Alternative Lenders Parse the Subprime Market with Google-Like Data Analysis

Douglas Merrill is nothing if not confident. And why not? He recently raised $73 million for his alternative lending firm, ZestCash, and he holds an unshakable belief that the company can expand the consumer credit market with technology that traditional banks don't have.

"As banks loosen credit, they aren't good at making loans to subprime customers," says Merrill, who is co-founder and CEO of the company.

Merrill says ZestCash uses data and analytics to undercut the draconian fees charged by payday lenders.

Merrill believes this tech is a good fit for banks hoping to improve upon their past performance in subprime credit. "It's reasonably likely that at some point traditional banks will reach out to partner with us," he says. "There are very few people in the world that have the 'big data' skills that we have. There are only a small number of players who do. If you aren't from Google, Amazon or eBay, then you don't have these skills," Merrill says.

Merrill was previously Google's CIO. He co-founded ZestCash in 2009 with Shawn Budde, the former head of subprime cards at Capital One.

ZestCash offers loans to borrowers that it finds reliable, but who would otherwise not quality for a bank loan. These borrowers often wind up at controversial payday lenders, where they find themselves subject to large interest rates and fees, with loans often rolled over at even higher fees. ZestCash uses proprietary technology that the firm compares to Google's search analytics to accrue and analyze thousands of pieces of information. Merrill didn't go into great detail as to what this data is, but says that "every bit of data is credit data."

By using this information and running it through its math engine, ZestCash contends it can determine a consumers' propensity to pay debts that go beyond basic loan, rent or credit card payments, which lets the firm to locate borrowers who have limited histories making those kinds of payments, or find the classic "single event" subprime borrower who otherwise is a good credit risk.

"The subprime market overall hasn't changed that much," Merrill says. "What's changing is the credit — people had access to subprime credit [leading up to the credit crisis] and credit that was badly underwritten."

ZestCash's fees vary based on the loan, but are typically less than half that of payday loans, according to Merrill. Borrowers have six months to pay off ZestCash loans, and can't take out new loans until the ZestCash loan has been paid. ZestCash did not reveal its default rate, but said it was less than the payday lending average of about 20 percent.

Since its formal launch in 2010, ZestCash has grown its staff to more than 75 people and has loaned millions of dollars to thousands of customers. ZestCash loans are currently available in Utah, Idaho, South Dakota and Missouri, and will be offered in additional states in the coming months. ZestCash will use about $50 million of the new $73 million to fund new loans, and also plans to expand its modeling capabilities and embark on a marketing campaign.

ZestCash isn't alone in hoping to jolt the subprime market. BillFloat CEO Ryan Gilbert says his firm is in conversations with financial institutions about technology partnerships. "There is an opportunity to take a low-cost decision model and offer a more profitable loan to near-prime and subprime borrowers," Gilbert says. Like Merrill, BillFloat's Gilbert says banks' ability to provide subprime loans has been hindered by the cost of underwriting, which has made the loans less profitable. He says it's cheaper to look at non-credit-score data, particularly for smaller loans.

"We look at the consumer's cash flow and relationships with other billers, phone companies and utility companies. We believe this data is more important for small for small-dollar short-term loans because it highlights the customers' true ability to meet their obligation."

Another active player in alternative credit research is Corelogic, which recently debuted a product called CoreScore that examines transactions such as car, rental, payday and child support payments. Another firm, eCredable, lets consumers record monthly bill payment accounts, request verification of their payment history and create a credit report that meets industry standards and can be shared with a creditor, service provider or employer.

Beth Robertson, director of payments research at Javelin, believes more companies will make better use of customer data, particularly information that can speak to a borrower's stability. "There are other types of data that aren't relative to payments. You could look at things like a driving record, for example," she says.

"This is a growth area for lenders, there are a lot of consumers with impaired credit but a good record of paying," says Craig Focardi, a senior research director at TowerGroup.