Fannie-Freddie’s Faith in FICO Tested by VantageScore

Barrett Burns has been lobbying Fannie Mae 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.’s lock on providing credit scores for loans backed by Fannie Mae and Freddie Mac. 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, 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 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.’”

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