ZestCash Inc., a lending startup co-founded by a former Google executive, uses technology it likens to Google's search analytics to perform loan underwriting for the underbanked, ranking hundreds of pieces of consumer information.
Douglas Merrill, Google Inc.'s former chief information officer, co-founded the alternative lender ZestCash, of Los Angeles, which went live in October 2010. Rather than rely on a traditional credit score, which depends on credit information that is not normally relevant to the underbanked, Merrill says the company uses proprietary technology to search hundreds of pieces of consumer information, including rent and prepaid phone payments. It also looks at traditional items like bankruptcy filings and credit cards.
Consumers are then ranked for credit-worthiness, and ZestCash makes its decision.
"The underbanked have very little data in their credit bureau files, so a FICO can't work," Merrill says.
The difficulty in underwriting small loans to the underbanked has been used as a justification for the huge interest and fees charged to such borrowers. Banks used to be involved in this space, calling their loans "industrial loans," to bypass state usury laws, says Steve Ledford, a partner with Novantas LLC of New York. But they largely abandoned the space in the 1980s because the loans were so difficult to underwrite.
Payday lenders then moved in to occupy the niche.
"ZestCash is competing to fulfill the same market demand," Ledford says.
ZestCash announced Thursday that it has received $11 million in funding from a syndicate of investors including LightSpeed Venture Partners, GRP Partners, and Flybridge Capital Partners. Merrill says the company plans to use the money to expand its operations. ZestCash, which claims several thousand customers currently, makes loans in only four states: Idaho, Missouri, South Dakota and Utah.
Consumers who take out payday loans roll those loans over an average of ten times, amassing fees and interest rate of 400% or more, according to the Center for Responsible Lending. Those loans can frequently wind up costing many times their original value, and they may never be paid off, experts say.
ZestCash charges fees that are half those of traditional payday lenders. Merrill says he hit upon the idea for the company after examining the situation of his sister-in-law, who is underbanked. She is in school, has three children and needed money to change the tires on her car. She might have turned to a payday lender without access to family resources, Merrill says.
"The under-banked have no relationship with a bank, or they may have one that does not provide credit," he says. "These folks have no option to use credit or a credit card to manage when something goes wrong, and so they will turn to payday loans."
ZestCash lets consumers borrow up to $800, but the loan must be repaid within six months.
After the initial online application, Merrill says a relationship officer calls the prospective customer and conducts another 10 minute interview. Customers are counseled on the phone to pursue other, less expensive alternatives, such as borrowing from family and friends. The relationship manager, who becomes the single point of contact over the life of the loan, also provides the customer with a phone number and email, so consumers can communicate with the manager if they are in danger of missing a payment or need their payments lowered.
"These things create a bond," Merrill says.
Though it says it undercuts payday lenders, ZestCash's fees are enormous. There is an origination fee of $15 for every $50 consumers borrow. On top of that, consumers must pay an annual percentage rate of 180% and late fees of $35. They also agree to bi-monthly payments of interest and principal.
Under those terms, a $500 loan will cost a consumers about $900 to repay over five months. Exorbitant, yes, but Merrill, who co-founded ZestCash with Shawn Budde, the former chief customer officer at Capital One Financial Corp., says the customer gets clarity in exchange for those fees.
There are upwards of 60 million unbanked and underbanked consumers in the U.S., according to various estimates. Since ZestCash is limiting itself initially to those with bank accounts and jobs, its target market is probably half as large, Merrill says.
According to Aite Group, of Boston, which surveyed 500 alternative finance consumers in February and March of 2011, 46% took out a payday loan in 2010, and of that amount 43% applied for a payday loan online.
"The economy is bad and people are having trouble making ends meet," Ron Shevlin, a senior analyst for Aite, says. "They are going online and looking for any lending source that might be able to help them."
ZestCash competes with a number of vendors currently occupying the underbanked lending space. BillFloat Inc., for example, provides consumers with money for specific expenses, such as a phone bill. It has received $16 million in venture funding from First Round Capital, Paypal Inc., and Venrock Management V LLC, since its launch last year. Consumers must pay off their loans in 30 days, or face fees, and the annual percentage rate is 36%.
Billfloat also uses proprietary, patent-pending technology that searches on numerous consumer variables that are different from traditional underwriting, such as how the consumer is earning money, cash flow, and spending velocity,
"We know where the money is going, and that helps us from a risk modeling and underwriting perspective," Ryan Gilbert, chief executive officer and co-founder of Billfloat, says. "It allows us to attract high-quality consumers who communicate their intent to us at time they want to do the transaction."
