4970 Federal Register / Vol. 71, No. 19 / Monday, January 30, 2006 / Rules and Regulations 

DEPARTMENT OF HOUSING AND 

URBAN DEVELOPMENT 

24 CFR Part 202 

[Docket No. FR–4625–F–03] 

RIN 2502–AH60 

Revisions to FHA Credit Watch 

Termination Initiative 

AGENCY: Office of the Assistant 

Secretary for Housing—Federal Housing 

Commissioner, HUD. 

ACTION: Final rule. 

SUMMARY: On December 17, 2004, HUD 

published an interim rule implementing 

certain regulations for the Federal 

Housing Administration (FHA) Credit 

Watch Termination Initiative. Under the 

initiative, FHA systematically reviews 

the early default and claim rates of 

mortgagees that have been approved to 

participate in the FHA single family 

mortgage insurance programs. 

Mortgagees with excessive default and 

claim rates are considered to be on 

Credit Watch status and, in cases of 

more severe performance deficiencies, 

HUD may terminate the mortgagee’s 

loan origination approval authority. 

Credit Watch status constitutes a 

warning to a mortgagee that its default 

and claim rates are in excess of 

permissible levels and that failure to 

achieve improvement may lead to the 

termination of its origination approval 

agreement. The final rule follows 

publication of the December 17, 2004, 

interim rule, takes into consideration 

the public comments received on the 

interim rule, and makes no changes at 

this final rule stage. 

DATES: Effective Date: March 1, 2006. 

FOR FURTHER INFORMATION CONTACT: 

Phillip Murray, Director, Office of 

Lender Activities and Program 

Compliance, Office of Housing, 

Department of Housing and Urban 

Development, 451 Seventh Street, SW., 

Room B–133, Washington, DC 20410– 

8000; telephone (202) 708–1515 (this is 

not a toll-free number). Persons with 

hearing or speech impairments may 

access this number via TTY by calling 

the toll-free Federal Information Relay 

Service at 1–800–877–8339. 

SUPPLEMENTARY INFORMATION: 

I. Background 

On April 1, 2003, HUD published a 

proposed rule (68 FR 15906) to amend 

the regulations for the Federal Housing 

Administration (FHA) Credit Watch 

Termination Initiative. Under the 

initiative, FHA systematically reviews 

the early default and claim rates of 

mortgagees that have been approved to 

participate in the FHA single family 

mortgage insurance programs. 

Mortgagees with excessive default and 

claim rates are considered to be on 

Credit Watch status and, in cases of 

more severe performance deficiencies, 

HUD may terminate the mortgagee’s 

loan origination approval authority. 

Credit Watch status constitutes a 

warning to a mortgagee that its default 

and claim rates are in excess of 

permissible levels and that failure to 

achieve improvement may lead to the 

termination of its origination approval 

agreement. The termination of a 

mortgagee’s origination approval 

agreement is separate and apart from 

any action taken by HUD’s Mortgagee 

Review Board for violations of FHA 

requirements under 24 CFR part 25. 

The regulations for the Credit Watch 

Termination Initiative are contained in 

24 CFR 202.3. 

The April 1, 2003, rule proposed 

various amendments to the regulations 

for the Credit Watch Termination 

Initiative. Specifically, the April 1, 

2003, rule proposed to: (1) Establish a 

fully computerized Credit Watch status 

notification process through use of the 

FHA Neighborhood Watch Early 

Warning System; (2) remove the 

regulatory ‘‘cap’’ on the default and 

claim rate for placing a mortgagee on 

Credit Watch status; (3) prohibit a 

mortgagee that has received a notice of 

proposed termination from establishing 

a new branch in the lending area 

covered by the proposed termination; 

(4) provide that the default and claim 

thresholds underlying the Credit Watch 

Termination Initiative apply to both 

underwriting and originating 

mortgagees; (5) codify the definition of 

‘‘underserved area’’ that is currently 

used under the Credit Watch 

Termination Initiative; (6) provide that 

the date of mortgage origination will be 

considered to be the date the loan 

transaction commences amortization, 

rather than the date of endorsement for 

FHA mortgage insurance; (7) specify the 

timeframes for the informal conference 

that may be requested by a mortgagee 

prior to termination; and (8) describe 

the procedures a terminated mortgagee 

must follow to have its origination 

approval agreement reinstated. 

The proposed regulatory changes 

were designed to improve the Credit 

Watch Termination Initiative, thereby 

strengthening HUD’s capacity to 

safeguard the FHA mortgage insurance 

fund. The preamble to the April 1, 2003, 

proposed rule provides additional 

details regarding the proposed 

regulatory changes to 24 CFR 202.3. 

On December 17, 2004 (69 FR 75802), 

HUD published an interim rule that 

considered the comments received on 

the proposed rule and made effective 

the proposed changes to the Credit 

Watch program contained in the April 1, 

2003, proposed rule. In response to the 

public comments requesting that HUD 

clarify the applicability of the Credit 

Watch Termination to underwriting 

mortgagees, HUD revised the rule to 

provide for separate regulatory language 

that specifically addresses underwriting 

mortgagees. The regulatory language did 

not alter the substance of the proposals, 

but rather provided greater clarity on 

how the performance of underwriting 

mortgagees would be subject to 

evaluation under the Credit Watch 

Termination Initiative. The regulatory 

provisions of the December 17, 2004, 

interim rule took effect on January 18, 

2005. However, in order to provide for 

public comment on the regulatory 

provisions regarding underwriting 

mortgagees, HUD invited public 

comments on that aspect of the interim 

rule for a period of 60 days. 

II. This Final Rule 

This final rule follows publication of 

the December 17, 2004, interim rule and 

takes into consideration the public 

comments received on the interim rule. 

After careful consideration of the public 

comments on the new language 

concerning the applicability of the 

Credit Watch Termination Initiative to 

underwriting mortgagees, HUD has 

decided to adopt the December 17, 

2004, rule as final without change. 

III. Discussion of the Public Comments 

on the December 17, 2004, Interim Rule 

The public comment period for the 

interim rule closed on February 15, 

2005. HUD received three public 

comments. Comments were received 

from two mortgage lenders and a 

national association representing 

mortgage bankers. This section of the 

preamble presents a summary of the 

significant issues raised by the public 

commenters on the December 17, 2004, 

interim rule and HUD’s responses to 

those issues. 

Comment: Before HUD terminates 

underwriting authority, HUD should 

take into consideration the lender’s 

overall national default/claim rate. One 

commenter wrote that nationwide 

lenders could be unfairly penalized by 

a termination action if a localized fraud 

scheme or unexpected local economic 

downturn increases a lender’s default 

rate above HUD’s termination threshold. 

HUD Response. HUD’s Credit Watch 

Termination Initiative focuses on a 

mortgagee’s performance within a HUD 

field office jurisdiction. A mortgagee’s 

default and claim rate within a HUD 


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Federal Register / Vol. 71, No. 19 / Monday, January 30, 2006 / Rules and Regulations 4971 

field office jurisdiction is compared to 

the overall default and claim rate of the 

entire HUD field office jurisdiction. 

Before HUD terminates the underwriting 

authority, it will consider mitigating 

issues raised by a mortgagee during its 

informal conference and in its written 

response. HUD’s evaluation of 

mortgagees on the basis of HUD field 

office jurisdiction coincides with the 

manner in which FHA approves 

mortgagees to operate. This method of 

evaluation recognizes that local market 

conditions and events may contribute to 

higher defaults and claims. 

Comment: HUD should develop 

guidelines that take into account 

potential difficulties for underwriting 

mortgagees to comply due to shifting 

local averages. One commenter wrote 

that because a mortgagee’s defaults are 

compared to the average rate in a local 

area, a lender could be terminated either 

due to a shift in the overall credit 

quality of a HUD local area, or by the 

gradual decline of a HUD local area’s 

average default and claim rate, rather 

than due to the quality of the loans the 

lender is originating. 

HUD Response. HUD believes that the 

compare ratio for all lenders within a 

HUD field office jurisdiction would be 

equally affected by a shift in the overall 

credit quality or by the gradual decline 

of a HUD field office area’s average 

default and claim rate. Furthermore, 

once a lender is terminated, while it 

cannot originate new FHA-insured 

loans, the lender’s previously insured 

and defaulted cases are still included in 

the universe that makes up the compare 

ratio. Lenders are subject to termination 

when their claim and default ratio 

indicate that they pose a greater risk to 

the FHA insurance fund than other 

lenders in the field office area. 

Additionally, the compare ratio for each 

round of Credit Watch Termination is 

based on a specific 24-month period. 

Therefore, based on a loan being insured 

and the beginning amortization date, 

loans are added and removed from the 

counts for each successive round of 

Credit Watch Termination. Finally, as 

mentioned in the interim rule’s 

preamble, HUD will periodically review 

the normal rate to determine whether 

the thresholds should be adjusted to 

reflect overall improvement in the FHA 

portfolio. 

Comment: HUD should provide 

adequate time and opportunity after the 

initial lender notification, yet prior to 

public notification of termination in the 

Federal Register, for the lender to be 

granted an informal conference with 

HUD to explain the reasons for the 

increased default/claims rate. 

HUD Response. As provided in 24 

CFR 202.3(c)(1)(ii) of the Credit Watch 

regulations, a mortgagee may request an 

informal conference after receiving a 

proposed termination letter. Mortgagees 

are provided the opportunity at the 

informal conference to fully explain the 

reasons for the mortgagee’s increased 

defaults and claims. The regulation 

provides that HUD must receive a 

request for the informal conference no 

later than 30 calendar days after the 

receipt date of the proposed termination 

letter from HUD, and that the 

conference must be held no later than 

60 days after the date of the proposed 

termination notice. HUD will not 

publish an announcement in the 

Federal Register that a mortgagee has 

had its origination approval agreement 

terminated until after the requested 

informal conference is held, after HUD 

has considered all relevant reasons and 

factors, and after HUD has upheld its 

decision to terminate a lender’s 

approval agreement. 

Comment: HUD should broaden and 

specify mitigation factors it will 

consider in making its termination 

decision. One commenter wrote that 

because of the severity of the penalty to 

the lender, the regulation should 

provide HUD with the ability to 

consider other mitigating factors in 

making its termination decision, such 

as: (1) The lender’s overall risk 

management plan and performance; (2) 

prior proactive lender notification to 

HUD of fraud or other significant issues 

the lender has discovered; (3) prior 

action the lender has taken against a 

correspondent who has contributed to 

the high default rate, such as 

terminating the lender’s relationship 

with the correspondent; and (4) prior 

action such as termination or other 

disciplinary action against the lender’s 

employees responsible for a high 

default/claim rate. 

Another commenter wrote that HUD 

should broaden and specify the factors 

that FHA will review in deciding not to 

terminate the direct endorsement 

approval of a mortgagee and 

communicate these circumstances to 

direct endorsement lenders. This 

commenter wrote that mortgagees have 

had little success in convincing FHA 

that particular circumstances justify the 

withdrawal of a termination notice. The 

commenter continued by writing that 

there are many factors beyond poor 

underwriting or lending in underserved 

areas that can cause a higher default rate 

from one lender to another. The 

commenter wrote that lenders 

specializing in a particular product or 

that service a particular borrower type 

may be at a disadvantage in the general 

FHA market in a given area due to the 

greater risk inherent in these products. 

Finally, the commenter wrote that if the 

FHA holds underwriting mortgagees 

accountable in the same manner as 

originating mortgagees, underwriting 

mortgagees may avoid doing business 

with certain originators based on 

product type and not on origination 

quality. The commenter wrote that 

lenders should be encouraged to adopt 

new, and potentially riskier, FHA 

products, and lenders should not be 

penalized for this. 

HUD Response. HUD appreciates the 

comments and the suggested mitigation 

factors. However, HUD believes that the 

current regulations address the concerns 

raised by the commenters and that a 

regulatory change is therefore 

unnecessary. HUD will notify a 

mortgagee that its origination approval 

agreement will terminate if the 

mortgagee’s default and claim rates are 

in excess of permissible levels. As 

mentioned above in this preamble, 

mortgagees that have received a 

proposed termination notice may 

request an informal conference at which 

the designated official will consider 

other relevant reasons and factors 

beyond the mortgagee’s control that 

contributed to the mortgagee’s high 

default and claim rate. Mortgagees will 

have the opportunity at the informal 

conference to present mitigating 

information, such as the actions 

identified by the commenters. 

Comment: HUD should take action 

only against a lender’s specific division 

responsible for the high default and 

claim rate. One commenter requested 

that HUD provide the flexibility to 

separately analyze a lender’s retail and 

correspondent divisions. The 

commenter suggested that when it can 

be determined that the claim and 

default rate is attributable to only one 

division, HUD should take action only 

against the division responsible for the 

high rate of defaults and claims. 

HUD Response. The current 

regulations already provide HUD with 

the flexibility to implement Credit 

Watch Termination actions against retail 

and correspondent divisions separately. 

Specifically, 24 CFR 202.3(c)(2) 

provides that HUD may ‘‘review the 

insured mortgage performance of a 

mortgagee’s branch offices individually 

and may terminate the authority of the 

branch or the authority of the 

mortgagee’s overall operation.’’

Comment: HUD should phase in the 

threshold for underwriting approval 

termination from 300 percent to 200 

percent over a year or more. One 

commenter wrote that FHA should 

follow the same process it used in 


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4972 Federal Register / Vol. 71, No. 19 / Monday, January 30, 2006 / Rules and Regulations 

originally introducing Credit Watch; 

that is, FHA should start with a compare 

ratio of 300 percent for a given time 

period and then, if concerns are 

addressed, the compare ratio threshold 

should be lowered quarterly by 25 

percent to arrive at a 200 percent 

compare ratio. The commenter 

explained that gradual implementation 

is important because Credit Watch 

covers loans made over a two-year 

period, and lenders will thus be 

evaluated for loans that were 

underwritten prior to the need to 

consider the consequences of Credit 

Watch. The commenter wrote that the 

goal of Credit Watch is not to terminate 

a lender’s underwriting authority, but 

rather to prompt lenders to change their 

policies where the compare ratios are far 

above the norm—and implementing the 

threshold gradually from 300 percent to 

200 percent will allow lenders to do 

this. 

HUD Response. At this time, HUD 

will not phase in Credit Watch 

thresholds. Should HUD decide to 

change and/or phase in the Credit 

Watch thresholds for underwriting 

mortgagees, it will announce this policy 

determination through Mortgagee Letter, 

Federal Register notice, or other means, 

as appropriate. 

Comment: Originating lenders should 

not be held responsible for defaults of 

which it has no knowledge. One 

commenter wrote that mortgages are 

often sold and transferred to new 

servicers, and that once the transfer 

takes place, the originating company 

gets virtually no information with 

regard to payments until the servicer 

seeks to impose a penalty or ask for repurchase of that loan. 

HUD Response. As announced in 

Mortgagee Letter 00–20, dated June 2, 

2000, the Neighborhood Watch Early 

Warning system provides lenders with 

loan performance data via the FHA 

Internet Connection. Mortgagees that 

have received a proposed termination 

notice may request an informal 

conference at which a designated 

official will consider other relevant 

reasons and factors beyond the 

mortgagee’s control that contributed to 

the mortgagee’s high default and claim 

rate. Mortgagees will have the 

opportunity at the informal conference 

to present mitigating information. 

IV. Small Business Concerns Related to 

Credit Watch Termination Initiative 

With respect to termination of the 

mortgagee’s origination approval 

agreement, or taking other appropriate 

enforcement action against a mortgagee, 

HUD is cognizant that section 222 of the 

Small Business Regulatory Enforcement 

Fairness Act of 1996 (Pub. L. 104–121) 

(SBREFA) requires the Small Business 

and Agriculture Regulatory Enforcement 

Ombudsman to ‘‘work with each agency 

with regulatory authority over small 

businesses to ensure that small business 

concerns that receive or are subject to an 

audit, on-site inspection, compliance 

assistance effort, or other enforcement 

related communication or contact by 

agency personnel are provided with a 

means to comment on the enforcement 

activity conducted by this personnel.’’

To implement this statutory provision, 

the Small Business Administration has 

requested that agencies include the 

following language on agency 

publications and notices that are 

provided to small business concerns at 

the time the enforcement action is 

undertaken. The language is as follows: 

Your Comments Are Important 

The Small Business and Agriculture 

Regulatory Enforcement Ombudsman and 10 

Regional Fairness Boards were established to 

receive comments from small businesses 

about federal agency enforcement actions. 

The Ombudsman will annually evaluate the 

enforcement activities and rate each agency’s 

responsiveness to small business. If you wish 

to comment on the enforcement actions of 

[insert agency name], you will find the 

necessary comment forms at http:// 

www.sba.gov.ombudsman or call 1–888–

REG–FAIR (1–888–734–3247). 

In accordance with its notice 

describing HUD’s actions on the 

implementation of SBREFA, which was 

published on May 21, 1998 (63 FR 

28214), HUD will work with the Small 

Business Administration to provide 

small entities with information on the 

Fairness Boards and National 

Ombudsman program, at the time 

enforcement actions are taken, to ensure 

that small entities have the full means 

to comment on the enforcement activity 

conducted by HUD. 

V. Findings and Certifications 

Regulatory Planning and Review 

The Office of Management and Budget 

(OMB) reviewed this rule under 

Executive Order 12866 (entitled 

‘‘Regulatory Planning and Review’’). 

OMB determined that this rule is a 

‘‘significant regulatory action’’ as 

defined in section 3(f) of the Order 

(although not economically significant, 

as provided in section 3(f)(1) of the 

Order). The docket file is available for 

public inspection between the hours of 

8 a.m. and 5 p.m. weekdays in the 

Regulations Division, Office of General 

Counsel, Department of Housing and 

Urban Development, 451 Seventh Street, 

SW., Room 10276, Washington, DC 

20410–0500. Due to security measures 

at the HUD Headquarters building, an 

advance appointment to review the 

docket file must be scheduled by calling 

the Regulations Division at (202) 708–

3055. 

Regulatory Flexibility Act 

The Regulatory Flexibility Act (RFA) 

(5 U.S.C. 601 et seq.) generally requires 

an agency to conduct a regulatory 

flexibility analysis of any rule subject to 

notice and comment rulemaking 

requirements unless the agency certifies 

that the rule will not have a significant 

economic impact on a substantial 

number of small entities. This final rule 

follows publication of a December 17, 

2004, interim rule that made several 

amendments to HUD’s regulations for 

the FHA Credit Watch Termination 

Initiative and solicited additional public 

comment on those provisions regarding 

underwriting mortgagees. 

The final rule provides that the 

default and claim thresholds underlying 

the Credit Watch Termination Initiative 

apply to both underwriting and 

originating mortgagees. This 

amendment will ensure that the 

performance of all mortgagees involved 

in FHA-insured mortgage transactions is 

evaluated. To the extent that the change 

will have an economic impact on small 

underwriting mortgagees that are 

presently not covered by Credit Watch 

Termination, it will be as a result of 

actions taken by the mortgagees 

themselves—that is, failure to undertake 

the sound business practices necessary 

to maintain default and claim rates at an 

acceptable level. 

The final rule also provides for a fully 

computerized Credit Watch notification 

process through use of the FHA 

Neighborhood Watch Early Warning 

System. This change will provide for a 

streamlined and more effective method 

of monitoring mortgagee performance 

and for notifying poor performing 

mortgagees that are in danger of having 

their origination approval agreements 

terminated by HUD. The change will not 

impose an undue burden on small 

entities, since it merely codifies a HUD 

policy that was previously announced 

through a Mortgagee Letter. Further, the 

majority of mortgagees (small and large) 

participating in the FHA mortgage 

insurance programs currently have 

access to the FHA Internet Connection 

that is used to provide such notification. 

The rule also removes the regulatory 

cap on the Credit Watch default and 

claim rates, and provides that a 

mortgagee will be considered to be on 

Credit Watch Status if it has a default 

and claim rate on insured mortgages 

that exceeds 150 percent of the normal 

rate and its origination approval 


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Federal Register / Vol. 71, No. 19 / Monday, January 30, 2006 / Rules and Regulations 4973 

agreement has not been terminated. This 

revision will not impose a significant 

economic impact on small entities, 

since the entities that will be affected by 

this change are poorly performing 

mortgagees that are already subject to 

termination of their origination approval 

agreements. 

The rule also prohibits a mortgagee 

that has received a notice of proposed 

termination of its origination approval 

agreement from establishing a new 

branch in the lending area covered by 

the proposed termination. The 

mortgagees to which this change will be 

applicable are those that already have 

been notified by HUD that their default 

and claim rates exceed an acceptable 

standard in specified geographic areas 

and that they are at risk of having their 

FHA mortgage origination approvals 

terminated. The rule closes a loophole 

previously used by mortgagees to evade 

HUD’s existing procedure for reviewing 

losses to the FHA mortgage insurance 

fund. 

The final rule also provides that, for 

purposes of the Credit Watch 

Termination evaluation, the date of 

mortgage origination will be considered 

to be the date the loan transaction 

commences amortization, rather than 

the date of endorsement for FHA 

mortgage insurance. This change will 

not impose any economic burden on 

small mortgagees; rather, the change 

will improve the accuracy of Credit 

Watch Termination evaluations by 

conforming HUD’s definition of the 

mortgage origination date to the 

beginning amortization date used to 

report defaults. Finally, the final rule 

will codify the existing definition of the 

term ‘‘underserved area’’ for purposes of 

Credit Watch Termination 

determinations. This amendment 

merely codifies existing policy and will, 

therefore, not impose any new economic 

burden on mortgagees. 

Accordingly, the undersigned certifies 

that this rule will not have a significant 

economic impact on a substantial 

number of small entities. 

Environmental Impact 

This final rule will not direct, provide 

for assistance or loan and mortgage 

insurance for, or otherwise govern or 

regulate, real property acquisition, 

disposition, leasing, rehabilitation, 

alteration, demolition, or new 

construction, or establish, revise, or 

provide for standards for construction or 

construction materials, manufactured 

housing, or occupancy. Accordingly, 

under 24 CFR 50.19(c)(1), this final rule 

is categorically excluded from the 

requirements of the National 

Environmental Policy Act (42 U.S.C. 

4321 et seq.). 

Executive Order 13132, Federalism 

Executive Order 13132 (entitled 

‘‘Federalism’’) prohibits, to the extent 

practicable and permitted by law, an 

agency from promulgating a regulation 

that has federalism implications and 

either imposes substantial direct 

compliance costs on state and local 

governments and is not required by 

statute or preempts state law, unless the 

relevant requirements of section 6 of the 

Executive Order are met. This rule does 

not have federalism implications and 

does not impose substantial direct 

compliance costs on state and local 

governments or preempt state law 

within the meaning of the Executive 

Order. 

Unfunded Mandates Reform Act 

Title II of the Unfunded Mandates 

Reform Act of 1995 (2 U.S.C. 1531–

1538) (UMRA) establishes requirements 

for Federal agencies to assess the effects 

of their regulatory actions on state, 

local, and tribal governments and the 

private sector. This final rule does not 

impose any Federal mandates on any 

state, local, or tribal government or the 

private sector within the meaning of 

UMRA. 

Catalog of Federal Domestic Assistance 

The Catalog of Federal Domestic 

Assistance Program number applicable 

to 24 CFR part 202 is 14.20. 

List of Subjects in 24 CFR Part 202 

Administrative practice and 

procedure, Home improvement, 

manufactured homes, Mortgage 

insurance, Reporting and recordkeeping 

requirements. 

■ Accordingly, for the reasons stated in 

the preamble, the interim rule for part 

202 of Title 24 of the Code of Federal 

Regulations, amending § 202.3(c)(2) and 

adding § 202.3(e), published on 

December 17, 2004, at 69 FR 75802, is 

promulgated as final, without change. 

Dated: January 20, 2006. 

Frank L. Davis, 

General Deputy Assistant Secretary for 

Housing. 

[FR Doc. 06–852 Filed 1–27–06; 8:45 am] 

BILLING CODE 4210–27–P 


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