The Hidden Risks Lurking in Pagaya Technologies

Pagaya Technologies (NASDAQ: PGY), once lauded as a pioneering fintech company transforming consumer credit underwriting with artificial intelligence, is now facing intensifying scrutiny. Beneath the veneer of innovation lies a business model riddled with hidden risks, troubling conflicts of interest, and a deteriorating balance sheet. We believe that Pagaya is on an unsustainable path, and investors should be deeply concerned. As short sellers, our thesis is grounded in detailed research, and we urge all market participants to look beyond the company’s AI narrative and focus on the hard numbers and questionable practices driving this business.

The Promise That Masked the Reality

Founded in 2016 and listed on the Nasdaq in 2022 via an $8.5 billion SPAC merger, Pagaya presented itself as a disruptive force in consumer lending. Unlike traditional lenders, Pagaya partners with fintech platforms such as SoFi, Ally Financial, Klarna, and banks like US Bancorp to provide a “second look” at borrowers initially rejected for their poor credit profiles. Using its proprietary AI technology, Pagaya claims it can better assess risk and approve borrowers overlooked by its partners.

Pagaya’s platform is integrated directly into the underwriting systems of these lending partners. When a borrower is declined, Pagaya’s algorithm purportedly reassesses the application using alternative data sources and more sophisticated models. The borrower is never made aware of this second review.

Once approved, the loan is quickly securitized into asset-backed securities (ABS) and sold to institutional investors through pre-funded special purpose vehicles. These ABS transactions include senior and junior tranches. The senior tranches are safer, while the lowest equity tranches absorb first losses.

Pagaya earns nearly all of its revenue from fees collected during this process. In Q3 2024, 97% of its revenue came from transaction fees. It books this revenue quickly, without retaining long-term credit risk — on paper.

Artificial Loan Volume Growth

Pagaya’s model incentivizes loan quantity over quality. Since 2018, it has raised approximately $27 billion across 66 ABS transactions, including $9.6 billion in 2024 alone. Most of these loans are issued to borrowers already rejected by more conservative lenders.

This creates a dangerous cycle: more risky loans lead to more fees, regardless of repayment ability. Performance data suggests Pagaya’s AI is not unearthing hidden gems, but simply greenlighting applicants who are more likely to default. Delinquencies and charge-offs have been rising across multiple vintages, particularly in 2024.

As interest rates rise and credit conditions tighten, this strategy grows even more precarious. Pagaya’s volume-driven model may collapse under the weight of mounting defaults.

High-Risk Tranches Held Internally

Contrary to market perception, Pagaya has been offloading the riskiest ABS tranches into its own managed vehicle, the Pagaya Opportunity Fund. This self-dealing ensures ABS deals close, but it exposes fund investors to deteriorating assets.

To close ABS transactions, all tranches must be subscribed. Senior tranches are bought by institutions like BlackRock and GIC. But junior tranches — which absorb first losses — are often left to the Opportunity Fund.

This creates a massive conflict of interest: Pagaya benefits from fee collection while pushing toxic risk onto fund investors. Disclosures were limited, and as 2024 performance declined, Pagaya invoked redemption restrictions, locking up investor capital in side pockets.

Israeli media outlets revealed that investors controlling $100M of the fund had raised legal and regulatory concerns, citing hidden intra-fund transactions.

The Appearance of Third-Party Validation

Pagaya frequently cites BlackRock and GIC to suggest credibility. But these firms only participate in the safest ABS tranches. The market overlooks the critical role of junior tranches. Without buyers for the riskiest pieces — often Pagaya itself via its fund — deals wouldn’t close.

This gives the illusion of broad institutional support, when in reality, the most dangerous risks are borne by trapped fund investors.

Concealed Deterioration

Delinquencies and defaults in lower ABS tranches have been rising. In response, Pagaya reportedly repurchased delinquent loans to stabilize performance optics — but this merely shifts risk to its own balance sheet.

These repurchases are short-term optics fixes. They do not solve underlying credit issues, and they increase direct exposure to underperforming loans. If the ABS machine falters, Pagaya’s true risk profile could quickly unravel.

The Risks of Shorting Pagaya

Shorting is inherently risky. Here’s what could go wrong:

• Short Squeezes: Small float and hype can cause painful volatility.

• Strategic Investment: Capital injections from partners could buoy the stock temporarily.

• Credit Market Improvement: If delinquencies fall, sentiment could stabilize.

• Narrative Resilience: Pagaya might issue well-timed AI announcements to rekindle enthusiasm.

• Legal Settlements: Quiet settlements may prevent regulatory fallout.

Key Watch Items

• Earnings Calls: Track securitization volume, delinquencies, and capital raises.

• Redemption Trends: If fund redemptions spike, ABS issuance may suffer.

• Insider Activity: Sales or buys can signal internal confidence.

• ABS Ratings: Watch for tranche downgrades or opacity.

Conclusion: Proceed With Caution

Pagaya’s model, built on flashy AI promises, is kept alive by recycling risk through its own captive fund. The illusion of robust securitization is breaking as defaults rise and capital gets trapped.

This is a house of cards built on junk-rated tranches and fee incentives. We believe the risk is asymmetric — the upside limited, the downside substantial.

But timing matters. Stay informed, watch for shifts, and proceed with caution.

Being right too early can feel a lot like being wrong.

At the time of writing, $PGY is trading at $18.30