The FICO Score: Valuable for More Than Just Credit Underwriting
The FICO® Score is a reliable metric used throughout the credit cycle, from underwriting to recoveries. Scores consistently indicate the write-off propensity for certain customers based on payment habits, credit usage, and other related factors. Unlike brand names that are widely used to identify generic products, such as Kleenex or Xerox for tissues and copies, the FICO Score is a proprietary credit metric produced by FICO (originally the Fair Isaac Corporation), but that doesn’t make it any less universal..
My experience with the FICO Score dates back to the 1980s at Citicorp when the scoring function was in its infancy. Before the score, creditors relied on the three major credit bureaus, which often had inconsistencies as highlighted by various updates to the Fair Credit Reporting Act. Some retailers preferred TransUnion, many banks preferred either Experian or Equifax, but what we found back in the day was that the FICO Score could tie the raw data together with a reliable metric.
The FICO Score proved reliable for business users scoring key stages of the credit cycle. For evaluating new account applications, the score was indicative of the customer’s future risk. It could be used to reject accounts or to adjust the base interest rate according to risk. As the account matured to more seasoned status, the score could be used for credit line increases and decreases. It was also strong for routinely updating the master file so collection queuing could be sensitive to customer risk and changes.
Almost 40 years later, the score remains relevant. Credit managers today use the metric for the same purposes as they did then, and the score has retained its importance by adapting to economic conditions such as the near collapse of 2008 and ensuing recession, in which the United States experienced 10% unemployment, and in our current recovery mode.
I recently had the opportunity to study the relevance of FICO scoring in the securitization process for asset-backed securities (ABS) in four vertical markets: automobile leasing, credit cards, prime auto loans, and subprime auto loans. It was an arduous experience that entailed reviewing each of the 296 public and private filings in 2016 and 2017 to understand whether investors rely on the FICO Score as much as lenders do. We found that nearly 100% of filings—including all registered with the Securities and Exchange Commission—explicitly cited the use of the FICO Score as an assessment of portfolio quality. These 296 securitization deals represented $235 billion in assets.
The takeaway is this: The FICO Score has uses beyond direct credit underwriting. It can be used as a universal metric that provides an objective assessment of credit risk. Not only is it meaningful to the credit manager or underwriter, but investors also make the same choice for a score when evaluating the value of a security based on credit.