WASHINGTON -- Digital Risk, a mortgage analytics firm, is mounting an assault on one of the lending industry's sacred cows.
It argues that credit scores such as FICO failed to predict large numbers of defaults during the mortgage-bust years -- most notably thousands of "strategic" walkaways by borrowers with high scores -- because they could not anticipate homeowners' reactions to economic stress.
It says that unless lenders use more sophisticated assessments that incorporate far more than credit histories, they may be misjudging not only many of today's high-risk borrowers but also applicants who are safer bets than their credit scores suggest.
According to one study conducted in 2009, 588,000 homeowners walked away from their homes strategically during 2008 alone. This amounted to 18 percent of all serious defaults that year. Fair Isaac, creator of the FICO score, acknowledged the problem, and last year he released an "analytic tool" that lenders can use to detect potential strategic defaulters -- high-scoring, credit-savvy borrowers primarily.
Digital Risk, however, says strategic default is not the only weakness of traditional credit scores. The company describes itself as the "nation's largest provider of mortgage risk, compliance, and transaction management solutions" and claims to have seven of the top 10 mortgage lenders as active clients.
In early August it introduced a risk-evaluation system that it says integrates credit characteristics with property and local real estate market data along with proprietary behavioral prediction models.
The behavioral component includes what the firm calls statistical "clusters" of borrower, property, and market situations -- 123 in all -- that give lenders a better idea of how an applicant will react to financial problems.
The system is based on analyses of more than 5 million loans originated between 2006 and 2011, plus a study of how 100,000 borrowers performed after having their loan terms modified, according to the company.
According to Alex Santos, president and co-founder of Digital Risk, two buyers with identical 690 FICO scores and down payments might be rejected -- Fannie Mae and Freddie Mac have average FICOs in the 760 range. Yet using Digital Risk's system, one of them could be identified as a safe bet and the other a disaster.
Anthony Sprauve, a FICO spokesman, said, "We continually work with our customers to make sure the FICO score is the best predictor of a person's likelihood to repay a debt. Our customers vote with their feet since, according to [research firm] Tower Group, lenders ask for FICO scores more than 90 percent of the time when buying scores from the big credit bureaus."
Digital Risk's system is being used by a small number of lenders, Mr. Santos said, but as a newcomer to the mortgage-risk-scoring marketplace, it will take time to be validated and widely accepted -- if ever.