Adverse selection and Fico scores have become buzz phrases in the mortgage industry in recent weeks. Oddly, these esoteric terms are embedded in one of the most vitriolic disputes to surface in the industry in recent memory.

The dispute first broke into public view when Ralph Mozilo, executive vice president of Countywide Funding Corp., Pasadena, Calif., said to American Banker that Freddie Mac was using credit scoring "almost as a weapon" to request that Countrywide buy back loans it had already sold to Freddie.

That phrase caused a lot of consternation at Freddie Mac. A few days later, at the convention of the Mortgage Bankers Association last week in San Diego, Leland Brendsel, chairman of Freddie Mac, reiterated to American Banker that Freddie Mac was not using credit scoring - which reduces creditworthiness to a single number - as the sole basis for requesting buybacks of loans.

He was asked "why certain loud people seem to think otherwise."

His response: "They've been selling us a lot of bad loans, and we caught them at it."

Asked if that comment was on the record, he confirmed that it was.

We took it as an obvious reference to Countrywide in the context of their quarrel. However, a spokesman and a spokeswoman for Freddie Mac said later that Mr. Brendsel was not referring to Countrywide, but rather to a group of lenders.

That spin appeared to mean that complaints of buyback requests stemming from credit scoring were not limited to Countrywide, something that had been reported previously but that Freddie Mac had not confirmed.

While squabbles among industry leaders can be entertaining but trivial, this one is dead serious and a clear indicator of the strong feelings the underlying issues are generating.

The issues are by no means narrow. Fannie Mae, the No. 1 housing finance company, is also involved. And even lenders not directly involved are watching with great interest from the sidelines.

Fannie's chairman, James A. Johnson, was quick to stake out some high ground a the MBA convention. He told lenders that his company would not request buybacks on the basis of credit scoring.

But that forbearance is only temporary. In a letter to lenders dated Oct. 24, the same day Mr. Johnson spoke, Fannie said it would soon be using Fico scores - scoring models from Fair, Isaac & Co. based on credit bureau reports - as part of all post-purchase reviews and would require all lenders to provide information that would permit Fannie to obtain credit reports for scoring purposes.

The letter said Fannie would not use credit scores as a basis for post- purchase reviews with lenders until the lenders have had time to adjust to the scoring process and incorporate it into their own underwriting.

Mr. Johnson also warned in his San Diego talk that Fannie Mae did not want to be "adversely selected" as an outlet for the riskiest loans. In other words, lenders should not send loans to Fannie that they fear Freddie may reject or challenge later on.

So lenders feel they are between a rock and a hard place. They believe underwriting judgment, which many regard as their stock in trade, is being second-guessed to the point where it is becoming a hazard rather than an asset.

Buybacks are an expensive proposition when they cannot be negotiated away - and especially nettlesome when profit margins are razor thin, as they have been this year. Assuming no change in interest rates since the loan was originated, lenders stand to lose a minimum of $1,500 per loan they buy back, and perhaps much more, depending on the gravity of the loan's defects. In addition, the staff time involved is considerable, they say.

Meanwhile, lenders are under pressure to make more loans to low-income groups, a process that requires flexibility. And some may also be stretching underwriting standards to bring in more volume in a slow sales year.

However these sensitive issues may be resolved, it's clear that credit scoring is here to stay and lenders will have to get in gear to meet the challenge.

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Lenders who need an education in credit scoring can get it at a series of half-day seminars that Fair, Isaac, of San Rafael, Calif., is conducting across the country this month. The first two are in San Francisco Nov. 8 and Los Angeles Nov. 10. Others will be held later in Boston, Chicago, Dallas, Washington, New York, and Atlanta.

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