If It Ain’t Broke, Don’t Fix It, But If It Is……

Back in the day, when I was starting out in banking, we had an underwriting model based on trust. We thought that if we lent you money, you would pay it back. As personal honor quietly left the scene and became a thing of the past, we had to find a new model. Some incredibly bright mathematicians began to develop intricate formulae that they perceived could replace honor with predictive behavioral systems. And guess what, for the most part they worked – the FICO score was born.

In fact ,FICO has worked fairly well for more that 4 decades until now. I have been led to believe that two of the major predictors may need to be revamped in light of current economic conditions. They are the formulae that calculate overall credit card debt to overall credit card availability and individual credit card account outstandings versus credit line. Given the problem banks are having relative to bad debt, many issuers are reducing their available lines to many cardholders. This is to be expected as many issuers began accepting lower and lower FICO scores in their quest for more and more borrowers until being an air breather became the standard criteria.

The issuers, as is their wont, overreacted dramatically and cut credit lines incredibly deep across their portfolios. One consumer I spoke with had a credit line cut from $10,000 to $300 with absolutely no explanation other than she hadn’t used the card in a while. Given the interest rate at well over 30% and no rewards program, it was no wonder the card was little used. The impact, however raised her overall outstanding debt to availability quite a bit, thus lowering her FICO score.

Her other creditors quickly noted the lowered score and pounced. The one account she used frequently to maximize mileage rewards had her credit line lowered from $30,000 to $7,500. She happened to have an outstanding balance of $6,000. Her ratio on this account jumped from a comfortable 20% to a whopping 80% overnight. Her FICO score went directly into the toilet. She always paid substantially more than the minimum payment and never, ever paid late. All she did was wake up in the morning. From being credit worthy and respectable to being a bum in the time it took to recalculate a formula.

The reason for my rant is that this could dramatically impact how we underwrite small merchants. Many mom and pop shops rely on their personal FICO score to access financing and try to accept credit and debit cards. If their FICO scores become distorted due to faulty mathematical modeling, we all have a problem. I presume that the geniuses that develop these models have grasped the problem and are diligently working to fix it. But as my dad used to say, “never presume. because when you do, you make a press out of you and me” or something like that. If it ain’t broke, don’t fix it, but if it is….

Paul Martaus