Giving money away is very easy, almost anyone can do it. However, unless one has a neverending supply of funds, giving money away is not something any human or company can afford to do for very long.
And while this seems like a rather trivial point, it actually ends up being a often missed critical component in the discussion of lending in the U.S. — particularly as it relates to the emergence of the new class of “alternative” or “digital” lenders recently flooding the marketplace. Lending is more than just giving away money and is much, much harder since the extra component to lending is the entirety of the hard part — having the money paid back.
Alternative lenders — particularly those that cater to consumers — often trumpet their ability to serve underserved markets using better Big Data tools to create more accurate credit profiles for consumers than the FICO scores that dominate traditional lending.
“Every day we see people who are innovating in lending. They say, ‘We’re going to Facebook to use their data points; we’re going to fine-tune our risk metrics.’ And that’s great, but at some point, when you strip everything away, the fees have to get somewhat close to the risk the lenders are taking,” Nathan Groff, chief government relations officer for Florida-based Veritec Solutions LLC told MPD CEO Karen Webster in a conversation earlier this year.
Those underserved markets are often high risk. Groff points out that those better measurements are at base still offering a more detailed picture of a sub-prime borrower, not offering an entirely different picture, which means that the alternative lenders emerging to compete with payday players are still pushed toward offering small-dollar, high-interest loans to hedge against the risk of lending to the sub-prime.
And while Doug Merrill, CEO and Founder of ZestFinance, probably wouldn’t exactly disagree with Groff entirely, he would likely dispute all those fine turnings are something that could just be stripped away, since his firm is built on the idea that better data builds more nuanced pictures and supports a wider variety of more tailored credit products.
And, arguably at least, Merrill knows from data, since he used to be Google’s CIO.
"All data is credit data; we just don’t know how to use it yet,” Merrill noted in an interview. “Same lesson applies here as applies to Google search quality. There’s actually hundreds and even thousands of small signals, if you know where to find them.”
ZestFinance launched in 2009 as an attempt to use data analytics and machine learning to build more accurate scores — and consequently offer better loans to consumers. Like many of the entrepreneurs PYMNTS has spoken to in the past, the company was created after its founder had a brush with an inefficient market up close. In this case, Merrill’s sister-in-law, a single mother, found herself with a surprise snow tire bill and without the cash flow to cover it.
Given that Google’s former information head is a relative, Merrill’s sister-in-law was obviously able to secure funds from a family member. But not every sub-prime borrower is so lucky, Merrill realized, and so ZestFinance initially launched as a lending platform to compete directly with the payday lenders of the world.
And those loans aren’t cheap. ZestFinance prices for risk like any rational lender, and that means APRs that are triple-digit.
“We are an expensive loan compared to credit cards or what you can get from your family,” he said. “The problem is not everyone can get credit cards or can borrow money from their family.”
And, in the last three months, the firm has also moved past focusing on sub-prime borrowers exclusively to include a group it is defining: almost-prime or near-prime borrowers. With the launch of a new product, Basix, in July, the firm is now targeting consumers whose credit just misses the threshold of banks or online marketplaces dedicated to prime borrowers only.
That installment loan program offers personal loans of $3,000–$5,000 to consumers with middling credit. The loan term is three years with rates of 26 percent to 36 percent per year. A more expensive than traditional loan but far from the massive APRs associated with payday lending.
"There is actually no money to be made on a bad credit deal; in the long run, it doesn’t create customers that want to borrow from you," Merrill noted. "We think we offer a fair price, and more importantly, we're offering a transparent deal. There are no surprises and no weird fees. In a market where deception is a recurring complaint, being upfront and fair is a real value proposition for customers."
And, it seems, a strong value prop for investors. Since its 2009 launch, the firm has landed $250 million in funding. The firm also announced its latest big backer this week; New York's Fortress Investment Group has provided the firm with a $150 million line of credit.
Those funds will go toward expanding Basix and underwriting more — currently, ZestFinance is financing loans with its own cash.
“The new money helps move forward with the program a bit faster," Merrill said. “It’s also honestly a huge vote of confidence that this little company has attracted such a huge company like Fortress.”
And so expanding faster is what is next on the company’s agenda, with what Merrill described as a foot on the gas pedal as it tries to snap up more of the borrowers that traditional banking isn’t serving.
“FICO-based underwriting doesn’t do a very good job of answering two questions: Can you pay us back? And if you can, will you pay us back? And that's what we're really good at seeing, because we look at thousands of small data clues that give us the answer."
And with additional funds to hand out, Merrill says they are getting more data every day to build better answers.
Investment Activity Recovers As October Dawns
The week ended Oct. 2 seemed to recover some investment momentum that had waned in the previous several weeks. The biggest single fund flow to begin the month, at least according to filings — and not official monies crossing hands — came from First Data, which made details public of its initial public offering through a document with the Securities and Exchange Commission. The firm, after years of being owned privately through a buyout from KKR, is offering 160 million shares in a total deal worth $3.2 billion.
Mobile advertising technology company InMobi, based in India, was quite a bit down the stretch in terms of deal size, with $100 million in debt and equity raised from a consortium of investors, helmed by Tennenbaum Capital Partners. Of that, $40 million has gone to pay off debt, according to news reports.
Also last week, in Europe, Kreditech grabbed $92 million to help build credit and banking products for the underbanked, earmarking the funds for technology and geographic expansion.
Below is the list of the top five investments ranked by size for the week.
The lumpiness of deals within fintech has led to a roller coaster ride in that group, as measured by average weekly activity. Below we can see that, smoothed out data shows an average deal size, total, of more than $300 million, which helps but a floor, and a bit of a rebound, in recent activity in the sector, and to end the quarter.
And though the deal making activity overshoots the end of the quarter by two days, the gestalt of the investment climate bears a look and some commentary, with the summary as detailed below.
With slightly more than $67 billion in total activity, our Investment Tracker has shown, as has been the case, a preponderance of banking, trade finance and logistics deals, with those areas showing some billion dollar plus headlines through the past several weeks. GE, LeasePlan and other large deals beyond the US borders, such as HSBC Brazil, come to mind.
There’s always the chance, and perhaps an increasingly likelihood, that other areas will get a bump as we move into the last few months of the year, especially as Square comes to market with its IPO, which industry watchers say will come by the end of 2015.