low capital requirement 2% to 3% over time.

Operator

John Hecht, Jefferies.

John Hecht

Congratulations on all the positive developments. I guess a quick follow-up on the AAA rating question, I guess, how much of the stack does the AAA account for and what's the cost of capital or spread difference in AAA versus the prior rating?

Gal Krubiner

It's Gal here. I will take it. So in reality, basically 40% of the cap stack is now has moved from what we used to have as a AA to a AAA. You can think about it from a perspective of 50 basis points to 70 basis points of additional saving, because usually spreads around the AAA are hovering around 75 basis points, could be 120 basis points, 140 basis points depending on the structure and the situation.
So from that perspective, at least 75 basis points to 100 basis points above 40% is very meaningful from a cost of capital, et cetera. The more interesting piece, I think, is the fact that we now in the category of people that could do that. There are not that many originators in the US that will originate assets of our kind with the 680 FICO, et cetera, that will have a AAA. So we should think about cost of capital in the context of the asset, and that making us a very strong, large leading producer of the personal loan that will have.
Now, on the funding side, additional benefit, competitive benefit of reduced capital cost to be able to price borrow better, and therefore, obviously to expand what we can originate. The last point I will make into that is that percentage could grow over time. As you know, it's based on the multipliers of that. So we started with 30%, 40%, but we do expect over time, around 50%, 55% of the capital stack to become AAA. And therefore these are the next milestones from us on the page shelf as such.

John Hecht

And second question is, you've hit your target partner ad much earlier in the year than we expected. So maybe talk about partner pipeline and any kind of changes to the characteristics of what you're looking for at this point in time.

Sanjiv Das

Sanjiv, I'll take this. So you're right. We have announced our partner pipeline to be pretty strong, pretty early on. I would say that across the board in PL, auto and POS that pipeline has been extremely strong. But I will emphasize that POS has in fact been completely off the charts in terms of the demand that we are seeing there.
As I mentioned in my script earlier, almost every discussion we start with the bank, starts with point of sale. People are seeing that the BNPL business, which now has essentially evolved into a form of retail lending. So high ticket size, large ticket size, longer duration, purpose driven, generally around home improvement or medical or education, which is very consistent with our personal loans business is the one that's really, really, really taking on traction and in fact, is a large part of our entry strategy now with banks.
The second thing I'll mention is that our business has become very enterprise driven and it's intentional. So what we do is we enter either into the PL side and then expand into POS and then into auto, or we enter in through POS and then expand into PL or into auto. So that enterprise piece is very important.
As you know, onboarding some of these enterprises can take some time. It can take about in the case of us, 18 months. But once you were in, moving into Elavon, literally happened in one quarter. Once you get in, it's almost like a moat. So you've gotten in. The technology integration takes a long time, but once you're integrated, you're part of the system of the enterprise.
And that's very important. We saw that in U.S. Bank, we announced LendingClub. We'll see this with the top five bank we just announced and so on and so forth. And one main, it's absolutely heading in that direction as well. So we started with auto, now we expect to onboard PL by the end of the year, launch it by the middle of next year. So it's all moving in a very systematic way across asset classes through these enterprises.

John Hecht

And then just quick follow-up on that. I assume the -- is there anything to note on the FRLPC margin on POS versus the consumer loans?

Gal Krubiner

Yes, so on that one, obviously, POS continues to be an investment area for us and asset class that we expect to grow ultimately. Obviously, as you know, personal loan is a more mature asset class with the highest FRLPC. Our goal is to continue to grow the asset, asset classes like auto and POS and drive higher margin consistent with what we have done with personal loans, and we have the roadmap to get there over time.

Operator

Timothy D'Agostino, B. Riley.

Timothy D'Agostino

At a high level, what assets and resources does Theorem bring to Pagaya? Also, could you share your perspective with the problems you solve for OneMain?

Gal Krubiner

It's Gal. I will take it. So we are very, very excited about the combination and the purchase of Theorem. Theorem for us is a little bit of an asset management that is focusing on consumer credit. We've been in touch with them for the last few years on and off, and just recently we managed to come to a conclusion that forcing hands and the Theorem team joining the Pagaya team is actually the right way to do it, and to bring value for everyone.
In a very short way of describing it, the main rationale for the transaction is that now that Theorem is part of Pagaya. While they are going to work completely independent, both on their investment committee and their research fees, they will have a very big access to the Pagaya network, if you will. So you should expect going forward that their LP's will have now the ability to actually select assets from a much bigger and wider possibilities and opportunities. Hence, utilizing the network that we are building with the major partners that Sanjiv just spoke about across the US.
And on the other side, from a Pagaya perspective, it's obviously very interesting to us to have additional funding diversification that could see some interest in the assets that we are producing on a go forward basis. I would just make the last point that the team is going to stay here and going to take the lead on building Theorem and the asset management business in Pagaya. And we have very high expectations and hopes that could get to the billions of dollars of LP capital too.
From the OneMain perspective, so OneMain is a new partner on our network. As Sanjiv said, we have the enterprise concept and approach to this. We started with them on the auto loan, which they are trying to build and ramp up even bigger part of their auto loan platform, and we are part of that already right now. And as we're thinking about what the future holds with them, we are starting to work on getting on the PL side too, and the integration that is needed from that, in order to be able to help them approve more customers on that side too.

Evangelos Perros

I'd just like to supplement what Gal rightly pointed out in terms of the customers that OneMain has. I think it's well known that their customer segment is very consistent with Pagaya's. And so, the one big thing that we'll solve for OneMain, obviously, given their acquisition of foresight, which pretty much doubles their volume with a segment that's consistent with ours is that we allow enable them to scale even more. So OneMain is this is a very serious acquisition for OneMain, and they see us as a very integral partner in helping them scale.
The second thing I would add is that when you scale at that level, more than scaling your business, the ability to get more approvals at the dealer with Pagaya's extended credit box is extremely powerful. And so we've very, very significantly enhanced the value proposition for OneMain, just as we do with Ally and with many of our auto partners. The approval at the dealer point of sale is extremely important. And I would say those are the principal things that we solve for them on auto today and eventually the same thing on BL.

Operator

Thank you. Ladies and gentlemen, we have reached the end of question-and-answer session. I would now like to turn the floor over to Gal Krubiner for closing comments.

Gal Krubiner

To close, I want to say that I'm very proud of the team execution this quarter. Everything we set out we're going to do at the start of the year we have accomplished. Our network and value proposition to the US lending ecosystem is stronger than ever.
Thank you all for joining us today, and I look forward to our continued partnership.

Operator

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.