Fannie-Freddie’s Faith in FICO Tested by VantageScore

Barrett Burns has been lobbying
Fannie Mae (FNMA) and Freddie Mac to adopt his credit-scoring system,
VantageScore, for years. So when he spotted Mel Watt, the
companies’ regulator, sitting in a Las Vegas hotel with his
family, Burns didn’t hesitate to approach and make his pitch.

“I said, ‘We’d be pleased to come down and present our
side of the business case to you,’” Burns, the chief executive
officer of VantageScore Solutions LLC, said he told Watt at the
annual Mortgage Bankers Association conference earlier this
month. “He said, ‘Yeah, come on down.’”

The CEO’s chance encounter with Watt was part of his
eight-year effort to break Fair Isaac Corp. (FICO)’s lock on
providing credit scores for loans backed by Fannie Mae and
Freddie Mac. (FMCC) VantageScore’s supporters say its scores better
predict creditworthiness for a broader spectrum of borrowers,
including minorities and first-time homebuyers who are
struggling to get mortgages today. In August, Fannie Mae and
Freddie Mac, which buy most of the new loans for home purchases,
began to study the feasibility of using VantageScore and other
alternatives to FICO.

“We were a fish swimming upstream against the current,”
Burns, 69, said. “Now, it seems the current has turned.”

FICO officials, whose rating system has been used by
lenders since 1989, say they welcome the competition.

Nontraditional Sources

“It keeps us on our toes,” said Anthony Sprauve, FICO’s
senior consumer credit specialist. “It’s good for the
marketplace to have choices. The fact that 90 percent of lending
decisions to be made in the U.S. use the FICO score is an
indication that the marketplace still believes in the FICO score
and is voting with its feet.”

VantageScore was founded in Stamford, Connecticut, in 2006
by credit-reporting companies Equifax (EFX), Experian and TransUnion.
After the housing market collapsed two years later and banks
tightened mortgage lending, civil-rights and consumer groups
began to embrace VantageScore’s system.

It includes rent and utility payments, which FICO’s current
model doesn’t, and reviews 24 months of consumer payment
history, which allows VantageScore to better rate consumers who
borrow infrequently. The system also incorporates data from
nontraditional lending institutions, such as credit unions, that
aren’t part of FICO’s model.

FICO’s Requirements

The National Fair Housing Alliance says minority borrowers
who don’t use credit often or who may use payday lenders in
inner-city neighborhoods are penalized by FICO or unable to get
a score. To rate consumers, FICO requires that they have
borrowed money from traditional sources such as banks and credit
cards within the past six months. The alliance also argues that
the way FICO models score past delinquencies can hurt minorities
who were disproportionately targeted by subprime lenders.

Without a FICO score, or with one below 620, Americans are
ineligible for a Fannie Mae or Freddie Mac mortgage.

FICO is working to address the issues raised by housing
groups. It’s developing new scoring methods that will help
provide more credit to consumers without traditional borrowing
histories and will make announcements about the changes in the
near future, Sprauve said.

“The credit landscape is changing and the consumer
landscape is changing,” Sprauve said. “We’re working very hard
to figure out how we evaluate the creditworthiness of that
segment of the population that doesn’t have a traditional credit
file.”

Pressing Fannie

With home lending to black and Hispanic borrowers at a 14-year low, the National Council of La Raza and the alliance are
pressuring Fannie Mae and Freddie Mac to adopt alternatives to
FICO, which may include VantageScore. In Congress, it has won
support from Republicans including Representative Spencer Bachus
from Alabama and Carolyn Maloney, a Democrat from New York.

“We’re at such a low for people of color” in the mortgage
market, said Jim Carr, a former Fannie Mae executive who is now
a scholar at the Opportunity Agenda, a New York-based
organization that works on racial equity issues. “We know, in
fact, that there are compensating factors, including alternative
credit scores that could open the doors immediately, and the
households impacted are” minority ones.

VantageScore says it can produce reliable assessments for
about 30 million more borrowers than conventional models. About
a third of those are black or Hispanic. Of those, 2.7 million
have prime or near-prime scores, based on the VantageScore
scale, which rates consumers on a range of 300 to 850, as does
FICO.

90% Share

VantageScore has gained acceptance with credit card
companies, auto lenders and some mortgage providers. It still
has to overcome resistance from Fannie Mae and Freddie Mac.

The mortgage companies have said in statements that
changing their scoring models would be complex and expensive.
They haven’t said when they expect to finish the review of
alternatives requested by the Federal Housing Finance Agency.

FICO has about a 90 percent share in home lending,
estimates Manav Patnaik, an analyst at Barclay’s Capital Inc.

“FICO is way too entrenched in all the risk models of the
banks and the customers and the lenders who use them to try to
tear it out of the system and put in somebody else,” Patnaik
said. “There’s a huge switching cost involved.”

Shares Down

FICO was concerned enough about VantageScore to file an
antitrust lawsuit against the company and its corporate parents
in 2006. A federal judge dismissed the case in 2011.

FICO, whose shares are down 2.3 percent this year, refers
to VantageScore as a potential threat to its business in filings
with the Securities and Exchange Commission.

“If we are unable to respond as quickly or effectively to
changes in customer requirements as our competition, our ability
to expand our business and sell our products will be negatively
affected,” the filings say.

Some lawmakers are pushing for Fannie Mae and Freddie Mac
to accept VantageScore, saying that competition is good for the
marketplace. Four members of Congress — two Democrats and two
Republicans — wrote a letter to Watt, the FHFA director, in
January, urging the use of multiple scores.

“The failed duopoly of Fannie Mae and Freddie Mac is
currently dependent on a monopoly that is detrimental” to the
companies, mortgage seekers, and taxpayers, one of the letter-writers, Republican Ed Royce of California, said this week in an
e-mail. Competition “will result in more predictive credit
scores for potential homebuyers and better allows Fannie and
Freddie to manage credit risk.”

VantageScore Lobbying

VantageScore has sponsored mortgage-industry conferences
and lobbies regulators and members of Congress. The company
spent more than $350,000 on lobbyists last year, according to a
database maintained at OpenSecrets.org. FICO spent about
$330,000.

Burns said Watt’s arrival at FHFA in January may present
VantageScore with an opportunity. Watt, 69, a former Democratic
congressman from North Carolina, has talked about expanding
access to credit and has been reviewing Fannie Mae and Freddie
Mac’s legal requirement to buy loans in “underserved” markets.

In 2008, Watt, then chairman of the oversight and
investigations subcommittee of the House Financial Services
Committee, held a hearing on credit scoring. In preparation, he
ran his own scores.

His VantageScore was perfect. His FICO score didn’t “begin
to approach” the maximum, he said at the time.

“I mean, I got a VantageScore, I kind of stuck my chest
out and said, ‘Hey, I’m doing all right,’” Watt said during the
hearing.

When he got his lower FICO score, he told the audience, “I
said, ’I don’t like that.’”

To contact the reporter on this story:
Clea Benson in Washington at
cbenson20@bloomberg.net

To contact the editors responsible for this story:
Vincent Bielski at
vbielski@bloomberg.net;
Maura Reynolds at
mreynolds34@bloomberg.net
Rob Urban


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