68656 Federal Register / Vol. 72, No. 233 / Wednesday, December 5, 2007 / Proposed Rules 

1 12 U.S.C. 4513(a), (b)(1), (b)(3). 

2 12 U.S.C. 1361(e)(1), (e)(3). 

3Risk-Based Capital, 66 FR 44730 (September 13, 

2001), 12 CFR part 1750. 

4Risk-Based Capital, 66 FR 44730 (September 13, 

2001), 12 CFR part 1750, as amended, 67 FR 11850 

(March 15, 2002), 67 FR 19321 (April 19, 2002), 67 

FR 66533 (November 1, 2002), 68 FR 7309 

(February 13, 2003), 71 FR 75085 (December 14, 

2006). 

DEPARTMENT OF HOUSING AND 

URBAN DEVELOPMENT 

Office of Federal Housing Enterprise 

Oversight 

12 CFR Part 1750 

RIN 2550–AA38 

Risk-Based Capital Regulation—Loss 

Severity Amendments 

AGENCY: Office of Federal Housing 

Enterprise Oversight, HUD. 

ACTION: Notice of Proposed Rulemaking. 

SUMMARY: The Office of Federal Housing 

Oversight (OFHEO) is amending 

Appendix A to Subpart B of 12 CFR part 

1750 Risk-Based Capital (Risk-Based 

Capital Regulation). The amendments 

are intended to enhance the accuracy 

and transparency of the calculation of 

the risk-based capital requirement for 

the Federal National Mortgage 

Association (Fannie Mae) and the 

Federal Home Loan Mortgage 

Corporation (Freddie Mac) (collectively 

the Enterprises). OFHEO proposes to 

amend further the Risk-Based Capital 

Regulation to change the loss severity 

equations that understate losses on 

defaulted single-family conventional 

and government guaranteed loans. 

OFHEO also proposes to amend the 

treatment of Federal Housing 

Administration (FHA) insurance in the 

Risk-Based Capital Regulation in order 

to conform the treatment to current law. 

DATES: Comments regarding this Notice 

of Proposed Rulemaking must be 

received in writing on or before March 

4, 2008. For additional information, see 

SUPPLEMENTARY INFORMATION. 

ADDRESSES: You may submit your 

comments on the proposed rulemaking, 

identified by ‘‘RIN 2550–AA38,’’ by any 

of the following methods: 

• U.S. Mail, United Parcel Post, or 

other Mail Service: The mailing address 

for comments is: Alfred M. Pollard, 

General Counsel, Attention: Comments/ 

RIN 2550–AA38, Office of Federal 

Housing Enterprise Oversight, Fourth 

Floor, 1700 G Street, NW., Washington, 

DC 20552. 

• Hand Delivery/Courier: The hand 

delivery address is: Alfred M. Pollard, 

General Counsel, Attention: Comments/ 

RIN 2550–AA38, Office of Federal 

Housing Enterprise Oversight, Fourth 

Floor, 1700 G Street, NW., Washington, 

DC 20552. The package should be 

logged at the Guard Desk, First Floor, on 

business days between 9 a.m. and 5 p.m. 

• E-mail: Comments to Alfred M. 

Pollard, General Counsel, may be sent 

by e-mail at RegComments@OFHEO.gov. 

Please include ‘‘RIN 2550–AA38’’ in the 

subject line of the message. 

FOR FURTHER INFORMATION CONTACT: 

David A. Felt, Deputy General Counsel, 

telephone (202) 414–3750, or Jamie 

Schwing, Associate General Counsel, 

telephone (202) 414–3787 (not toll free 

numbers), Office of Federal Housing 

Enterprise Oversight, Fourth Floor, 1700 

G Street, NW., Washington, DC 20552. 

The telephone number for the 

Telecommunications Device for the Deaf 

is (800) 877–8339. 

SUPPLEMENTARY INFORMATION: 

I. Comments 

OFHEO invites comment on all 

aspects of the proposed amendments to 

the Risk-Based Capital Regulation, and 

will take all relevant comments into 

consideration before issuing the final 

regulation. OFHEO requests that 

comments submitted in hard copy also 

be accompanied by the electronic 

version in Microsoft Word or in a 

portable document format (PDF) on 3.5′′ 

disk or CD–ROM. 

Copies of all comments will be posted 

on the OFHEO Internet Web site at 

http://www.OFHEO.gov. In addition, 

copies of all comments received will be 

available for examination by the public 

on business days between the hours of 

10 a.m. and 3 p.m. at the Office of 

Federal Housing Enterprise Oversight, 

Fourth Floor, 1700 G Street, NW., 

Washington, DC 20552. To make an 

appointment to inspect comments, 

please call the Office of General Counsel 

at (202) 414–3751. 

II. Background 

Title XIII of the Housing and 

Community Development Act of 1992, 

Pub. L. 102–550, titled the Federal 

Housing Enterprise Financial Safety and 

Soundness Act of 1992 (the Act) (12 

U.S.C. 4501 et seq.) established OFHEO 

as an independent office within the 

Department of Housing and Urban 

Development to ensure that the 

Enterprises are adequately capitalized, 

operate safely and soundly, and comply 

with applicable laws, rules and 

regulations. The Act provides that the 

Director of OFHEO (the Director) is 

authorized to make such determinations 

and take such actions as the Director 

determines necessary with respect to the 

issuance of regulations regarding, 

among other things, the required capital 

levels for the enterprises.1 The Act 

further provides that the Director shall 

issue regulations establishing the riskbased capital test and that the RiskBased Capital Regulation, subject to 

certain confidentiality provisions, shall 

be sufficiently specific to permit an 

individual other than the Director to 

apply the risk-based capital test in the 

same manner as the Director.2

Pursuant to the Act, OFHEO 

published a final regulation setting forth 

a risk-based capital test which forms the 

basis for determining the risk-based 

capital requirement for each Enterprise.3

The Risk-Based Capital Regulation has 

been amended to incorporate corrective 

and technical amendments that enhance 

the accuracy and transparency of the 

calculation of the risk-based capital 

requirement.4

Consistent with the Act, OFHEO 

proposes to amend further the RiskBased Capital Regulation to change 

certain loss severity equations that 

understate losses on defaulted singlefamily conventional and government 

guaranteed loans. OFHEO also proposes 

to amend the treatment of FHA 

insurance in the Risk-Based Capital 

Regulation in order to conform the 

treatment to current law. 

As currently specified, certain loss 

severity equations allow the Enterprises 

to record negative losses (i.e., profits) on 

foreclosed mortgages during the 

calculation of the risk-based capital 

requirement. Unaltered, the current loss 

severity equations overestimate 

Enterprise recoveries for defaulted 

government-guaranteed and low loan-tovalue (LTV) loans. The results generated 

by the current loss severity equations 

are not consistent with the goals of the 

Risk-Based Capital Regulation and 

result in significant reductions in the 

risk-based capital requirements of the 

Enterprises. The amendments to the 

relevant equations are set forth below. 

A. Loss Severity 

Loss Severity is the net cost to an 

Enterprise of a mortgage loan default. 

The Risk-Based Capital Regulation uses 

the costs associated with different 

events following the default of a 

mortgage to determine the total loss or 

cost to an Enterprise. Loss severity rates 

are computed as of the date of default 

and are expressed as a percentage of the 

unpaid principal balance of a defaulting 

loan. In general, losses on a loan include 

the unpaid principal balance of the 

loan, lost interest, foreclosure costs, and 

expenses related to real-estate-owned. 

See paragraph 3.6.3.6.1, Calculation of 


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Federal Register / Vol. 72, No. 233 / Wednesday, December 5, 2007 / Proposed Rules 68657 

5 12 CFR part 1750 (2006), Subpart B, Appendix 

A, ¶ 3.6.3.6.1[c]. 

6 Id. ¶ 3.6.1[h] and ¶ 3.6.3.6.2.1. 

7 Id. ¶ 3.6.3.6.5.1[a]. 

8The 120% figure reflects the total costs observed 

on defaulted loans in the benchmark loss 

experience (the loan amount (100%), the 

foreclosure expenses (3.7%) and real estate-owned 

(REO) expenses (16.3%). 

Single Family and Multifamily Mortgage 

Losses Overview.5 Losses may be 

reduced by mortgage insurance 

proceeds, pool-level credit enhancement 

proceeds, and recovery proceeds from 

the sale of the foreclosed property, as set 

forth at paragraph 3.6.1[h], subtitled 

Specification of Mortgage Default and 

Loss and paragraph 3.6.3.6.2.1, 

subtitled, Single Family Gross Loss 

Severity Overview.6

Since the adoption of the Risk-Based 

Capital Regulation, OFHEO has gained 

extensive operating experience with the 

administration of the rule. A review of 

the loss severity equations as currently 

specified indicates that changes are 

required to correct deficiencies in the 

equations related to the calculation of 

loss severity rates for single-family 

conventional and FHA mortgages and 

single-family Department of Veterans 

Affairs (VA) mortgages. In addition, the 

current treatment of FHA insurance 

associated with single-family loans with 

an LTV below 78% is inconsistent with 

current law and should be corrected as 

detailed below. 

i. Conventional Single-Family Loan 

Groups 

The current treatment for calculating 

loss severity rates for conventional 

single-family loan groups is set forth in 

the Risk-Based Capital Regulation, 

paragraph 3.6.3.6.5.1, as a subtopic 

under the general heading of Single 

Family and Multifamily Net Loss 

Severity Procedures.7 The following 

equation shows the loss severity model 

for conventional and FHA mortgages in 

the RBC regulation: 

LS

DR

MQ PTR F MI

DR

m

SF

m

MQ

m m

m

MF =

+ 



 





+

× 



 



 + −

+ 



 





1

1

2

12

1

2

6 6 6

1

2

+ − −

+ 



 





+

R RP ALCE

DR

m m

m

MF MR

Where: 

LSmSF = Net loss severity for conventional 

and FHA single-family loans in month m 

MIm = Mortgage insurance proceeds in month 

m 

ALCEm = Aggregate limit credit enhancement 

in month m 

MR = Months to recovery 

F = Foreclosure costs 

MQ = Months delinquent 

PTRm = Pass through rate for payments in 

month m 

R = REO expenses 

RPm = (0.61/LTVq) = Recovery proceeds in 

month m. The 0.61 is the recovery rate 

on defaulted loans in the benchmark loss 

experience as a percentage of the 

predicted house price using the HPI. 

LTVq = Loan to value ratio in month q 

(current LTV) 

DRm = Discount rate in month m 

This equation produces negative 

losses (profits) for low LTV loans. This 

result, profits on defaults, is 

inconsistent with the stress 

environment envisioned by the statute. 

Specifically, the problem arises with the 

term used to estimate the value of 

recovery proceeds as a percentage of the 

loan amount outstanding, RPm, which is 

set equal to 0.61/LTVq. This term yields 

a value greater than one when LTVq falls 

below 61%, resulting in the projected 

recovery proceeds exceeding the 

defaulted UPB. If the projected recovery 

proceeds exceed the other costs as well 

as the defaulted UPB, the result is a 

negative loss (profit). 

More specifically, RPm is problematic 

because it relies on LTVq, which 

represents the estimated current LTV of 

a loan, assuming the mortgaged property 

has appreciated in value at the mean 

rate for the Census Division. Because 

LTVq incorporates mean rather than 

actual house price appreciation, using 

LTVq to measure how the loan amount 

compares to the property value can be 

misleading. Not all property values 

change at the mean rate; some perform 

less well. Loans with low LTVq values 

that default generally are collateralized 

by properties whose values appreciated 

much less than properties securing 

other loans originated at the same time, 

and in the same Census Division. Such 

loans would normally only default 

rather than prepay if the defaulting 

borrowers cannot fully pay off the loan 

by selling the house because their actual 

current LTV ratio is higher than LTVq. 

Thus the recovery rate generally is less 

than 61% on these defaulted loans. 

The problem with the estimate of 

recovery proceeds has become acute, 

because the volume of loans in the 

Enterprises’ portfolios with low LTVq

has increased sharply in recent years 

due to rapidly rising house prices. 

While only a very small percentage of 

loans with low values of LTVq default 

in the RBC model, there are now so 

many loans with low LTVq values that 

the effects are pronounced. When this 

model specification was selected, this 

problem was relatively small, as there 

were few defaulting loans generating 

gains. Alternative specifications that 

avoided this issue added considerable 

complexity to the model and had other 

problems. 

Profiting on defaults also is not 

consistent with the credit stress 

environment envisioned in the RiskBased Capital Regulation. Despite 

having a low LTV, a homeowner may 

face unemployment and an illiquid 

housing market in the RBC stress 

environment. Upon foreclosure, the 

Enterprise would face the challenge of 

selling the property in the same illiquid 

market, making the prospect of a profit 

highly unlikely. Substantial profits on 

defaulted loans would be unlikely in 

any event because the law in a number 

of states requires any ‘‘extra’’ proceeds 

from a foreclosure to revert to the 

mortgagee, not the holder of the 

mortgage. 

OFHEO proposes to correct the loss 

severity equation for conventional and 

FHA mortgages such that the results of 

the equation are constrained to be nonnegative. This change will eliminate the 

possibility of the Enterprises profiting 

on defaulted mortgages in the stress test 

model. The change addresses the 

weakness in the recovery equation and 

produces results that are more 

consistent with the credit stress 

environment envisioned in the RBC 

Regulation. 

As part of its analysis, OFHEO 

considered two alternatives. One 

alternative would have restricted 

recovery proceeds to 120% of the 

outstanding loan amount.8 Another 

alternative considered would have 

required the loss severity equation to be 

non-negative, except that MI and 

aggregate level credit enhancements 

payments would be received in full. 

These alternatives were not proposed 


rwilkins on PROD1PC63 with PROPOSALS2EP05DE07.015</MATH>
68658 Federal Register / Vol. 72, No. 233 / Wednesday, December 5, 2007 / Proposed Rules 

9 12 CFR part 1750 (2006), Subpart B, Appendix 

A, ¶ 3.6.3.6.5.1[b]2. 

10 Id. ¶ 3.6.3.6.4.3[a]1. 

because they would produce gains on 

defaults for certain loans. 

ii. Veterans Administration Mortgages 

The current treatment for calculating 

loss severities for single-family VAguaranteed mortgages is set forth in the 

Risk-Based Capital Regulation at 

paragraph 3.6.3.6.5.1 as a subtopic 

under the general heading of Single 

Family and Multifamily Net Loss 

Severity Procedures.9 The current loss 

severity equation for VA loans utilizes 

the same equation for recovery proceeds 

as the conventional and FHA loss 

severity equation, and thus may also 

generate negative losses. In order to 

address this issue, OFHEO proposes an 

amendment to revise the loss severity 

equation for VA loans such that the 

results of the equation are constrained 

to be non-negative. 

During the development of this 

proposed amendment, OFHEO 

considered removing the recovery 

proceeds term from the VA loss severity 

equation in order to reduce the negative 

losses. However, this alternative does 

not accurately reflect the VA guarantee 

program, which may allow both 

recovery proceeds and the VA guarantee 

to be used to offset losses. 

iii. Federal Housing Administration 

Insurance 

The current treatment for 

consideration of FHA insurance in the 

calculation of loss severities is set forth 

in the Risk-Based Capital Regulation. 

See paragraph 3.6.3.6.4.3, as a subtopic 

under the general heading Mortgage 

Credit Enhancement Procedures.10 The 

current equation cancels mortgage 

insurance for all loans when the LTV 

falls below 78%. Although this 

treatment is appropriate for loans with 

private mortgage insurance, FHA 

insurance remains in force irrespective 

of the LTV of a mortgage. OFHEO 

proposes not to cancel FHA insurance 

by amending the current equation. 

B. Capital Impact of Proposed 

Amendments 

The following table shows the 

estimated capital impact of all of the 

proposed amendments at September 30 

and December 31, 2006. 

TABLE 1.—ESTIMATED CAPITAL IMPACT OF PROPOSED AMENDMENTS

[Billions of dollars] 

Quarter Interest rate scenario 

RBC requirement 

Current 

regulation 

Current 

regulation with 

proposed 

amendments 

Change * 

Fannie Mae ........................... 2006 3Q ................................ Up-Rate ................................. $22.5 $32.0 $9.5 

Down-Rate ............................ 16.4 25.1 8.6 

2006 4Q ................................ Up-Rate ................................. 26.9 36.6 9.8 

Down-Rate ............................ 9.1 16.6 7.5 

Freddie Mac .......................... 2006 3Q ................................ Up-Rate ................................. 14.9 19.4 4.5 

Down-Rate ............................ 13.8 18.2 4.4 

2006 4Q ................................ Up-Rate ................................. 15.3 20.7 5.4 

Down-Rate ............................ 12.9 17.5 4.5 

* Figures may not sum precisely due to rounding. 

The proposed amendments 

substantially increase the RBC 

Requirement in both the up and down 

interest rate scenarios for both 

Enterprises for the two quarters 

analyzed. However, if the proposed 

amendments had been in effect during 

the analyzed periods, total capital 

would have exceeded the RBC 

Requirement and the capital 

classifications of the Enterprises would 

not have changed. 

Regulatory Impacts 

Executive Order 12866, Regulatory 

Planning and Review 

The proposed amendments to the 

Risk-Based Capital Regulation 

incorporate corrections to the loss 

severity equations used to calculate the 

risk-based capital requirements of the 

Enterprises. The proposed amendments 

to the Risk-Based Capital Regulation are 

not classified as an economically 

significant rule under Executive Order 

12866 because they do not result in an 

annual effect on the economy of $100 

million or more or a major increase in 

costs or prices for consumers, 

individual industries, Federal, state or 

local government agencies, or 

geographic regions; or have any 

significant adverse effects on 

competition, employment, investment, 

productivity, innovation, or on the 

ability of United States-based 

enterprises to compete with foreignbased enterprises in foreign or domestic 

markets. Accordingly, no regulatory 

impact assessment is required. 

However, as a regulatory action with 

significant policy implications, the 

proposed amendments were submitted 

to the Office of Management and Budget 

for review under applicable provisions 

of Executive Order 12866. 

Executive Order 13132, Federalism 

Executive Order 13132 requires that 

Executive departments and agencies 

identify regulatory actions that have 

significant federalism implications. A 

regulation has federalism implications if 

it has substantial direct effects on the 

states, on the relationship or 

distribution of power between the 

Federal Government and the states, or 

on the distribution of power and 

responsibilities among various levels of 

government. The Enterprises are 

federally chartered entities supervised 

by OFHEO. The proposed amendments 

to the Risk-Based Capital Regulation 

address matters with which the 

Enterprises must comply for Federal 

regulatory purposes. The proposed 

amendments to the Risk-Based Capital 

Regulation address matters regarding 

the risk-based capital calculation for the 

Enterprises and therefore does not affect 

in any manner the powers and 

authorities of any state with respect to 

the Enterprises or alter the distribution 

of power and responsibilities between 

Federal and state levels of government. 

Therefore, OFHEO has determined that 

the proposed amendments to the RiskVerDate Aug<31>2005 18:37 Dec 04, 2007 Jkt 214001 PO 00000 Frm 00004 Fmt 4701 Sfmt 4702 E:\FR\FM\05DEP2.SGM 05DEP2

rwilkins on PROD1PC63 with PROPOSALS2
Federal Register / Vol. 72, No. 233 / Wednesday, December 5, 2007 / Proposed Rules 68659 

Based Capital Regulation have no 

federalism implications that warrant 

preparation of a Federalism Assessment 

in accordance with Executive Order 

13132. 

Paperwork Reduction Act 

The proposed amendments do not 

contain any information collection 

requirement that requires the approval 

of OMB under the Paperwork Reduction 

Act (44 U.S.C. 3501 et seq.). 

Regulatory Flexibility Act 

The Regulatory Flexibility Act (5 

U.S.C. 601 et seq.) requires that a 

regulation that has a significant 

economic impact on a substantial 

number of small entities, small 

businesses, or small organizations must 

include an initial regulatory flexibility 

analysis describing the regulation’s 

impact on small entities. Such an 

analysis need not be undertaken if the 

agency has certified that the regulation 

does not have a significant economic 

impact on a substantial number of small 

entities. 5 U.S.C. 605(b). OFHEO has 

considered the impact of the proposed 

amendments to the Risk-Based Capital 

Regulation under the Regulatory 

Flexibility Act. The General Counsel of 

OFHEO certifies that the proposed 

amendments to the Risk-Based Capital 

Regulation are not likely to have a 

significant economic impact on a 

substantial number of small business 

entities because the regulation is 

applicable only to the Enterprises, 

which are not small entities for 

purposes of the Regulatory Flexibility 

Act. 

List of Subjects in 12 CFR Part 1750 

Capital classification, Mortgages, 

Risk-based capital. 

Accordingly, for the reasons stated in 

the preamble, OFHEO is amending 12 

CFR part 1750 as follows: 

PART 1750—CAPITAL 

1. The authority citation for part 1750 

continues to read as follows: 

Authority: 12 U.S.C. 4513, 4514, 4611, 

4612, 4614, 4618. 

2. Amend Appendix A to subpart B of 

part 1750 as follows: 

a. In paragraph 3.6.3.6.4.3[a]1, revise 

the explanation following the equation; 

b. In paragraph 3.6.3.6.5.1[a] revise 

equation; 

c. In paragraph 3.6.3.6.5.1[b]2 revise 

equation. 

Appendix A to Subpart B of Part 1750—Risk-Based Capital Text Methodology and Specifications 

* * * * * 

3.6.3.6.4.3 * * * 

[a] * * * 

1. * * * 

Where: 

m′ = m, except for counterparties rated below BBB, where m′ = 120 

MIExp if LTV UPB

UPB m

LG

ORIG

m

LG

ORIG

LG = × 



 



 < 













 1 0 78 an . d conventional loan

 (78%) = the L

MIExp otherwise m

LG = 0

0 78 . TV at which MI is cancelled if payments are current

* * * * * 

3.6.3.6.5.1 * * * 

[a] * * * 

LS MAX

DR

MQ PTR F MI

DR

m

SF

m

MQ

m m

m

=

+ 



 





+

× 



 



 + −

+ 



 



1

1

2

12

1

2

6



+ − −

+ 



 











































 MF +

m m

m

MF MR

R RP ALCE

6 DR 6

1

2

, 0

















[b] * * * 

2. * * * 

LS

F MQ PTR R RP

DR

m

VA

m m

m

MF =

++ × 



 



 + − ( ) −

+ 



 





max

.

,

1

12

0 30

1

2

6

 0





























* * * * * Dated: October 11, 2007. 

James B. Lockhart III, 

Director, Office of Federal Housing Enterprise 

Oversight. 

[FR Doc. 07–5101 Filed 12–4–07; 8:45 am] 

BILLING CODE 4220–01–P 


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