Zestcash to expand Web-based loans into more US states

The startup uses a Web-based underwriting process to cut these loans' risk and costs, and offer borrowers better terms

Zestcash, a startup that's trying to disrupt the "payday" loans market by using novel search and data analysis techniques, is about to expand into more U.S. states.

Zestcash offers small, short-term loans that it says are less costly and more convenient than those offered by traditional "payday" lenders, so called because their loans must often be paid back on the borrower's next payday.

Co-founded in 2009 by former Google CIO Douglas Merrill and former Capital One Chief Customer Officer Shawn Budde, Zestcash lends money to customers in Utah, Idaho, South Dakota and Missouri, and plans to expand to four other states in the first quarter next year.

"We're right on the edge of a massive growth spurt," said Merrill, the company's CEO. He declined to disclose the new states but said they represent a larger potential customer base than the existing states.

Payday loans are usually sought by people who have bad credit and little or no cash reserves, to deal with emergency expenses such as health issues or car repairs.

Unlike companies that provide conventional, long-term loans for needs such as buying a home, payday lenders usually don't turn to credit bureaus to qualify their applicants. Most applicants have short, checkered credit histories, so payday lenders assume many clients will default and build those costs into their fees.

Zestcash, which started lending in 2010, uses technology to gather information about applicants and make better informed decisions about them. By doing so, it says, its customers have lower default rates, so Zestcash doesn't have to collect such big penalty fees.

Borrowers must pay back typical payday loans in two weeks, but Zestcash provides loans ranging from three months to eight months, Merrill said. Borrowers pay both principal and interest with each installment.

Zestcash says it's flexible with late payments. If borrowers request more time to pay, it tries to accommodate them, even allowing skipped and partial payments.

"As long as a borrower is in touch with us, we don't consider them in default and go to great lengths to work out a payment arrangement that works for them," he said.

Zestcash loans can cost borrowers half as much as a typical payday loan from another vendor, according to Merrill.

With other payday services, he said, borrowers who take out a two-week loan on average let it roll over nine times before paying it off, each time getting hit with a hefty penalty, so that, for example, a $300 loan could end up costing them $900.

Marc DeCastro, research director of consumer banking & community banking at IDC, is unimpressed with the fact that Zestcash, like payday lenders, charges sky-high interest rates. According to Zestcash's website, its maximum rate is 300 percent while its average is 180 percent.

However, it is innovative that Zestcash loan terms are longer, which makes installments smaller and easier to handle for borrowers, assuming the customers are financially responsible, he said.

Still, DeCastro isn't sure the Zestcash business will be sustainable over the long term, because the risks associated with this type of loan are so high, especially when lending to people online. "I don't see a huge market," he said.

Clearly, Merrill and his team see a big opportunity, and so do the company's backers. In July, Zestcash closed a $19 million funding round, including $11 million from Lightspeed Venture Partners and GRP Partners with participation from Flybridge Capital Partners.

At the time, the company also announced it had grown its staff to more than 40 and had done business with thousands of customers who had borrowed in aggregate more than $1 million.

The key to success is doing a better job of vetting prospective borrowers, Merrill said. "We're thinking about this as an underwriting problem," he said.

Zestcash collects data on applicants that is freely available on the Web, and complements it with data it buys from data brokers. It analyzes the data with its proprietary technology, using more than 1,000 variables to assess the risk of lending to each applicant.

Thus, instead of flying blind, Zestcash thinks it has a better chance of lowering its default risks. "We built a set of crawlers and parsers," he said. "We format the data into structures and make it useful."

The Zestcash average loan is for $600 with a six-month term. Merrill declined to disclose the company's default rate, but said it is lower than the average for payday lenders.

Stessa Cohen, research director of banking/investment services at Gartner, said Zestcash is going after a market where "there's definitely opportunities and interest."

It should add mobile access to its site and services, she said, because a portion of its pool of potential customers may not have Internet access via a conventional PC.

Merrill said that's in the company's future plans. "It's something I'd love to work on down the road," he said.

To expand, Zestcash needs to be aggressive with its marketing, because it lacks a physical presence in its potential customers' neighborhoods, where payday lenders have stores, Cohen said.

At the same time, because it is online-only, it avoids the expenses of maintaining physical stores.

Zestcash's customer base is what's known as "underbanked," people who are typically employed but live paycheck to paycheck with minimal or no savings and no access to credit cards.

More than 75 percent of the "underbanked" go online in any given week, mostly for email and social networking. More than two-thirds have engaged in a financial transaction online.

Zestcash deliberately started in four smaller states and limited its growth, while it gave its technology and business model its first run.

So far it has worked as expected, and now it's ready to expand.

Juan Carlos Perez covers search, social media, online advertising, e-commerce, web application development, enterprise cloud collaboration suites and general technology breaking news for The IDG News Service. Follow Juan on Twitter at @@JuanCPerezIDG.

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