$PGY vs $UPST Are They Really Similar?
Ever since its public market debut in 2022, investors have been constantly comparing Pagaya Technologies Ltd. (NASDAQ: PGY) and Upstart Holdings, Inc. (NASDAQ: UPST) since they are both AI-driven fintechs. However, there is no merit to this comparison due to both fintechs’ drastically different business models. Upstart works directly with consumers to provide them access to unsecured loans, while Pagaya works with banks to improve their lending capacities. With interest rates not expected to fall anytime soon, Pagaya’s business model appears to be more immune to macroeconomic headwinds than that of Upstart which is why investors could make gains by going long on PGY stock and short on UPST stock.
PGY & UPST Fundamentals
Business Model
The core of this article is Pagaya’s and Upstart’s business models. While both companies are AI-driven fintechs, they operate in very different ways. Pagaya’s business model is a B2B2C model where its clients use its AI platform to go through their initially declined loan applications to find good loans among them. Then, Pagaya bundles these loans and sells them to institutional investors in the form of ABS or to private investors.
This is a win-win-win situation for all parties involved. First, borrowers get the loans they need. Lenders add new customers, while taking no credit risk, as well as getting the majority of the upfront fees. Finally, ABS investors have their risk spread out across different sectors and different lenders while receiving a better return on the ABS since they pre-fund the loans Pagaya’s AI includes in the ABS.
As such, Pagaya realizes revenue from 3 fees which are AI integration fees charged to its partners, execution fees which are loan markups before they are put into ABS structures in addition to other fees for packaging the ABS, as well as contract fees which are charged to the private capital Pagaya manages to purchase loans.
In comparison, Upstart deals directly with consumers by acting as an intermediary between borrowers and lending partners. However, since these loans are considered as “second look”, Upstart’s partners don’t retain all of these loans on their balance sheet. Instead, Upstart bundles these loans and sells them as ABS, but still retains some of them on its balance sheet as according to its latest Q3 earnings report, it held loans worth nearly $1 billion.
While this is similar to what Pagaya does to an extent, there is a major difference in how both companies operate. Pagaya’s ABS are pre-funded, meaning that in case its partners don’t want to hold these loans it wouldn’t be left holding them on its balance sheet. This isn’t the same with Upstart since if its partners don’t want to hold the originated loans it is left holding them before bundling them and selling them as ABS. This is risky for a company with a weak balance sheet like Upstart as in case there’s a low demand for its loans, it would be burdened with the credit risk of these loans, unlike Pagaya which carries almost zero balance sheet risk.
Who Has The Better AI?
When it comes to each company’s AI, the results paint a good picture of who has the better capabilities. Pagaya is currently the number one personal loan ABS issuer by issuance size in the US as it raised more than $18 billion in ABS transactions since 2018 and $12 billion since 2012. In fact, its last four ABS issuances were oversubscribed by an average of 2 times, meaning that demand for its ABS was more than the available units. Furthermore, it added 6 new investors to its network since August, 2 of which have more than $400 billion in assets under management. This is a great indicator of the quality of Pagaya’s AI decisions as investors are rushing to pre-fund the loans processed through its platform without knowing the nature of the loans that will be included in the ABS.
Meanwhile, demand for Upstart’s ABS appears to be softening. In the 9 months ended September 30, the fintech reported that 53% of its loans were sold as ABS to institutional investors. This figure pales in comparison to 65% over the same period last year. Although Upstart bulls may attribute this to the worsening macroeconomic conditions, why are institutions still showing confidence in Pagaya’s ABS, knowing that they are pre-funded?
Another factor to consider is each fintech’s partners. Upstart’s largest partner is New Jersey-based regional bank Cross River Bank. Meanwhile, Pagaya just onboarded a top 5 US bank in terms of assets into its network along with a top 4 OEM captive finance company by US vehicle sales. The fintech is also in discussions with 80% of the top 25 US banks and has more than 10 opportunities across banks and auto captives that are in the later stages of business case development and onboarding.
The next factor in determining which AI is better is delinquencies. In the nine months ended September 30, Upstart’s charge-offs increased a staggering 53% YoY from $70.8 million to $108.1 million. At the same time, the fintech’s management shared in the Q3 earnings call that half of its auto loan book is taking on excess defaults and expects this to persist in Q4 as well.
However, Pagaya was quick to react to the macro headwinds by developing newer AI models that improve pricing by focusing on reducing delinquency rates which translates to higher returns for every incremental unit of underwritten risk. For instance, the company introduced an updated credit model in Q3 in its personal loan product that could lead to up to a .5% increase in annualized asset return. Therefore, it is no wonder that Pagaya was able to attract the top 5 bank and the top 4 OEM captive finance company to its platform in Q3. As such, it becomes clear that Pagaya takes the lead in terms of its AI capabilities.
Navigating Through Macro Headwinds
Based on both fintechs’ business models and AI capabilities, it is safe to assume that Pagaya is built to thrive in the current macro environment, while Upstart would only be able to rebound if macro conditions improve. In fact, looking at each company’s latest earnings call is enough to see the difference between both of them.
“Our ability to approve borrowers in this environment has remained the constraint on platform growth for most of the past quarter. On the funding side of our business, banks continue to manage balance sheets conservatively and seek to unwind existing asset positions in secondary markets.
Our underwriting of primer higher income borrowers has become more conservative over this past quarter, as their loss rates accelerate and converge with the broader default trends across the borrower spectrum. This has been a headwind for our volumes and fee revenues over this past quarter versus our contemplated guidance.”
UPST’s management in the Q3 earnings call.
“Our business is also benefiting from two structural macro tailwinds. First, banks are tightening their lending standards, pulling back on new originations as they face tight liquidity conditions, and increasing regulation. Additionally, private credit is increasingly stepping in the excess capital to deploying traditional banking assets.
Given Pagaya’s position in the ecosystem, we can offer an attractive solution to both lending institutions and asset managers. If these trends continue, all else being equal, we expect they will be supportive to our growth in the near term.”
PGY’s management in the Q3 earnings call.
The reason behind both tones is due to their vastly different business models unlike what many investors think. Since Upstart directly deals with borrowers, it has to maintain a marketing presence so that more borrowers would use its platform to receive their loans. Meanwhile, Pagaya doesn’t have to rely on marketing spend to increase its exposure. In fact, its marketing costs declined 56% YoY in the 9 months ended September 30th from $90.2 million to $40.1 million.
Instead, Pagaya relies on its partners’ customer acquisition costs since if more borrowers apply for loans at its partners, more loans would be processed through its platform. So for Upstart to grow, it has to increase its marketing spend, while Pagaya wouldn’t have to do so.
But even if Upstart ramps up its marketing efforts, its volume would still pale compared to Pagaya. In Q3, Upstart had an application volume of nearly $13 billion, and with a conversion rate of 9.5%, its transaction volume was $1.2 billion. On the other hand, Pagaya evaluated applications worth more than $182 billion in Q3, and its network volume was $2.1 billion at a very low conversion rate of less than 1%.
The difference in volume is simply incomparable. If Pagaya’s conversion rate increases once the macro conditions improve, its network volume could grow substantially which is why it might be better positioned to capitalize on any macro improvements in 2024.
Risks
It goes without saying that there are risks for any investment. The risk facing the bearish thesis on UPST stock is that since it is heavily impacted by macro conditions, its outlook may improve if the Fed starts cutting interest rates earlier than expected. Analysts expect this to happen in the second half of 2024, but if the upcoming CPI print shows that inflation is approaching the Fed’s 2% target, it could be a sign that rate cuts may be sooner than expected.
As for the bullish thesis on Pagaya, the main risk would be competition. Currently, there’s no platform similar to Pagaya. However, if large banks invest more funds into developing AI software, it could limit its revenue growth potential as it mainly depends on attracting major banks that process a huge number of transactions.
Technical Analysis
PGY stock is in a bearish trend as it is trading in a downward channel. Looking at the indicators, the stock is below the 200, 50, and 21 MAs which is a bearish sign. Meanwhile, the RSI is neutral at 40 and the MACD recently turned bullish.
As for the fundamentals, PGY is benefiting from the current macro conditions as banks are tightening their lending requirements, meaning that more applications are processed through the company’s platform. With that in mind, the company will also benefit greatly from improved macro conditions as its conversion rate could increase from the current low levels of below 1% which would translate to more revenues. As such, bullish investors could find the range between $1 and $1.2 a good level to build a long position.
PGY & UPST Forecast
In summary, there is a misconception among investors that Pagaya and Upstart are competitors. As is, Upstart is mainly dependent on macro conditions as shown by its financial performance during this credit cycle. Meanwhile, Pagaya’s business model is more immune to macro conditions since it depends on its partners processing loans through its platform. Although both companies’ moat is their respective AI models, Pagaya’s is showing signs indicating that it is better performance-wise given the strong demand for its ABS compared to Upstart which shows that investors are more confident in Pagaya’s loans. Although improving macro conditions will benefit both companies, Pagaya has the potential to benefit more than Upstart due to its business model, which is why investors may find it profitable to go long on PGY stock and short on UPST stock.
PGY & UPST Fundamentals
Business Model
The core of this article is Pagaya’s and Upstart’s business models. While both companies are AI-driven fintechs, they operate in very different ways. Pagaya’s business model is a B2B2C model where its clients use its AI platform to go through their initially declined loan applications to find good loans among them. Then, Pagaya bundles these loans and sells them to institutional investors in the form of ABS or to private investors.
This is a win-win-win situation for all parties involved. First, borrowers get the loans they need. Lenders add new customers, while taking no credit risk, as well as getting the majority of the upfront fees. Finally, ABS investors have their risk spread out across different sectors and different lenders while receiving a better return on the ABS since they pre-fund the loans Pagaya’s AI includes in the ABS.
As such, Pagaya realizes revenue from 3 fees which are AI integration fees charged to its partners, execution fees which are loan markups before they are put into ABS structures in addition to other fees for packaging the ABS, as well as contract fees which are charged to the private capital Pagaya manages to purchase loans.
In comparison, Upstart deals directly with consumers by acting as an intermediary between borrowers and lending partners. However, since these loans are considered as “second look”, Upstart’s partners don’t retain all of these loans on their balance sheet. Instead, Upstart bundles these loans and sells them as ABS, but still retains some of them on its balance sheet as according to its latest Q3 earnings report, it held loans worth nearly $1 billion.
While this is similar to what Pagaya does to an extent, there is a major difference in how both companies operate. Pagaya’s ABS are pre-funded, meaning that in case its partners don’t want to hold these loans it wouldn’t be left holding them on its balance sheet. This isn’t the same with Upstart since if its partners don’t want to hold the originated loans it is left holding them before bundling them and selling them as ABS. This is risky for a company with a weak balance sheet like Upstart as in case there’s a low demand for its loans, it would be burdened with the credit risk of these loans, unlike Pagaya which carries almost zero balance sheet risk.
Who Has The Better AI?
When it comes to each company’s AI, the results paint a good picture of who has the better capabilities. Pagaya is currently the number one personal loan ABS issuer by issuance size in the US as it raised more than $18 billion in ABS transactions since 2018 and $12 billion since 2012. In fact, its last four ABS issuances were oversubscribed by an average of 2 times, meaning that demand for its ABS was more than the available units. Furthermore, it added 6 new investors to its network since August, 2 of which have more than $400 billion in assets under management. This is a great indicator of the quality of Pagaya’s AI decisions as investors are rushing to pre-fund the loans processed through its platform without knowing the nature of the loans that will be included in the ABS.
Meanwhile, demand for Upstart’s ABS appears to be softening. In the 9 months ended September 30, the fintech reported that 53% of its loans were sold as ABS to institutional investors. This figure pales in comparison to 65% over the same period last year. Although Upstart bulls may attribute this to the worsening macroeconomic conditions, why are institutions still showing confidence in Pagaya’s ABS, knowing that they are pre-funded?
Another factor to consider is each fintech’s partners. Upstart’s largest partner is New Jersey-based regional bank Cross River Bank. Meanwhile, Pagaya just onboarded a top 5 US bank in terms of assets into its network along with a top 4 OEM captive finance company by US vehicle sales. The fintech is also in discussions with 80% of the top 25 US banks and has more than 10 opportunities across banks and auto captives that are in the later stages of business case development and onboarding.
The next factor in determining which AI is better is delinquencies. In the nine months ended September 30, Upstart’s charge-offs increased a staggering 53% YoY from $70.8 million to $108.1 million. At the same time, the fintech’s management shared in the Q3 earnings call that half of its auto loan book is taking on excess defaults and expects this to persist in Q4 as well.
However, Pagaya was quick to react to the macro headwinds by developing newer AI models that improve pricing by focusing on reducing delinquency rates which translates to higher returns for every incremental unit of underwritten risk. For instance, the company introduced an updated credit model in Q3 in its personal loan product that could lead to up to a .5% increase in annualized asset return. Therefore, it is no wonder that Pagaya was able to attract the top 5 bank and the top 4 OEM captive finance company to its platform in Q3. As such, it becomes clear that Pagaya takes the lead in terms of its AI capabilities.
Navigating Through Macro Headwinds
Based on both fintechs’ business models and AI capabilities, it is safe to assume that Pagaya is built to thrive in the current macro environment, while Upstart would only be able to rebound if macro conditions improve. In fact, looking at each company’s latest earnings call is enough to see the difference between both of them.
“Our ability to approve borrowers in this environment has remained the constraint on platform growth for most of the past quarter. On the funding side of our business, banks continue to manage balance sheets conservatively and seek to unwind existing asset positions in secondary markets.
Our underwriting of primer higher income borrowers has become more conservative over this past quarter, as their loss rates accelerate and converge with the broader default trends across the borrower spectrum. This has been a headwind for our volumes and fee revenues over this past quarter versus our contemplated guidance.”
UPST’s management in the Q3 earnings call.
“Our business is also benefiting from two structural macro tailwinds. First, banks are tightening their lending standards, pulling back on new originations as they face tight liquidity conditions, and increasing regulation. Additionally, private credit is increasingly stepping in the excess capital to deploying traditional banking assets.
Given Pagaya’s position in the ecosystem, we can offer an attractive solution to both lending institutions and asset managers. If these trends continue, all else being equal, we expect they will be supportive to our growth in the near term.”
PGY’s management in the Q3 earnings call.
The reason behind both tones is due to their vastly different business models unlike what many investors think. Since Upstart directly deals with borrowers, it has to maintain a marketing presence so that more borrowers would use its platform to receive their loans. Meanwhile, Pagaya doesn’t have to rely on marketing spend to increase its exposure. In fact, its marketing costs declined 56% YoY in the 9 months ended September 30th from $90.2 million to $40.1 million.
Instead, Pagaya relies on its partners’ customer acquisition costs since if more borrowers apply for loans at its partners, more loans would be processed through its platform. So for Upstart to grow, it has to increase its marketing spend, while Pagaya wouldn’t have to do so.
But even if Upstart ramps up its marketing efforts, its volume would still pale compared to Pagaya. In Q3, Upstart had an application volume of nearly $13 billion, and with a conversion rate of 9.5%, its transaction volume was $1.2 billion. On the other hand, Pagaya evaluated applications worth more than $182 billion in Q3, and its network volume was $2.1 billion at a very low conversion rate of less than 1%.
The difference in volume is simply incomparable. If Pagaya’s conversion rate increases once the macro conditions improve, its network volume could grow substantially which is why it might be better positioned to capitalize on any macro improvements in 2024.
Risks
It goes without saying that there are risks for any investment. The risk facing the bearish thesis on UPST stock is that since it is heavily impacted by macro conditions, its outlook may improve if the Fed starts cutting interest rates earlier than expected. Analysts expect this to happen in the second half of 2024, but if the upcoming CPI print shows that inflation is approaching the Fed’s 2% target, it could be a sign that rate cuts may be sooner than expected.
As for the bullish thesis on Pagaya, the main risk would be competition. Currently, there’s no platform similar to Pagaya. However, if large banks invest more funds into developing AI software, it could limit its revenue growth potential as it mainly depends on attracting major banks that process a huge number of transactions.
Technical Analysis
PGY stock is in a bearish trend as it is trading in a downward channel. Looking at the indicators, the stock is below the 200, 50, and 21 MAs which is a bearish sign. Meanwhile, the RSI is neutral at 40 and the MACD recently turned bullish.
As for the fundamentals, PGY is benefiting from the current macro conditions as banks are tightening their lending requirements, meaning that more applications are processed through the company’s platform. With that in mind, the company will also benefit greatly from improved macro conditions as its conversion rate could increase from the current low levels of below 1% which would translate to more revenues. As such, bullish investors could find the range between $1 and $1.2 a good level to build a long position.
PGY & UPST Forecast
In summary, there is a misconception among investors that Pagaya and Upstart are competitors. As is, Upstart is mainly dependent on macro conditions as shown by its financial performance during this credit cycle. Meanwhile, Pagaya’s business model is more immune to macro conditions since it depends on its partners processing loans through its platform. Although both companies’ moat is their respective AI models, Pagaya’s is showing signs indicating that it is better performance-wise given the strong demand for its ABS compared to Upstart which shows that investors are more confident in Pagaya’s loans. Although improving macro conditions will benefit both companies, Pagaya has the potential to benefit more than Upstart due to its business model, which is why investors may find it profitable to go long on PGY stock and short on UPST stock.
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