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When satire is no laughing matter

Dear Colleague:

As this newsletter was being finalized, we learned that a bipartisan bill had been introduced into the U.S. House of Representatives that would “require Fannie Mae and Freddie Mac to establish procedures for considering certain credit scores in making a determination whether to purchase a residential mortgage, and for other purposes.” In other words, the bill would make Fannie Mae and Freddie Mac consider credit-scoring models besides the three outdated FICO 04 models they currently use when deciding what loans to purchase. We’ll have more to say about this news in the next issue of The Score, but until then, we hope you’ll read about the bill here.

For now, a few words on something we came across recently in our own reading: a recent opinion article in The Wall Street Journal that took a satirical look at the credit scoring industry. As implied by its headline, “My Tour of FICO Scores, Fido Loans, Whatever,” the article mainly poked fun at our chief competitor, but we didn’t find much in it to laugh about. The best satire is grounded in familiarity with its target and, unfortunately, what author Andy Kessler “knows” about credit scoring is largely tired old myths that we’ve worked for years to dispel.

Contrary to Kessler’s blanket statements about credit scoring models, some of today’s models actually do include such data as rent, utility, and telecom payments. Moreover, these models do not ding borrowers for positive behaviors such as paying off a mortgage or a collection account. These criteria are among the characteristics of the VantageScore® 3.0 scoring model we introduced in 2013, a model that is now used by thousands of lenders and has been emulated by our competitors.

Kessler’s observations better fit past decades, when there was little innovation of note and credit scoring models would receive occasional updates, but their inputs—the factors models consider when calculating scores—changed very little. You could also forget any modifications made with consumers’ benefit in mind. That lack of innovation arose because there wasn’t any meaningful competition. Models today are now more predictive, consistent, and inclusive—chiefly because competition has driven all of us in the industry to develop better approaches to measuring creditworthiness.

Although competition among model developers has created scoring alternatives for many types of lending, this is not true for mortgages. The reason for this anomaly is the current GSE lockout. The GSEs mandate the use of credit scores generated by older FICO models, built using consumer data from the late 1990s. Many mortgage lenders are reluctant to upgrade to newer credit-scoring models because their mortgage origination software is designed to accommodate that mandate. 

Unbeknownst to many, FICO has enjoyed a government-sanctioned monopoly in the mortgage market for decades. To ensure that credit scoring models keep improving, competition and a fair playing field must be established and preserved in this lending sector.

Kessler is right about the importance of ensuring that consumers understand the connections between their financial habits and their credit scores. But Kessler’s suggested remedy—publishing the algorithms used to calculate scores—would be counterproductive. However, disclosing the complex computer code wouldn’t really help consumers understand credit scoring or better manage their finances. Exposing score modelers’ proprietary methods would severely hinder innovation and competition in model development.

To promote consumer awareness, we instead support educational efforts like CreditScoreQuiz.org, our venture with Consumer Federation of America, and other websites that offer free credit scores and content. Such websites provide personalized consumer credit education by coupling free credit scores and free credit reports with additional educational content tailored to individuals’ credit histories. This helps consumers better understand how their financial habits affect their credit scores.

All the best for the holiday season,

Barrett Burns

WalletHub.com expands offerings with free VantageScore® credit scores

WalletHub.com, a website devoted to news, information, and user reviews of financial-services products, has added free VantageScore® credit scores to its roster of services.

The site will provide users who complete a free registration process with VantageScore® 3.0 credit scores based on credit-file data compiled by TransUnion, one of the three national credit reporting companies (CRCs).

“Credit files and credit scores are hugely important for consumers in a post-Great Recession environment, when lenders are perhaps being more judicious with account approval and the economic recovery has left many behind,” said Odysseas Papadimitriou, CEO of Evolution Finance, the parent company of WalletHub.com.

He added that WalletHub is the first score provider to offer daily updates to users’ credit reports and VantageScore® credit scores. “Financial institutions don’t review outdated data when considering applicants for account approval, and we feel consumers should not have to manage their finances or personal information on a delayed basis,” Papadimitriou said. “The real-time nature of TransUnion’s consumer data is a perfect fit.”

“Access to free credit scores from models that lenders use in actual lending decisions is an important step toward consumer awareness and understanding of the relationship between their scores and the behaviors that cause scores to rise or fall,” said VantageScore CEO Barrett Burns. “By offering VantageScore credit scores in a context of broader personal-finance information and education, WalletHub provides a great resource for empowering consumers to take control of their financial futures.”

Do different credit scoring models really produce wildly different scores?

By John Ulzheimer
The Ulzheimer Group

One of the most persistent myths regarding credit scores is that each of us has one, unique, three-digit score that lenders use to determine our credit risk. That myth dovetails with yet another myth, which is that if your credit score is calculated by five different credit scoring models, then the five scores are going to be different in a meaningful way. That myth in turn leads to yet another, which is that if your score isn’t calculated using a certain brand of credit score, then it must not be “real.”

Now that we’ve identified this intertwined “mess of myths,” let’s try to unravel the truth about each.

First, we do not have just one “true” credit score—in fact, most of us have several dozen, and that number is on the rise. Credit scores are calculated by credit scoring models—software installed at each of the credit reporting companies (CRCs), which the CRCs use to generate credit scores based on the credit reports they have compiled on consumers in their respective databases. Scoring models are developed by competing companies, including VantageScore Solutions, FICO, and even the CRCs themselves.

Every few years, credit scoring models are rebuilt or “redeveloped” and newer versions of the software are installed at each of the three CRCs. And because older versions of the scoring software are still commercially available and being used by lenders, the CRCs do not normally decommission them.

Consequently, there are actually more than 70 such credit scores commercially available today for lenders to use. As a result, each of us potentially has more than 70 credit scores, not just one.

Second, it is unlikely that your credit scores will be wildly different simply because they are calculated by different scoring models or brands. Some have suggested that scores calculated by different scoring models can be differ significantly, varying by more than 100 points. That’s quite an overstatement. Although it’s true that different scoring models can and will likely produce different three-digit scores, those scores are not going to be radically different to the tune of a variance of more than 100 points.

With the exception of a number of lenders using older versions of the VantageScore® model, all general-use credit scoring models are now based on a normalized scale or “range” of 300 to 850. Older VantageScore® models use the range of 501 to 990. All credit scores calculated from those models are built to do the same thing, which is to predict how well you will repay your obligations. Those scoring models see the exact same credit files from the three CRCs and consider the same information when determining your score: payment history, debt usage, credit inquiries, account diversity, and the age of your credit accounts.

People whose credit reports reflect good debt-management habits, including timely payment of their bills and prudent use of their available borrowing limits, are going to all have good scores, regardless of the score type or brand used. People whose reports reflect spottier habits, such as occasional late payments or the “maxing out” of card limits, will have more middling credit scores. And people who have poor credit habits—multiple, frequent late payments, defaulted loans, bankruptcies, etc.—will have low credit scores. These observations are true for all of the 70-plus credit scores in commercial circulation today.

Although scores generated by different models (including different models by the same developer) are likely to differ numerically, they are still going to tell the same story about the consumer’s likelihood of repayment despite any numerical variance. For example, if I have a VantageScore® credit score of 795 and a score of 825 from another scoring model, the scores are certainly different numbers, but they nonetheless convey the same overall message, which is that I have very strong credit, reflecting good credit habits and a resulting small risk of defaulting. If my habits worsen, each score will decline by a more or less comparable degree. Conversely, if I begin with lower scores from two different models and then improve my credit habits, both scores will increase more or less proportionately. 

Finally, there is no such thing as a meaningless credit score. Many years ago, the term “fake” scores (or some variation of that) was used to describe credit scores that were being given away or sold to consumers by certain websites. And although that may have been true more than 10 years ago, it’s no longer true today.

The difference between a fake credit score and an authentic credit score has nothing to do with what type or brand of score it is. Instead, the difference between a fake and a real credit score is about whether or not it is used by companies, like banks and other lenders, to make lending decisions. Any credit score type or brand that is used by lenders as a basis for their decisions is an authentic credit score, subject to the usage guidelines of the Equal Credit Opportunity Act. 

Every single score type and brand that is being given to consumers by credit card issuers, banks, credit unions, and consumer education websites is the same type and brand of scores that is sold by the CRCs when you apply for credit. There is no difference other than who’s buying the score.

Did You Know…Your rights to free credit scores?

In last month’s Did You Know article, we identified numerous ways you can exercise your right to claim free credit reports from the national credit reporting companies (CRCs). This month, we’re going to focus on your right to obtain free credit scores. Although the list of places where you have the right to get a free credit score isn’t as extensive as the list for obtaining free credit reports, it’s still not that difficult to get your hands on that three-digit number at no cost. 

First things first; let’s clearly define the term “credit score.” A credit score, according to the Fair Credit Reporting Act (FCRA), is a numeric value derived from a model used by someone who makes loans to predict the likelihood of certain credit behaviors, such as default. Practically speaking, a credit score is a three-digit number based on your credit report(s) that summarizes the level of credit risk you pose to a lender, credit card issuer, or some other service provider. A credit score is not the same thing as a credit report.

The FCRA confers the right to a free credit score or scores to consumers under only two scenarios. They are:

  1. When you apply for a mortgage loan: When you prequalify or apply for a mortgage loan, you have the right to what’s referred to as a Score Disclosure Notice. You have had the right to receive that notice since a 2003 amendment to the FCRA. This is an autopilot notice, which means your scores will be provided to you even if you haven’t asked for them. The notice will contain your three-digit score or scores, the key factors affecting your scores, and language explaining what a credit score is and why lenders often request them. The notice must be sent to you as soon as reasonably possible.

  2. When you are denied or adversely approved for credit based on a credit score: Since 2011, consumers who have been denied credit or approved but with less than favorable terms because of their credit score have had the right to a free copy of the score that was used by the lender in making its decision.

If you are denied credit based on your credit score, then you’re going to receive what’s formally referred to as a Notice of Adverse Action, although most people simply call them denial letters. This notice, which is also an autopilot notice, will contain several categories of information, including from what credit reporting company the lender pulled your credit report, the actual three-digit credit score used by the lender, and the score range of that credit score, which normally falls in the range of 300 to 850. The Adverse Action notice almost always comes in the mail.

If you are approved for credit but at less than favorable terms, then you’ve been “adversely approved” and have the right to see your credit score as well. The notice you’ll receive will either be the Risk-Based Pricing Notice or the Credit Score Disclosure Notice, depending on which notice your lender chooses to send. In either case, the notice will contain information about how lenders use credit scores, the actual three-digit score used by the lender, and the applicable score range.

The Risk-Based Pricing Notice and the Notice of Adverse Action must both contain information explaining why your scores weren’t higher. That information is formally known as a reason code, but is commonly referred to as a score factor or an adverse action code. You can learn much more about reason codes at www.ReasonCode.org.

Five Questions (Plus One) with Richard Johns, executive director, SFIG

Richard Johns is the first and only person to serve as executive director for The Structured Finance Industry Group (SFIG) since its formation in 2013. SFIG’s growing membership includes roughly 300 institutional members, including investors, issuers, and other participants in the structured finance industry. A member-driven advocacy organization, SFIG has more than 50 actively engaged committees and task forces, representing industry viewpoints across all aspects of the regulatory and legislative landscape.

Johns took time to answer our Five Questions (plus a bonus sixth one, just for fun) in the midst of final arrangements for SFIG’s annual conference, ABS Vegas, which will be held from February 28-March 2 in Las Vegas. Last Year’s ABS Vegas event attracted more than 6,500 industry participants, making it the largest structured finance conference in the world.

One of SFIG’s core principles is inclusion, which is underscored by your extensive and diverse board. How are you able to achieve consensus with so many different market participants who would have, at times, opposing points of view? 

Well, I guess if we are going to use the word “achieve” consensus, you really need to start with people disagreeing…otherwise you are simply documenting existing consensus. I’m not sure there is much difference at SFIG as compared to my old issuance days when you would come to market and expect a natural tension between the issuer and investor. Issuers wanted tighter spreads, investors wanted a wider range—and eventually you all settle on a number where the market will reflect sufficient liquidity to satisfy both parties. Policy positions are not necessarily all that different; you just have different variables. For example, instead of a spread, the operative variable may be disclosure or the amount of risk retention. So in essence, both sides are motivated to find the middle ground and support a solution that maintains a robust but liquid market. We’ve had numerous examples where this process has worked, thus enabling us to present an “agreed-upon market view,” which in turn affords significant benefit for rule makers.

There are times, of course, when members’ positions are so far opposed that you can’t reach an overall agreement. In those cases, we still try to find the areas where there are common views, share those consensus positions with the rule makers, explain where the differences of opinion are and, hopefully, give some insight underlying those differences of opinion. So now, even if we don’t have a fully agreed position to advocate, we have still managed to educate the rule makers regarding the reasons for any disagreements and the reasons underlying those disagreements, and thus, hopefully aid the rule makers in their process of making decisions.

How is SFIG promoting the securitization industry as a career path for women?

I’m not sure I would describe this process as the promotion of securitization as a career path for women, but rather that if women do chose securitization as a career path, we are taking steps to facilitate women’s success in this arena. We are extremely fortunate to have eight strong women associates on the SFIG staff, and these women represent two-thirds of our team. Our female staff members, coupled with an incredible amount of female talent and leadership in our membership and a board that is committed to the cause, leaves us very well positioned to actively support women in this industry. In addition, we launched SFIG’s Women in Securitization (WiS) initiative at the beginning of this year. We have had noticeable successes already. There was a fabulous launch event at ABS Vegas; WiS Week during the summer, which allowed us to host a series of roundtables across the country; we kicked off a mentoring program; we provided a WiS panel at ABS East, where the challenges facing women in the industry were given equal airtime as compared to topics like Reg AB II, risk retention and high-quality securitization; and this week, we hosted a workshop on networking skills in New York.

2016 promises to deliver even greater accomplishments as we focus on educating member organizations’ senior management on best practices and policies and continue to build out personal professional development opportunities for women. We already have a great event to look forward to at ABS Vegas, where WiS will take front and center stage with a full plenary panel session as part of the agenda. So please stay tuned, because if you don’t, you will miss something important.

In a nutshell, what is at stake in the Madden v. Midland Funding Supreme Court case and what is the position of SFIG and its membership?

Earlier this year, the Second Circuit Court of Appeals ruled that a debt buyer, who purchased defaulted credit card accounts from a national bank, is not entitled to collect the interest rate set under the cardholder agreement, as has been allowed since the 1800’s by the National Bank Act. The court decided that the usury laws of the state took precedence over the interest rate set by the cardholder’s agreement. This decision will have far reaching implications for the securitization of consumer loans. SFIG is submitting an amicus curiae brief to the U.S. Supreme Court in support of the defendant, asking the Supreme Court to take the appeal. If the Supreme Court upholds the Second Circuit’s decision, then industry participants will be required to evaluate the applicability of the pertinent state usury law to each and every individual loan included in a securitization. 

What are the regulatory and policy priorities for SFIG in the coming year?

Ha! Ha! It may be easier to list what isn’t on our agenda. It used to be that when a rule proposal came out, we all commented on it and then the rule was passed, and we all implemented it. Then we moved on to the next issue.

The process doesn’t seem to work like that anymore. Take something like risk retention—that was one of our first letters back in late 2013, and it still isn’t to be implemented for another year yet for ABS product, so I’m sure we will continue to work on interpretation until at least that point.

Reg AB II is another great example. The “roll-on, roll-off” process for regulation seems to have become simple “roll-on.” So our agenda is incredibly broad and covers not just rule-making proposals but also market development opportunities. 

In addition to Reg AB II and risk retention we will be focusing on Basel’s Fundamental Review of the Trading Book, Basel’s STC (simple, transparent, comparable) capital proposal (and other similar high-quality securitization initiatives), NSFR, and derivatives. We will also be pushing a number of market development initiatives covering marketplace lending, solar, and China, plus a variety of mortgage finance initiatives.

What role is SFIG playing in the effort to reform the mortgage industry, including providing clarity for lenders and investors? And GSE reform? 

Well, of course, the biggest thing we have on our agenda is our RMBS 3.0 project. This is aimed at removing uncertainty and building trust in the market by creating ranges or examples of best practices across a variety of areas within the private label market. So far, we have issued three releases for the project, coupled with three specific conferences/symposia. In our most recent release, we finished a comprehensive set of representations and warranties (47 in total) and released a template for the establishment of a “deal agent” role that provides an alignment of interest with investors in a transaction. In addition to putting more detail on that framework during 2016, we expect to have a robust agenda addressing issues like simplifying and streamlining bondholder communication, proposing standards for the disclosure of data and due diligence findings in a Reg AB II environment, standardizing the disclosure of loan underwriting methods, and working with members to implement a standardized set of roles and responsibilities.

As regards GSE reform, we do not expect Congress to tackle full-scale housing finance reform until after the presidential elections. However, over the next year, we will continue to see administrative efforts that will affect how our housing finance system works, particularly through the efforts of the FHFA and the GSEs to create a common securitization platform and single security. SFIG has been and will continue to be an advisor on these multiyear projects through our participation on the Common Securitization Solutions’ Industry Advisory Group.

Bonus sixth question: Who throws the best cocktail party in Vegas? (Hint: it occurs at ABS Vegas.)

It seems like I’m caught between two fabulous choices, with both the VantageScore and the SFIG Women in Securitization events taking place at different points on the Sunday of the conference.

That being said, I’m going to choose VantageScore for sentimental reasons. Since SFIG has gone through its remarkably fast establishment, there have been many milestones that stick in the mind which have helped to chart our swift evolution. One of those was that first conference at the Cosmo [The Cosmopolitan Hotel in Las Vegas] …walking towards that opening night cocktail reception, passing by the VantageScore “glamazons” on their stilts, and entering into the arena to be greeted by lights flashing, music pumping from the DJ on the stage, and a remarkable display of glass-blowing filling the center of the room. That was truly one of those moments where a couple of the board members and I looked at each other, big smiles on our faces, and simply thought “SFIG has arrived!” Thanks, VantageScore.

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