The world of credit: Fifty years of FICO (1956-2006)John J. Hudockcredit, Internet, Web based tools
"FICO" is a registered
trademark for a family of credit-risk scoring products and not a
synonym for Fair Isaac
Corporation. The risk score is the result of a mathematical
algorithm formula using a variety of inputs, which predicts the
likelihood that a person will become delinquent when repaying a
credit obligation at some point in the next 24 months.
These risk inputs are listed on each residential credit report.
The intent of each of these statements is to justify the risk
impacts involved in determining credit scores. It is generally
accepted that FICO was first coined by credit bureau programmers to
shorten their code for Fair, Isaac & Company (which was their
official corporate name until 2003) whenever the programmers typed
our names in the context of our credit risk scoring models.
Although it's easy to understand why people might think FICO is
still simply shorthand for Fair Isaac Corporation, the fact is that
it is registered as a specific trademark. Using it as a corporate
synonym is incorrect.
Now, credit scoring models use both traditional and
non-traditional sources for their workups. Traditional sources,
current furnishers of information (creditors) reporting to credit
bureaus via credit reports, public records, etc. are the majority
of sources used. Lenders also use custom scores that take other
information to which they are privy, such as the credit application
information and the person's account history (if the applicant is
an existing customer), to help predict different aspects of credit
risk.
The accuracy of the scoring system has always been questioned.
According to a Fair Isaac representative, the lenders have always
been aware of this situation, which is why they typically use
manual underwriting practices to process credit applications from
people with and without credit histories. Fair Isaac introduced its
new FICO Expansion Score in July 2004 after roughly 18 months of
development, so that means that Fair Isaac began formally
addressing this particular problem in early 2003. I believe it has
not been completely resolved and produces inaccurate conclusions in
many situations.
Regardless, Fair Isaac was one of the fastest growing companies
in the world. Fair Isaac still has a lot to say about whether you
get a loan. They are a leading developer of credit scoring systems.
The firm offers statistics-based predictive tools for the consumer
credit industry. Customers include credit card companies,
retailers, commercial lenders, insurers and telecommunications
service providers. Fair Isaac's analytic and decision-management
products and services used around the world include applicant
scoring for insurers and financial-risk and database management
products for financial concerns.
Their income appears to come from the following service
areas:
1. Collections and recovery
2. Fraud prevention
3. Mortgage banking
4. Consumer solutions
5. Marketing services
6. Insurance solutions
7. Risk scoring services
8. Pre-score services
On April 6, 2004 on their Web site, www.fairisaac.com, Fair Isaac
began indicating that their services were being used to make
decisions 25 billion times each year, 68.5 million each day and 793
times each second. That's a lot of decisions! Fair Isaac has since
stopped illustrating its daily, monthly and yearly decision
statistics.
Where did it all start?
Mr. Fair and Mr. Isaac started Fair Isaac with an initial
investment of $400 each. In their first year, they developed a
complete billing system for Carte Blanche, one of the first credit
cards. They incorporated in 1960, and in 1961, Fair Isaac moved to
San Rafael, Calif. The two men led very private lives. We have been
researching specifics since 1999, and our conclusions have been
very limited.
William Rodden Fair (1922-1996)
Bill Fair, as he was known, was born in California on Dec. 13, 1922
and died Jan. 19, 1996. Rodden was his mother's maiden name.
Fair was one of the two founders of Fair Isaac. He was chairman
of the board of directors, as well as president of the company,
from the company's incorporation in 1960 until his retirement in
1991. After his retirement, he continued as consultant to the
company on technical matters and also served as chairman of the
board.
Fair received degrees from the California Institute of
Technology, Stanford
University and the University
of California, Berkeley. He also had membership in many
organizations, such as the American
Association for Advancement of Science, the Society of California
Pioneers, The Institute for Operations Research and the
Management Sciences, and Caltech Associates.
Earl Judson Isaac (1921-1983)
Earl J. Isaac was recognized as an excellent mathematician. He was
born in New York on Aug. 7, 1923. His mother's maiden name was
Fuller, and he died at the age of 62 in Marin, Calif. on Dec. 12,
1983. There's little more known about Isaac.
Together, they developed the scoring system using a combination
of item scoring, factoring and segmentation, which can predict an
individual's potential credit default risk. Mathematically, they
revolutionized the way the financial services industry extended
credit. In 1970, FICO developed the first scoring system for a bank
credit card. This credit card was offered by Connecticut Bank and Trust. Then,
in 1989, Fair Isaac installed the first general-purpose FICO
scoring system at Equifax,
named BEACON.
Two years later, Fair Isaac's reign of power began when all
three national credit bureaus - Equifax, Experian and TransUnion - started utilizing
the risk scoring system. With this venture, they have grown to the
point where they now have almost absolute control over the entire
credit scoring industry.
In 1998, as Fair Isaac's rapid growth had the company bursting
at the seams, it started work on a new corporate headquarters near
downtown San Rafael.
The company didn't move any employees or business functions.
That's because most of the executive team had already migrated to
Minnesota over the previous few years, starting when the company
hired Minnesota resident Thomas Grudnowski as its chief executive
on Dec. 2, 1999. But after Grudnowski took the helm, Fair Isaac
backed out of the deal. Only two of the planned four buildings were
erected, and only 40 percent of the space was leased, according to
Paige Steers, spokeswoman for building owner Equity Office in
Chicago.
According to proxy statements filed with the U.S. Securities and Exchange
Commission, Grudnowski earned $1,370,128 in salary and bonuses
alone in 2002, up from $813,463 in 2001 - a raise of 68 percent. He
made more than $3.1 million in salary, bonuses, stock options and
other compensation in 2005.
(By comparison, Thomas F. Chapman, chairman and CEO of Equifax,
received $5,627,589 in total compensation in 2005, almost a year
after he announced his retirement. On Sept. 21, 2005, Rick Smith
became CEO of Equifax.)
Fair Isaac already had a significant presence in the Twin
Cities, having acquired database-marketing company Dynamark in
1992. On April 13, the company hired Charles Osborne as chief
financial officer from the University of Minnesota
Foundation.
Fair Isaac's global sales, human resources, marketing and
information technology departments are all based in Minnesota. San
Rafael remains home to employees who work on the research and
development of Fair Isaac's trademark analytics tools, software
product development and business development, according to Larry
Rosenberger, who was once the companys CEO and now is vice
president of analytic research and development.
In 2004, Fair Isaac, considered the backbone of the lending
industry, moved its corporate headquarters to Minneapolis.
2004 Employees: 3,058
2005 Employees: 2,796
The company is operating in more than 60 countries, offering
financial solutions to most of the world with its credit
analysis.
Fair Isaac is using genetic algorithms as part of its new
predictive technology. It is calling them "Adaptive Random Trees"
(ART) and claims they allow a better way to build decision trees
for attaining specified projections.
Fair Isaac has constantly been developing methods to determine
incremental predictive power. Some might say that Fair Isaac's
traditional segmentation method relies too heavily on past
activity, as does ART. Many argue that any activity that is almost
seven and 10 years old should not be part of today's
creditworthiness evaluation.
In many instances, as part of Fair Isaac's scoring and the
repository reporting, an ill-advised bankruptcy damages an
individual's financial reputation for ten years. This time frame
may be too long to have a realistic effect on one's current
creditworthiness.
It could be argued that Fair Isaac has infringed on our
financial privacy to too great a degree, but it has succeeded in
developing a standard uniform credit comparison system that was
necessary for our banking system. I hope detractors realize that a
program cannot be created to allow an individual to correct his own
credit history while still maintaining accuracy and integrity. But
Fair Isaac's reign as undisputed king of the credit scores may be
coming to an end.
On March 14, 2006, in an unprecedented cooperative venture
involving the three national credit bureaus, VantageScore was released.
VantageScore is an innovative consumer credit risk score offering
greater consistency and predictability to consumers and credit
grantors. Its patent-pending development methodologies enable
institutions to rank a consumer's creditworthiness more accurately
than other scores currently available in the marketplace.
In my opinion, however, the VantageScore marketing team's
approach in launching this product was very ineffective. They
concentrated on the consumers and credit-counseling agencies
instead of the credit resellers and lenders. It is irrelevant to
consumers and credit-counseling agencies what scoring method is
being used. The only common consideration is accuracy.
John J. Hudock is president of The International Credit Club
and The World of Credit, two companies specializing in credit
report problems and scores. He also has online continuing education
courses on credit approved by the Pennsylvania Department of
Banking and the Pennsylvania Department of Continuing Legal
Education. John can be reached at (877) 829-5432 or e-mail
[email protected]. He invites e-mails on
any credit topic, will answer each one and publish any that will
benefit his readers. Please be specific with your
questions.
