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Covid May Have Infected Your Credit As Well

In the wake of the coronavirus outbreak, many consumers found that their credit score had fallen even though nothing else changed and their credit history is good. Whether and how much your FICO score may have declined is largely a function of how much credit you have outstanding and how the score is ciphered.

Financial institutions looking to mitigate risk in their lending portfolios have unceremoniously reduced credit limits for many Americans, often without providing notice. Some consumers even found their accounts closed. Having learned the hard lessons of the financial crisis in 2008, banks are moving more swiftly to lower the potential for credit losses as the economic fallout from the pandemic ripples through the labor market. And while many issuers will do so, they are not required to notify card holders of changes in their credit limits.

About 30% of the credit model computed by Fair Isaac Corporation is attributed to the ratio of credit outstanding to total credit available (or credit limit). This ratio, called the credit utilization ratio, has been found to have predictive power regarding potential default in times of stress. The higher the utilization, the greater the potential risk and so a lower ratio is better.

Assuming that your outstanding credit balances have not changed, you still might have experienced a drop in your score. In this case, if the bank lowers the limit, then the ratio increases all else equal.

According to data company, nearly 1 in 4 Americans had their credit limits reduced or even curtailed during the 30 day period between March 15 and April 15. The percentage was even higher among Millennials and Gen Z: over 36%, due in general to shorter credit histories and employment tenure.

Responding to the recurring cycle of recessions over time, Fair Isaac has developed a new metric that attempts to predict the financial stress likely to affect potential defaults based on individual consumers’ credit histories. The new tool, 10 years in development, is called the FICO Resilience Index, a scaled number from 1 to 99 that the company claims can refine credit decisions especially at the margins on a case by case basis rather than blanket changes across all borrowers within a credit zone.

According to FICO, consumers with a Resilience Index value of 1 to 44 are least likely to experience significant financial hardship in the face of a recession. Conversely, scores above 70 could signal a high probability that the borrower will fall behind on payments during an economic downturn. A value of 60 to 69 signals a “high sensitivity” to deteriorating financial conditions. 

The index promises to be most useful at the margin, where credit decisions could go either way, typically around a FICO score of 680. According to a study by research firm Quantilytic, application of the index between 2010 and 2015 could have resulted in the approval of 600,000 additional mortgages for borrowers with FICO scores of 680 to 699.

The tool is being rolled out to lenders for use as an additional data point, or a scaling factor in computing an adjusted FICO score. So far adoption is not widespread but the index is offered by Experian and Equifax to commercial customers.

Ultimately, all the traditional factors that determine good credit still apply; in particular, maintaining a low balance relative to available credit and paying on time. If you find that your limit has been reduced, it may be worth a call to ask why and request a reevaluation. And bear I mind that for consumers with good credit, the practical impact is likely to be small.

Christopher A. Hopkins, CFA

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