Rating Agencies: Credit Scores Will Keep Dropping

Paul Jakub, who owns a specialty paint shop outside Philadelphia, got a call last month from four of his employees finishing up a business trip to a Las Vegas trade show. They were trying to check out of a hotel but the company's credit card was being declined.

Jakub quickly wired money to the group. But he says his access to credit has all but vanished, even though he has never missed a payment.

One card with a $50,000 limit was canceled by Advanta (ADVNA) last month after the issuer shut down all of its small-business credit card accounts. Capital One (COF) suddenly cut his limit on another card from $50,000 to $500, saying he hadn't used the credit line in 120 days. And his American Express (AXP) business card with no preset spending limit—paid off in full each month—imposed a $12,500 limit on his account, which had a $27,000 balance at the time. Because Jakub was over his new limit on that card, his three personal credit cards also were canceled.

The solid credit score of 740 he had owned just a few weeks earlier tumbled to 673 by July 8.

"You need a credit card in today's day and age," Jakub said. "I can't even pay for a plane ticket or to rent a car."

Americans' ratings have begun to tumble

Like many Americans, Jakub, 42, is seeing his credit score dip through no fault of his own. Worried about rising default rates, banks are preemptively— sometimes for what seem like capricious reasons—closing accounts, raising minimum payments, and cutting credit limits.

Even though the recession is more than a year old, it is only recently that credit scores began dropping. That's because many borrowers struggled to pay off credit card bills and mortgages even as the economy floundered. But now, with rising unemployment and continued depression in the housing market, many people can no longer afford to do so. Rating agency Experian (EXPGF.PK) says that Americans' median credit score at VantageScore, competitor to the better-known FICO score, fell eight points in March—down about 1% from a year earlier. Credit scores in March 2008 were still on the rise even though the housing market was in free fall. (When BusinessWeek requested the FICO scores, none of the rating agencies would provide them.)

Experian wasn't the only rating agency to register a drop. TransUnion's average TransRisk score also showed a similar 1% decline in the first quarter, compared with the same period a year earlier.

Angela Granger, vice-president of analytics and research and development at Experian, said credit scores have lagged a bit behind the growing jobless rate. "Even though people were losing jobs in late 2008 and early this year, when somebody loses a job…it might take six months for them to miss a payment," she said. "As the unemployment rate continues to increase, we expect to see delinquencies increase and that will drive scores down."

Equifax: Some consumers raised scores

"Credit scores are going to follow the economy," said Seth J. Chandler, professor of Law at the University of Houston. "When people are poorly off—and unemployment insurance runs out and they've exhausted their friends' resources—they're going to start missing payments."

However, Equifax (EFX) showed a different pattern. The average Equifax Risk Score in May rose 0.3% from May 2008. Yet the uptick is so miniscule that the pattern might be better described as relatively flat. Equifax attributes the slight increase to the fact that many Americans in this economic environment are using credit cards less frequently, paying off balances, and keeping current on payments. These consumers are balancing out the delinquent borrowers.

"Generally speaking, Equifax data has shown a polarization of credit scores over time within the consumer population," the company said in an e-mail to BusinessWeek.

"While there are numerous factors that can impact a credit score, more recent increases in average credit-risk scores are a function of shifts to the 'tails'—or lowest or highest risk ends of the risk spectrum."

"banks are requiring higher scores"

Cristian de Ritis, director of credit analytics for Moody's Economy.com, who has studied quarterly Equifax scores going back years, said he's puzzled that the company's scores haven't dropped, given the deteriorating economy and credit-limit reductions. Credit line cuts can result in lower scores because the debt-to-credit-limit ratio typically makes up a major portion of a credit score.

"Even if the average score stays flat and doesn't drop, the fact is that banks are requiring higher scores. So in a relative sense, they have fallen," de Ritis said. "For the individual, what this means is more restricted access to credit—and that makes it more difficult to maneuver if a hardship should come up or if you have to take out a loan."

Chandler said a customer's creditworthiness goes well beyond credit scores. The mortgage meltdown proved that credit scores are an imperfect predictor, he said.

"Lenders have discretion on how they use these credit scores," Chandler said. "Although they are valuable tools, they're not oracular truth. They're quite imperfect."

That will provide cold comfort to Paul Jakub the next time he attempts to rent a car.

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