Will Fintechs Kill the FICO Score?

The FICO score is under assault by today's new breed of lenders.

Yes, it's an industry standard for measuring credit risk and still widely used, but several marketplace lending executives and venture capitalists who spoke at CB Insights' Future of Fintech conference last week said that it may have outlived its usefulness.

Ron Suber, the president of the online lender Prosper Marketplace, said his company uses FICO for the limited purpose of screening candidates – only people with scores of 640 or higher are considered for a loan – and has lots of other tools at its disposal for the ultimate credit decision.

"Prosper gets 500 pieces of data on each borrower; the FICO score is just one data point," Suber said.

FICO's creator and its main users, the big credit bureaus, were not there to defend themselves, and they did not chime in for this article either. Experian and TransUnion did not respond to requests for interviews by deadline. Equifax said its expert was unavailable for an interview due to scheduling conflicts. Fair Isaac did not comment.

Plenty of defenders are out there.

"The rumors of the demise of the credit score have been greatly exaggerated," credit analyst John Ulzheimer said. "It's still the best risk-assessment tool in the market and is used ubiquitously across all mainstream lending-decision platforms."

Yet the discussion at the Future of Fintech conference, and other public comments lately by industry players, leave the strong impression that change is underway.

Mike Cagney, the chief executive of the online lender Social Finance, announced in January that SoFi has become a "FICO-Free Zone," meaning it no longer factors FICO scores into its loan-qualification process. Instead, the company considers potential borrowers' employment history, track record of meeting financial obligations and monthly cash flow to determine if they are creditworthy.

SoFi said the FICO model is flawed and outdated; it's less of an indicator of how a borrower will behave in the future and more a reflection of past behavior.

"Our approach to underwriting is based on transparency and balancing the needs of our members and investors, and we found that the FICO score was anything but transparent," Cagney said at the time of the announcement, "so we threw it out."

Kathryn Petralia, co-founder and chief operating officer of Kabbage, said at the conference that her company, an online small-business lender based in Atlanta, does not use FICO to determine creditworthiness (it does use it in benchmarking and reporting to investors). The company obtains small-business sales data from Amazon, eBay and other online marketplaces, shipping data from UPS, and data from business checking accounts, payment processors, accounting platforms, and social media to analyze and estimate businesses' revenue streams.

The business owner's personal credit score is not that relevant in Kabbage's view. Small-business owners are sometimes highly leveraged because they are putting personal assets on the line to get capital for their business, which negatively affects their credit scores.

"Entrepreneurs tend to have low FICO scores because they're always scrambling to fund the business," said Matt Harris, partner at Bain Capital Ventures in Palo Alto. "Even the best ones sometimes have low FICO scores like 600 or 650."

One marketplace lender told Harris that his company built a model that proves conclusively that looking at a business owner's FICO score is not only unhelpful, but actually misleading. Yet the lender was required to report its loan book in FICO bands.

"The regulators, the rating agencies and all the wholesale lenders built their whole infrastructure on FICO," Harris said at the conference. "That is not going away. It highlights the opportunity for disruption, but it's also a massive challenge if you want to build a big loan book and all the people you go to for money ask you to rank things in terms of something that's irrelevant to your customers."

Arjan Schutte, founder and managing partner at Core Innovation Capital, a fintech-focused venture capital firm based in Los Angeles, is another FICO critic. "Where I think there's a lot of opportunity is in looking at a much broader set of data that are compliant with the same set of standards as traditional ones, to be able to score the unscorable," he said at the conference.

One startup, Oportun, which his firm invests in, "has been successful because it's not making loans to subprime customers, but to people who are off the grid, who are prime or near-prime customers," Schutte said. "That's a powerful idea and there's a ton of opportunity for the unbanked."

Best Option for Now?

Some in the fintech industry still see life in FICO.

"Right now, it may be that FICO is the best," said Rebecca Kaden, partner at the Seattle venture capital firm Maveron. "Nothing has proved that wrong, even with the newer data sets that are out there today."

Platform lenders collect thousands of pieces of data on potential borrowers, but not all of that data is meaningful, she pointed out. "And what we don't know yet, and what has to be developed over time, is how do you correlate what actually does matter and develop that core capability in the company?"

Education and income, for instance, are likely to correlate to low credit risk, but other surprising factors might offer insights. Inventure, a company that makes small loans in Africa, scrapes information off consumers' phones.

"They learned that the time of day you text, who you text and how many times a day you text on your phone become really meaningful to how creditworthy a customer is," Kaden said.

Klarna, a Stockholm-based company that provides point-of-sale credit for online retailers, including several in the U.S., pulls FICO scores, especially if it is going to finance a big-ticket purchase like a $5,000 TV.

"There have been a lot of attempts over the past six years at using different data sets, such as social media data," said Colin Luce, Klarna's head of sales and business development for North America. "I would say most of them have been pretty unsuccessful. Most companies that revert to one of those alternative data sets end up coming back to FICO."

Klarna also looks at other types of data before extending an offer of credit – not so much to measure creditworthiness but to identify with certainty that consumers are who they say they are. "For most purchases, for us, it's about contextual clues about individual transactions," he said. "Things like, are they using all caps, are they copying and pasting in their email address?"

The company even tracks SKU-level data. "Over the past 10 years we've found that there's never been diaper fraud at 11:30 in the morning," Luce said. But a transaction in which a person is buying two iPads at 3 a.m. is a higher risk, he said.

In the traditional banking world, credit scores are alive and well.

"Last year alone, over 20 billion credit scores were calculated across the FICO and VantageScore brands," the analyst Ulzheimer said.

Most midsize and large lenders use a combination of custom-developed credit scores, application-scoring systems and pooled credit scores either as an alternative to traditional credit bureau scores or in combination with credit bureau scores, he noted.

The movement to alternative data is a good trend only if the alternative data is actually helpful and allows lenders to make incrementally better decisions than they would have made using a traditional credit report and credit score, in Ulzheimer's view.

"Generally only consumers who lack a traditional credit report and credit score benefit from lenders using alternative data," he said. "But for consumers who have a thin or nonexistent credit report, lenders are left with no other alternatives than using nontraditional data for risk assessment."

Editor at Large Penny Crosman welcomes feedback at penny.crosman@sourcemedia.com.