Fair Isaac Corporation (FICO) increasingly irrelevant

Fair Isaac Corporation (FICO), the creator of the FICO score, has not been immune to the current recession.  Its stock, like the large banks and financial institutions that buy its services, has plummeted from about $23 in Mar. 2008 to $10 in Mar. 2009.  If this trend continues, the company’s stock will continue to fall. 

However, FICO has a rather unique problem that also threatens its profitability and existence: a large portion of its business is obtained from providing the holy grail-like algorithm to determine FICO scores, which are becoming increasingly irrelevant in this deep recession.

This irrelevance is a direct result of skittish credit card companies continuing to cancel accounts and reduce credit lines on customers with great credit scores and a proven ability to repay loans.   As reported most recently by USA Today, cancellation of a credit card account or reduction of a credit limit hurts a customer’s credit score drastically.  In some cases, it can cause a score to drop as much as one hundred points.  For this reason, the credit card companies and banks are in many ways FICO’s worst enemies. 

Furthermore, credit card companies and banks are not weighing credit scores as much as before  because the FICO score is now more likely to misjudge a customer as a bad risk when, in fact, the customer is a good risk.   Some companies have lowered credit score ranges to accommodate this problem, but the adjustment is not directly proportionate to a given customers reduction in available credit.  In fact, most companies have raised their standards, a move which compounds the problem.  Customers whose available credit has been reduced tremendously, by $75,000 for example, are more likely to suffer.  In many cases, these victims are the more credit worthy customers. 

To say that this is happening to a minority of borrowers, as suggested by Scott Talbott, senior vice president of government affairs for the Financial Services Roundtable, is to minimize a current and growing problem.  As some of the banks have realized in asking FICO to look into the matter, alienating good prospects will directly affect financial institutions’ ability to profit. 

As FICO is realizing, its algorithm is not bullet-proof --few subjective algorithms are.  The algorithm is inherently flawed because it is built on certain assumptions (or premises in mathematical jargon), and one assumption is that financial institutions will lend money responsibly by extending more credit to more credit worthy customers. Contrarily, as we have seen time and time again, the credit card companies have become increasingly unpredictable and have demonized some of their best customers. 

In conclusion, unless FICO reevaluates and modifies its formula to remain relevant during a deep recession and to better accommodate panicky financial institutions, especially credit card issuers, it is headed in the direction of total irrelevancy and possible bankruptcy.  Furthermore, inaction on FICO’s part to fix its weakness will enable the three major credit bureau’s competitive project, the Vantage Score, to capitalize on a major flaw.  

Comments

[Dianne G]

This brings up a point that is really keeping me awake at night. Aside from the horribly slippery slope that my family is now on due to this rotten economy, we are driving a 12-year-old van. She's going to need to be replaced at some point. Our credit is getting dinged every week or two, it seems. I am wondering if anyone or any committees have considered this problem as well for auto loans? Will our recent spate of horrible luck & credit negate us from getting an auto loan at a decent rate? Mind you, we now have a ridiculously low 2% rate & I know we won't see that again, but I sure don't want to have to pay 20%.