After merging with and going public through a special purpose acquisition company (SPAC), artificial-intelligence-driven lending platform Pagaya Technologies (PGY 3.06%) started trading independently on June 23, and what a wild ride it has been.

The stock fell to $2.42 in the middle of July and now has shot up to almost $30.50 per share and a roughly $20.6 billion market cap. The reason has been an incredibly low public float revealed in its recent registration statement, which led investors to take advantage as they have on so many post-SPAC companies in an effort to drive the price higher.

But given that this move has nothing to do with fundamentals, is the stock actually a buy?

The business model

Pagaya is part of the burgeoning fintech ecosystem and is a lending platform that essentially serves as the middleman for consumers, fintechs and banks, and institutional investors. Using artificial programming interfaces, Pagaya enables consumers to access credit, banks, and fintechs to increase their customer base and earn fee income, and institutional investors to generate healthy returns.

Person looking at computer.

Image source: Getty Images.

Pagaya partners with various banks and fintech companies including LendingClubSoFi Technologies, Prosper, and Upgrade. In many cases, although not all, these partners will send certain loan requests to Pagaya, which can do the underwriting using artificial intelligence -- the company had 16 million training points as of September 2021. If the loan is approved, the partner bank originates the loan and Pagaya then pairs it with an institutional investor such as an asset manager or pension fund on the other side of its network. Pagaya is currently originating personal loans, auto loans, and mortgages, but is planning to get into the credit card, point-of-sale, and insurance segments as well.

Here's how a personal loan goes through the Pagaya platform: A consumer would come to a Pagaya banking partner for a personal loan. The partner would kick the loan request to Pagaya, which would underwrite and price the loan. Even though Pagaya is doing the underwriting, the consumer would see the loan being issued by the banking or fintech partner, which is important for the partner because it can leverage that consumer relationship in other ways and potentially cross-sell other products. 

Once the loan is issued, Pagaya then facilitates the sale of the loan from the banking or fintech partner to institutional investors, which are buying and funding the loan. Pagaya also relies on the securitization markets to offload loans so it can operate in a capital-light manner. As explained by CEO Gal Krubiner at a conference at the end of last year, if a loan has an annual percentage yield (APY) of 14% to 16%, which was common during the zero-interest rate environment in 2021, the investor can expect to make a 5% or 6% return. Pagaya gets a fee of around 8% to 9% and gives about 30% to 40% of that fee to its banking partners for originating the loan and continuing to service it.

An effective business being manipulated

Pagaya has an interesting business model. At the end of the second quarter of 2021, network volume on Pagaya had achieved a run rate of $4.7 billion annually. The company also has a massive total addressable market of roughly $4 trillion.

And the company does seem to offer an interesting value proposition for multiple parties. Its technology allows consumers to efficiently access credit and in some cases can help borrowers who may not have qualified under traditional credit scoring metrics access loans. Institutional investors are easily paired with loans that meet their risk appetite and return thresholds. Bank and fintech companies can generate fee income without taking on balance sheet risk and increase the number of new customers coming into their ecosystem. For instance, in the fourth quarter of 2021 SoFi leveraged its partnership with Pagaya to generate 7,700 referred loans.

But right now, shares are simply being manipulated. The company has a tiny public float right now, which is why the stock price has exploded over the last two weeks. After a SPAC announces its planned target, investors often have the option of redeeming shares for the net asset value price of the SPAC if they don't like the target. That can leave a small float because existing shareholders like the SPAC sponsors, company founders, and other investors are locked up from selling their shares for a certain period after the close of the combination. According to Yahoo! Finance, of the nearly 459 million outstanding shares, only about 308,000 are available to trade. Eventually, though, the lock-up period will end and more shares will flood the market.

Credit and funding issues

From an operational standpoint, there are other issues as well. As has been noted by other fintech companies that sell loans to institutional investors, funding is drying up as interest rates have soared. Higher rates increase the cost of capital for institutional investors, which in turn leads them to request higher returns on the loans. That generally dampens volume because Pagaya will likely have to charge higher APYs that some borrowers don't want to pay and other borrowers will no longer qualify for loans.

Finally, investors may have concerns about credit quality. In a recent report from the Kroll Bond Rating Agency (KBRA) on past Pagaya asset-backed securities, cumulative net loss (CNL) rates on several vintages from 2021 are exceeding the KBRA's initial expectations at this point in time.

Furthermore, the KBRA increased its CNL assumptions for Pagaya's most recent $360 million asset-backed security to a midpoint range of 16.05%. The previous securitization had a CNL assumption of 13.55%. This is mostly due to the fact that government stimulus programs have all but ended and many experts expect economic conditions to get more difficult and put more pressure on the consumer.

Is Pagaya stock a buy?

Pagaya has launched an interesting business model that I do find somewhat intriguing. But right now the stock is being manipulated by retail traders taking advantage of the small float, which won't last.

Furthermore, I see operational issues because the company is too reliant on the capital markets for funding, which typically doesn't end well in a rising-rate environment, as seen by a similar company, Upstart Holdings, this year. The company will need to figure out a way to become less reliant on the capital markets. Furthermore, KBRA reports also show that credit quality has started to deteriorate, so Pagaya needs to further prove out that its artificial intelligence underwriting technology can hold up in a more difficult economic environment.

In 2021, Pagaya lost more than $91 million and generated revenue of nearly $475 million. That means the company trades at more than 43 times 2021 revenue. Considering the manipulated trading and the fact the company is in a very difficult environment, I would avoid the stock right now. The company may merit consideration if and when the stock price falls.