Although Fannie Mae and Freddie Mac will soon be able to use third-party credit score models, analysts say that does not spell the end for FICO.
The Federal Housing Finance Agency published a final rule Aug. 13 that allows the government-sponsored enterprises to approve third-party credit score models in the secondary mortgage buying process. Currently, only the FICO score provided by Fair Isaac Corp. is required. The move illustrates another threat to FICO losing its dominant grip on the underwriting market.
The FHFA's final rule removed a technical requirement that would have prohibited VantageScore from the mortgage application process because it is jointly owned by the three major consumer reporting agencies, Equifax Inc., Experian PLC and TransUnion. By dropping the conflict-of-interest requirement that the FHFA had included in the origination proposal, the regulator effectively gave VantageScore a green light to compete for FICO's entrenched position with Fannie and Freddie.
Although an outright replacement of the FICO score is unlikely, Compass Point analyst Isaac Boltansky said at the highest level, the rule should be viewed as a positive for VantageScore and a "headline negative" for FICO.
"The FHFA's final rule opens the door for VantageScore to compete, which is a consequential development in and of itself," Boltansky said in an Aug. 14 note. "But our sense is that FICO retains a relative advantage given incumbency bias, industry adoption, cost-benefit dynamics and lingering competitive concerns."
Since 1995, FICO has benefited from Fannie's and Freddie's long-held recommendation that FICO scores be used for evaluating all mortgage loan applications. The FICO score has remained the industry standard, used by both banks and the housing administration for underwriting.
"FICO's high market share, reputation for consistency with lenders and recognized brand will likely help it defend its market position," said Moody's analyst Edmond DeForest. Plus the loss of its GSE exclusivity presents "little near-term impact" because only about 2% of Fair Isaac's annual revenues are at risk, the analyst said in a note following the announcement.
DeForest does not expect a material impact to revenue, profits or free cash flow over the next two years.
But the FHFA rule comes amid an increasing shift toward the use of non-FICO score data in underwriting. Digital lenders use alternative data such as the age and brand of a loan applicant's smartphone or what time of day they visited a lender's website. Fair Isaac itself is expanding beyond its traditional FICO score. Last fall, the company announced a partnership with Experian and financial management company Finicity Corp. to launch the UltraFICO Score, which taps into consumer-contributed information about their checking, savings and money market accounts.
Still, Boltansky noted that it could take almost four years for Fannie and Freddie to approve and adopt a new credit score model. The FHFA has a four-step approval process that could take 24 months, and the regulator estimates an additional 18 to 24 months for industry adoption.
"There is a window for change, but we caution that there is a lengthy runway ahead," Boltansky said.