75802 Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Rules and Regulations 

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.

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: 

• The Federal eRulemaking Portal at 

http://www.regulations.gov; or 

• 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, 

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

§ 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 § 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 

§ 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 

75804 Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Rules and Regulations 

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 

Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Rules and Regulations 75805

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 HUDapproved 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 § 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 riskmanagement 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 

75806 Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Rules and Regulations 

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 

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

■ Accordingly, for the reasons described 

in the preamble, HUD amends 24 CFR 

part 202 as follows:

PART 202—APPROVAL OF LENDING 

INSTITUTIONS AND MORTGAGEES

■ 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).

■ 2. In § 202.3, revise paragraph (c)(2) 

and add paragraph (e) to read as follows:

§ 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. 

75808 Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Rules and Regulations 

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 

§ 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 

§ 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 § 202.5 and the specific 

requirements of §§ 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 

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