Why Fair Isaac Crashed in July

FICO's Recent Challenges and Future Outlook

Fair Isaac, the company behind the widely used FICO credit score, experienced a significant drop in its stock price in July. Shares fell by 21.4%, according to data from S&P Global Market Intelligence. This decline was driven by two key events that negatively impacted investor sentiment.

First, the Federal Housing Finance Agency (FHFA) announced that lenders for government-sponsored entity (GSE) mortgages could now use an alternative credit scoring model called VantageScore 4.0. This change came as a blow to FICO, which has long held a near-monopoly on credit scoring in the U.S. The new rule allows lenders to assess borrowers' creditworthiness using VantageScore without needing to invest in new technology infrastructure.

VantageScore was developed in 2017 by the three major credit bureaus with the goal of incorporating alternative data sources that traditional FICO scores do not consider. This makes it particularly useful for evaluating borrowers who may have limited or no established credit history. Since Fannie Mae and Freddie Mac loans make up about half of all mortgage loans in the U.S., this shift could significantly impact the demand for FICO scores.

Mixed Earnings Report and Forward Guidance

In addition to the FHFA announcement, FICO released its second-quarter earnings report, which showed mixed results. The company reported solid growth, with a 20% increase in revenue and a 34% rise in its Scores segment. FICO also beat both revenue and adjusted earnings per share expectations. However, the company did not raise its full-year revenue guidance, which disappointed some investors.

Moreover, the growth rate in the Scores segment was lower than the 41% price hike FICO implemented late last year. This slowdown in growth raised concerns among investors about the sustainability of FICO’s performance.

The FHFA director, Bill Pulte, had previously criticized FICO’s price increases and appears to be seeking ways to reduce the costs associated with originating mortgages. While the FICO score itself is a small portion of the total cost of a mortgage, Pulte’s stance suggests that regulatory pressure on FICO’s pricing strategies could continue.

Valuation and Investor Sentiment

Despite the recent drop, FICO still trades at 37 times this year’s earnings estimates. While this valuation is not cheap, it represents a more reasonable price compared to earlier this year when the stock was nearly double its current level. The FICO score remains the go-to credit score for most lenders, which supports the company’s long-term value.

However, the ongoing tension with the FHFA director could create uncertainty for investors. FICO has been raising prices regularly over the past seven years, so there may be limited room for further price increases. This could limit future revenue and profit growth, which might affect investor confidence.

Investment Considerations

Investors considering FICO should weigh these factors carefully. While the company still holds a dominant position in the credit scoring industry, the potential for regulatory challenges and competition from alternative models like VantageScore could impact its long-term prospects.

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