FICO scores did nothing to prevent the subprime crisis, so what use are they? That was the gist of some recent comments by bankers and other industry participants to BS&T.
When we asked Fair Isaac & Co., the Minneapolis-based creator of the lending industry's dominant credit score, it defended its FICO scorecard for doing what it promises -- predicting the likelihood of borrowers defaulting -- but acknowledged that certain aspects relevant to the current crisis are outside the scope of the score, such as the trajectory of property values and applicants' incomes. (See related article.) Moreover, points out Tom Quinn, Fair Isaac's VP of global scoring, lenders themselves decide what score represents acceptable risk.
Almost every lender now uses technology to automatically assess loan applicants, and almost every lending decision is based substantially on the applicant having what is deemed to be an acceptable credit score. That score, which can be the knockout criterion among many factors weighed, is probably a FICO. Once Fannie Mae and Freddie Mac required in the mid-1990s that mortgages sold to the agencies be approved using their automated underwriting process, which leverages the FICO, the credit-scoring method really took off.
The subprime mortgage sector initially was defined in the mid-1990s as one for applicants with less than prime credit scores. At the time, a score of 620 was standard for government agency-underwritten mortgages. It is widely acknowledged that part of the reason for today's record foreclosures is that lenders kept lowering the (score) bar. Indeed Tom Brown, CEO of the New York hedge fund Second Curve Capital, remarked in his presentation at BAI's Retail Delivery show in mid-November that Fannie and Freddie progressively lowered the FICOs required on the mortgages the agencies bought.
What's the Value of a FICO?
One bank SVP attending BS&T's Executive Summit in October, however, questioned how meaningful a high FICO score is anyway. The executive, who preferred not to be named, noted the irony that, "Our bank's regulators congratulated us on doing the right thing in that our borrowers who defaulted all had good FICO scores. So the implication was, we couldn't have predicted a problem."
That sentiment was echoed by Summit presenter Doug Dolton, founder and chief executive of Zopa.com, the person-to-person lending site. "Before, I never saw people with 750 FICOs just default," he says. "Today you're seeing people with really good credit scores -- and bam! -- they just default."
Dolton was interviewed after an address in which he told attendees that Zopa had stopped doing business in the U.S. because applicants' credit quality here has become so poor. Even if Zopa were willing to obtain FICOs on applicants -- which it is not for regulatory reasons -- Dolton tells BS&T, "FICOs are meaningless for unsecured loans because they were built on mortgage and car loans and credit cards." He adds that his former company, Service Financial Corp., which made personal loans, built its own credit score that he says was more predictive than the FICO.
While Fair Isaac cannot comment on a scoring method with which it is not familiar, company spokesman Craig Watts shares an analysis that he says demonstrates that "the FICO score continues to do what it was designed to do." Of more than 10 million mortgage holders analyzed in April 2008 by the Atlanta-based credit bureau Equifax, those with high credit scores six months before (FICOs of around 750) were 80 times less likely to be in default than those with low scores (under 500), according to Watts. "Those aren't projections, but actual performance," he stresses.
At a lending roundtable at the BS&T summit, Gee Gee Patridge, CFO of Jackson, Miss.-based BankPlus ($2.1 billion) defended FICOs as one of many underwriting tools. FICOs can't anticipate eventualities, such as home values falling below their mortgage values, interest rates rising and applicants losing their jobs, she pointed out.
Asked about alternatives to FICOs, Patridge added, "I don't think we need a new scoring system. We have to go back to sound lending practices" -- a sentiment espoused by commentators on either side of the FICO debate.