Pagaya Technologies Ltd. Q1 FY2024 Earnings Call

Good day, and welcome to the Pagaya 1Q 2024 Earnings Conference Call. 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.

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 earnings supplement and press release. With that, let me turn the call over to Gal.

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 5 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 a moment. 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. 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 clear proof that our strategy is working and that there is 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 base 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 detail 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 to build the right infrastructure and capabilities to put us on this path. The connectivity we built thus far, with 30 of the country's largest loan origination systems 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 adds 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 stronger and increasing the overall pool of economics we can share in. And we are growing new enterprise-grade lenders to the network, from top consumer banks 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 while 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. We are in advanced conversations now with several counterparties to execute forward flow and whole loan sale arrangements that could exceed $1 billion in total size. Based on our ongoing conversations 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 to new enterprise-grade lending partners. That has been and remains our North Star for our future growth and company potential. That will ensure that we have the foundation in place to achieve our ambition of becoming 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 to be an excellent tier of growth for Pagaya. Point-of-sale is the fastest-growing consumer credit market, far outpacing the growth of total consumer credit. 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 proposition is very strong. Why give your customer away when you can partner with Pagaya? The power of that value proposition is creating momentum for our future pipeline. As such, we are in discussions with several large payment businesses that we aim to integrate over the next 12 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. 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 loans, 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 to 18 months. Regarding our existing lending partners, we continue to deepen our relationships with them, 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 has 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.

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. 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 a 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 our 30-day delinquency rate, it's fair to say that in both personal loans and auto, Pagaya is already outperforming the market. 30-day delinquencies for 6-, 9-, and 12-month seasoned personal loans are at their lowest levels since April 2021, averaging 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 carefully monitor 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 8-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's 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 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.

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 a 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—which are more scaled and our highest margin product—continued 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 Revenue 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 scale 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 are 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 loans 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 reduce 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 $1 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 positivity. 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 the assets retained. We are 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 achieve positive net cash flow by early 2025. Moving on to our balance sheet and cash flow; as of March 31, our investments in loans and securities net of non-controlling interest, were $804 million. As a result of excess funding issuance, we added gross new investments in loans 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 by $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 issuances 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 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 positivity 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.

Please note that the first question comes from John Hecht with Jefferies.

Thanks for all the great detail on the call. You spent a lot of time on the capital efficiency going forward, and you talked about forward flow agreements and whole loan sales. Gal, you even cited maybe $1 billion in the pipeline and a 2% goal for the committed capital. I'm just wondering, are those $1 billion flow arrangements going to come into effect this quarter, or are these just developments over the course of the year? I'm just wondering about the cadence of how to think about this.

Hi John, it's Gal here. Thank you very much for your question. I think the way to think about it is we are very focused on these points, as you mentioned, and I did mention that in my previous remarks. The main thing to consider is the following: because we have such a vast majority of connections to the biggest asset managers in the world, we already have all the connectivity to the folks we are discussing with. So what we're just now focusing on is moving these relationships that have been, as you can imagine, very strong and robust on the ABS to lead to transactions that are both on the pass-through structures, which are making us retain a much smaller piece, and on the forward flow agreements that we are actually having with a few counterparties to be able to come to fruition in the very near future. We are now in the midst of negotiation, and we hope very soon we will be announcing this.

Okay, great. And then you had a lot of very big adds of partners on the lending front in the latter part of last year. I know there's an onboarding process and a ramp period that occurs. I'm wondering how those new partnerships are ramping relative to expectations.

Hi John, I'll take this. A couple of things. One is we talked about the new partners we onboarded last quarter, but we also mentioned the disciplined approach with which we monitor the volumes. There are a couple of things that I have looked at. One is I want to make sure that the quality of the flow is before we sort of turn on the taps completely. The quality of the flow is very carefully monitored, and that's what we are doing in the first quarter. We are watching for debt-to-income ratios, loan-to-value ratios, and those kinds of things as we bring on new partners to prepare for the flow. What I'm seeing so far is that the quality is quite good. The other thing is with some of these auto partners, obviously, as you know, we go dealer by dealer, and it takes a little bit of time to ramp it up. By the time we reach full potential, it's normally 6 to 9 months in terms of steady state, and we want to do this the right and disciplined way. Take the case of a different sector, like U.S. Bank, for example; we are seeing enriched customer data coming in. So we started to leverage that to see how we can continue to improve the quality of the flow. We are pacing ourselves before we ramp this up.

That's very helpful, and I appreciate the focus on the flow. My final question is about the point-of-sale verticals—it's becoming increasingly important and a good driver of growth. I'm wondering if you could maybe just give us the characteristics of the typical loan structure in that channel relative to, say, the installment loan business.

Yeah, John. Let me start by giving you the high level of how we think about it, and then Sanjiv will get into specifics and details. POS is definitely one of the frontiers for growth for us, mainly because today, literally all of the banks are looking to have that as a product. This is one of the areas where we have the strongest pipeline of partners, and banks are calling us and asking how we can help them accelerate their penetration into this market. This is a market that the banks were a little bit left behind in, and they want to keep up with the FinTechs. Pagaya, quite frankly, is perhaps the best solution that allows them to keep the customers and not give them away to anyone else while still offering that outcome. For us, it is clear why to partner with someone—you need to keep the customer when you can partner with Pagaya to retain them. So that's the thesis we have and the excitement that we see from the banks. The first piece that you can appreciate on the non-bank side is a typical pain for that exists out there, and there is some kind of progression or maturity into loans of around 6 to 12 months. Again, a very interesting play for Pagaya because we have so much knowledge and capabilities on the full personal spectrum. We come in as a natural add-on, helping the BNPL providers enhance their ability to collect fees by extending loans. Sanjiv, do you want to add anything?

Sure. I mean, look, as both of you said, the POS is indeed the fastest-growing sector in the consumer world. As a former banker, I know that when we were moving from personal installment loans to purpose-driven loans, the quality of the credit was substantially higher. There are three major categories where we are seeing this growth within POS: health, education, and home improvement. So those are the three major sectors where we are experiencing growth. The term structure is very similar to personal loans, which is why it fits Pagaya's model perfectly.

The next question comes from Joseph Vafi with Canaccord Genuity.

Great to see all the progress across partners, P&L, balance sheet, all facets of the business. Just to start, looking at the shareholder letter, it indicated that total application flow was up about 5%. But obviously, network volume was up more than application flow. I was wondering if you could drill down into underwriting in the quarter a little bit and what might have been driving the higher network volume versus application flow? And then I have a follow-up.

Yeah. Thanks for the question. I'll take that. So look, application flow continues to grow. As you mentioned, the value proposition of our product is quite unique. So as we add more partners, application flow will continue to grow, and has been doing that for the last few quarters. What we're doing is being very disciplined in our approach and focusing significantly more on the channels that will drive those with higher unit economics and drive higher FRLPC. As a result, those are the channels where we have more mature relationships. So that's why you would see effectively network volume growing at a faster rate than the application flow. Think about it as a higher conversion ratio for those types of channels that yield higher economics.

And Joe, maybe one additional point on this. If you think about it, as we move into stronger institutions that have a higher quality of flow, you will expect to see lower growth on applications, but every application represents a much more qualified borrower that we would like to lend to—so there is an inverse relationship here. As the company gets bigger, and therefore we are lending to more unique marquee partners, the ratio between the two is rather different.

Sure. That's great. That makes a lot of sense. And then secondly, I appreciate the movement to new funding sources to reduce net retention. I think that's a big positive here. Just wondering as you move to forward flows or other vehicles, is there a potential impact on the line in FRLPC upside from the investment side of the business?

No. Thank you for the question. We will continue to, as you have seen, accelerate the fee generation power of the business and improve the unit economics. Obviously, the diversification of the funding sources will allow us to lower the net retention of what we're keeping from the deals. But I think over time, we will continue to see that growth in FRLPC while we continue to diversify our funding sources. So overall, as we look forward, we do expect the FRLPC to range between 3% to 4%, in line with what we have provided in terms of guidance before.

The next question comes from Michael Legg with Benchmark.

Great results, guys. Question on the $1.9 billion raised. What was the cost of capital after fees and expenses for that?

Mike, it's Gal. The cost of capital for this transaction, think about it from an investment-grade perspective; it's trending below 7%. So it’s really robust and much stronger, lower cost of capital compared to what we had in the past and even a little lower than investment grade, something around 8%.

Okay, great. And then on the investment in loans and securities of the $800 million, do you have the tranches on that, like how many are from '23 issuances versus '21, '22? Do we have a breakout on that?

Yeah, I'll take that. The majority of what we currently have in the portfolio is driven by the 2023 and 2024 vintages, as previous vintages have mostly paid down or amortized. As we look forward, one thing I want to highlight is that in the recent transactions we did, what's important to remember is that the mix of the portfolio is shifting. In the last deal that we executed, we retained a much larger portion of the debt compared to the equity securities. The quality of the portfolio is improving, and this has two very positive implications. First, we are able to secure better financing because the debt can now support the paydown of the secured borrowings. More importantly, given the mix and quality of what we're retaining, it is expected to be accretive both to the P&L and the balance sheet overall.

Great. And then just last question. Just on the consumer. Are you seeing anything regionally or anything that gives indication of what you're seeing with the consumer?

Yes. So I just want to set the stage. Pagaya is in a unique place that can see, quite frankly, most of the consumer credit trends, the fact that we are connecting to over 30 originators gives us a very wide understanding of how these trends are actually happening. We have a very unique vantage point on that. What we are seeing, and I think you heard us talking about the 2023 vintages, especially on personal loans, as well as generally in consumer credit, there is a very steady environment already since the start of 2023. You did hear some different narratives with different earnings calls from other companies. We heard and saw a little bit of softening on the higher FICO type of borrowers. But from our perspective, it's driven primarily because of higher demand for these segments. As we think about it, people are migrating from the more average FICO to the higher FICO, leading to a bit of over-competition, resulting in slightly higher losses. We are not operating in that segment because we don't see the value there at the moment, and we are sticking to the lower 670 to 680 ranges. The performance there, as I've mentioned, has been very stable since 2023. We are hopeful and looking forward to continue to watch it closely as we move into 2024.

The next question comes from the line of David Scharf with Citizens JMP.

I had a general question about unit economics and how we ought to think about them evolving. There are obviously a lot of moving pieces associated with how rapidly you're growing both asset classes beyond personal loans as well as exploring new funding structures. Maybe a question for you, Evangelos. Personal loans are the most profitable product. Does the FRLPC margin change over time as you do more auto and more point-of-sale lending versus personal loans? And then on the funding side, do the fees from your capital markets partners change as you engage in more whole loan sales and forward flows? I'm just trying to understand how the business evolves; it may be considerably different mix, even just 12 months from now, which could impact the consolidated unit economics.

Great. Thanks for the question. We see very positive momentum on our FRLPC growth, right? I think it's actually faster than we expected, partly due to the value proposition we are offering to our lending partners and also because of our disciplined approach this year to focus on the higher fee-paying partnerships. As you pointed out, personal loans are now at 6% this quarter, which is the highest it has been in our history, up 300 basis points year-over-year. We believe we can achieve similar outcomes for auto and even POS over time. Obviously, these continue to be investment areas for us and a few years behind, let’s say, personal loans. But the playbook is the same, and we know we can achieve it in those verticals as well. Now to your question, generally as we look ahead, we have provided you guidance historically of FRLPC being between 3% and 4%, and even now this quarter, again, it's at 3.8%, which is at the high end of the range. It will always be a mix of new partners coming in at lower economics offset by higher fee-paying channels. So we feel very comfortable maintaining that 3% to 4%. Regarding funding, the capital markets fees remain stable; they don’t change significantly between the different products across ABS and other funding sources we are using. Over time, given our access to capital from our network of over 115 partners, we can achieve this new diversified source of funding while targeting an average 2% to 3% net retention over time across all verticals.

Got it. No, that's very helpful. And on the risk retention front, it sounds like you're in a lot of advanced discussions and making terrific progress there. As we think about modeling the balance sheet exposure, with that 2% to 3% of network volume target, do you have a timeframe in mind when you hope to achieve that? Is that as early as the end of the current year or is that a longer-term goal?

Yeah. The 2% to 3% is an average that we expect to achieve over time. We have actually demonstrated that in our history if you go back. What I would say is we're progressing very fast in diversifying our funding sources. We're already in discussions with multiple parties to execute on forward flow agreements or whole loan sales that could each lead up to $1 billion. I can't speak specifically on the timing, but overall, we're making progress throughout the year, and we do expect to see benefits from those arrangements for the remainder of the year.

Great. And if I can just add one quick product question. Specifically for Elavon, I know it's the old NOVA Merchant Solutions. It's one of the world's largest merchant processors. Are they actually providing point-of-sale loans currently? I wasn't exactly sure what the product set is at Elavon.

Hi David, I'll take this. The short answer is they are about to with the Pagaya solution. For example, we met with the BNPL POS lending head, and we know that is the direction they want to go in. As you rightly pointed out, they are a top 5 payment processor, and my background in banking demonstrates that the ability for a payment processor to add more value to the merchant at the point-of-sale is critical to them. We've been talking about very late-stage discussions, and we are obviously onboarding right now in terms of making sure that we fulfill their additional value proposition.

And David, as you can see, it's exactly what I mentioned when I spoke about POS. This is a great use case of someone who is looking to add capabilities within a bank context, looking to enhance their operations. We value this partnership highly, and they are a very good partner with substantial capabilities. Together with Pagaya, the potential to open this up and become a major business for them is quite appealing, not just to us but also to them.

The next question comes from Harold Goetsch with B. Riley.

My question is on the automotive channel. Could you just give us an update on the automotive partners like Ally and others and where they're at in their rollout by state or by a number of dealerships? And how is the overall auto business going for you?

Hi Har, it’s Gal. I will take this question. The auto loan space is something we've been working on a lot recently. We are focusing on completing the rollout with Ally; there are a few states left. With Westlake and others, we are continuously improving the product and finding the right places where we can add the most value. The auto loan business, in general, has been a little softer throughout the year, particularly from a funding perspective compared to personal loans. Therefore, as we maintain a disciplined focus on higher unit economics, as well as higher returns, we might shift more towards personal loans or other products while we see strengthening in different areas. This is a very good use case of how Pagaya is navigating both the long-term growth of lending to more partners and increasing network capabilities, while simultaneously managing the short-term goals of allocating capital efficiently.

Does that answer your question, Mr. Ward? We will move to the next question. The next question comes from Sanjay Sakhrani with KBW.

Hi. This is actually Steven Kwok filling in for Sanjay. Within the prepared remarks, you talked about further improving the unit economics and that you made some additional changes in the first two weeks of the second quarter. Could you just provide an update on where we are within the process? And then how does the benefit flow through? Do we see it on the take rate side, the production cost side, or both?

Thanks for the question. As we mentioned, our strategy is now to continue to be very disciplined while improving unit economics across the portfolio. What I wanted to highlight in the prepared remarks is we continue to take action, as we did in the early part of Q2, to further increase the fees as our value proposition to lenders continues to resonate. This will take effect over time, and we expect to see the full impact translate to higher FRLPC and be visibly felt in Q3, ultimately reflecting both in the take rate and the FRLPC rate.

If I may add to what EP just said, which is part of our remarks, I feel very, very confident in our pricing power today in the market. I believe we can deliver the FRLPC numbers that we are projecting for Q3. In many of our top five accounts, we have a dominant share of their business, and we are realizing that our ability to work closely with them to increase our pricing is actually very high.

This concludes our question-and-answer session. I would now like to turn the conference back over to Gal Krubiner for closing remarks.

Thank you. To close, I want to speak for a minute on our growing value proposition in the U.S. lending ecosystem. We have truly a unique solution for lenders in the U.S. that can add real value immediately. You're seeing this reflected in the additions of top banks and lenders to our network, the increasing fees we're earning, and the rapid pace of funding that we are bringing to our network. Thank you all for joining today, and I look forward to our continued partnership in the future.

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.