What happened

Shares of artificial intelligence (AI) credit platform Pagaya Technologies (PGY 7.33%) gained 90% in July, according to data provided by S&P Global Market Intelligence. The company announced several new rounds of funding even in this tight environment.

So what

It hasn't been easy to asses credit in this climate of rising interest rates. Pagaya operates a platform that assesses credit risk through AI and identifies more opportunities for loans without increasing the risk to lenders, similar to the popular stock Upstart. Its model includes generating funding from institutional investors to fund the loans it approves. As interest rates get hiked, there are fewer borrowers looking for loans, and the rate of defaulting on a loan naturally goes up. That makes it harder to approve loans, which impedes Pagaya's business.

This has all been playing out as expected, but the company still posted formidable performance in the 2023 first quarter. Revenue growth decelerated, but it still increased 9% over last year, with network volume up 12%. Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) was $2 million, down from $4.4 million last year. That was attributed to its acquisition of home-buying company Darwin. Net loss was $61 million, worse than $25 million last year. Adjusted net loss was $11 million, which mostly accounts for share-based compensation.

Pagaya still has a robust funding network that continues to grow. It's headquartered in Tel Aviv and operates the largest consumer credit fund in Israel, and it's the No. 1 issuer of personal asset-backed securities transactions in the U.S.

Pagaya announced two new deals in June and July for further funding, deepening confidence in its ability to execute in any environment. It now has paid funding through 2025, and its newest round of funding was the first-ever paid funding to receive a AA rating.

Now what

AI-based lending is still in its infancy. Pagaya's model appears to be working, but it's too early to say if it's going to truly disrupt the decades-old model of traditional credit scoring.

However, these models are testing their mettle in this unfavorable environment. That gives Pagaya both the opportunity to demonstrate that its model is better and the chance to improve its data in a hard environment. Management said that early-stage delinquencies on personal loan vintages from the 2022 fourth quarter are 55% lower than vintages from a year earlier, and they are outperforming the market benchmark. 

There's a lot to be excited about here, but there's plenty of risk as Pagaya carves out a spot in this new industry.