GSEs Struggle to Update Credit Scoring Models

WASHINGTON — Despite pledges last year to move "aggressively" to implement new credit scoring models at the government-sponsored enterprises, the Federal Housing Finance Agency's effort appears to have stalled.

Consumer groups have been urging Fannie Mae and Freddie Mac to adopt a new credit score model offered by FICO or an alternative one by VantageScore that would make it easier for Hispanics and African-Americans to obtain mortgages.

FHFA Director Mel Watt told lawmakers last November that "we have the pedal to the metal" on adopting a new model, but it appears to have been a longer slog than the agency and GSEs anticipated. Both FICO and VantageScore said the effort is continuing.

"It is a very complex undertaking and it takes time, Jim Wehmann, who heads FICO's scoring business, said in an interview.

Barrett Burns, VantageScore's chief executive, agreed that "Fannie and Freddie are taking a good long look at updating their models."

"They are taking a good hard look at us," he said in an interview. "Our request of them is to allow competition and specifically to allow lenders to use either FICO or us."

At issue is the fact that the GSEs continue to use the FICO 4 credit scoring model, which was introduced in 2004. But FICO has made significant changes since then, and lawmakers and community groups have urged Fannie and Freddie to move to the current model, which is FICO 9.

In January, Watt told House Financial Services Committee members that he had instructed Fannie and Freddie to evaluate both the feasibility and the operational challenges related to using the updated FICO model and alternative models like VantageScore.

But Watt also cautioned that the "costs of changing from one FICO model to another FICO model or from FICO to an alternative credit scoring are heavy and the systems that have to be adjusted are complicated."

Since then, however, little progress appears to have been made.

"FHFA is continuing to engage with Fannie Mae and Freddie Mac to identify the financial, operational, and system implications for the enterprises and the mortgage finance industry of using updated credit scores, and we are engaging with lenders, consumer groups, investors and the primary credit score modeling companies to discuss these issues," a spokesman for the FHFA said.

Pete Mills, senior vice president at the Mortgage Bankers Association, said the FHFA has been meeting with the GSEs and industry groups about the credit scoring initiative.

"There are a number of operations issues and risk management issues that need to be considered. FHFA is moving at a deliberate pace," Mills said.

But James Carr, a former Fannie executive, said it's imperative that Fannie and Freddie update to FICO 9.

"Why are we dragging our feet in using a sophisticated credit scoring tool when you know for a fact that the old tool is inferior?" Carr said. "In my view, failing to update your credit scoring model when you know it has a deleterious effect on people of color should be a disparate-impact challenge. If they don't change, then it is a problem."

Carr is currently chair and professor of Wayne State University's Department of Urban Studies and Planning in Detroit. He previously served at the Center for American Progress and the Fannie Mae Foundation.

At a recent Department of Housing and Urban Development fair-housing conference, Steven Rosenbaum, chief of housing and civil enforcement at the Department of Justice, briefly touched on the subject of credit scoring.

"We talk about access to credit in terms of what impact credit scoring has on minority borrowers' access to credit or increasing the cost of that access to credit," Rosenbaum said.

The Justice Department official declined repeated requests to clarify or expand on his remarks.

Lisa Rice, the executive vice president of the National Fair Housing Alliance, who spoke on the same panel with Rosenbaum, said he was likely referring to the fact that a lower credit score increases a borrower's cost of credit.

"By using outdated credit scoring systems, you are limiting access to credit and also increasing the cost of credit to certain borrowers," she said.

FICO, based in San Jose, Calif., updated its credit scoring model last year and decided to exclude certain late payments associated with medical collections. FICO 9 is "our most predictive general purpose credit score," said Will Lansing, the company's chief executive.

But FICO 9 is still dependent on data submitted to the credit bureaus. Currently information that could help improve minority borrowers' scores, such as regular rental and utility payments, isn't routinely reported to the credit bureaus.

FICO is working to get this payment data and use it as a secondary score, according to Wehmann. People who are not approved for a credit card can be run them through this additional process to obtain a score, he said.

"It is a big opportunity for on-ramping people who don't have a credit bureau file," he said, or have such limited data that FICO can't calculate a score.

Such a system is being tested by credit card issuers that will begin reporting the cardholder's payment history to the credit bureaus.

"Then the borrower will obtain a traditional FICO score," Wehmann said, and apply for mortgage or other forms of credit.

Meanwhile, VantageScore is still trying to get a foothold in a mortgage market dominated by FICO. The company claims it can score 30 million to 35 million more people than other credit scoring models.

"Of those additional people we score, 9.5 million are Latino or African-Americans," Burns said.

Roughly 2.7 million have credit scores above 600 and could qualify for a Federal Housing Administration single-family loan, he said.