As noted futurist Faith Popcorn said (all the way back in 1991): “You can trust a crystal ball about as far as you can throw it.”
With respect to what is next for the global economy, everybody’s crystal ball seems cloudy at the moment. While we at FICO do not claim any unique foresight into what is ahead for the U.S. economy, we are well positioned to share how the FICO® Score has shifted during past instances of widespread financial stress, as well as how it could react to the current stresses being driven by the economic effects of the COVID-19 pandemic.
As part of a month-long FICO virtual event series, I had the opportunity to present on the topic of “FICO® Score Trends Through Economic Downturns and Natural Disasters, and What They Can Tell Us About the Road Ahead.” The presentation in its entirety can be viewed here.
The aim of the session was to convey a sense of the potential outer bounds for FICO® Score shifts that may result from whatever the coming months may bring. To that end, we highlighted historical observations such as FICO® Score dynamics in the U.S. during the Great Recession and in Texas during Hurricane Harvey, as well as some FICO® Score simulations that address outlier credit reporting scenarios.
Some of the key takeaways from this session include:
- In aggregate, FICO® Score movement is gradual, even in times of substantial shifts in economic conditions.
- The FICO® Score has been a stable and highly effective tool for rank ordering credit risk through prior fluctuations in economic conditions, and we expect the FICO® Score to continue to provide strong risk rank ordering through the current COVID-19 pandemic.
- The relationship between credit scores and odds of repayment can and do shift substantially through the cycle; and the extent of the shift is most often driven by exogenous factors to the score, information that isn’t captured (or at least isn’t captured first) in the credit report data. Examples of such factors are changes in macroeconomic conditions, employment status, and shifts in lender underwriting standards. The extent of the odds-to-score relationship shift during the current pandemic, will depend on the length and depth of this COVID-19-driven economic downturn. It is important that lenders track this relationship closely and get faster insights than the odds-to-score analysis can provide by using other early delinquency monitoring reports to spot potential signs of trouble in their portfolio.
- It is important to consider changes to underwriting strategy on a refined, segment level. When a severe and unanticipated event like the COVID-19 pandemic surfaces, the initial response is often to do something fast and broad ---for example, increasing the minimum FICO® Score cutoff by X points for all applicants. But it is critical to quickly segue to a more refined approach: to adjust lending strategies by focusing on those specific segments expected to show more (or less) deterioration in their repayment behavior during a period of financial stress. This can be accomplished by using additional data sources to segment your portfolio, such as consumer contributed data, or total amount of available revolving credit (as a proxy for credit lifeline). Many will successfully weather this pandemic---using the necessary data and tools will help you to manage potential emerging risks without cutting off access to credit for those resilient customers.
We continue to actively work with our partners at the credit reporting agencies to monitor developing trends and near-term shifts in credit bureau data resulting from the impacts of COVID-19, and any shifts in FICO® Score dynamics driven by those changes in data. FICO has also collaborated with select partners to make trend reports available for clients, and they are available now. The intent is to promptly report any findings from this monitoring to our clients, via additional webinars, blog posts, etc. Make sure to check back here at fico.com/blogs to stay up to date!