Continued: Don't blame FICO for subprime mess, Fair Isaac says

Mark Greene came to Fair Isaac a year ago to fix the business. Lately, he's spending much of his time defending the company's reputation.

The two tasks are not mutually exclusive. The subprime crisis has taken its toll on Fair Isaac's customers, and that's hurt revenue, profit and share price. But in the search to assign blame for the troubles befalling consumers and the financial industry, some are pointing at the Minneapolis company's chief product -- the FICO credit score -- which has become an industry standard for assessing whether a consumer is a good credit risk.

In the past year, executives at large institutions such as HSBC and Washington Mutual, along with some securities analysts, have questioned the effectiveness of the score. "I think FICO did break down," Washington Mutual executive David Beck told a June finance conference.

In December, CIBC World Markets analyst Meredith Whitney wrote in a research note: "FICO scores, the long-trusted gauge for lenders in determining risk and price, will prove virtually meaningless in this credit cycle."

Most recently, a story in BusinessWeek took Fair Isaac to task, saying the score doesn't work properly.

Greene doesn't buy any of it. "By failure to do some of the basics of due diligence, checking for collateral and assessing capacity to repay, banks got themselves in trouble," he said last week.

He insists that, during the frenzied real estate boom, Fair Isaac often reminded its clients about the appropriate use of the FICO scores as one of many tools to help institutions make lending decisions. But like children, Greene said, some clients just didn't listen to Fair Isaac's advice.

Some outside analysts agree.

"It's an easy rush to judgment to look at somebody like Fair Isaac and say they're the keeper of the keys," said J.R. Reagan, head of risk, compliance and security for BearingPoint management and technology consultants. "But all they do is provide a score."

JMP Securities senior analyst Kevane Wong believes the industry abused a useful tool. "You can use a hammer to help build a house; you can use it to break down walls," Wong said.

Since the subprime crisis surfaced a year ago, a pattern has been repeated in case after case across the country: Greedy mortgage brokers relaxed underwriting standards and loaned money to get borrowers into homes they couldn't afford. Pressed for time, some lenders skipped verifying income and employment data.

If the customer's credit score was good, that was good enough for them. Even some credit rating agencies used credit scores, which are designed to measure an individual consumer's risk, to gauge the credit worthiness of pooled mortgage-backed securities. Greene calls that "a misapplication of the FICO score."

For Fair Isaac, the criticism of its signature product comes at a bad time. The company missed first-quarter earnings, and downgraded its revenue and earnings estimates for all of 2008. Its stock is down 23 percent year-to-date, and closed Friday down 1 percent, at $24.75.

"No one is happy with where our share price is," said Greene, who added that, on top of missing its numbers, the company is feeling the pain from operating in the ailing financial services sector. Fewer new credit accounts being opened translates into less revenue for Fair Isaac.

Greene is also working to repair the company's reputation for arrogance and poor customer service that led to some "customer ill will," Wong said.

The trifecta could push more customers to VantageScore, the rival credit score created by Equifax, Experian and Trans Union that's relatively new to market. Although Greene says Fair Isaac has yet to lose a customer to the new score, Wong said some banks might be using both scores to test out VantageScore, and that VantageScore has definitely put pricing pressure on the FICO product. In fiscal 2007, Fair Isaac got about 22 percent of its sales and about 62 percent of operating income from its scoring solutions division, which includes FICO.

Fair Isaac hopes new and improved products will regain investor and customer confidence. FICO 08, the company's latest refining of its score, launches in May at two of the three credit bureaus. It's billed as being 5 to 15 percent more accurate in the subprime arena than the current version. Greene said the timing is purely coincidental, adding that the score's revamping was "well underway" before he joined the company.

The new formula also will no longer count "authorized users" in order to curb the practice of "piggybacking." That's when so-called credit-repair companies promise to boost an individual's credit score by making a subprime consumer an "authorized user" on a blemish-free account.

Fair Isaac learned of the practice last year, and now reports all discoveries of such companies to regulatory authorities such as the Federal Trade Commission. The FTC has yet to file any enforcement actions and would not comment about the legality of such credit-repair offers.

In addition to the new score, Fair Isaac also is launching a credit capacity index, designed to help lenders determine whether a consumer is able to handle future debts.

Kara McGuire • 612-673-7293