[Federal Register Volume 69, Number 242 (Friday, December 17, 2004)]
[Rules and Regulations]
[Pages 75802-75809]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-27536]



[[Page 75801]]

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Part V





Department of Housing and Urban Development





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24 CFR Part 202



Revisions to FHA Credit Watch Termination Initiative; Interim Rule

Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / 
Rules and Regulations

[[Page 75802]]


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DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

24 CFR Part 202

[Docket No. FR-4625-I-02; HUD-2004-0014]
RIN 2502-AH60


Revisions to FHA Credit Watch Termination Initiative

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

ACTION: Interim rule.

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SUMMARY: On April 1, 2003, HUD published a proposed rule to amend the 
regulations for the Federal Housing Administration (FHA) Credit Watch 
Termination Initiative. Specifically, HUD proposed to provide for a 
fully computerized Credit Watch status notification process through use 
of the FHA Neighborhood Watch Early Warning System; remove the 
regulatory ``cap'' on the default and claim rates for placing a 
mortgagee on Credit Watch status; 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; provide 
that the default and claim thresholds underlying the Credit Watch 
Termination Initiative apply to both underwriting and originating 
mortgagees; codify the definition of ``underserved area'' that is 
currently used under the Credit Watch Termination Initiative; 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; specify the timeframes for the 
informal conference that may be requested by a mortgagee prior to 
termination; and describe the procedures a terminated mortgagee must 
follow to have its origination approval agreement reinstated.This 
interim rule follows publication of the April 1, 2003, proposed rule, 
and takes into consideration the public comments on the proposed rule. 
In addition, this rule further clarifies the applicability of the 
Credit Watch Termination Initiative to underwriting mortgagees, and 
requests comments on the regulatory provisions regarding underwriting 
mortgagees.

DATES: Effective Date: January 18, 2005.
    Comments Due Date: February 15, 2005.

ADDRESSES: Interested persons are invited to submit comments regarding 
this rule to the Regulations Division, Office of General Counsel, Room 
10276, Department of Housing and Urban Development, 451 Seventh Street, 
SW, Washington, DC 20410-0500. Electronic comments may be submitted 
through either:
    <bullet> The Federal eRulemaking Portal at http://www.regulations.gov; or
    <bullet> The HUD electronic Web site at http://www.epa.gov/feddocket. Follow the link entitled ``View Open HUD Dockets.'' 
Commenters should follow the instructions provided on that site to 
submit comments electronically.
    Facsimile (FAX) comments are not acceptable. In all cases, 
communications must refer to the docket number and title. All comments 
and communications submitted will be available for public inspection 
and copying between 8 a.m. and 5 p.m. weekdays at the above address. 
Copies are also available for inspection and downloading at http://www.epa.gov/feddocket.

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--HUD's April 1, 2003, Proposed Rule

    On April 1, 2003 (68 FR 15906), HUD published a proposed rule to 
amend the regulations for the Federal Housing Administration (FHA) 
Credit Watch Termination Initiative. Through the Credit Watch 
Termination 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 to make 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.

II. Significant Differences Between this Interim Rule and the April 1, 
2003, Proposed Rule

    This interim rule follows publication of the April 1, 2003, 
proposed rule, and takes into consideration the public comments 
received on the proposed rule. The changes made to the April 1, 2003, 
proposed rule in response to public comment are as follows:
    1. Clarification of applicability to underwriting mortgagees. In 
response to several comments, this interim rule clarifies the 
applicability of the Credit Watch Termination Initiative to 
underwriting mortgagees. The April 1, 2003, proposed rule made clear 
that underwriting mortgagees would be included within the scope of the 
Credit Watch Termination Initiative. However,

[[Page 75803]]

HUD agrees that additional clarification would be helpful regarding the 
effects of Credit Watch Termination evaluations on the ability of 
mortgagees with direct endorsement approval to underwrite FHA-insured 
mortgage loans. Accordingly, HUD has revised the rule to provide for 
separate regulatory language that specifically addresses underwriting 
mortgagees. For example, the rule now clarifies that the Secretary may 
terminate an underwriting mortgagee's direct endorsement approval under 
24 CFR part 203 to underwrite FHA-insured mortgages if the mortgagee 
has a rate of defaults and claims on insured mortgages underwritten in 
an area that exceeds the established Credit Watch Termination 
thresholds. The termination of a mortgagee's direct endorsement 
approval under the Credit Watch Termination Initiative is separate and 
apart from the termination of a mortagee's direct endorsement approval 
under 24 CFR part 203.
    The new regulatory language does not alter the substance of the 
proposals contained in the April 1, 2003, proposed rule but, rather, 
provides greater clarity on how the performance of underwriting 
mortgagees would be subject to evaluation under the Credit Watch 
Termination Initiative. Although the language of the proposed rule did 
not explicitly reference termination of a mortgagee's direct 
endorsement approval, the preamble to the proposed rule made clear that 
the regulatory amendments were designed to ``emphasize HUD's authority 
to terminate the ability of a mortgagee to originate or underwrite FHA-
insured single family mortgages where the mortgagee has demonstrated an 
unacceptably high default and claim rate'' (see 68 FR 15906, at 15907, 
third column). The ability of a mortgagee to underwrite FHA-insured 
mortgages is provided by its direct endorsement approval and, 
therefore, the termination of a mortgagee's direct endorsement approval 
was contemplated by the proposed rule.
    Because the new regulatory language was not part of the April 1, 
2003, proposed rule, HUD is issuing these changes on an interim basis 
and soliciting public comment for a period of 60 days. HUD will issue a 
follow-up final rule addressing the significant issues raised by the 
public commenters on the new language concerning the applicability of 
the Credit Watch Termination Initiative to underwriting mortgagees. HUD 
will not consider public comments submitted in response to other 
provisions of this interim rule. These provisions were contained in the 
April 1, 2003, proposed rule and, therefore, have already been the 
subject of public comments. A discussion of the significant issues 
raised by the public commenters on the April 1, 2003, proposed rule and 
HUD's responses to these comments is located in section III of this 
preamble.
    2. Removal of last sentence of proposed Sec.  202.3(c)(2)(ii). For 
purposes of clarity, and at the request of a public commenter, HUD has 
removed the last sentence of proposed Sec.  202.3(c)(2)(ii), which 
provided that a ``poor performing mortgagee on Credit Watch status is 
in danger of having its origination approval agreement terminated by 
HUD.''
    3. Other clarifying changes. HUD has also taken the opportunity 
afforded by this interim rule to make several non-substantive changes 
to enhance the clarity of the Credit Watch regulations (for example, 
revising the headings of certain paragraphs).

III. Discussion of the Public Comments on the April 1, 2003, Proposed 
Rule

    The public comment period for the proposed rule closed on June 1, 
2003. HUD received four public comments on the proposed rule. Comments 
were received from a city, a national association representing mortgage 
bankers, a mortgage lender, and a national community development 
organization. The comments were generally supportive of the proposed 
rule, but also requested clarification of some of the proposed 
regulatory changes and offered suggestions for improving the rule. This 
section of the preamble presents a summary of the significant issues 
raised by the public commenters on the April 1, 2003, proposed rule, 
and HUD's responses to these issues.

A. Comments Regarding Use of the FHA Neighborhood Watch Early Warning 
System

    Comment: Support for electronic notification of Credit Watch 
status. The commenter wrote that ``[h]aving the Credit Watch 
notification information available online would enhance [the 
commenter's] ability to monitor its own and its FHA correspondents' 
production on an ongoing, live basis.''
    HUD response. HUD appreciates the commenter's support. The interim 
rule adopts these provisions of the proposed rule without change. HUD 
agrees that a fully computerized Credit Watch notification system 
provides a streamlined and more effective method of monitoring 
mortgagee performance.

B. Comments Regarding Removal of the Regulatory ``Cap'' on the Credit 
Watch Default and Claim Rate

    Comment: Support for removal of regulatory cap. Two commenters 
wrote that HUD's clarification that a lender will be considered to be 
on Credit Watch status if its rate of defaults and claims exceeds 150 
percent of the normal rate will strengthen the Credit Watch Termination 
Initiative.
    HUD response. HUD appreciates the support expressed by the 
commenters. HUD has adopted the proposed regulatory amendment without 
change. The amendment will strengthen the Credit Watch Termination 
Initiative by eliminating the need for regulatory waivers to authorize 
placement of mortgagees with default and claims rates greater than 200 
percent on Credit Watch status.
    Comment: HUD should clarify the threshold for termination of a 
mortgagee's origination approval agreement. One commenter requested 
that the rule provide clarification regarding the threshold claim and 
default rate that may trigger termination of a mortgagee's origination 
approval agreement. The commenter was uncertain about the impact of the 
last sentence of proposed Sec.  202.3(c)(2)(ii), which provides that a 
``poor performing mortgagee on Credit Watch status is in danger of 
having its origination approval agreement terminated by HUD.'' The 
commenter wrote that this sentence implies that the default and claim 
ratio required for placement on Credit Watch status (150%) would 
suffice to terminate a mortgagee's origination approval agreement. The 
commenter wrote that this would contradict both the language of Sec.  
202.3(c)(2)(iii) and the policy stated in Mortgagee Letter 2002-20 that 
a mortgagee's origination approval agreement may be terminated only if 
its rate of default and claims exceeds 200% of the normal rate and the 
national default and claim rate for insured mortgages. The commenter 
wrote that ``the current 200% termination threshold is sufficient for 
FHA to monitor lenders with excessive claim and default rates,'' and 
suggested that HUD remove the last sentence of proposed Sec.  
202.3(c)(2)(ii).
    HUD response. For purposes of clarity, HUD has adopted the 
commenter's suggestion and removed the last sentence of proposed Sec.  
202.3(c)(2)(ii). The proposed regulatory language was not intended to 
imply that a mortgagee placed on Credit Watch status with a default and 
claim rate of less than 200% of the normal rate

[[Page 75804]]

is subject to termination. As the commenter notes, the regulations are 
clear that a mortgagee is subject to termination only if its rate of 
defaults and claims exceeds 200 percent of the normal rate and also 
exceeds the national default and claim rate for insured mortgages. The 
language of the proposed rule was designed to remind a poor performing 
mortgagee that placement on Credit Watch status is a warning that its 
default and claim rate is unacceptable and, that unless corrective 
action is taken, the rate may soon rise to a level triggering possible 
termination of its origination approval agreement.
    Comment: HUD should not establish a firm threshold for placement on 
Credit Watch status. One commenter made this suggestion. The commenter 
wrote that, over time, as mortgagees manage their portfolio, the 
``normal rate'' band will narrow, and make it more difficult for 
mortgagees to operate below this threshold on an ongoing basis.
    HUD response. HUD adopted the proposed regulatory amendment without 
change. However, 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 conduct national Credit Watch evaluations for 
mortgagees that operate on a national basis. One commenter expressed 
concerns over HUD's conducting Credit Watch evaluations on a regional 
basis. The commenter suggested that for mortgagees operating on a 
national basis, HUD's review should consider the mortgagee's national 
default and claim rate, not just defaults and claims in one region.
    HUD 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.

C. Comments on Limitations on the Establishment of New Branches

    Comment: Support for limitation on the establishment of new branch 
offices. Two commenters wrote that elimination of this loophole in the 
current regulations would strengthen the Credit Watch Termination 
Initiative and promote access to affordable loans for underserved 
communities.
    HUD response. HUD appreciates the support expressed by the 
commenters. This interim rule adopts the proposed regulatory amendment 
without change.
    Comment: Objection to the mandatory prohibition of new branch 
offices in the lending area covered by a proposed termination. One 
commenter wrote that before imposing such a prohibition, HUD should 
consider the mortgagee's national rate of defaults and claims, and the 
risk management process and internal controls that the mortgagee has 
implemented to manage the rate of defaults and claims at the local 
level.
    HUD response. HUD's review analyzes the performance of every FHA 
approved mortgagee branch in each geographic area served by a HUD field 
office. HUD's regulations permit HUD to terminate the origination 
approval agreement with any mortgagee having a default and claim rate 
that exceeds 200 percent of the default and claim rate within the 
geographic area served by a HUD field office, and also exceeds the 
national default and claim rate. Since HUD's Credit Watch Termination 
Initiative is based on statistics, a mortgagee's risk management 
processes and internal controls would not be considered prior to 
prohibiting a mortgagee from establishing new branches. Further, a 
mortgagee with significant risk management processes and internal 
controls will be less likely to receive a termination letter from HUD.

D. Comments on Inclusion of Underwriting Mortgagees

    Comment: Support for inclusion of underwriting mortgagees. Two 
commenters wrote that the inclusion of underwriting mortgagees would 
promote increased access to affordable loans for underserved 
communities and strengthen the Credit Watch Termination Initiative.
    HUD response. HUD appreciates the support expressed by the 
commenters. The inclusion of underwriting mortgagees will help to 
ensure that the performance of all mortgagees involved in FHA-insured 
mortgage transactions is properly evaluated. As noted above in this 
preamble, HUD has revised the rule to provide for separate regulatory 
language that specifically addresses underwriting mortgagees. HUD is 
issuing these changes on an interim basis and soliciting public comment 
for a period of 60 days. HUD will issue a follow-up final rule 
addressing the significant issues raised by the public commenters on 
the new language regarding underwriting mortgagees.
    Comment: HUD should ``phase-in'' the Credit Watch termination 
thresholds for underwriting mortgagees. One commenter wrote that this 
would provide underwriting sponsors with time to implement the 
necessary changes to internal procedures and to educate their FHA 
correspondents of the pending changes. The commenter suggested that the 
thresholds be ``phased-in'' in a manner similar to that used by HUD for 
loan originators under Mortgagee Letter 99-15.
    HUD response. HUD has not adopted the change requested by the 
commenter. However, HUD has revised the rule to clarify the 
requirements applicable to underwriting mortgagees and is requesting 
public comments on the new regulatory language. Further, prior to 
implementation of the regulatory changes made by this interim rule, HUD 
will issue guidance (such as a Mortgagee Letter) that will provide 
additional information to assist underwriting mortgagees in their 
compliance efforts.
    Comment: HUD should take into consideration proactive measures 
taken by sponsors against unscrupulous loan correspondents. Two 
commenters wrote that underwriting sponsor mortgagees are removed from 
the mortgage origination process, and sometimes the victims of fraud 
perpetuated by unscrupulous loan correspondents. Accordingly, the 
commenters suggested that the rule should exclude default and claim 
performance numbers from the Credit Watch evaluation of sponsor 
mortgagees where the sponsor discovers and reports fraud committed by a 
correspondent, or where the sponsor has terminated the correspondent.
    HUD response. Since HUD's Credit Watch Termination Initiative is 
based on statistical data, it would not be possible to exclude the 
default and claim numbers of sponsoring mortgagees where the sponsor 
discovers and reports fraud. However, HUD would consider these issues 
if the mortgagee received a termination letter and presented those 
issues to HUD.
    Comment: HUD should provide guidance to sponsors on the evaluation 
and the performance of their loan correspondents using the Neighborhood 
Watch Early Warning System. One commenter made this recommendation. The 
commenter wrote that HUD should provide sponsors with formal 
descriptions of the factors taken into consideration when evaluating 
the performance of FHA correspondents, in order to assist the sponsors 
in proactively managing the performance of their correspondents. 
Further, the commenter recommended that HUD develop a system to notify 
sponsors of audit results, Credit Watch actions, and other actions 
taken against FHA correspondents. The commenter wrote that HUD could 
provide a web-link where actions against FHA

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correspondents are outlined and updated monthly.
    HUD response. As noted above, HUD has revised the rule to clarify 
the new requirements applicable to underwriting mortgagees and is 
requesting public comments on this new regulatory language. Further, 
HUD will issue guidance to assist mortgagees in the implementation of 
the new requirements established by this interim rule. In addition, 
HUD's Internet site at: http://www.hud.gov/offices/hsg/sfh/lender/lendterm.cfm includes a list of all lenders whose origination approval 
agreements have been terminated as a result of the Credit Watch 
Termination Initiative. HUD also notes that the causes and descriptions 
of administrative actions taken by HUD's Mortgagee Review Board against 
HUD-approved mortgagees are regularly published in the Federal 
Register. HUD suggests that sponsors also require that loan 
correspondents provide them with audit reports or other actions taken 
by HUD.
    Comment: The rule should permit FHA to look at mitigating factors 
underlying the default and claim rates of an underwriting mortgagee. 
One commenter made this suggestion. The commenter wrote that a 
mortgagee operating in an urban area, or primarily serving first-time 
homebuyers, might experience a higher default and claim rate than a 
mortgagee operating in a suburban area or primarily working on 
refinances.
    HUD response. HUD regulations permit a mortgagee to request an 
informal conference with the Deputy Assistant Secretary for Single 
Family Housing, or that official's designee, prior to the termination 
of its origination approval agreement. During the informal conference, 
the mortgagee has the opportunity to present HUD with explanations for 
its high default and claim rate. However, the mortgagee must be able to 
explain how the issues presented caused it to have a default and claim 
rate higher than the average for the area.
    Comment: The rule should clarify how the Credit Watch Termination 
Initiative will apply to sponsoring mortgagees. One commenter made this 
suggestion. The commenter was unsure how the placement on Credit Watch 
status would affect an underwriting sponsor mortgagee. For example, the 
commenter asked whether a sponsor mortgagee terminated in a given HUD 
office area would be prohibited from underwriting loans in that area.
    HUD response. HUD agrees with the commenters. As noted above, this 
rule clarifies the applicability of the new regulatory requirements to 
underwriting mortgagees. Specifically, HUD has revised the rule to 
provide for separate regulatory language to specifically address the 
applicability of the Credit Watch Termination Initiative to 
underwriting mortgagees. Because the new regulatory language was not 
part of the April 1, 2003, proposed rule, HUD is issuing these changes 
on an interim basis and is requesting public comments for a period of 
60 days. HUD will issue a follow-up final rule addressing the 
significant issues raised by the commenters on the new language 
concerning underwriting mortgagees.

E. Comments Regarding Mortgage Origination Date

    Comment: The Credit Watch Termination Initiative should continue to 
use the FHA endorsement date as the mortgage origination date. One 
commenter made this suggestion. The commenter wrote that since the 
primary purpose of the Credit Watch Termination Initiative is to 
mitigate risk to the FHA mortgage insurance fund, the date of FHA 
endorsement should be the starting point for evaluation of a 
mortgagee's performance. The commenter wrote that until a loan is 
endorsed, there is no risk to the FHA mortgage insurance fund and the 
mortgagee bears all of the risk.
    HUD response. HUD has not adopted the suggestion made by the 
commenter. HUD currently evaluates performance based on loans that have 
been endorsed. HUD's regulations at Sec.  203.255(b) require that 
lenders submit loans to HUD for endorsement within 60 days from loan 
closing. However, there may be a gap in time from the origination date 
(beginning amortization date) and the endorsement date based on the 
period of time after closing in which a mortgagee submits a loan for 
insurance to HUD. Additional time may elapse if the mortgagee has 
failed to provide HUD with all of the required documents. These time 
gaps have resulted in inconsistencies among the starting dates used by 
HUD to evaluate mortgagee loan performance. Using the beginning 
amortization date instead of the endorsement date provides a uniform 
starting date for HUD's analysis. Further, since the beginning 
amortization date is now used throughout HUD for loan performance 
analysis, this interim rule has the added benefit of conforming the 
Credit Watch procedures to other HUD loan performance evaluation 
procedures.
    Comment: Support for use of the amortization date as the mortgage 
origination date. In contrast to the preceding comment, one commenter 
supported the use of the amortization date to determine the date of 
mortgage origination under the Credit Watch Termination Initiative. The 
commenter wrote that the amortization date is easier to track and would 
be a more consistent starting date between loans.
    HUD response. Use of the amortization date provides a more uniform 
starting date for Credit Watch evaluations, and improve the accuracy of 
these evaluations. Accordingly, this interim rule adopts the proposed 
regulatory amendment without change.

F. Comments Regarding Informal Conference Prior to Termination

    Comment: HUD should establish a more detailed process for reviewing 
mortgagee performance prior to termination. One commenter made this 
suggestion. The commenter suggested that a mortgagee should be 
permitted to initiate the formal review and present mitigating 
information, such as the number of loans in underserved areas and the 
number of loans that were streamlined refinances involving minimal 
underwriting. The commenter wrote that the mortgagee should also have 
the opportunity to present a risk-management plan pertaining to the 
branch, and that HUD should terminate the mortgagee only if the 
improvement plan is not met.
    HUD response. HUD has decided not to revise the rule in response to 
this comment. HUD undertakes a comprehensive review of mortgagee 
performance prior to sending a proposed termination notice. For 
example, HUD analyzes a mortgagee's portfolio by insurance fund (i.e., 
Mutual Mortgage, General, and Special Risk), and by census tract 
designation (i.e., served, underserved and undesignated). HUD also 
evaluates the impact of streamline-refinanced loans for each mortgagee 
prior to issuing a proposed termination notice. HUD also notes that 
each mortgagee is required to have a quality control plan and to 
perform regular quality control reviews that will bring potential 
problems to its attention. In addition, mortgagees should use HUD's 
Neighborhood Watch Early Warning System to monitor the performance of 
their branches and take prompt corrective action before receipt of a 
proposed termination letter from HUD.
    Comment: HUD should establish a process to allow the public to 
comment on the FHA lending performance of questionable mortgagees. One 
commenter made this suggestion, writing that community groups and 
neighborhood residents have first-hand knowledge of mortgagee 
operations that

[[Page 75806]]

the mortgagee will not volunteer in a process only involving HUD and 
the mortgagee. The commenter wrote that HUD should publicize any 
requests for an informal conference on HUD's Web site and invite 
community groups to comment during the conference. Further, the 
commenter advocated that HUD also solicit public comments as part of 
the reinstatement process for a mortgagee that has been terminated. The 
commenter suggested that HUD provide the public with the mortgagee's 
corrective action plan and require that the mortgagee meet with the 
public to discuss their comments on the plan.
    HUD response. HUD's Credit Watch Termination Initiative is based on 
statistical data, rather than fact-finding. Soliciting the involvement 
of community groups in the informal conference process and in the 
reinstatement process would change the essence of Credit Watch 
Termination to more of a fact-finding initiative. However, if community 
groups are aware of concerns regarding FHA approved mortgagees, they 
should notify the quality assurance division directors in FHA's four 
Homeownership Centers (HOCs). HUD publishes a list of mortgagees that 
have had their origination approval agreements terminated in the 
Federal Register and on HUD's Internet site.

G. Comments Regarding the Definition of Underserved Area

    Comment: Concerns about the definition of ``underserved area.'' One 
commenter wrote that defining the term ``underserved area'' through the 
use of census tracts would perpetuate abuses. The commenter wrote that 
a mortgagee that is the predominant lender in a census tract would 
never be penalized if the benchmark default rate used for determining 
possible termination is the default rate of the census tract in 
question.
    HUD response. HUD has not revised the rule in response to this 
comment. HUD's data analysis of a mortgagee's performance by census 
tract involves aggregating the loans for all census tracts that are 
identified as being underserved, served, or undesignated within the 
jurisdiction of a HUD office. Mortgagee performance within specific 
census tracts is not analyzed.
    Comment: HUD should not consider the servicing of underserved areas 
in evaluating a mortgagee's performance. One commenter wrote that under 
the current regulations, it is permissible for a mortgagee to have a 
default and claim rate higher than 200% of the normal rate, if the 
mortgagee primarily serves lower-income underserved areas. The 
commenter wrote that HUD's apparent tolerance of higher defaults rates 
for mortgagees doing business in underserved areas might perpetuate 
property flipping and other FHA program abuses leading to higher rates 
of default in these areas. To avoid this adverse outcome, the commenter 
recommended that HUD either: (1) Apply its default rates uniformly 
regardless of the neighborhoods served by the mortgagee; or (2) perform 
the Credit Watch analysis at a geographical level smaller than the HUD 
Field Office level. Under the second option, if a mortgagee primarily 
focused on the inner city, the default rate analysis would be performed 
on the level of the city, instead of the HUD Field Office level. The 
commenter wrote that since a HUD Field Office encompasses a number of 
metropolitan areas and rural parts of a state, a smaller geographical 
unit, such as a metropolitan area, a county and/or a city, may be a 
more appropriate comparison.
    HUD response. HUD considers a mortgagee's default and claim rate by 
census tract designation (i.e., underserved, served, and undesignated). 
Mortgagee Letter 99-15 further clarifies that if a mortgagee's rate of 
defaults and claims does not exceed 200% of the HUD field office's rate 
of defaults and claims in underserved census tracts, then the 
mortgagee's performance is acceptable in underserved tracts. Therefore, 
HUD does apply its default rates uniformly regardless of the census 
tract designation served by the mortgagee.
    HUD's evaluation of mortgagee branch performance by HUD field 
office designation is consistent with the method used by FHA to approve 
mortgagees to operate. However, HUD will consider the issue of a 
lender's business being concentrated in a smaller area if presented by 
the mortgagee in response to a proposed termination notice.

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). Any changes 
made to the rule subsequent to its submission to OMB are identified in 
the docket file, which is available for public inspection in the 
Regulations Division, Room 10276, Office of General Counsel, Department 
of Housing and Urban Development, 451 Seventh Street, SW., Washington, 
DC 20410-0500.

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

[[Page 75807]]

that the rule will not have a significant economic impact on a 
substantial number of small entities. This rule makes several 
amendments to HUD's regulations for the FHA Credit Watch Termination 
Initiative. First, consistent with the goals of the Administration 
regarding the increased use of technology in government, the interim 
rule 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 existing HUD policy 
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 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 they are at risk of having their FHA mortgage origination approvals 
terminated. The intent of this rulemaking is to close a loophole used 
by mortgagees to evade HUD's existing procedure for reviewing losses to 
the FHA mortgage insurance fund.
    The interim rule also 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 who 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 interim 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 interim rule will codify the existing definition of the 
term ``underserved area'' for purposes of Credit Watch Termination 
determinations. This amendment will merely codify 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. Notwithstanding HUD's determination that this rule will not 
have a significant economic impact on a substantial number of small 
entities, HUD specifically invites comments regarding less burdensome 
alternatives to this rule that will meet HUD's objectives as described 
in this preamble.

Environmental Impact

    This interim 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), this interim 
rule is categorically excluded from the requirements of the National 
Environmental Policy Act (42 U.S.C. 4332 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 interim 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 described in the preamble, HUD amends 24 
CFR part 202 as follows:

PART 202--APPROVAL OF LENDING INSTITUTIONS AND MORTGAGEES

0
1. The authority citation for 24 CFR part 202 continues to read as 
follows:

    Authority: 12 U.S.C. 1703, 1709, and 1715b; 42 U.S.C. 3535(d).


0
2. In Sec.  202.3, revise paragraph (c)(2) and add paragraph (e) to 
read as follows:


Sec.  202.3  Approval status for lenders and mortgagees.

* * * * *
    (c) * * *
    (2) Credit Watch Termination. (i) Scope and frequency of review. 
The Secretary will review, on an ongoing basis, the number of defaults 
and claims on mortgages originated, underwritten, or both, by each 
mortgagee in the geographic area served by a HUD field office. HUD will 
make this rate information available to mortgagees and the public 
through electronic means and will issue instructions for accessing this 
information through a Mortgagee Letter.

[[Page 75808]]

For this purpose, and for all purposes under paragraph (c) of this 
section, a mortgage is considered to be originated in the same federal 
fiscal year in which its amortization commences. The Secretary may also 
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.
    (ii) Credit Watch Status. Mortgagees are responsible for monitoring 
their default and claim rate performance. A mortgagee is considered to 
be on Credit Watch Status if, at any time, the mortgagee has a rate of 
defaults and claims on insured mortgages originated, underwritten, or 
both, in an area which exceeds 150 percent of the normal rate and its 
origination approval agreement has not been terminated.
    (iii) Notice of termination. (A) Notice of termination of 
origination approval agreement. The Secretary may notify a mortgagee 
that its origination approval agreement will terminate 60 days after 
notice is given, if the mortgagee had a rate of defaults and claims on 
insured mortgages originated in an area which exceeded 200 percent of 
the normal rate and exceeded the national default and claim rate for 
insured mortgages.
    (B) Notice of termination of direct endorsement approval. The 
Secretary may notify a mortgagee that its direct endorsement approval 
under 24 CFR part 203 will terminate 60 days after notice is given, if 
the mortgagee had a rate of defaults and claims on insured mortgages 
underwritten in an area which exceeded 200 percent of the normal rate 
and exceeded the national default and claim rate for insured mortgages. 
The termination of a mortgagee's direct endorsement approval pursuant 
to this section is separate and apart from the termination of a 
mortgagee's direct endorsement approval under 24 CFR part 203.
    (C) No need for prior action by Mortgagee Review Board. The 
termination notices described in paragraphs (c)(2)(ii)(A) and (B) of 
this section may be given without prior action by the Mortgagee Review 
Board.
    (D) Underserved areas. Before the Secretary sends the termination 
notice, the Secretary shall review the Census tract concentrations of 
the defaults and claims. If the Secretary determines that the excessive 
rate is the result of mortgage lending in underserved areas, as defined 
in 24 CFR 81.2, the Secretary may determine not to terminate the 
mortgagee's origination approval agreement and/or direct endorsement 
approval.
    (iv) Request for informal conference. Prior to termination the 
mortgagee may submit a written request for an informal conference with 
the Deputy Assistant Secretary for Single Family Housing or that 
official's designee. HUD must receive the written request no later than 
30 calendar days after the date of the proposed termination notice. 
Unless HUD grants an extension, the informal conference must be held no 
later than 60 calendar days after the date of the proposed termination 
notice. After considering relevant reasons and factors beyond the 
mortgagee's control that contributed to the excessive default and claim 
rates, the Deputy Assistant Secretary for Single Family Housing or 
designee may withdraw the termination notice.
    (v) Limitation on the establishment of new branches. Upon receipt 
of a proposed termination notice of its origination approval agreement, 
the mortgagee shall not establish a new branch or new branches for the 
origination of FHA-insured mortgages in the area or areas that are 
covered by the proposed termination notice. As of January 18, 2005, a 
mortgagee that is in receipt of a notice of proposed termination may 
not establish any new branch in the location or locations cited in the 
proposed termination notice until either:
    (A) The proposed termination notice is withdrawn or
    (B) The Secretary reinstates the mortgagee's origination approval 
agreement, in accordance with paragraph (e) of this section.
    (vi) Effects of termination. (A) Termination of origination 
approval agreement. If a mortgagee's origination approval agreement is 
terminated, it may not originate single family insured mortgages unless 
the origination approval agreement is reinstated by the Secretary in 
accordance with paragraph (e) of this section, notwithstanding any 
other provision of this part except Sec.  202.3(c)(2)(vii)(A).
    (B) Termination of direct endorsement approval. If a mortgagee's 
direct endorsement approval is terminated, it may not underwrite single 
family insured mortgages for the area(s) identified in the termination 
notice, unless the direct endorsement approval is reinstated by the 
Secretary in accordance with paragraph (e) of this section, 
notwithstanding any other provision of this part except Sec.  
202.3(c)(2)(vii)(A).
    (vii) Rights and obligations in the event of termination. 
Termination of the origination approval agreement and/or direct 
endorsement approval shall not affect:
    (A) The eligibility of the mortgage for insurance, absent fraud or 
misrepresentation, if the mortgagor and all terms and conditions of the 
mortgage had been approved before the termination by the Direct 
Endorsement or Lender Insurance mortgagee or were covered by a firm 
commitment issued by the Secretary; however, no other mortgages 
originated or underwritten after the date of termination by the 
mortgagee shall be insured unless the mortgagee's origination approval 
agreement and/or direct endorsement approval is reinstated by the 
Secretary;
    (B) The right of a mortgagee whose direct endorsement approval has 
been terminated to transfer cases to another mortgagee with direct 
endorsement approval for the area covered by the termination.
    (C) A mortgagee's obligation to continue to pay insurance premiums 
and meet all other obligations, including servicing, associated with 
insured mortgages;
    (D) A mortgagee's right to apply for reinstatement of the 
origination approval agreement and/or direct endorsement approval in 
accordance with paragraph (e) of this section; or
    (E) A mortgagee's right to purchase insured mortgages or to service 
its own portfolio or the portfolios of other mortgagees with which it 
has a servicing contract.
* * * * *
    (e) Reinstatement. (1) General. A mortgagee whose origination 
approval agreement and/or direct endorsement approval has been 
terminated under paragraph (c) of this section may apply for 
reinstatement if:
    (i) The origination approval agreement and/or direct endorsement 
approval for the affected branch or branches has been terminated for at 
least six months; and
    (ii) The mortgagee continues to be an approved mortgagee meeting 
the general standards of Sec.  202.5 and the specific requirements of 
Sec. Sec.  202.6, 202.7, 202.8 or 202.10, and 202.12.
    (2) Application for reinstatement. The mortgagee's application for 
reinstatement must:
    (i) Be in a format prescribed by the Secretary and signed by the 
mortgagee;
    (ii) Be accompanied by an independent analysis of the terminated 
office's operations and identifying the underlying cause of the 
mortgagee's unacceptable default and claim rate. The independent 
analysis must be prepared by an independent Certified Public Accountant 
(CPA) qualified to perform audits under the government auditing 
standards issued by the General Accounting Office; and

[[Page 75809]]

    (iii) Be accompanied by a corrective action plan addressing each of 
the issues identified in the independent analysis described in 
paragraph (e)(2)(ii) of this section, along with evidence demonstrating 
that the mortgagee has implemented the corrective action plan.
    (3) HUD action on reinstatement application. The Secretary will 
grant the mortgagee's application for reinstatement if the mortgagee's 
application is complete and the Secretary determines that the 
underlying causes for the termination have been satisfactorily 
remedied.

    Dated: October 28, 2004.
John C. Weicher,
Assistant Secretary for Housing-Federal Housing Commissioner.
[FR Doc. 04-27536 Filed 12-16-04; 8:45 am]
BILLING CODE 4210-27-P