Keeping a spotlight on credit scores

Are credit scores inflated? That’s the take-away from a recent headline based on an analysis from Moody’s Analytics.

Lenders, investors and regulators would be wise to read and internalize the Moody’s report, however they should also consider a number of underlying factors.

Firstly, the notion that average credit scores are rising should come to no one’s surprise. If scores weren’t improving, there would be something wrong with the models.

Credit scoring models are based on the premise that past credit behaviors are indicative of the likelihood of a future default. The models include factors related to a consumer’s use of credit, payment history, level of indebtedness and availability of credit, and credit seeking behavior, among others.

With the Great Recession in the rearview mirror, many of the negative marks such as delinquencies, foreclosures and even bankruptcies, are farther back in consumers’ credit history with a smaller impact on credit scores, or have dropped off the credit files entirely.

Unemployment is at a 50-year low, home prices have, on average, recovered after hitting rock bottom, and cost of borrowing remains low; all positively contributing to a strong credit performance. At the same time, post-crisis, consumers have been more prudent in their use of credit, and credit underwriting standards have improved (the ability to repay requirements with most mortgages is one driving force of this trend). Collectively, these all point to higher credit scores.

In short, credit scores are pro-cyclical in nature. They are derived from historical data and respond to it. Credit scoring models are designed to reward a consumer for recent positive credit behavior. With the passage of time, recent behavior overshadows a past financial misstep or challenge. Conversely, as the credit cycle eventually shifts downward, credit scores will respond and begin to reflect the changes in consumers’ behaviors.

Secondly, it is imperative to remember that the objective of a credit scoring model is to “rank order” the total pool of scoreable consumers based on their risk. The score is only a relative measure of risk. In other words, we are individually compared with the total scoreable population. The meaning of the score, or the actual level of risk, changes in response to the overall level risk in the system.

For example, the default rates experienced for loans with a specific credit score would have been significantly higher in 2008 compared to what it was in 2018, reflective of the very different points in the credit cycle and the level of risk in the system. Well-built models maintain their ability to “rank order”, with lower credit scores resulting in higher levels of risk compared to higher scores. However, these models are not designed to capture the changes in the actual risk levels.

Therefore, lenders must be diligent, anticipate and react to changes in risk levels, adjusting credit score cut-offs as well the broader underwriting criteria (Debt-to-Income, Loan-to-Value, etc.) to manage a portfolio’s expected performance under changing economic conditions.  Lenders should validate models regularly and closely monitor performance of their portfolios.

The OCC provides extensive supervisory guidance on model validation best practices.[1] In particular, the OCC notes that validations of credit scoring models should occur at least annually if not more often, and that, “where models and model output have a material impact on business decisions, including decisions related to risk management and capital and liquidity planning, and where model failure would have a particularly harmful impact on a bank’s financial condition, a bank’s model risk management framework should be more extensive and rigorous.” If volatility were to increase rapidly, lenders will consider model validations more frequently than annually.

Importantly, this work must be done for models developed both internally and by third parties, such as models built by VantageScore.

There always will be some bad apples in the bunch when it comes to risk management. A consumer lender who underwrites solely on credit scores will and should be exposed because credit scores are not intended to be a substitute for prudent underwriting criteria. Scores should only be used as an integrated component of sound underwriting standards.

The bottom line is that yes, credit scores are improving alongside the broader economy and that is to be expected. Lenders must refrain from complacency or loosening standards too much, even as volatility remains low, because we all witnessed what can happen should stress be introduced into the economy.

Barrett Burns

CEO and president, VantageScore Solutions


(1) Supervisory guidance on model risk management, OCC 2011-12, 2011

Time for a Fannie and Freddie Refresh?

Why Fannie and Freddie need newer credit scoring models:

Competition for FICO would foster a more sustainable housing system

Roll Call op-ed, April 8, 2019

by James Lockhart, first director of the FHFA and senior fellow at the Bipartisan Policy Center

OPINION — Housing policy is suddenly back in the news. The Senate Banking Committee held hearings on housing finance reform recently and the Trump administration wants federal agencies to draft reform plans for mortgage securitization giants Fannie Mae and Freddie Mac. But after 10 years in conservatorship, winding down these government-sponsored enterprises and restructuring the mortgage market will be Herculean tasks.

We can start by revisiting a proposed regulatory rule on credit scoring.

Fannie Mae and Freddie Mac require institutions that either sell them loans or service their purchased loans to use credit scores produced by the Fair Isaac Corporation, or FICO. These scores provide a metric to predict borrower loan performance. The Federal Housing Administration also requires lenders seeking their mortgage insurance to use FICO scores, effectively creating a credit-scoring monopoly for nearly every mortgage application in the United States.

While FICO was once widely relied on as the only provider in town, alternative credit scores are on the rise. Some include rental housing, utility and other payment data, resulting in more credit information and, for many consumers, potentially higher scores.

The Federal Housing Finance Agency, as Fannie and Freddie’s regulator and conservator, has long been exploring the use of such alternatives. After decades studying newer scores (and a major housing crisis), there must be something better. Congress thought so. To end the existing monopoly and hasten the use of newer models, Congress passed a law last spring that included a provision with a simple and straightforward title: credit score competition.

Regretfully, FHFA ignored Congress’ intent in its proposed rule-making, currently out for comment. The agency proposed restrictions that would effectively preserve the current outdated models and a government-sanctioned monopoly, including the prohibition of “an Enterprise from approving any credit score model developed by a company that is related to a consumer data provider through any common ownership or control, of any type or amount.” This restriction effectively put the brakes on FICO’s main competitor, VantageScore, although they compete in other credit categories.

In all my years of federal service, I have never seen a regulation, or even a proposed rule, that presumed to dictate such targeted exclusion from what should be a competitive market.

There are and will be other financial technologies that will want to enter the mortgage credit scoring market. Yet the proposed rule’s overly restrictive business assessment requirements, coupled with a strange statement that the selected scoring model will not be reviewed for seven years, may prevent more predictive and inclusive models in the future.

FHFA didn’t just ignore Congress — it also snubbed the Treasury Department, which serves on the agency’s advisory board. In 2017, the Treasury released a major report noting the potential for these new approaches “to meaningfully expand access to credit and the quality of financial services.” Of course, adopting these new models will require time and money from Fannie, Freddie and other market participants. There are serious implementation and operational challenges to overcome that should not be taken lightly.

However, Fannie Mae and Freddie Mac’s key missions are to provide liquidity and stability to the mortgage market and to promote affordable housing. New credit score models and competition could lead to more consumers with scores, safely expanding access to credit. With more granular data, new models may also more accurately assess one’s ability to repay mortgage debt.

Mortgages for affordable housing must be sustainable. A decade ago, the failure of Fannie and Freddie caused hardships and foreclosures for millions of Americans. The newer models should help to guard against these mistakes of the past by empowering lenders with more accurate and predictive measures of loan performance.

It’s time for a fresh start on many fronts, which includes ending the conservatorships of Fannie and Freddie and restructuring the mortgage market. An easier but effective move is to withdraw this misguided proposed rule. FHFA needs to write a new rule that truly promotes innovation and competition in credit scoring to foster a more sustainable housing system.


James B. Lockhart III was the first director of FHFA and is now a senior fellow at the Bipartisan Policy Center.

The Bipartisan Policy Center is a D.C.-based think tank that actively promotes bipartisanship. BPC works to address the key challenges facing the nation through policy solutions that are the product of informed deliberations by former elected and appointed officials, business and labor leaders, and academics and advocates from both ends of the political spectrum. BPC is currently focused on health, energy, national security, the economy, financial regulatory reform, housing, immigration, infrastructure and governance. Follow BPC on Twitter or Facebook.

Tune in to the VantageScore Podcasts

Most people find their days are packed with something to do and somewhere to run to. Which is why the daily commute can be a good time to reflect and feed ourselves some worthy brain food. To that end, VantageScore is proud to introduce two new avenues to learn about the latest news and insights in credit scoring.

Tune in, and please do share amongst your colleagues in your credit circles.

VantageScore Podcast Series

Last month, VantageScore launched its own podcast series that showcases open conversations with industry influencers. These podcasts help cement VantageScore as a thought leader in the field and drive the conversations around credit scoring for the purpose of continuing to increase consumer and industry awareness of the VantageScore brand.

The first podcast guest was Dara Duguay, CEO of Credit Builders Alliance and one of the key leaders helping consumers establish credit in the United States. Her work has helped millions of consumers achieve their financial goals and become empowered users of credit.

Just recently launched, the second podcast features well-known credit expert John Ulzheimer, who has more than 25 years of experience in the consumer credit industry. You probably know him from the “New York Times”, “Wall Street Journal”, CNBC, “The Today Show” and even in our very own Score newsletter.

Links to the most common podcast platforms are as follows:




Consumer Credit Podcast Series

In partnership with “American Banker”, we just began a four-part series focused on credit scoring in the credit card industry. Aimed at those who have (or have yet to) attend the Consumer Credit Summit at Card Forum, these podcasts highlight leaders in the credit scoring industry who have impacted the cards market and their thoughts on what is to come.

The first podcast in the series “The Changing Dynamics of Consumer Behavior and Performance in the Card Market” features Nidhi Verma, vice president, TransUnion who discusses the demand for healthy credit and greater access to it with Penny Crosman, editor at large, “American Banker”.

To listen to their discussion, visit:

Next up is Kevin Yuann, vice president and general manager, at NerdWallet, so stay tuned!

5 Questions with David Hendler

David Hendler is the Founder and Principal of Viola Risk Advisors, LLC that was established in November 2014. David believes that the“Feb2018” sophisticated risk management, capital management, and regulatory exposure management communities have an unmet need for a holistic, enterprise-wide approach toward risk assessment in a transparent, dynamic and open forum fashion. 

David has a unique background as a veteran senior financial services analyst. Over his 30+ years on the Wall Street buy & sell sides and as a senior member of the independent research company CreditSights he has covered investment & financial risk advisory from both the corporate debt & equity research disciplines. 

On the buy-side he started his career at New York Life Insurance Company. On the sell-side for 15 years he worked at various firms including: Drexel Burnham Lambert, J.P. Morgan Securities, UBS Securities, Smith Barney Inc., & Credit Suisse First Boston. David made the Institutional Investor All-Stars from both the debt (1995) and equity sides (2000).

We are grateful to David for taking the time to share his insights on past economic issues and how it impacts both the present and future economy.

1) There is much speculation about whether the economic recovery has peaked and we are in for a cycle change. In your estimation, where are we in the consumer credit cycle?

VRA: The consumer credit cycle is long in the tooth as they used to say. So, there has not been a major consumer default cycle since the last credit crisis, which mostly bore out in the mortgage and subprime mortgage loan markets. The credit card cycle has not really been tested since the early 2000s and somewhat so during the mortgage crisis, but not as bad as it could have been if the Fed had not hyper-eased its monetary policy and bailed out the banking system as well as most of the capital markets and financial system. The auto loan cycle has not been bad since the late 1990s after several mono-line subprime/near prime lenders and other bank car lenders/lessors hit the wall with all kinds of losses in new and used car finance. Then the biggest consumer loan market, the student loan market, continues to have the highest delinquencies of the five major consumer groups (home mortgages, credit card, auto loans, student loans and unsecured consumer). Student loan borrowers have taken out more debt than the credit card or auto loan sectors as colleges have become unaffordable for the middle class, thus the lending binge.

So, to wrap up, we are in the later innings of the consumer credit cycle as the Fed’s easy money policies and thus lower borrowing rates have lessened the burden of carrying all the debt accumulated. We are at or near the all-time highs of debt to disposable income, so any catalyst (higher rates, slower economy leading to higher unemployment) can tip the Humpty Dumpty consumer over, and then fall to pieces.

Then there is the millennial generation and their untested-through-a-cycle behavior in repaying debts which are concentrated in credit cards and student loans. Millennies, as we call them, are a breed apart in their consumption of luxury items at such a young age (travel, restaurants, experiences) and have lower savings rates as a result given their “live for today” generational anthem. So, lots of different potential inflection points that could coalesce at the same time and lead to a more brutal consumer default recession than most prognosticators have factored.

2) Before the economic crisis in 2007-8, you issued a research statement warning about artificially inflated credit scores. What role did that play in ensuring defaults?

VRA: Fake mortgage company credit scores were a problem for many a large mortgage lenders and securitizers like Countrywide Credit, Washington Mutual and others not with us in the mono-line subprime originator business. It was not as much of a factor in the credit card business as it was a different set of borrowers in the prime and super prime sectors that did not need to “prime up” their score. With the GSEs, Fannie Mae & Freddie Mac, still in conservatorship, the conventional, smaller size mortgages have not ramped up at the big banks. Big banks have focused on the jumbo mortgage market of high prime to super prime mortgage borrowers. And these higher net worth borrowers are credit seasoning low and well. Some mortgage banks like Quicken Loans have stepped into the conventional space as originators that quickly securitize to the institutional investor market. The big banks have ceded this turf since conventional mortgages have onerously high capital charges on mortgage servicing assets. And the higher retained interests under the Dodd-Frank Act and the old bad memories of mortgage put back costs that have caused the big banks to underplay conventional mortgages. So no wonder the mortgage market is underproducing relative to demographic growth and demand even under an adjusted level to remove NINJA (no income, no job) and other “scratch and dent” unjustified loans of the mid-2000s mortgage craze.

So, to wrap it up, the fake credit scores did egg on the mortgage crisis and defaults, but much of that has been blunted off in this go-round as discussed above. More likely the next credit default crisis will be with credit cards, student loans, unsecured consumer, and auto loans as terms have lengthened towards 60 months and loan sizes have almost doubled with all the newfangled radar/GPS mapping/ultra stereo systems and other electronic gadgets that can add another $5K to $10K+ to a car’s price. 

3) What economic factors are you watching closely today?

VRA: Unemployment rising to higher levels, 6-9 percent+, is always the negative indicator. But it is a huge lagging indicator. So, Millenny analysts looking for that will be way behind the action curve. We at VRA look at lagging net charge-offs in cards with a 12-month to 18-month lag. If those figures pierce 4 percent to 5 percent, then we are in for a load of credit default trouble. Usually once it heads that way, it is a one-way stop to 6 percent+ in losses on a coincident basis. At 6 percent, the credit card math starts to break down and the securitization of card pools by bank issuers and other issuers are not as easy to palm off on institutional investors. Lagged charge-offs will be linchpinned by the factors cited in the previous question. So higher short-term rates and/or slowing economics. With the presidential race almost in progress with less than two years to go, this may be delayed as the the Fed seems to be on presidential elections monetary policy hold. 

4) Has regulation effectively guarded against a repeat of the overly risky practices that led to the mortgage crisis?

VRA: To some extent, yes. As noted, higher retained interests on securitization, higher capital charges on mortgage servicing and other high-risk I/Os and other residual interests have put somewhat of a squash on the near-prime to subprime mortgage lending business. But banks and especially Wall Street banks are highly creative especially in arbitraging the trifecta of company concerns as how to optimize or minimize: a) capital impacts, b) tax consequences and at the same time c) preserve or improve NRSRO ratings. This coup can be highly lucrative for high fees for the underwriting capital markets banks, and a good spread business for the bank originators that eventually hold in a packaged securitized form.

Right now we at VRA believe there is much more risk in the unsecured consumer loan market that is bootstrapped by smartphone/instant lending finance and lending. And this is going on in the commercial area with regards to direct lending by shadow banks including hedge funds/private equity companies/BDCs (business development companies) and other non-bank banks that are being warehoused and lent to underwritten by the big bank and other financial player communities. This is related to the rise in leveraged lending arenas that US bank regulators have their antenna up on, but have not specifically identified the problem or problem banks and shadow banks. We at VRA have some early thoughts on the culprits and the eventual problem banks, but that may be for another Q&A.

5) What is the state of independent financial research in today’s market?

VRA: Like other market players, it is an evolution for independent financial research. The business has been traditionally a subscription-based payment business. But with MiFid II standards required in the European region for buy-side firms to pay for all research (including broker produced), the available budgets to sell into for the independent providers has shrunk, which was an unforeseen consequence. Low rates have made it more difficult for fixed-income money managers/insurance companies/pension funds to pay for research, as that has also put a huge damper on their management fees. So the pressures are formidable.

We at VRA have a healthy subscription business. But the real opportunity is in the bespoke consulting business, where clients’ core challenges in various parts of risk management can be serviced in a unique/value-added/business-useful approach. Independent research needs to be positioned as a trusted advisor with custom-delivered features. A traditional subscription approach to research reports is too impersonal, difficult to justify and thus mostly a relic of the credit crisis aftermath.

Viola Risk Advisors seeks to be the most business-useful risk management consultant for global companies interested in a holistic approach to stakeholder stack analysis focused on the capital structure stack goals of debt and equity investors. And business-useful for the risk-exposure management needs of counterparty risk/enterprise risk management and supervisory authority/regulatory risk management clients. Only by addressing these interrelated concerns in a clear and transparent way in writing can companies optimize their overall risk management goals.


Viola Risk Advisors, LLis driven to be the best research provider of holistic, enterprise-wide risk management and capital structure investment views focused on “Risk Advisory on Global Companies for Global Companies.” As part of this endeavor we will focus on key risk exposures including: counterparty, regulatory, and investment securities & other financial instruments owned by debt & equity investors.  

These risk exposures are of most concern to our worldwide customer base that spans various communities including: counterparty/enterprise risk management, institutional investment managers, governmental and regulatory authorities, corporate strategy, and ultra-high net worth investors.  As pragmatic thought-leaders, our analysis and reports will be “business-useful” by providing easy-to-use, leading-edge, unique, value-added, and actionable trading & exposure management views.  In combination, this research will allow risk managers, investors, regulators, and corporate strategists the ability to make the best risk-investment-strategic decisions and reap the best outcomes.

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