The writer is an analyst at Autonomous Research
Twenty-six million US consumers are estimated to be “credit invisible”, lacking a financial track record with any credit bureau.
And up to 53m are estimated to have no traditional credit rating score from Fico, the listed provider of the metric that underpins trillions of dollars in lending decisions in the US.
Others who may be creditworthy can find themselves caught in a cycle of low credit scores and riskier lending alternatives due to a lack of traditional credit access.
Underlying many of these cases are real structural disadvantages. The US Bureau of Consumer Financial Protection has found that ethnic minority populations are more likely to experience credit invisibility across age ranges and that low-income consumers are more likely to start out with negative credit profiles triggered by events like debt collections. Consumers who recently entered the US and those dependent on cash payments make up a substantial portion of unscored individuals.
Pressure is now mounting to deal with such disparities. Among multiple US government proposals to address credit inequities are stronger regulatory oversight for credit bureaus that collect and analyse data on consumers and the creation of a public consumer credit bureau to challenge the private operators.
But one change could be more effective in removing the bottleneck to credit access — ending Fico’s longstanding credit scoring monopoly at the heart of mortgage underwriting.
Following the credit scoring model’s creation in 1989 — the only one of its kind at the time — it became central to US mortgage lending in 1995 when Fannie Mae and Freddie Mac began mandating its use for mortgage-backed security underwriting.
Fico is now fully embedded in mortgage approvals and has grown to dominate other lending categories. The benefit that Fico has provided historically is a stable, single scoring model when no other existed, but the downside is that newer, more innovative models cannot be widely adopted.
Fico and competing firms have developed more analytically-sophisticated scoring models that improve inclusiveness while minimising risk. But these models cannot be fully deployed when the government-approved model is currently limited to traditional credit variables and a single provider is dominant.
That position might now be challenged on several fronts.
Given the commercial opportunity, credit bureaus like Equifax, Experian, and TransUnion — alongside lenders and Fico itself — have been pursuing alternative credit data and analytics for some time. This includes using newer scoring models, rental and utility payment data, bank account data, and phone and internet records as indicators of creditworthiness alongside traditional metrics.
Another recent example is a programme by large US banks to share checking and savings data with the goal of identifying individuals who lack credit scores but still meet creditworthiness standards for credit card applications.
This initiative emerged from the Roundtable for Economic Access and Change (Project REACh) set up by the US Treasury to find new solutions to consumer finance inequities.
But the most notable solution from the bureaus is their joint venture VantageScore — a direct credit scoring competitor to Fico that provides credit scores to 40m otherwise unscored individuals.
The US Federal Housing Finance Agency has asked Fannie Mae and Freddie Mac to consider approving a newer Fico model, as well as VantageScore, for use by lenders.
If the latter is approved, lenders can begin extending mortgages to up to 40m additional consumers and would receive an implicit signal to go further with alternative models in other lending categories.
This decision would also end Fico’s effective monopoly in mortgage lending and would have implications for its rich valuation. The company has made the most of this dominant role by systematically renegotiating pricing with lenders since 2018. This has driven outsized revenue and margin growth.
With expectations for continued monopolistic price increases with limited lender pushback, Fico shares trade on a price equivalent to 40-50 times its forecast earnings over the next 12 months.
The stasis created by a dominant scoring model limits the full potential of innovation to solve credit access challenges. It is likely that pressure to diversify models will grow further, even without breaking Fico’s effective monopoly. But a clear government mandate would go further still in encouraging the use of readily available innovations to expand credit access.