[Federal Register Volume 71, Number 19 (Monday, January 30, 2006)]
[Rules and Regulations]
[Pages 4970-4973]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 06-852]



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Part II





Department of Housing and Urban Development





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24 CFR Part 202



Revisions to FHA Credit Watch Termination Initiative; Final Rule

  Federal Register / Vol. 71, No. 19 / Monday, January 30, 2006 / Rules 
and Regulations  

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DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

24 CFR Part 202

[Docket No. FR-4625-F-03]
RIN 2502-AH60


Revisions to FHA Credit Watch Termination Initiative

AGENCY: Office of the Assistant Secretary for Housing--Federal Housing 
Commissioner, HUD.

ACTION: Final rule.

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SUMMARY: On December 17, 2004, HUD published an interim rule 
implementing certain regulations for the Federal Housing Administration 
(FHA) Credit Watch Termination Initiative. Under the initiative, FHA 
systematically reviews the early default and claim rates of mortgagees 
that have been approved to participate in the FHA single family 
mortgage insurance programs. Mortgagees with excessive default and 
claim rates are considered to be on Credit Watch status and, in cases 
of more severe performance deficiencies, HUD may terminate the 
mortgagee's loan origination approval authority. Credit Watch status 
constitutes a warning to a mortgagee that its default and claim rates 
are in excess of permissible levels and that failure to achieve 
improvement may lead to the termination of its origination approval 
agreement. The final rule follows publication of the December 17, 2004, 
interim rule, takes into consideration the public comments received on 
the interim rule, and makes no changes at this final rule stage.

DATES: Effective Date: March 1, 2006.

FOR FURTHER INFORMATION CONTACT: Phillip Murray, Director, Office of 
Lender Activities and Program Compliance, Office of Housing, Department 
of Housing and Urban Development, 451 Seventh Street, SW., Room B-133, 
Washington, DC 20410-8000; telephone (202) 708-1515 (this is not a 
toll-free number). Persons with hearing or speech impairments may 
access this number via TTY by calling the toll-free Federal Information 
Relay Service at 1-800-877-8339.

SUPPLEMENTARY INFORMATION:

I. Background

    On April 1, 2003, HUD published a proposed rule (68 FR 15906) to 
amend the regulations for the Federal Housing Administration (FHA) 
Credit Watch Termination Initiative. Under the initiative, FHA 
systematically reviews the early default and claim rates of mortgagees 
that have been approved to participate in the FHA single family 
mortgage insurance programs. Mortgagees with excessive default and 
claim rates are considered to be on Credit Watch status and, in cases 
of more severe performance deficiencies, HUD may terminate the 
mortgagee's loan origination approval authority. Credit Watch status 
constitutes a warning to a mortgagee that its default and claim rates 
are in excess of permissible levels and that failure to achieve 
improvement may lead to the termination of its origination approval 
agreement. The termination of a mortgagee's origination approval 
agreement is separate and apart from any action taken by HUD's 
Mortgagee Review Board for violations of FHA requirements under 24 CFR 
part 25.
    The regulations for the Credit Watch Termination Initiative are 
contained in 24 CFR 202.3.
    The April 1, 2003, rule proposed various amendments to the 
regulations for the Credit Watch Termination Initiative. Specifically, 
the April 1, 2003, rule proposed to: (1) Establish a fully computerized 
Credit Watch status notification process through use of the FHA 
Neighborhood Watch Early Warning System; (2) remove the regulatory 
``cap'' on the default and claim rate for placing a mortgagee on Credit 
Watch status; (3) prohibit a mortgagee that has received a notice of 
proposed termination from establishing a new branch in the lending area 
covered by the proposed termination; (4) provide that the default and 
claim thresholds underlying the Credit Watch Termination Initiative 
apply to both underwriting and originating mortgagees; (5) codify the 
definition of ``underserved area'' that is currently used under the 
Credit Watch Termination Initiative; (6) provide that the date of 
mortgage origination will be considered to be the date the loan 
transaction commences amortization, rather than the date of endorsement 
for FHA mortgage insurance; (7) specify the timeframes for the informal 
conference that may be requested by a mortgagee prior to termination; 
and (8) describe the procedures a terminated mortgagee must follow to 
have its origination approval agreement reinstated.
    The proposed regulatory changes were designed to improve the Credit 
Watch Termination Initiative, thereby strengthening HUD's capacity to 
safeguard the FHA mortgage insurance fund. The preamble to the April 1, 
2003, proposed rule provides additional details regarding the proposed 
regulatory changes to 24 CFR 202.3.
    On December 17, 2004 (69 FR 75802), HUD published an interim rule 
that considered the comments received on the proposed rule and made 
effective the proposed changes to the Credit Watch program contained in 
the April 1, 2003, proposed rule. In response to the public comments 
requesting that HUD clarify the applicability of the Credit Watch 
Termination to underwriting mortgagees, HUD revised the rule to provide 
for separate regulatory language that specifically addresses 
underwriting mortgagees. The regulatory language did not alter the 
substance of the proposals, but rather provided greater clarity on how 
the performance of underwriting mortgagees would be subject to 
evaluation under the Credit Watch Termination Initiative. The 
regulatory provisions of the December 17, 2004, interim rule took 
effect on January 18, 2005. However, in order to provide for public 
comment on the regulatory provisions regarding underwriting mortgagees, 
HUD invited public comments on that aspect of the interim rule for a 
period of 60 days.

II. This Final Rule

    This final rule follows publication of the December 17, 2004, 
interim rule and takes into consideration the public comments received 
on the interim rule. After careful consideration of the public comments 
on the new language concerning the applicability of the Credit Watch 
Termination Initiative to underwriting mortgagees, HUD has decided to 
adopt the December 17, 2004, rule as final without change.

III. Discussion of the Public Comments on the December 17, 2004, 
Interim Rule

    The public comment period for the interim rule closed on February 
15, 2005. HUD received three public comments. Comments were received 
from two mortgage lenders and a national association representing 
mortgage bankers. This section of the preamble presents a summary of 
the significant issues raised by the public commenters on the December 
17, 2004, interim rule and HUD's responses to those issues.
    Comment: Before HUD terminates underwriting authority, HUD should 
take into consideration the lender's overall national default/claim 
rate. One commenter wrote that nationwide lenders could be unfairly 
penalized by a termination action if a localized fraud scheme or 
unexpected local economic downturn increases a lender's default rate 
above HUD's termination threshold.
    HUD Response. HUD's Credit Watch Termination Initiative focuses on 
a mortgagee's performance within a HUD field office jurisdiction. A 
mortgagee's default and claim rate within a HUD

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field office jurisdiction is compared to the overall default and claim 
rate of the entire HUD field office jurisdiction. Before HUD terminates 
the underwriting authority, it will consider mitigating issues raised 
by a mortgagee during its informal conference and in its written 
response. HUD's evaluation of mortgagees on the basis of HUD field 
office jurisdiction coincides with the manner in which FHA approves 
mortgagees to operate. This method of evaluation recognizes that local 
market conditions and events may contribute to higher defaults and 
claims.
    Comment: HUD should develop guidelines that take into account 
potential difficulties for underwriting mortgagees to comply due to 
shifting local averages. One commenter wrote that because a mortgagee's 
defaults are compared to the average rate in a local area, a lender 
could be terminated either due to a shift in the overall credit quality 
of a HUD local area, or by the gradual decline of a HUD local area's 
average default and claim rate, rather than due to the quality of the 
loans the lender is originating.
    HUD Response. HUD believes that the compare ratio for all lenders 
within a HUD field office jurisdiction would be equally affected by a 
shift in the overall credit quality or by the gradual decline of a HUD 
field office area's average default and claim rate. Furthermore, once a 
lender is terminated, while it cannot originate new FHA-insured loans, 
the lender's previously insured and defaulted cases are still included 
in the universe that makes up the compare ratio. Lenders are subject to 
termination when their claim and default ratio indicate that they pose 
a greater risk to the FHA insurance fund than other lenders in the 
field office area. Additionally, the compare ratio for each round of 
Credit Watch Termination is based on a specific 24-month period. 
Therefore, based on a loan being insured and the beginning amortization 
date, loans are added and removed from the counts for each successive 
round of Credit Watch Termination. Finally, as mentioned in the interim 
rule's preamble, HUD will periodically review the normal rate to 
determine whether the thresholds should be adjusted to reflect overall 
improvement in the FHA portfolio.
    Comment: HUD should provide adequate time and opportunity after the 
initial lender notification, yet prior to public notification of 
termination in the Federal Register, for the lender to be granted an 
informal conference with HUD to explain the reasons for the increased 
default/claims rate.
    HUD Response. As provided in 24 CFR 202.3(c)(1)(ii) of the Credit 
Watch regulations, a mortgagee may request an informal conference after 
receiving a proposed termination letter. Mortgagees are provided the 
opportunity at the informal conference to fully explain the reasons for 
the mortgagee's increased defaults and claims. The regulation provides 
that HUD must receive a request for the informal conference no later 
than 30 calendar days after the receipt date of the proposed 
termination letter from HUD, and that the conference must be held no 
later than 60 days after the date of the proposed termination notice. 
HUD will not publish an announcement in the Federal Register that a 
mortgagee has had its origination approval agreement terminated until 
after the requested informal conference is held, after HUD has 
considered all relevant reasons and factors, and after HUD has upheld 
its decision to terminate a lender's approval agreement.
    Comment: HUD should broaden and specify mitigation factors it will 
consider in making its termination decision. One commenter wrote that 
because of the severity of the penalty to the lender, the regulation 
should provide HUD with the ability to consider other mitigating 
factors in making its termination decision, such as: (1) The lender's 
overall risk management plan and performance; (2) prior proactive 
lender notification to HUD of fraud or other significant issues the 
lender has discovered; (3) prior action the lender has taken against a 
correspondent who has contributed to the high default rate, such as 
terminating the lender's relationship with the correspondent; and (4) 
prior action such as termination or other disciplinary action against 
the lender's employees responsible for a high default/claim rate.
    Another commenter wrote that HUD should broaden and specify the 
factors that FHA will review in deciding not to terminate the direct 
endorsement approval of a mortgagee and communicate these circumstances 
to direct endorsement lenders. This commenter wrote that mortgagees 
have had little success in convincing FHA that particular circumstances 
justify the withdrawal of a termination notice. The commenter continued 
by writing that there are many factors beyond poor underwriting or 
lending in underserved areas that can cause a higher default rate from 
one lender to another. The commenter wrote that lenders specializing in 
a particular product or that service a particular borrower type may be 
at a disadvantage in the general FHA market in a given area due to the 
greater risk inherent in these products. Finally, the commenter wrote 
that if the FHA holds underwriting mortgagees accountable in the same 
manner as originating mortgagees, underwriting mortgagees may avoid 
doing business with certain originators based on product type and not 
on origination quality. The commenter wrote that lenders should be 
encouraged to adopt new, and potentially riskier, FHA products, and 
lenders should not be penalized for this.
    HUD Response. HUD appreciates the comments and the suggested 
mitigation factors. However, HUD believes that the current regulations 
address the concerns raised by the commenters and that a regulatory 
change is therefore unnecessary. HUD will notify a mortgagee that its 
origination approval agreement will terminate if the mortgagee's 
default and claim rates are in excess of permissible levels. As 
mentioned above in this preamble, mortgagees that have received a 
proposed termination notice may request an informal conference at which 
the designated official will consider other relevant reasons and 
factors beyond the mortgagee's control that contributed to the 
mortgagee's high default and claim rate. Mortgagees will have the 
opportunity at the informal conference to present mitigating 
information, such as the actions identified by the commenters.
    Comment: HUD should take action only against a lender's specific 
division responsible for the high default and claim rate. One commenter 
requested that HUD provide the flexibility to separately analyze a 
lender's retail and correspondent divisions. The commenter suggested 
that when it can be determined that the claim and default rate is 
attributable to only one division, HUD should take action only against 
the division responsible for the high rate of defaults and claims.
    HUD Response. The current regulations already provide HUD with the 
flexibility to implement Credit Watch Termination actions against 
retail and correspondent divisions separately. Specifically, 24 CFR 
202.3(c)(2) provides that HUD may ``review the insured mortgage 
performance of a mortgagee's branch offices individually and may 
terminate the authority of the branch or the authority of the 
mortgagee's overall operation.''
    Comment: HUD should phase in the threshold for underwriting 
approval termination from 300 percent to 200 percent over a year or 
more. One commenter wrote that FHA should follow the same process it 
used in

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originally introducing Credit Watch; that is, FHA should start with a 
compare ratio of 300 percent for a given time period and then, if 
concerns are addressed, the compare ratio threshold should be lowered 
quarterly by 25 percent to arrive at a 200 percent compare ratio. The 
commenter explained that gradual implementation is important because 
Credit Watch covers loans made over a two-year period, and lenders will 
thus be evaluated for loans that were underwritten prior to the need to 
consider the consequences of Credit Watch. The commenter wrote that the 
goal of Credit Watch is not to terminate a lender's underwriting 
authority, but rather to prompt lenders to change their policies where 
the compare ratios are far above the norm--and implementing the 
threshold gradually from 300 percent to 200 percent will allow lenders 
to do this.
    HUD Response. At this time, HUD will not phase in Credit Watch 
thresholds. Should HUD decide to change and/or phase in the Credit 
Watch thresholds for underwriting mortgagees, it will announce this 
policy determination through Mortgagee Letter, Federal Register notice, 
or other means, as appropriate.
    Comment: Originating lenders should not be held responsible for 
defaults of which it has no knowledge. One commenter wrote that 
mortgages are often sold and transferred to new servicers, and that 
once the transfer takes place, the originating company gets virtually 
no information with regard to payments until the servicer seeks to 
impose a penalty or ask for re-purchase of that loan.
    HUD Response. As announced in Mortgagee Letter 00-20, dated June 2, 
2000, the Neighborhood Watch Early Warning system provides lenders with 
loan performance data via the FHA Internet Connection. Mortgagees that 
have received a proposed termination notice may request an informal 
conference at which a designated official will consider other relevant 
reasons and factors beyond the mortgagee's control that contributed to 
the mortgagee's high default and claim rate. Mortgagees will have the 
opportunity at the informal conference to present mitigating 
information.

IV. Small Business Concerns Related to Credit Watch Termination 
Initiative

    With respect to termination of the mortgagee's origination approval 
agreement, or taking other appropriate enforcement action against a 
mortgagee, HUD is cognizant that section 222 of the Small Business 
Regulatory Enforcement Fairness Act of 1996 (Pub. L. 104-121) (SBREFA) 
requires the Small Business and Agriculture Regulatory Enforcement 
Ombudsman to ``work with each agency with regulatory authority over 
small businesses to ensure that small business concerns that receive or 
are subject to an audit, on-site inspection, compliance assistance 
effort, or other enforcement related communication or contact by agency 
personnel are provided with a means to comment on the enforcement 
activity conducted by this personnel.'' To implement this statutory 
provision, the Small Business Administration has requested that 
agencies include the following language on agency publications and 
notices that are provided to small business concerns at the time the 
enforcement action is undertaken. The language is as follows:

Your Comments Are Important

    The Small Business and Agriculture Regulatory Enforcement 
Ombudsman and 10 Regional Fairness Boards were established to 
receive comments from small businesses about federal agency 
enforcement actions. The Ombudsman will annually evaluate the 
enforcement activities and rate each agency's responsiveness to 
small business. If you wish to comment on the enforcement actions of 
[insert agency name], you will find the necessary comment forms at 
http://www.sba.gov.ombudsman or call 1-888-REG-FAIR (1-888-734-
3247).

    In accordance with its notice describing HUD's actions on the 
implementation of SBREFA, which was published on May 21, 1998 (63 FR 
28214), HUD will work with the Small Business Administration to provide 
small entities with information on the Fairness Boards and National 
Ombudsman program, at the time enforcement actions are taken, to ensure 
that small entities have the full means to comment on the enforcement 
activity conducted by HUD.

V. Findings and Certifications

Regulatory Planning and Review

    The Office of Management and Budget (OMB) reviewed this rule under 
Executive Order 12866 (entitled ``Regulatory Planning and Review''). 
OMB determined that this rule is a ``significant regulatory action'' as 
defined in section 3(f) of the Order (although not economically 
significant, as provided in section 3(f)(1) of the Order). The docket 
file is available for public inspection between the hours of 8 a.m. and 
5 p.m. weekdays in the Regulations Division, Office of General Counsel, 
Department of Housing and Urban Development, 451 Seventh Street, SW., 
Room 10276, Washington, DC 20410-0500. Due to security measures at the 
HUD Headquarters building, an advance appointment to review the docket 
file must be scheduled by calling the Regulations Division at (202) 
708-3055.

Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) (5 U.S.C. 601 et seq.) 
generally requires an agency to conduct a regulatory flexibility 
analysis of any rule subject to notice and comment rulemaking 
requirements unless the agency certifies that the rule will not have a 
significant economic impact on a substantial number of small entities. 
This final rule follows publication of a December 17, 2004, interim 
rule that made several amendments to HUD's regulations for the FHA 
Credit Watch Termination Initiative and solicited additional public 
comment on those provisions regarding underwriting mortgagees.
    The final rule provides that the default and claim thresholds 
underlying the Credit Watch Termination Initiative apply to both 
underwriting and originating mortgagees. This amendment will ensure 
that the performance of all mortgagees involved in FHA-insured mortgage 
transactions is evaluated. To the extent that the change will have an 
economic impact on small underwriting mortgagees that are presently not 
covered by Credit Watch Termination, it will be as a result of actions 
taken by the mortgagees themselves--that is, failure to undertake the 
sound business practices necessary to maintain default and claim rates 
at an acceptable level.
    The final rule also provides for a fully computerized Credit Watch 
notification process through use of the FHA Neighborhood Watch Early 
Warning System. This change will provide for a streamlined and more 
effective method of monitoring mortgagee performance and for notifying 
poor performing mortgagees that are in danger of having their 
origination approval agreements terminated by HUD. The change will not 
impose an undue burden on small entities, since it merely codifies a 
HUD policy that was previously announced through a Mortgagee Letter. 
Further, the majority of mortgagees (small and large) participating in 
the FHA mortgage insurance programs currently have access to the FHA 
Internet Connection that is used to provide such notification.
    The rule also removes the regulatory cap on the Credit Watch 
default and claim rates, and provides that a mortgagee will be 
considered to be on Credit Watch Status if it has a default and claim 
rate on insured mortgages that exceeds 150 percent of the normal rate 
and its origination approval

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agreement has not been terminated. This revision will not impose a 
significant economic impact on small entities, since the entities that 
will be affected by this change are poorly performing mortgagees that 
are already subject to termination of their origination approval 
agreements.
    The rule also prohibits a mortgagee that has received a notice of 
proposed termination of its origination approval agreement from 
establishing a new branch in the lending area covered by the proposed 
termination. The mortgagees to which this change will be applicable are 
those that already have been notified by HUD that their default and 
claim rates exceed an acceptable standard in specified geographic areas 
and that they are at risk of having their FHA mortgage origination 
approvals terminated. The rule closes a loophole previously used by 
mortgagees to evade HUD's existing procedure for reviewing losses to 
the FHA mortgage insurance fund.
    The final rule also provides that, for purposes of the Credit Watch 
Termination evaluation, the date of mortgage origination will be 
considered to be the date the loan transaction commences amortization, 
rather than the date of endorsement for FHA mortgage insurance. This 
change will not impose any economic burden on small mortgagees; rather, 
the change will improve the accuracy of Credit Watch Termination 
evaluations by conforming HUD's definition of the mortgage origination 
date to the beginning amortization date used to report defaults. 
Finally, the final rule will codify the existing definition of the term 
``underserved area'' for purposes of Credit Watch Termination 
determinations. This amendment merely codifies existing policy and 
will, therefore, not impose any new economic burden on mortgagees.
    Accordingly, the undersigned certifies that this rule will not have 
a significant economic impact on a substantial number of small 
entities.

Environmental Impact

    This final rule will not direct, provide for assistance or loan and 
mortgage insurance for, or otherwise govern or regulate, real property 
acquisition, disposition, leasing, rehabilitation, alteration, 
demolition, or new construction, or establish, revise, or provide for 
standards for construction or construction materials, manufactured 
housing, or occupancy. Accordingly, under 24 CFR 50.19(c)(1), this 
final rule is categorically excluded from the requirements of the 
National Environmental Policy Act (42 U.S.C. 4321 et seq.).

Executive Order 13132, Federalism

    Executive Order 13132 (entitled ``Federalism'') prohibits, to the 
extent practicable and permitted by law, an agency from promulgating a 
regulation that has federalism implications and either imposes 
substantial direct compliance costs on state and local governments and 
is not required by statute or preempts state law, unless the relevant 
requirements of section 6 of the Executive Order are met. This rule 
does not have federalism implications and does not impose substantial 
direct compliance costs on state and local governments or preempt state 
law within the meaning of the Executive Order.

Unfunded Mandates Reform Act

    Title II of the Unfunded Mandates Reform Act of 1995 (2 U.S.C. 
1531-1538) (UMRA) establishes requirements for Federal agencies to 
assess the effects of their regulatory actions on state, local, and 
tribal governments and the private sector. This final rule does not 
impose any Federal mandates on any state, local, or tribal government 
or the private sector within the meaning of UMRA.

Catalog of Federal Domestic Assistance

    The Catalog of Federal Domestic Assistance Program number 
applicable to 24 CFR part 202 is 14.20.

List of Subjects in 24 CFR Part 202

    Administrative practice and procedure, Home improvement, 
manufactured homes, Mortgage insurance, Reporting and recordkeeping 
requirements.


0
Accordingly, for the reasons stated in the preamble, the interim rule 
for part 202 of Title 24 of the Code of Federal Regulations, amending 
Sec.  202.3(c)(2) and adding Sec.  202.3(e), published on December 17, 
2004, at 69 FR 75802, is promulgated as final, without change.

    Dated: January 20, 2006.
Frank L. Davis,
General Deputy Assistant Secretary for Housing.
[FR Doc. 06-852 Filed 1-27-06; 8:45 am]
BILLING CODE 4210-27-P