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Alternative Market Briefing

Now is a good time to invest in consumer loans

Thursday, August 27, 2020

Edward Mallon
B. G., Opalesque Geneva:

Now is an extremely attractive time to be a provider of capital and an investor in consumer credit, argues fund manager Pagaya Investments.

Consumer financing: a stable history

Pagaya's focus on consumer financing assumes a continuation of the sector's history of stable returns, especially since consumer financing covers more than half of the U.S. credit market.

"Most investors are unfamiliar with consumer credit - a resilient asset class with high yields and inefficient pricing," the managers argue.

The loans (home, student, car, credit cards, and personal) offer a high yield versus the risk, they are crisis resistant, of short duration, with low volatility and low correlation. Today, such loans have tighter underwriting standards, higher pricing, and good value in secondary trades. There is still a lot of dry powder in the current pandemic environment, they say. Furthermore, the impact of unemployment is very narrow. There is opportunity in new loan origination with higher spreads, less risky investors, and no competition.

Pagaya's CIO Edward Mallon will present in the upcoming Fixed Income Alternatives Strategies webinar on 9th September at 10 am EST.

Revolution through AI

Pagaya's investment process uses artificial intelligence (AI) to increase returns and mitigate risk. Whereas most investors will purchase rated bonds financing a portfolio of individual loans, Pagaya will purchase individual 3 to 5-year self-amortising personal loans. And whereas most investors will mitigate risk through the structure, Pagaya will mitigate risk through active underwriting, using AI to evaluate borrower's individual credit attributes (over a thousand attributes per borrower) and sensitivity to key economic factors. The result is a return profile in the high single digits, versus low to mid-single digits.

"Pagaya is one of the only asset managers in the world solely focused on using cutting-edge machine learning technologies and big data analytics to predict default rates and evaluate credit risk for borrowers in the U.S.," managing director Paride "Alex" de Calice tells Opalesque.

At the core of Pagaya's capabilities, he continues, is Pagaya Pulse, a proprietary independent underwriting system using advanced Machine Learning technologies, i.e. a model trained on actual performances of past loans, as well as traditional asset management considerations and soft logical considerations borrowed from the world of national intelligence. It is designed to maximize returns while mitigating risk in all market conditions.

Current opportunities in consumer loans

The impact of unemployment created a lot of opportunities for Pagaya and has not impacted their portfolio even though it has disproportionately impacted lower-wage earners, problematic industries (e.g. travel and leisure), and certain geographies. The firm's quant-based underwriting has proven to be highly effective, especially these days.

Furthermore, risk premiums have increased spreads by 300-500 bps in the consumer loans market, which is equal to 20 - 40% with tighter credit conditions. That means getting paid more to take less risk.

Finally, the disruption of capital markets has stranded assets on lenders balanced sheets. Using their quant-based approach, the managers can pick through assets and select those they believe to have the best risk-adjusted returns.

Current economic scenario

Most people expect a divergence of consumer behaviour in an economically stressful scenario, and anticipate that there will be a significant uptick in defaults and a deteriorated investment opportunity set.

Counterintuitively, Pagaya has found that this is not the case.

The bottom line, they say, is that consumer credit is a defensive, stable asset class throughout the business cycle.

According to Pagaya, during economic downturns, consumers behave rationally and seek to increase their availability of liquidity. They decrease expenditures, increase savings, and pay down debt. Indeed, according to a survey by Betterment, when consumers had an unexpected windfall of cash, such as the stimulus check, 61% of people used the money to save or pay off debt.

In downturns, the cost of capital also increases, which reduces access to capital. Consequently, there is less competition for those that remain capital providers. At the same time, lending standards are tighter during uncertain conditions. In fact, the net percentage of banks tightening standards for credit card loans has risen to 38.5%, the highest rate since mid-2009. Banks have also reported less supply of loans.

The result is a better selection of borrowers, due to tighter lending standards, along with higher pricing from a higher cost of capital and less supply of loans. It also means that there is a greater margin of safety for investors today.


Pagaya Investments is a data-centric manager based in New York and Tel Aviv, with about 100 employees (65% with a tech background). It was co-founded in 2016 by ex-UBS banker Gal Krubiner, former real estate entrepreneur Yahav Yulzari, former BlackRock managing director Ed Mallon and Talpiot program graduate Avital Paro. The board of directors includes Avi Zeevi (Viola Group), Harvey Golub (former American Express CEO) and Dan Petrozzo (Oak).

The firm has closed six ABS deals in the past year, accumulating over $1.5bn in AuM to package into collateral for investment securities.

Upcoming webinars:

Investor Workshop: The Keys to Asymmetric Returns
Time: Tuesday September 1st, 2020, at 10 am EST
Details and free registration here:

Fixed Income Alternatives Strategies
Time: Wednesday, September 9th, 2020, at 10 am EST
Details and free registration here:

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