If there's one example of institutional investors' appreciation of the latest technology and its ability to benefit credit approvals, Pagaya Technologies' steady stream of asset-backed securities (ABS) offerings may be the one.
In the third quarter, Pagaya originated $2.1 billion in consumer loans through its bank and nonbank "partners," a 10% increase over the same period last year despite 2023's higher rates and uncertain economic and credit outlooks. Investors have readily stepped up to buy Pagaya's $6.3 billion in ABS issuance so far this year, the proceeds of which pre-fund auto, unsecured consumer and single-family-home loans sold through its partners' platforms. The fintech recently closed its fourth auto ABS deal this year, for $300 million, following a $700 million consumer loan securitization earlier in November.
Becoming a top securitizer of consumer loans in relatively short order—Pagaya was founded in 2016—indicates investors' approval of its business model and its technology-driven credit analysis and loan pricing. Pagaya works with a variety of lenders, recently announcing the integration of its personal-loan product with a top-five U.S. bank, and its auto product with a top four captive auto finance company.
Paul Limanni, Pagaya's chief capital officer, recently spoke to Asset Securitization Report (ASR) about what has driven the company's success in a year of uncertainty and volatile markets, its ABS strategy, and how its sophisticated technology, including artificial intelligence, drives its business.
ASR: What makes Pagaya attractive to lending partners?
Limanni: We work with existing lenders and they can use an API to ping pricing engines to provide a price to customers and originate the loans, and then sell them to a Pagaya financing vehicle. A large bank may want to grow its origination activity in the nonprime auto space or cross-sell different products, but that business may not sit efficiently on its balance sheet. We're a way to do that in a relatively riskless and capital efficient manner.
We've seen tremendous opportunity because of how macro volatility has caused competitors and lenders to shrink back.
ASR: How does Pagaya use the ABS market?
Limani: When you look at the $18 billion we've raised in total, that cash funds our origination partners over a short funding window. Pagaya has never securitized inventory risk; we've typically had a closed, 100% committed pool of capital that we fill [with loans] while raising the next pocket of money. So we don't operate a balance sheet.
ASR: What prompted Pagaya's origination growth this year?
Limani: We've seen tremendous opportunity because of how macro volatility has caused competitors and lenders to shrink back. When you don't run a balance sheet, you never have to worry about the market moving against your aggregate position. We're able to run a much tighter feedback loop of pricing because we're always raising pre-funded pools of capital. If the market moves we can move with it on the next transaction and be able to update risk pricing in real-time. That enables us to stomach a lot more of the volatility that causes others to hit the pause button.
ASR: Pagaya's recent consumer loan securitization was upsized significantly. What does that say about the consumer-loan market and Pagaya's approach?
Limanni: People are still debating what the economic outcome will be, but we're seeing a lot of investor interest where the market is today, and we see the market improving and potentially better pricing levels.
We offer investors what they want, and we're able to build sizable and commercially viable trades with rational and thoughtful cutoff points, attachments, spreads and yields. Predictability and thoughtfulness are really what gets these trades done. We bring smart structures that aren't too complex, with viable ratings, a good secondary market, and transparency into what's being purchased, so our many repeat investors can validate the investment decisions they made in the past and again today.
We know broadly how to make an asset manager or credit fund or insurance company happy with the type of exposure they're getting, so we try to give it to them using the greatest common denominator that fits everybody, and that way we can broaden our investor base.
ASR: That suggests investors must also be confident in Pagaya's underwriting.
Limanni: Our goal is to perform in line and frankly better than peers in each market. We market ourselves as a rational commercial structure that does what it's supposed to do. So when folks look at our 2023 originations, they can look back at the volatility of 2022 and whether those deals are performing as we said they would.
ASR: Pagaya markets itself as a fintech using AI to transform how banking partners approve and acquire customers. To what extent do you talk to ABS investors about the technology?
Limanni: We talk about it, but this market segment adopted sophisticated technology relatively early on as a viable form of underwriting. We're using AI techniques to quickly rank, order and filter data, and that's definitely been a selling point. At the end of the day, what matter's most to the ABS world is performance.
Everyone runs the same risks in terms of ongoing loan management, but if you price the asset correctly at the beginning, your tail outcomes will be a lot more manageable.
ASR: How does AI fit in, specifically?
Limanni: We work with some of the largest banks, and from a data standpoint within their regulatory constraints. However, AI lets us be incredibly efficient and fast at filtering out the noise and honing in on what needs to be changed or adjusted to improve credit performance. The result of that may be expanded lending, because we can see things others can't. However, a firm can't be pure technology or pure commercial business, and we try to find a happy middle ground.
ASR: What is Pagaya's outlook for the consumer lending market?
Limanni: I don't want to speak to the broader market, but as we look at what is coming through our technology and the assets we're originating, our portfolio has been resoundingly resilient over the last year. We're seeing delinquency levels and charge-off rates on transactions originated at the beginning of this year materially lower than where things were in 2022, and that has continued through this year.
We don't know how events will unfold, but we do know that the number one thing to get right is pricing loans appropriately at origination. Everyone runs the same risks in terms of ongoing loan management, but if you price the asset correctly at the beginning, your tail outcomes will be a lot more manageable.
ASR: How has Pagaya adjusted its lending criteria, given concerns about a recession?
Limanni: We've been looking for the right mix of borrowers that can stomach cash-flow disruption and volatility, and we're focusing on taking more of those bets than market-neutral bets.
ASR: Any adjustments to satisfy Pagaya's investors?
Limanni: We're constantly getting feedback from investors, and 2022 has been a year of higher capital costs for everybody. So it's not only getting base returns right for each part of the capital stack but making sure they feel comfortable with the risk they're taking in the downside scenarios. Every deal we do is effectively a new market-to-market on where yields, structures, and other deal factors need to be.
