FICO Faces Federal Legislators

As 2015 draws to a close, some are celebrating the good times just gone by, while others are just looking forward to getting on to a new year. For the good folks at the Fair Isaac Corporation — better known as FICO — this year’s yuletide wind-down is probably a bit closer to the former than the latter.

While considered the gold standard of credit rating for the last 26 years or so, FICO has spent the last 12 months facing closer scrutiny than it has in some time. Analysts, bankers and lenders of all stripes are increasingly wondering if FICO’s methods for credit evaluation are out-of-date, especially when compared to the Big Data, cloud-based systems that seem better positioned to score the credit risk for a wider swath of consumers.

“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,” Doug Merrill, CEO and founder of ZestFinance (and former CIO of Google), noted in a recent interview.

Alternate credit rating systems are especially common in alternative financial services operations. Lenders either use their own proprietary credit ranking algorithms (Zest, Kabbage, Oportun, CAN Capital, etc. ) or leverage the increasingly popular FICO alternative, VantageScore.

In fact, according to an outside survey, more than 6 billion VantageScore credit scores were used from July 1, 2014, to June 30, 2015, more than doubling the previous 12 month-period, during which just 3 billion VantageScore credit scores were accounted for.

“We are seeing tremendous growth in many consumer lending categories, and bypassing the 6 billion scores used marks a major milestone for the VantageScore model,” Barrett Burns, president and CEO of VantageScore Solutions, said.

“Lenders are clearly seeing the benefits of greater predictiveness, consistency and the ability to score more people that the VantageScore model provides, and consumers are reaping the benefits of innovation bred by the competition we bring to the credit scoring market,” Burns added.

However, there is still one category where almost no progress has been made, according to Burns, and that is mortgage origination, where FICO reigns supreme.

But maybe not for too much longer, especially if federal legislators get their way.

Congressional representatives Edward Royce (R-CA) together with Terri Sewell (D-AL) recently introduced HR 4211, the Credit Score Competition Act of 2015, which will allow Fannie Mae and Freddie Mac to use credit scoring models other than FICO.

“The GSEs’ [Fannie and Freddie] use of a single credit score is an unfair practice that stifles competition and innovation in credit scoring,” said Royce. “Breaking up the credit score monopoly at Fannie and Freddie will also assist them in managing their credit risk and decreases the potential for another taxpayer bailout.”

In a statement released with the bill, Royce and Sewell noted that Fannie and Freddie’s 90 percent share of the secondary mortgage market, combined with their reliance on a single credit scoring model, has basically created a monopoly in credit scoring. Since mortgages that do not clear the FICO standard (and only the FICO standard) cannot be purchased by Fannie or Freddie, banks won’t underwrite those loans, and those homebuyers are essentially frozen from the market.

“Fannie Mae and Freddie Mac are the largest mortgage purchasers in the nation, but they rely on credit score models that don’t necessarily take into account something as simple as whether borrowers have paid their rent on time,” added Sewell. “Homeownership is an integral part of the American Dream that shouldn’t be out of the reach for low-income, rural and minority borrowers who lack access to traditional forms of credit. This legislation takes an important step towards addressing this issue and helps make homeownership a reality for more Americans across the country/”

Both Sewell and Royce also noted that the monolithic standard does not necessarily head off a future mortgage crisis but, in fact, might make one more likely by stifling innovation in credit scoring and handcuffing lenders who might otherwise like to find better risk assessment tools.

FICO, for its part, has responded by noting that the “monopoly claims are overblown” and by noting that they are supportive of a process that might include a more expansive view of credit scoring.

However, they also take factual issue with the accusations leveled against them.

First, the idea that FICO is excluding mass numbers of consumers is a bit misleading, according to Joanne Gaskin, senior director of scores and analytics at FICO.

“The implication that the GSEs’ use of the FICO score is locking potential buyers out is without merit. Today, 190 million consumers receive a FICO score. There are an additional 28 million consumers that have information at the three major credit bureaus but do not obtain a FICO score for the following reasons: “inactive credit” (e.g., three to four years since any account was last updated), “collection-only” (i.e., this is the only information in their credit file) or they have only a single account that is “too new” (less than six months’ payment history).”

Further, she notes, giving those people a credit score is not actually doing them any favors, depending on why it is they don’t have one presently.

“Scoring these individuals is not only analytically unsound but will lock many consumers into low scores effectively freezing them out of mainstream credit. It is punitive to return a low score to these consumers whose credit status is frozen in time — often as a result of a period of prior financial distress.”

Finally, she notes, there are resources already in place to help those consumers.

“A consumer without a credit score can avail themselves of the GSEs manual underwriting process as a pathway to homeownership,” she noted.

For now, the issue is settled, as federal offices are more or less closed for the holiday already (PYMNTS sought comment from Fannie, Freddie and FHA official, but we were informed that no comment would be available until 2016).

But it seems certain it will come up again and often once 2016 is underway.