Artificial intelligence (AI) is looking like more than a buzzword. Unlike other fads that have come and gone in recent years, AI is proving to have real-world impact, and investors are riding the trend. The stock of chip maker Nvidia, whose devices help power AI technology, is up 230% this year, while Amazon's cloud computing business is booming as it launches more generative AI services, and JPMorgan Chase is testing its own generative AI to assist with wealth management and customer service.
As with pretty much anything new and not fully tested, this could lead to incredible shareholder gains, or it could flop and take investor funds with it. Based on how things are going so far, the potential for high gains looks compelling, and investors shouldn't be deterred from taking a chance on some AI stocks that could explode.
Pagaya Technologies (PGY 7.33%) is a relative newcomer that uses AI to assist in credit evaluation and lending, and it's gaining momentum. It could skyrocket, and investors should stop and take a look.
A better way to asses credit
Pagaya operates a double-sided credit evaluation platform that uses AI to asses and approve loan applications. It works with banks, which run applications through Pagaya's software on the one side, and investors, who buy the loans as asset-backed securities (ABS) on the other side. AI is an integral part of the model, since Pagaya can run an application through tens of thousands of data points to get a more accurate portrait of a borrower's credit risk than the standard credit scoring system. That gets more loans approved without adding risk to the lender. It also provides constant new data to the system, which keeps refining itself to become even more accurate.
The company has several products and targets multiple types of loans like personal loans, auto loans, and credit card payments. Until recently, Pagaya worked with smaller credit partners, but it recently inked deals with several large enterprise partners that should create important new revenue drivers. It already works with well-known financial institutions like SoFi Technologies and Klarna's buy now, pay later services to assist in underwriting their loans. It also works with online bank Ally, which has a huge auto loan segment, in 41 states, and it just announced a partnership with what it called a "top-5 bank by assets" that it didn't name.
The top five largest U.S. banks by assets are, in order: JPMorgan Chase, Bank of America, Citibank, Wells Fargo, and U.S. Bancorp. This is a groundbreaking development, since it gives Pagaya exposure to billions of dollars in new loan applications to process. It's now integrated with 28 lenders in five markets.
Gaining momentum despite high interest rates
As Pagaya continues to post strong performance and successfully evaluate and sell loans, it's attracting interest from new enterprise partners on both sides of the business.
Despite the challenges posed by higher interest rates, which weigh on the lending industry, Pagaya is reporting higher revenue and increasing profitability. In the 2023 third quarter, network volume increased 10% over last year to $2.1 billion and exceeded company projections of about $1.95 billion. Point-of-sale application volume, which is a six-to-12 month product, doubled sequentially from the 2023 second quarter and increased by six times from the first quarter.
Revenue rose 4% to $212 million. One way the company measures its profitability is with a metric it calls revenue from fees less production costs, which increased 29% to $73 million, and improved by half a point as a percentage of network volume to 3.4%. That's within its target range of 3% to 4%, and it's highest margin in the past six quarters.
Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) swung from a $5 million loss last year to a $28 million profit and surpassed company estimates of $15 million. Pagaya reported positive operating income for the first time as a public company, and its net loss narrowed from $75 million last year to $22 million.
In this early growth stage, it will take time to become highly profitable, even if things go according to plan. Each time the company brings a new partner into the system, it goes through a multi-year process to retrieve and create accurate data points for the lender and maximize its capabilities. Management explained that the first year with a new lender is all about getting its products up and running, while the second year is ramping up throughout the network. Only in the third year, or expansion year, does it expect to increase volume. An investment in Pagaya right now is a bet on its future growth.
A massive market opportunity
Pagaya is expanding its business at an almost dizzying speed. Aside from the above-mentioned deals, Pagaya is now also working with Westlake Financial, which has 50,000 domestic auto dealerships. Its rental product Darwin is being used by three top real estate investment companies: BLVD Residential, My Community Homes (which is backed by investment firm KKR), and Rithm Capital
Management's medium-term ambition is $25 billion in loan volume, $1 billion in revenue from fees, and $500 million in EBITDA. It's aiming to make this happen through a three-pronged strategy: partnering with more and larger banks, increasing loan conversion rates through improving its AI technology, and improving its funding model by lowering costs and driving demand.
Pagaya says it's in talks with 80% of the top 25 U.S. banks, with 10 opportunities in banking and auto lending. These partners present an opportunity of $2 billion to $3 billion annually.
Finally, on the other side of the platform, it added six new investors recently for a total of 93. It's the No. 1 issuer of personal ABS loans in the U.S., and has raised $6 billion so far this year to fund its loans.
Only for the risk tolerant right now
There are currently five Wall Street analysts that cover Pagaya stock, and the lowest analyst price target is 62% higher than today's price. The highest is nearly 400%.
There's undoubtedly risk associated with any young company, and even more so with a company posting losses. Most investors would want to keep an eye on Pagaya at this early stage. But the potential here is huge, and risk-tolerant investors might want to follow the analysts and take a small bite.
