Ken Rees is the founder and CEO of online fintech lender Elevate. The company serves credit-challenged borrowers at rates far lower than so-called payday lenders. His firm also aims to help customers improve their credit ratings and eventually gain access to increasingly lower interest rates. In this interview, he discusses how technology is recasting the state of the market for those with damaged — or no — credit. He participated on a panel of fintech CEOs at a recent conference – “Fintech and the New Financial Landscape” – at the Federal Reserve Bank of Philadelphia.

Knowledge at Wharton: Please give us an overview of your company.

Ken Rees: Elevate credit was founded to be one of the few fintech companies focused exclusively on the needs of truly non-prime consumers — people with either no credit score at all or a credit score between 580 and 640. These are people who have very limited options for credit and as a result have been pushed into the arms of unsavory lenders like payday lenders and title lenders, storefront installment lenders, things like that. We’ve now served over 2 million consumers in the U.S. and the U.K. with $6 billion worth of credit, and saved them billions over what they would have spent on payday loans.

Knowledge at Wharton: Most people would be surprised to learn how big that group is.

Rees: Let me start with just the statistics on the customers in the U.S. because people still think of the U.S. middle class as being a prime, stable group of people who has access to bank credit. That really isn’t the case anymore. We refer to our customers as the new middle class because they’re defined by low savings rates and high income volatility.

You’ve probably heard some of the stats — 40% of Americans don’t even have $400 in savings. You’ve got upwards of nearly half of the U.S. that struggle with savings, struggle with expenses that come their way. And banks aren’t serving them very well. That’s really what’s led to the rise of all of these storefront, payday, title, pawn, storefront installment lenders that have stepped in to serve what used to be considered a very small percentage of the credit needs in the U.S. But as the U.S. consumer has experienced increasing financial stress, in particular after the recession, now they’re serving very much a mainstream need. We believe it’s time for more responsible credit products, in particular ones that leverage technology, to serve this mainstream need.

Knowledge at Wharton: If someone doesn’t have $400 in the bank, it sounds like by definition they’re  a subprime borrower.

“You’ve got upwards of nearly half of the U.S. that struggle with savings, struggle with expenses that come their way.”

Rees: Well, it’s interesting. There’s a connection between the financial situation of the customer, which usually is some combination of the amount of savings you have versus your income versus the expenses you have, and then the credit score. One of the problems with using the credit score to determine creditworthiness is that there isn’t necessarily a 100% correlation between a customer’s ability to repay a loan based on cash flows in and out of their bank account and their credit score.

Maybe they don’t have a credit score at all because they’re new to the country or young, or maybe they went through a financial problem in the past, went through bankruptcy, but have since really focused on improving their financial health. That fundamentally is the challenge. The opportunity for companies like ours is to look past the FICO score and look into the real financial viability and financial health of that consumer.

Knowledge at Wharton: Are these the people who have been abandoned by banks? Are banks just not interested — they have bigger fish to fry? What’s happening there, because we’re talking about, at a minimum, 40% of all Americans.

Rees: Banks definitely want to serve this customer, they just don’t know how. When I met with a president of a large bank, he said, “My problem as the president is the average credit score of the customers I’m providing credit to is 720 to 740. Very high quality credit. The average credit score of the customers that are opening up checking accounts in my branches is 560 to 580, very poor.” So, he’s got this huge gulf. And he knows the only way that he’s going to grow his business and keep customers from going down the street to a payday lender or a title lender is to find a way to serve that need. But banks have lost their focus.

The regulatory environment really pushed them away from serving the average American, chasing the prime and super-prime customer base. And that makes sense in the wake of the Great Recession. But it’s left almost an atrophying of the financial instincts of banks, so they know how to serve the best of the best, but they no longer really understand how to serve their average consumer.

Knowledge at Wharton: What are the average rates for payday lenders?

Rees: According to the CFPB [Consumer Financial Protection Bureau] it’s some 400% plus. You certainly see much higher than that, 600% is oftentimes the kind of real-world APRs that consumers are forced to pay when banks and other mainstream providers don’t find a way to serve them.

Knowledge at Wharton: Are these typically short-term loans?

Rees: Typically. But one of the things that the CFPB pointed to is, and the basic concept of a payday loan is, I need a little bit of money, but in two weeks I’m going to fully pay that off and I won’t need money again. Well, that’s sort of absurd on face value. Who has a financial issue that’s really solved in two weeks’ time?

That’s what leads to this cycle of debt that so many of the consumer groups and the CFPB have pointed to, where the customer takes out their first loan but then they can’t pay it all off, so they have to repay maybe just the interest and they keep rolling that over, over time. It’s actually one of the reasons why we’ve been very supportive of the proposed new rules that the CFPB has been working on to provide some better oversight for the payday lending industry.

Knowledge at Wharton: So it’s a trap for them?

Rees: It certainly can be. Of course, the flip side is there are plenty who will say, and with some justification, that there’s even a higher cost form of credit, and that’s not having access to credit at all. If a customer’s car breaks down and they’re unable to get into work and they lose their job, or their child needs to go to the doctor, lack of access to credit is much more potentially painful than even a 400% payday loan.

So again, we think the answer is as we’ve all heard this expression, not letting perfect be the enemy of good, providing a way to deal with the real-world needs that consumers have for access to credit, to deal with the real-world issues they face, but doing it in a way that’s much more responsible than the traditional products that are available to consumers.

“The opportunity for companies like ours is to look past the FICO score and look into the real financial viability and financial health of that consumer.”

Knowledge at Wharton: How would your company handle that same customer? What sort of rates do you charge and how do you work to help them to avoid that vicious credit cycle that you talked about?

Rees: It’s interesting, being able to serve this customer, there is just no way to do it in a large-scale fashion by having an artificially low rate. In fact, what tends to happen is that when people try to achieve an artificially low rate, they do things like adding a lot of fees to the credit product. Maybe they take collateral for the customer, title loans being a good example of that. Twenty percent of title loans ends in the customer losing their car. Of course, lawsuits and other things happen when you’re trying to keep the rate artificially low.

We think — for being able to serve the vast percentage of customers — we’re typically at a high double-digit, low triple-digit rate for consumers.

Knowledge at Wharton: What would that range be?

Rees: We have a variety of products. We have a credit card product that’s more of a traditional priced product. But then we have a line of credit product that has an APR in the 90s [in percentage]. Then some of our products can go up from that.

But we recognize that the first-time customer is always the riskiest transaction. Based on successful performance history, the customer’s second loan is typically half of the APR of their first loan. And by the third loan, we’re typically getting them down to 36%. What we try to do that I think is unique in financial services, because financial services can be a very transactional business, is to build a partnership where we’re really jointly working with that customer to build up their credit profile, build up their financial health. We report to credit bureaus to help them see an improvement in their credit score. That’s a virtuous cycle because based on that we’re able to lower the rates to them as well.

Knowledge at Wharton: Who are the ‘credit invisibles?’

Rees: This came from a study that the CFPB did where they found that about 25% of the U.S. had either no credit score at all or had such thin credit data that it couldn’t really be used effectively. That’s one of the biggest problems, if you’re new to the country or you’re young or maybe you just came from a family where credit was not really a focus. And you wake up in your 30s and you want to get access to credit, a credit card or a personal loan, and you just don’t have the background to be able to do it, so you are pushed out of the system, and it’s very hard to get back in.

That’s a big opportunity for us and one of the reasons why we invest so much in alternative data sources, because if you just looked at credit bureau data you’re going to keep not serving those customers. A big additional source of data for us to serve the credit invisibles [and other credit-challenged borrowers] is things like bank account transaction information. We now get a full year of detailed transaction information from the customer to give us a sense of their income, their income volatility, expenses, expense volatility, how they use their money, how much they’re putting into savings. That’s giving us some really fantastic ways to much better serve the credit invisible that historically we would, like most lenders, have a hard time underwriting.

Knowledge at Wharton: What is your source of financing?

Rees: We have largely hedge fund financing. One of the most interesting things that’s really validated our approach to lending has been the advent of a new U.S. Bank product. U.S. Bank has really wanted to serve the non-prime consumer for a while. What they recently came out with was a $1,000 installment loan to be repaid in three payments with an APR of 70%. Now it’s sort of interesting, they have essentially free cost of capital. They’re serving their own customers whom they know, so there’s really no fraud. And they’ve found that a 70% APR product is what it’s going to take to have a mass ability to serve these unmet consumer needs.

It does suggest that the 36% that a lot of well-meaning consumer groups have been pushing is really not going to get the job done. It’s going to push customers into the arms of loan sharks or just take away access to credit. But if you can start thinking about how to legitimately serve in a sustainable and profitable fashion, you’re probably going to be in that sort of higher double-digit rate, and if this can be offered up in a mainstream fashion, you really just basically shut down the entire payday loan, title loan, pawn business. And I think that’s very exciting.

Knowledge at Wharton: What percentage of your customers move from the high double-digit or triple-digit loan and over time cut that in half and further reduce it and get down to the 36% that you’re talking about?

Rees: I don’t have the number right in front of me, but it’s over half of the customers in that Rise product who have experienced a rate reduction over time. … So we’ve got tens of thousands of customers that have gotten down to 36%, which for this customer base, a customer that had been paying four, five, 600% on a payday loan, to be able to get the rate down to 36% is very transformative. … From a public policy perspective, it begins to bring customers who have been excluded from traditional credit sources back into the mainstream.

Knowledge at Wharton: Some of that 50% — are they improving their credit score?

Rees: You’re getting at what I think is probably the worst aspect of these non-bank lenders like payday lenders, title lenders. Everybody talks about the cycle of debt. But in some ways there is a cycle of non-prime behavior that happens because they don’t typically report to credit bureaus. You can have the best payday loan customer of all time, every other week making an on-time payment for five years. It doesn’t impact their FICO score. That’s a real problem.

“If this can be offered up in a mainstream fashion, you really just basically shut down the entire payday loan, title loan, pawn business.”

We do report to the big bureaus, and we have seen meaningful improvements in credit scores over time. That’s an area that we’d like to invest even more in. Right now we provide free credit monitoring and things like this, but what we’re working on are more AI-driven capabilities to help really coach a customer through the challenge of trying to increase their credit score and get better financial health. It’s something that not a lot of customers really understand, the connection between what they do and their credit score and how they manage their money and their financial health. We think that’s an interesting opportunity for us as a lender, and really a responsibility for us as a lender as well.

Knowledge at Wharton: How do you reach these people online if they’re typically going to a storefront lender?

Rees: It’s a combination of the most old-fashioned and the most cutting-edge approaches. And the old-fashioned, we send out a lot of mail.

Knowledge at Wharton: Snail mail, paper, hard copy?

Rees: Snail mail, yes. One-hundred million pieces of snail mail a year. That’s been a very good channel for us. But increasingly, especially to reach, let’s say, credit invisibles, people who don’t have a credit file, because we actually leverage credit bureau information to be able to put together these pre-approved offers of credit through the mail, now we’re also using digital campaigns.

One that I was finding really fascinating is geofencing technology, where you can essentially identify all the payday loan and title loan and pawn stores in the country, and whenever we can tell that customer has walked into one, because they’re holding their cellphone, we can start pushing advertising to them. That’s really the key — helping people to understand there are better options. Customers who maybe feel like they’ve been pushed out of the banking system so long that there just isn’t a way back in. If we can get smarter in how we access that customer and really stop them from going through those negative behaviors, give them a better option and hopefully put them on the path towards better financial health.

Knowledge at Wharton: What’s been the success rate with that push marketing?

Rees: I would have to say direct mail is still better. We’re still working on that. But I think it does suggest the way forward, which is using really an omnichannel approach to reaching the customer, everything from the mail they receive to advertisements they see on their phone. And then even to partnerships, so a lot of the big aggregators of customers, people like Credit Karma, Lending Tree, also want to be able to find ways to monetize that traffic and have non-prime credit opportunities. There is not a whole lot of that available for a non-prime customer that goes to a Credit Karma or a Lending Tree or something like that. So, that’s another big growth opportunity for us as well.