FICO shares have lost over half their value. Is its competitive advantage still that strong?
On Tuesday, September 29, the shares lost 26.52% in a single trading session and the next day fell to $592.47. Since the end of June they have written off roughly half their value, about 70% from last October's high of $1,998. Yet results show no deterioration. The segment that licenses credit scores to banks and mortgage lenders increased revenue by 41% in the last reported quarter and achieved a segment operating margin of 91%.
Key points
The segment in which FICO sells credit scores has an operating margin of 91% and mortgage scores in the last quarter brought in 97% more than a year ago. The number of scores sold grew only by single-digit percentages, with the rest accounted for by higher prices.
FICO shares are 67% below last year's high, even though revenue for nine months grew by 27%. Results have not yet captured the change in mortgage market rules that the market priced in within a week.
VantageScore costs 99 cents at TransUnion, while FICO charges up to about $114 per borrower for a closed mortgage. However, Rocket clients saved an average of $1,600 mainly thanks to better loan terms, and that cannot be offset by a discount on the score.
FICO repurchased its own shares for $3.05 billion over nine months, four times more than it generated in free cash flow. In the third quarter it bought them at an average price of $1,149, nearly double the price at the end of September.
The current share price already prices in a loss of roughly 27% of mortgage revenue. The planned transition from three credit bureaus to two alone would reduce FICO's fees from each mortgage by a third.
Growth was driven mainly by higher unit prices for mortgage scores. The company has repeatedly raised them in recent years because lenders selling loans to government-sponsored agencies had no full alternative. During September this certainty collapsed in three steps. The regulator opened the market to a competing model for all lenders, announced a common pricing grid for both models, and the largest U.S. mortgage lender announced it would prefer the competitor. One of the owners of the competing model offers scores for 99 cents.
The market now values the company as if its most profitable leverage had stopped working. Whether that is confirmed will be shown only by lenders' decisions in the coming quarters.
The company at the center of this dispute is Fair Isaac Corporation $FICO, the creator of the FICO score. According to the company, 90% of the largest U.S. lenders use it, and for decades it was the only model that Fannie Mae and Freddie Mac accepted for purchased mortgages. Besides scores, the company sells software for credit risk management and fraud detection.
One week opened FICO to competition it had not had to fear for decades
American banks hold most mortgages not on their balance sheets but sell them to the semi-state agencies Fannie Mae and Freddie Mac. For decades they accepted only loans assessed with a FICO score, so every lender that wanted to sell a mortgage had to pay FICO. In April the agencies began accepting the competing VantageScore 4.0 on a pilot basis, initially only from selected lenders. From September 9, according to regulator FHFA, any approved lender may use it without special permission. Classic FICO remains available and no end date has been set. Lenders choose the model for each loan individually.
The approval itself hardly changed the lender's economics. The agencies set a fee for each purchased loan based on a pricing grid (LLPA), in which the score level plays a major role. VantageScore carried a 20-point penalty because it usually comes out higher than FICO. A borrower therefore usually could not get into a cheaper band with the competing score. On the evening of September 28, FHFA Director Bill Pulte announced a transition to a single grid, and according to HousingWire the published grid removes the 20-point penalty. The effective date has not been announced.
That created a reason to switch. If a borrower has a higher VantageScore than FICO, the competing model can reduce the fee. Rocket Mortgage $RKT announced the same day that it will switch to VantageScore 4.0 in the fourth quarter as the default model for loans to Fannie Mae, Freddie Mac, VA, and other eligible mortgages. According to the company, four-month testing showed that clients who saved on the change paid on average $1,600 less at closing. FICO remains at Rocket for FHA, jumbo loans, second homes, and investment properties, and the broker division offers both scores.
Price added to the rule changes. TransUnion $TRU extended the price of $0.99 for a standalone VantageScore 4.0 mortgage score through the end of 2028. According to the registry's own data, more than 1,100 mortgage lenders adopted the model this year, including nine of its 15 largest customers in this segment.
FICO shares fell 26.52% on September 29 to $617.87 and the next day to $592.47. Analyst houses began cutting target prices en masse, Bank of America down to $700. On Thursday, October 1, the shares strengthened by about 12% when Pulte wrote that he had discussed with CEO Will Lansing that FICO's direct licensing program on the FHFA side should go through.
However, the same evening HousingWire, citing Bloomberg, wrote that FHFA is preparing another step. Lenders could pull only two credit reports instead of three for agency loans. The announcement is expected no earlier than October 12 and the change would take effect one to three months after it. The shares weakened by about 7% after hours.
Approval does not mean transition. Between May and August, when only selected lenders could use the competing model, VantageScore 4.0 accounted for about 9% of mortgages assessed by the agencies. Rocket is so far the only large lender that made the competitor the default choice. Banks, mortgage insurers, and investors in mortgage securities have models and historical data built on FICO, and transitioning means costs for them.
None of the September decisions has yet reduced the number of mortgages that FICO scores. However, all of them target the mechanism that allowed the company to raise prices every year. A lender selling loans to the agencies had nowhere to go.