Federal Housing Administration (FHA) Single Family Lender Insurance Process: Eligibility, Indemnification, and Termination, 62335-62342 [2010-25441]

Agencies

• DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

[Federal Register Volume 75, Number 195 (Friday, October 8, 2010)]
[Proposed Rules]
[Pages 62335-62342]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2010-25441]


=======================================================================
-----------------------------------------------------------------------

DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

24 CFR Part 203

[Docket No. FR-5156-P-01]
RIN 2502 AI58


Federal Housing Administration (FHA) Single Family Lender 
Insurance Process: Eligibility, Indemnification, and Termination

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

ACTION: Proposed rule.

-----------------------------------------------------------------------

SUMMARY: Through this proposed rule, HUD continues its efforts to 
improve and expand the risk management activities of the Federal 
Housing Administration (FHA). The proposed regulatory changes will 
update and enhance the Lender Insurance process through which the 
majority of FHA-insured mortgages are endorsed for insurance. Most 
significantly, the proposed rule would provide additional guidance on 
HUD's regulations implementing the statutory requirements regarding 
mortgagee indemnification to HUD of insurance claims in the case of 
fraud, misrepresentation, or noncompliance with applicable loan 
origination requirements. The proposed rule also provides that 
mortgagees must continually maintain the acceptable claim and default 
rate required for eligibility to initially be delegated Lender 
Insurance authority, in order to retain such authority. In addition, 
this proposed rule also provides that HUD will review Lender Insurance 
mortgagee performance on a continual basis. HUD also proposes to revise 
the methodology for determining acceptable claim and default rates, to 
more accurately reflect mortgagee performance, and to streamline the 
approval process for Lender Insurance mortgagees that have undergone a 
corporate restructuring. The Department has also taken the opportunity 
afforded by this proposed rule to make two technical corrections to the 
regulations and to solicit public comment on whether FHA mortgagees 
should be required to submit mortgage loan case binders to HUD 
electronically.

DATES: Comment Due Date: December 7, 2010.

ADDRESSES: Interested persons are invited to submit comments regarding 
this proposed rule to the Regulations Division, Office of General 
Counsel, Department of Housing and Urban Development, 451 Seventh 
Street, SW., Room 10276, Washington, DC 20410-0500. Communications must 
refer to the above docket number and title. There are two methods for 
submitting public comments. All submissions must refer to the above 
docket number and title.
    1. Submission of Comments by Mail. Comments may be submitted by 
mail to the Regulations Division, Office of General Counsel, Department 
of Housing and Urban Development, 451 Seventh Street, SW., Room 10276, 
Washington, DC 20410-0001.
    2. Electronic Submission of Comments. Interested persons may submit 
comments electronically through the Federal eRulemaking Portal at 
https://www.regulations.gov. HUD strongly encourages commenters to 
submit comments electronically. Electronic submission of comments 
allows the commenter maximum time to prepare and submit a comment, 
ensures timely receipt by HUD, and enables HUD to make them immediately 
available to the public. Comments submitted electronically through the 
https://www.regulations.gov Web site can be viewed by other commenters 
and interested members of the public. Commenters should follow the 
instructions provided on that site to submit comments electronically.

    Note:  To receive consideration as public comments, comments 
must be submitted through one of the two methods specified above. 
Again, all submissions must refer to the docket number and title of 
the rule. No Facsimile Comments. Facsimile (FAX) comments are not 
acceptable.

    Public Inspection of Public Comments. All properly submitted 
comments and communications submitted to HUD will be available for 
public inspection and copying between 8 a.m. and 5 p.m. weekdays at the 
above address. Due to security measures at the HUD Headquarters 
building, an advance appointment to review the public comments must be 
scheduled by calling the Regulations Division at 202-708-3055 (this is 
not a toll-free number). Individuals with speech or hearing impairments 
may access this number via TTY by calling the toll-free Federal 
Information Relay Service at 800-877-8339. Copies of all comments 
submitted are available for inspection and downloading at https://www.regulations.gov.

FOR FURTHER INFORMATION CONTACT: Mark Ross, Acting Director, Office of 
Single Family Program Development, Office of Housing, Department of 
Housing and Urban Development, 451 Seventh Street, SW., Room 9278, 
Washington, DC 20410-8000; telephone number 202-708-2121 (this is not a 
toll-free number). Persons with hearing or speech impairments may 
access this number via TTY by calling the Federal Information Relay 
Service at 1-800-877-8339.

SUPPLEMENTARY INFORMATION:

I. Background

    The Federal Housing Administration (FHA) was established by 
Congress in 1934 to improve nationwide housing standards, to provide 
employment and stimulate industry, to improve conditions with respect 
to home mortgage financing, to prevent speculative excesses in new 
mortgage investment, and to eliminate the necessity for costly second 
mortgage financing. FHA-insured single family mortgages are originated 
and underwritten through the Direct Endorsement process. A majority of 
FHA-insured mortgages that are originated under the Direct Endorsement 
process are endorsed for insurance by mortgage lenders through a second 
process, the Lender Insurance process.
    The Direct Endorsement and Lender Insurance processes are not 
separate programs; rather, they are the mechanisms that enable FHA-
approved lenders to consider single family mortgage applications 
without first submitting paperwork to HUD. The Lender Insurance process 
is authorized under section 256 of the National Housing Act (12 U.S.C. 
1715z-21). The HUD regulations that presently govern the Direct 
Endorsement and Lender

[[Page 62336]]

Insurance processes are codified at 24 CFR part 203 (entitled Single 
Family Mortgage Insurance).
    The Direct Endorsement process is described in Sec.  203.5 and is 
available to mortgagees who meet the requirements set forth in Sec.  
203.3. Under Direct Endorsement, the mortgagee determines that the 
proposed mortgage is eligible for insurance under applicable 
regulations, and submits the required documents to FHA in accordance 
with Sec.  203.255. The Direct Endorsement mortgagee's performance is 
subject to pre-endorsement and post-endorsement review by the 
Secretary.
    Direct Endorsement mortgagees that meet the requirements of Sec.  
203.4 may be approved for Lender Insurance, as described in Sec.  
203.6. Under the Lender Insurance process, a mortgagee conducts its own 
pre-insurance review and insures the mortgage without a pre-endorsement 
review by HUD. In order to be eligible to participate in the FHA single 
family programs as a Lender Insurance mortgagee, an FHA mortgage lender 
must be an unconditionally approved Direct Endorsement mortgagee that 
is high performing--i.e., for at least 2 years prior to its application 
for Lender Insurance authority, the mortgagee must have had a claim and 
default record acceptable to HUD.

II. This Proposed Rule

    Through this proposed rule, HUD continues its efforts to improve 
and expand the risk management activities of FHA. The proposed 
regulatory changes will update and enhance the Lender Insurance 
process. Most significantly, the proposed rule would revise HUD's 
regulations implementing the statutory requirements regarding lender 
indemnification to HUD of insurance claims in the case of fraud, 
misrepresentation, or noncompliance with applicable loan origination 
requirements. The proposed rule will also provide that mortgagees, in 
order to retain their Lender Insurance authority, must continually 
maintain the acceptable claim and default rate required of them when 
they were initially delegated such authority. In addition, this 
proposed rule provides that HUD will review Lender Insurance mortgagee 
performance on a continual basis. HUD also proposes to revise the 
methodology for determining acceptable claim and default rates to more 
accurately reflect mortgagee performance, and to streamline the 
approval process for Lender Insurance mortgagees that have undergone a 
corporate restructuring. The Department has also taken the opportunity 
afforded by this proposed rule to make two technical corrections to the 
regulations.
    The proposed regulatory changes are as follows:
    1. Lender indemnification for insurance claims. Under section 
256(c) of the National Housing Act (12 U.S.C. 1715z-21(c)), an FHA-
approved Lender Insurance mortgagee may be required to indemnify HUD 
for the loss if the mortgage loan was ``not originated in compliance 
with the requirements established by the Secretary, and the Secretary 
pays an insurance claim * * * within a reasonable period specified by 
the Secretary.'' HUD may also require indemnification at any time ``if 
fraud or misrepresentation was involved in connection with 
origination'' of the mortgage loan. FHA may impose indemnifications, 
irrespective of whether the noncompliance, fraud, or misrepresentation 
caused the mortgage default. Currently, the section 256 statutory 
indemnification requirement is limited to mortgagees with Lender 
Insurance authority. On January 20, 2010, the Department announced that 
it would seek changes to section 256 of the National Housing Act, to 
apply the indemnification provisions to all Direct Endorsement 
lenders.\1\
---------------------------------------------------------------------------

    \1\ See HUD press release HUD No. 10-016, available at: https://portal.hud.gov/portal/page/portal/HUD/press/press_releases_media_advisories/2010/HUDNo.10-016.
---------------------------------------------------------------------------

    The section 256 statutory indemnification requirements are 
currently codified at Sec.  203.255(f)(4). HUD proposes to create a new 
Sec.  203.255(g) that would provide additional guidance on the 
statutory requirements of section 256.
    As discussed, the section 256 indemnification requirements are 
applicable to claims paid in connection to a mortgage that was not 
``originated'' in accordance with FHA requirements. For purposes of 
Sec.  203.255(f), this proposed rule would define the term 
``origination'' as meaning ``the process of creating a mortgage, 
starting with the taking of the initial application, continuing with 
the processing and underwriting, and ending with the mortgagee 
endorsing the mortgage note for FHA mortgage insurance.'' The proposed 
definition of ``origination'' would apply only to indemnifications for 
mortgages endorsed for FHA mortgage insurance under section 256 of the 
National Housing Act by authorized Lender Insurance mortgagees, and is 
not being proposed by HUD to apply in any other contexts related to the 
FHA programs.
    As noted, cases of fraud or misrepresentation may require 
indemnification at any time. However, for cases not involving fraud or 
misrepresentation, section 256(c) limits the Department's ability to 
require indemnification to insurance claims paid within a ``reasonable 
time period'' established by HUD. New Sec.  203.255(g) would implement 
this timing requirement by codifying HUD's longstanding practice of 
requiring indemnification for FHA insurance claims paid ``within five 
years from the date of mortgage insurance endorsement.'' The date of 
endorsement is a fixed date, and therefore has the benefit of being 
known to both HUD and the Lender Insurance mortgagee. Moreover, 5 years 
is a reasonable ``seasoning'' period for a particular mortgage loan to 
either perform or go into default and for the Department to ascertain 
whether errors in the origination of the mortgage loan were made, while 
not being so long a time frame so as to burden mortgagees with the 
possibility of indemnification for a long-ago endorsed mortgage loan.
    Section 256(c) authorizes HUD to require indemnification where the 
mortgage was not originated in compliance with the HUD-established 
requirements. Proposed Sec.  203.255(g) identifies the origination 
requirements for which HUD may seek indemnification if the Lender 
Insurance mortgagee knew or should have known that the requirements 
were not followed in the origination of the mortgage. HUD will seek 
such remedy for violations of FHA origination requirements that HUD 
deems serious and material; for example, in cases where the mortgage 
should never have been endorsed by the mortgagee, because FHA would not 
have insured the mortgage absent proper adherence to the Lender 
Insurance process. Specifically, a mortgagee may be required to 
indemnify HUD if it failed to, among other actions: (1) Verify and 
analyze the creditworthiness, income, and/or employment of the 
mortgagor in accordance with FHA requirements; (2) verify the source of 
assets brought by the mortgagor for payment of the required down 
payment and/or closing costs in accordance with FHA requirements; (3) 
address property deficiencies identified in the appraisal affecting the 
health and safety of the occupants or the structural integrity of the 
property in accordance with FHA requirements; or (4) ensure, in 
accordance with the requirements of Sec.  203.5(e), that the appraisal 
of the property serving as security for the mortgage loan satisfies FHA 
appraisal

[[Page 62337]]

requirements. HUD may seek indemnification irrespective of whether the 
violation caused the mortgage default.
    HUD deems violations of the origination requirements identified in 
the proposed rule as serious and material, because they pertain to the 
core analyses that must be performed for all properly underwritten 
mortgage loans. The purpose of mortgage loan underwriting is to 
evaluate the willingness and financial capability of the mortgagor to 
pay the loan, and to assess the physical condition of the property that 
is to serve as security for the mortgage loan, in order to determine 
whether it constitutes adequate collateral. These basic underwriting 
principles are enshrined in the so-called ``Four C's of Credit'' 
(credit, capacity, capital, and collateral) commonly referred to in the 
mortgage lending industry. The origination requirements listed above 
correspond to these fundamental underwriting functions. Accordingly, 
HUD believes that indemnification may be an appropriate remedy where 
the mortgagee knew or should have known that these requirements were 
not followed in the origination of the mortgage loan.
    The proposed rule would also specify that the demand for 
indemnification will be made by either the Secretary or the Mortgagee 
Review Board. Under an indemnification agreement, the originating 
mortgage lender agrees to either abstain from filing an insurance 
claim, or to reimburse FHA if a subsequent holder of the mortgage files 
an insurance claim and FHA suffers a financial loss.
    2. Acceptable claim and default rate for Lender Insurance 
mortgagees. Section 256(b) of the National Housing Act requires that 
the Secretary of HUD, in deciding whether to grant a mortgagee's 
application for Lender Insurance approval, consider ``the experience 
and performance of the mortgagee compared to the default rate of all 
insured mortgagees in comparable markets.'' HUD has implemented this 
statutory requirement at Sec.  203.4(b), which requires that ``a 
mortgagee must have had an acceptable claim and default record for at 
least 2 years prior to its application for'' Lender Insurance 
authority. The present regulation defines an acceptable claim and 
default as at or below 150 percent of either: (1) The national average 
rate for all insured mortgages; or (2) if the mortgagee operates in a 
single state, the average rate for insured mortgages in the state.
    The current regulation may make it easier for a single state 
mortgagee to meet the acceptable standard if the mortgagee operates in 
a state that has a high default rate. In contrast, a mortgagee would be 
disadvantaged by having its claim and default rate compared to the 
national average if the mortgagee operates in two states that have high 
default rates, even if the mortgagee is in full compliance with FHA 
requirements and otherwise eligible for Lender Insurance approval. To 
address these potential concerns, HUD proposes to revise the 
methodology for computing the acceptable claim and default rate for 
Lender Insurance approval. The proposed rule would revise Sec.  
203.4(b) by providing that a mortgagee is eligible for the Lender 
Insurance program if its claim and default rate is at or below 150 
percent of the average rate in the state(s) where the mortgagee 
operates. The proposed methodology will more accurately reflect 
mortgagee performance by evaluating each mortgagee based on its actual 
area of operations.
    3. Need to maintain acceptable claim and default rate. As noted, 
Sec.  203.4(b) requires that mortgagees have an acceptable claim and 
default rate as an eligibility criterion for initial Lender Insurance 
approval; however, the regulation does not specify what constitutes an 
acceptable claim and default rate for purposes of maintaining Lender 
Insurance approval. This proposed rule emphasizes that a Lender 
Insurance mortgagee must continually maintain the acceptable claim and 
default rate required of them when they were initially granted Lender 
Insurance authority. HUD will review Lender Insurance mortgagee 
performance on a continual basis, and mortgagees that fail to maintain 
the required claim and default rate will be subject to termination of 
their Lender Insurance authority.
    4. Lender Insurance approval in the case of merger, acquisition, or 
restructuring. Section 256 of the National Housing Act requires that 
HUD consider ``the experience and performance of the mortgagee'' in 
determining the appropriateness of delegating the Secretary's authority 
to endorse mortgages for FHA insurance. HUD's implementing regulations 
at Sec.  203.4(b) elaborate on the statutory requirement by providing 
that ``a mortgagee must have had an acceptable claim and default record 
for at least 2 years prior to its application for'' Lender Insurance 
authority. As discussed above in this preamble, the Lender Insurance 
process is reserved for high-performing mortgagees. The performance 
history requirement helps to ensure that only those mortgagees with a 
proven track record are eligible for Lender Insurance authority.
    Newly formed business entities that do not have a performance 
record are, therefore, ineligible for Lender Insurance approval. This 
is true even if the newly formed lending institution was created by a 
merger, acquisition, or reorganization where one or more of the 
participating entities had Lender Insurance approval, and the new 
resulting lending institution retains the structure, staff, and 
operational protocols that would--absent the 2-year historical 
performance requirement--make the new entity eligible for Lender 
Insurance authority under section 256 of the National Housing Act. 
Deferral of Lender Insurance eligibility is merited for new corporate 
entities that have not had the time to establish an acceptable 
performance track history. However, in the case of new entities created 
by a merger, acquisition, or reorganization, it is possible to forecast 
future performance with a high degree of certainty based on the 
performance history of the predecessor entities. To deny Lender 
Insurance eligibility to such mortgagees simply for purposes of 
``running out the clock'' is contrary to the rationale of the 
performance history requirement and the Lender Insurance process.
    In the past, the Department has addressed this issue through the 
granting of case-by-case regulatory waivers, a process that has the 
potential to be lengthy and, on occasion, administratively burdensome. 
This proposed rule would eliminate the need for regulatory waivers by 
codifying the conditions under which the Secretary may grant Lender 
Insurance authority to a mortgagee with less than the required 
historical performance record. The proposed criteria would permit HUD 
to evaluate the performance of the new mortgagee based on the 
performance history of the predecessor corporate entities, while also 
safeguarding against the possibility that a mortgagee with a poor track 
record might attempt to circumvent the purposes of section 256 by 
acquiring or merging with a high-performing lending institution.
    First, the mortgagee must be an entity created by a merger, 
acquisition, or reorganization completed less than 2 years prior to the 
date of the mortgagee's application for Lender Insurance approval. 
Secondly, one or more of the entities participating in the merger, 
acquisition, or reorganization must have had Lender Insurance approval 
at the time of the corporate restructuring. Third, all of the lending 
institutions participating in the corporate

[[Page 62338]]

restructuring must have had an acceptable claim and default record for 
the 2-years preceding the mortgagee's application for Lender Insurance 
approval. Fourth, and last, the extrapolated claim and default record 
of the mortgagee derived by aggregating the claims and defaults of the 
entities participating in the merger, acquisition, or reorganization, 
for the 2-year period prior to the mortgagee's application for Lender 
Insurance approval, constitutes an acceptable rate of claims and 
defaults.
    The proposed new process would permit, but not compel, HUD to grant 
Lender Insurance authority to those mortgagees meeting the criteria 
outlined above. While a rebuttable presumption in favor of granting 
approval would be established by a mortgagee that meets all four of the 
required criterions, HUD may consider other available evidence or data 
indicative of performance, and may deny the application for Lender 
Insurance authority and require the mortgagee to wait until it 
establishes an acceptable performance track record. The proposed 
regulatory provision is consistent with HUD's responsibility to 
evaluate mortgagee experience and ensure that Lender Insurance 
authority is provided only to high-performing lenders that comply with 
FHA requirements, while also facilitating the provision of FHA-
insurance by new lending institutions created by a corporate 
restructuring.
    5. HUD reviews. Consistent with its duty to protect the FHA 
insurance fund, HUD monitors mortgagee performance on an ongoing basis 
(see, for example, the present regulation at 24 CFR 202.3 providing for 
such HUD reviews). However, the current Lender Insurance regulation at 
Sec.  203.4(c) only refers to an annual performance review. This 
proposed rule would clarify that HUD will monitor a mortgagee's 
eligibility to participate in the Lender Insurance program on a 
continual basis.
    6. Termination of Lender Insurance authority. This proposed rule 
would revise Sec.  203.4(d), which governs terminations of Lender 
Insurance authority, for purposes of clarity and readability. The 
proposed rule would provide additional specificity on the grounds for 
termination. Revised Sec.  203.4(d) provides that HUD may immediately 
terminate the mortgagee's approval to participate in the Lender 
Insurance program, if the mortgagee violates any of the requirements 
and procedures established by the Secretary for mortgagees approved to 
participate in the Lender Insurance program, the Direct Endorsement 
program, or the Title II Single Family mortgage insurance program, or 
if HUD determines that other good cause exists. In addition, the 
proposed rule clarifies that terminations of Lender Insurance approval 
are effective upon receipt of HUD's notice of such termination. The 
proposed rule would also revise Sec.  203.4(d) to clarify that pursuant 
to section 256(d) of the National Housing Act (12 U.S.C. 1715z-21(d)), 
HUD termination decisions are not subject to judicial review and that 
terminations instituted under Sec.  203.4(d) are distinct from 
withdrawal of mortgagee approval by the Mortgagee Review Board under 24 
CFR part 25.
    7. Lender insurance pre-insurance review. The present regulations 
at Sec.  203.255(f)(1) require that mortgagees conduct a pre-insurance 
review of mortgages insured under the Lender Insurance process. The 
regulations provide that the pre-insurance review must meet HUD 
requirements, but does not specify the requirements for applicable 
reviews, instead providing that ``HUD will directly inform 
participating mortgagees of its minimum requirements for pre-insurance 
review.'' This proposed rule would codify existing Lender Insurance 
practice concerning the pre-insurance review provisions, by specifying 
that Lender Insurance mortgagees are responsible for conducting the 
pre-insurance review that would otherwise be performed by HUD under the 
Direct Endorsement process.
    8. Technical correction. In addition to the proposed regulatory 
changes discussed above in this preamble, HUD has taken the opportunity 
afforded by this proposed rule to make a nonsubstantive change to the 
existing regulations. The proposed rule would make a technical 
correction to Sec.  203.4(a), which incorrectly cross-references to 
Sec.  203.5 as containing the requirements for Direct Endorsement 
approval. These approval procedures are codified at Sec.  203.3.

III. Issue Under Consideration: Mandatory Electronic Submission of Case 
Binders

    In addition to soliciting public comment on the proposed regulatory 
changes described above in this preamble, the Department solicits 
comment on a possible change to current recordkeeping and submission 
requirements that the Department is considering. The present Direct 
Endorsement regulations at 24 CFR 203.255(b) require mortgagees to 
submit to HUD specified documentation within 60 days after the date of 
closing of a mortgage loan (collectively, these documents and 
certifications are referred to as the mortgage loan ``case binder''). 
The Lender Insurance regulations at 24 CFR 203.255(f)(2) provide that 
mortgagees must maintain records, including origination files, in a 
manner and for a time frame prescribed by HUD, and must make these 
mortgage loan ``case binders'' available to HUD staff upon request.
    Customarily, case binders are maintained and submitted to HUD in 
hard-copy paper format. Given changes in technology that facilitate the 
electronic submission and storing of mortgage loan records, HUD is now 
considering requiring by June 2012 that all case binders be submitted 
electronically regardless of the insurance process used by a mortgagee. 
Although Lender Insurance mortgagees are not currently required to 
submit case binders (except upon HUD's request for a post-endorsement 
technical review), under HUD's proposal they would be required to 
submit these mortgage loan records electronically within a specified 
time frame following insurance of the mortgage. The final rule may 
contain regulatory text requiring the electronic submission of case 
binders, and HUD invites public comment on such a possible change, 
including the appropriateness of a June 2012 implementation date, the 
costs and benefits that would be associated with the electronic 
submission of case binders, and what the required time frames should be 
for submission of electronic case binders following insurance of the 
mortgage. For more information about the costs and benefits of this 
provision, please see the regulatory planning and review section of 
this preamble.

IV. Findings and Certification

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 an economically 
significant regulatory action, as provided under section 3(f)(1) of the 
Order).
    This proposed rule would modify three existing areas affecting FHA-
approved lenders. First, this rule would impose indemnification 
provisions to all approved mortgagees with Lender Insurance authority. 
Second, this rule would amend the methodology and requirements for 
determining an acceptable claim and default rate. Lastly, this rule 
would amend the 2-year

[[Page 62339]]

historical performance requirement for mortgagees resulting from 
merger, acquisition, or reorganization. Other provisions of this rule 
describe clarifying or technical changes which would not produce an 
economic impact. The proposed rule also solicits comments on a possible 
change to current recordkeeping and submission requirements that the 
Department is considering. To the extent that these amendments have any 
economic impact, it would be to reduce the compliance costs currently 
borne by lenders, by clarifying and providing additional instructions 
that supplement existing FHA requirements and procedures. This rule, as 
proposed, would not have an economic effect of greater than $100 
million and thus does not require a regulatory impact analysis. The 
reasons for HUD's determination are as follows:
    Indemnification Requirements. With regard to the proposed 
indemnification provisions, this proposed rule codifies much of 
existing HUD practice, and this rule alone should not result in a 
dramatic change in underwriting practices and the quality of FHA loans, 
assuming that all of FHA's Direct Endorsement lenders currently conduct 
due diligence in extending FHA-insured loans. A marginal change will be 
encountered by those lenders with ineffective risk management practices 
and/or those lenders who have refused to execute an indemnification 
agreement. HUD expects there to be some reduction in claims paid by 
FHA, but not a noticeable reduction in the claims rate attributed to 
this change by itself. FHA's average loss rate on claims for first 
quarter Fiscal Year (FY) 2010 (October 1, 2009 to February 28, 2010) 
properties conveyed to HUD and subsequently sold was approximately 60 
percent. For every claim averted, there would be a transfer (loss 
avoidance) of approximately $73,000 to FHA.
    The primary change is that all Direct Endorsement lenders with 
Lender Insurance authority will be subject to indemnification 
procedures and will not be able to negotiate the settlement, as is the 
current practice. This facet of the rule could lead to an efficiency: 
the initial process by a lender of deciding whether to indemnify FHA 
will be eliminated, and would be accompanied by reductions in the 
length and cost of negotiations. Time and effort may be saved because 
the costs of a lengthy preparation for both FHA and the lender in 
coming before the Mortgage Review Board are reduced by this proposed 
rule. The number of signed indemnifications for the last seven fiscal 
years (FY 2004 through the end of FY 2010) has averaged 1,282 
indemnification agreements annually. If the average negotiation costs 
are one percent of the loan amount for both FHA and the lender 
(approximately $140,000 is currently the average FHA-insured mortgage 
amount), then the transaction costs to avoid or delay the 
indemnification would be $1,400 per loan. Over an average of 1,300 
indemnifications, the aggregate transaction costs saved by this rule 
would be $1.7 million.
    Acceptable Claim and Default Rate. The proposed rule would make two 
changes regarding acceptable claim and default rates for Lender 
Insurance mortgagees. First, HUD proposes to more accurately evaluate a 
mortgagee's performance record by basing the claim and default rate 
comparison on the mortgagee's actual area of operations. The proposed 
rule also clarifies that, in order to retain their Lender Insurance 
authority, mortgagees must continually maintain the acceptable claim 
and default rate required of them when they were initially delegated 
such authority.
    To simulate the impact of the proposed changes, HUD used data on 
active Direct Endorsement lenders. By moving to a consistent 
methodology, regional lenders are compared not to a national standard, 
but to their peers operating in the same area. Using as a base the 
total number of 1,945 currently active Direct Endorsement lenders, an 
additional 18 lenders would have the claim and default rate necessary 
for Lender Insurance authority under this proposed rule. However, the 
proposed requirement that Lender Insurance mortgagees maintain the 
acceptable default and claim rate initially required for Lender 
Insurance eligibility appears to result in a minimal reduction in the 
number of Direct Endorsement lenders that would be deemed to eligible 
for Lender Insurance authority. Specifically, 113 out of the 1,945 
currently active Direct Endorsement mortgagees would no longer have the 
necessary claim and default rate to maintain Lender Insurance 
authority; however, these mortgagees would retain their Direct 
Endorsement authority and could continue to participate in FHA 
programs.
    The combined effect of the two proposed changes would be to reduce 
the number of Direct Endorsement mortgagees eligible for Lender 
Insurance authority (a reduction of 54). In the short run, this effect 
can be thought of as a transfer between lenders of different regions. 
In the longer run, HUD expects the impact of this rule to be 
geographically neutral. Lenders will not be permanently reduced as a 
result of this rule; rather, HUD expects that lenders who can meet the 
eligibility criteria will eventually assume the business of those 
lenders who could not meet the new eligibility criteria.
    Lender Insurance Approval in the Case of Corporate Restructuring. 
The proposed rule would facilitate the compliance of new lending 
institutions resulting from a merger, acquisition, or reorganization 
with the statutory requirements for Lender Insurance approval. The 
proposed rule would thus make changes designed to provide additional 
regulatory flexibility and better reflect existing market conditions. 
The regulatory 2-year performance history requirement may impose a 
burden on lenders whose compliance with FHA requirements was not 
affected by the business reorganization. Although HUD has in the past 
granted regulatory waivers to address this problem, the proposed rule 
will codify a solution that is less administratively burdensome than 
the regulatory waiver process.
    Mandatory Electronic Submission of Case Binders. The present Direct 
Endorsement regulations require mortgagees to submit case binders to 
HUD within 60 days after the date of closing of a mortgage loan. 
Customarily, case binders are maintained and submitted to HUD in hard-
copy paper format. Given changes in technology that facilitate the 
electronic submission and storing of mortgage loan records, the 
proposed rule solicits comments on whether HUD should require that all 
case binders be submitted electronically. Although Lender Insurance 
mortgagees are not currently required to submit case binders (except 
upon HUD's request), under HUD's proposal they would be required to 
submit these mortgage loan records electronically within a specified 
time frame following insurance of the mortgage.
    The minimum cost of this change to mortgagee would be zero. Most 
companies already possess the technology to process electronic 
documents for their investors. In addition, there are currently seven 
lenders that submit a total of 250,000 electronic case binders 
annually. These firms would not incur additional costs for submitting 
electronic binders to FHA. Although most companies already subscribe to 
a service that transmits electronic documents, sending them to FHA 
would impose an additional cost. A reasonable estimate of the 
additional cost per loan is a transaction fee in the range of $9 to $17 
per case binder, with an upfront cost of $5,000 to $15,000 per firm. 
With 4,000 firms, the aggregate

[[Page 62340]]

fixed cost of this portion of the rule would range from $20 million to 
$60 million. If FHA has an average of 1.5 million loans, then 1.25 
million loans would be affected (1.5 million minus 250,000). The 
aggregate variable cost of this requirement would constitute from $11 
million to $21 million ($9 to $17 multiplied by 1.25 million).
    The low-cost-scenario is defined as the case where the fixed and 
variable costs are lowest and the high-cost scenario where the costs 
are highest. The annualized cost over 10 years at a 3 percent discount 
rate would be $14 million in the low-cost scenario and $29 million 
annually in the high-cost scenario. At a 7 percent discount rate, the 
annualized cost over 10 years would be $15 million annually for the 
low-cost scenario and $31 million for the high-cost scenario.
    The net cost, however, of moving to mandatory electronic submission 
should not be lesser the gross cost described above, since there will 
be some substitution from more expensive postal to electronic 
submission. These benefits are expected to last for the next 10 years 
until a new investment is required. Consider, for example, if the case 
binders of one-half of all loans were mailed to FHA at a cost of $30 
per binder, then the annual savings of postal costs would be $18.7 
million. This provision generates net benefits for the low-cost of 
transmission scenario (a total of $44 million at a 3 percent discount 
rate over 10 years) but not for the high-cost of transmission of 
scenario (a net cost of $81 million at the 3 percent discount rate). 
The annualized net benefit in the low-cost scenario is $5.4 million and 
the annualized net cost in the high-cost scenario is $9.6 annually.
    The docket file is available for public inspection in the 
Regulations Division, Office of General Counsel, Department of Housing 
and Urban Development, 451 7th Street, SW., Room 10276, Washington, DC 
20410-0500. Due to security measures at the HUD Headquarters building, 
please schedule an appointment to review the docket file by calling the 
Regulations Division at 202-402-3055 (this is not a toll-free number). 
Individuals with speech or hearing impairments may access this number 
via TTY by calling the toll-free Federal Information Relay Service at 
800-877-8339.

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.
    The proposed rule would not add any new regulatory burdens on FHA-
approved mortgage lenders. Rather, as noted above in this preamble (see 
the section captioned ``Regulatory Planning and Review''), the proposed 
rule would codify much of existing practice regarding indemnification. 
Specifically, the proposed rule would codify a definition of the term 
``origination'' for purposes of indemnification, specify time limits on 
HUD's ability to demand indemnification in cases not involving fraud or 
misrepresentation, and identify specific defects in mortgage loan 
origination that may prompt HUD to seek indemnification. The primary 
change is that all Lender Insurance mortgagees will be subject to 
indemnification and will not be able to negotiate a settlement in lieu 
of indemnification. As noted in the ``Regulatory Planning and Review'' 
section of this preamble, this change may have a marginal impact on 
those lenders with ineffective risk management practices and who have 
refused to execute an indemnification agreement. Accordingly, to the 
extent that indemnification provisions of this proposed rule have any 
economic impact, it will be as a result of the lender's own actions--
i.e., its inability or unwillingness to comply with prudent risk 
management practices--and not as a result of HUD regulatory action.
    HUD also proposes to revise the methodology for determining 
acceptable claim and default rates. The regulatory change will more 
accurately evaluate a mortgagee's performance record by basing the 
claim and default rate comparison on the mortgagee's actual area of 
operations, rather than on the national average. This change would have 
an overall beneficial economic impact on small business lenders.\2\ HUD 
data indicates that an additional ten small business lenders would be 
deemed to have an acceptable claim and default rate for purposes of 
Lender Insurance authority as a result of this change. (There are 
currently 602 active small business Direct Endorsement mortgagees 
participating in FHA programs.)
---------------------------------------------------------------------------

    \2\ The Small Business Administration size standard regulations 
at 13 CFR 121.201 define small business lenders and mortgagees as 
having less than $7 million in annual revenues for nondepository 
firms and assets under $175 million for depository firms.
---------------------------------------------------------------------------

    The proposed rule also specifies that mortgagees must maintain the 
acceptable claim and default rate required of them when they were 
initially granted Lender Insurance authority, in order to retain such 
authority, and that HUD will monitor mortgagee performance on an 
ongoing basis. As noted in the ``Regulatory Planning and Review'' 
section of this preamble, this provision of the proposed rule would 
result in a minimal reduction in the number of Direct Endorsement 
lenders that would be deemed eligible for Lender Insurance authority 
(113 out of a total of 1,945 currently active Direct Endorsement 
mortgagees). However, the economic impacts of this change should be 
minimal, as these lenders will continue to be able to participate in 
FHA programs as Direct Endorsement mortgagees. Moreover HUD reiterates 
that Lender Insurance authority is reserved for high-performing 
mortgagees that have a proven track record of risk management and sound 
underwriting practices. The regulatory change would merely require that 
Lender Insurance mortgagees maintain the same performance record that 
first made them eligible for Lender Insurance authority. To the extent 
that the proposed amendment has any impact, it will be as a consequence 
of the lender's inability to maintain acceptable risk management 
practices, and not as a result a HUD regulatory mandate.
    The proposed rule also would make several changes designed to 
provide additional regulatory flexibility and better reflect existing 
market conditions. For example, the proposed rule would facilitate the 
compliance of new lending institutions created by a merger, 
acquisition, or reorganization with the statutory requirements for 
Lender Insurance approval. Under HUD's regulations implementing section 
256 of the National Housing Act, mortgagees must comply with a 2-year 
performance history requirement in order to qualify for Lender 
Insurance approval. As a new business entity, the lending institution 
created by a merger, acquisition, or reorganization would not be able 
to comply with the performance 2-year history requirements, and thus 
would be ineligible for Lender Insurance authority. The regulatory 2-
year performance history requirement may impose a burden on lenders 
whose compliance with FHA requirements is not affected by the business 
reorganization. Although HUD has in the past granted regulatory waivers 
to address this problem, the proposed rule will codify a solution that 
is less administratively burdensome than the regulatory waiver process.

[[Page 62341]]

    The proposed rule also solicits comment on a possible change to 
current recordkeeping and submission requirements. In light of changes 
in technology that facilitate the electronic submission and storing of 
mortgage loan records, HUD is considering requiring that case binders 
be submitted electronically regardless of the insurance process used by 
a mortgagee. As discussed in detail in the ``Regulatory Planning and 
Review'' section of this preamble, the proposed change likely would 
reduce the economic burden imposed on mortgagees by no longer requiring 
that they incur the cost of maintaining paper records (except in the 
worst high-cost scenario). Moreover, these benefits are expected to 
last for the next 10 years until a new technology investment is 
required.
    Accordingly, for the above reasons, 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 effect on a substantial number of 
small entities, HUD specifically invites comments regarding any less 
burdensome alternatives to this rule that will meet HUD's objectives, 
as described in this preamble.

Executive Order 13132, Federalism

    Executive Order 13132 (entitled ``Federalism'') prohibits an agency 
from publishing any rule that has federalism implications if the rule 
either imposes substantial direct compliance costs on state and local 
governments and is not required by statute, or the rule preempts state 
law, unless the agency meets the consultation and funding requirements 
of section 6 of the Executive Order. This rule will not have federalism 
implications and would 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 on the private sector. This proposed rule does 
not impose any federal mandates on any state, local, or tribal 
governments, or on the private sector, within the meaning of UMRA.

Environmental Impact

    This proposed rule does 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 rule 
is categorically excluded from environmental review under the National 
Environmental Policy Act of 1969 (42 U.S.C. 4321).

Paperwork Reduction Act

    The information collection requirements for this proposed rule have 
been approved by the Office of Management and Budget (OMB) under the 
Paperwork Reduction Act of 1995 (44 U.S.C. 3501-3520) and assigned OMB 
control number 2502-0059. In accordance with the Paperwork Reduction 
Act, an agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information, unless the collection 
displays a currently valid OMB control number.

Catalogue of Federal Domestic Assistance

    The Catalogue of Federal Domestic Assistance Number for the 
principal FHA single family mortgage insurance program is 14.117.

List of Subjects in 24 CFR Part 203

    Hawaiian Natives, Home improvement, Indians--lands, Loan programs--
housing and community development, Mortgage insurance, Reporting and 
recordkeeping requirements, Solar energy.

    Accordingly, for the reasons discussed in the preamble, HUD 
proposes to amend 24 CFR part 203 to read as follows:

PART 203--SINGLE FAMILY MORTGAGE INSURANCE

    1. The authority citation for part 203 is revised to read as 
follows:

    Authority: 12 U.S.C. 1709, 1710, 1715b, 1715z-16, 1715u, and 
1717z-21; 42 U.S.C. 3535(d).

    2. In Sec.  203.4, amend paragraph (a) by revising the reference 
``Sec.  203.5'' to read ``Sec.  203.3'' and revise paragraphs (b), (c), 
and (d), to read as follows:


Sec.  203.4  Approval of mortgagees for Lender Insurance.

* * * * *
    (b) Performance: Claim and default rate. (1) In addition to being 
unconditionally approved for the Direct Endorsement program, a 
mortgagee must have had an acceptable claim and default rate (as 
described in paragraph (b)(3) of this section) for at least 2 years 
prior to its application for participation in the Lender Insurance 
program, and must maintain such a claim and default rate in order to 
retain Lender Insurance approval.
    (2) HUD may approve a mortgagee that is otherwise eligible for 
Lender Insurance approval, but has an acceptable claim and default 
record of less than 2 years, if:
    (i) The mortgagee is a an entity created by a merger, acquisition, 
or reorganization completed less than 2 years prior to the date of the 
mortgagee's application for Lender Insurance approval;
    (ii) One or more of the entities participating in the merger, 
acquisition, or reorganization had Lender Insurance approval at the 
time of the merger, acquisition, or reorganization;
    (iii) All of the lending institutions participating in the merger, 
acquisition, or reorganization had an acceptable claim and default 
record for the 2 years preceding the mortgagee's application for Lender 
Insurance approval; and
    (iv) The extrapolated claim and default record of the mortgagee 
derived by aggregating the claims and defaults of the entities 
participating in the merger, acquisition, or reorganization, for the 2-
year period prior to the mortgagee's application for Lender Insurance 
approval, constitutes an acceptable rate of claims and defaults, as 
defined by this section.
    (3) A mortgagee has an acceptable claim and default rate if its 
rate of claims and defaults is at or below 150 percent of the average 
rate for insured mortgages in the state(s) in which the mortgagee 
operates.
    (c) Reviews. HUD will monitor a mortgagee's eligibility to 
participate in the Lender Insurance program on a continual basis.
    (d) Termination of approval. (1) HUD may immediately terminate the 
mortgagee's approval to participate in the Lender Insurance program, in 
accordance with section 256(d) of the National Housing Act (12 U.S.C. 
1715z-21(d)), if the mortgagee:
    (i) Violates any of the requirements and procedures established by 
the Secretary for mortgagees approved to participate in HUD's Lender 
Insurance program, Direct Endorsement program, or the Title II Single 
Family mortgage insurance program; or
    (ii) If HUD determines that other good cause exists.
    (2) Such termination will be effective upon receipt of HUD's notice 
advising of the termination. Within 30 days after receiving HUD's 
notice of termination, a

[[Page 62342]]

mortgagee may request an informal conference with the Deputy Assistant 
Secretary for Single Family Housing or designee. The conference will be 
conducted within 30 days after HUD receives a timely request for the 
conference. After the conference, the Deputy Assistant Secretary (or 
designee) may decide to affirm the termination action or to reinstate 
the mortgagee's Lender Insurance program approval. The decision will be 
communicated to the mortgagee in writing, will be deemed a final agency 
action, and, pursuant to section 256(d) of the National Housing Act (12 
U.S.C. 1715z-21(d)), is not subject to judicial review.
    (3) Termination of an origination approval agreement under part 202 
of this chapter or termination of Direct Endorsement approval under 
Sec.  203.3(d)(2) for a mortgagee or one or more branch offices 
automatically terminates Lender Insurance approval for the mortgagee or 
the branch office or offices, without imposing any further requirement 
on the mortgagee or such offices to comply with this paragraph.
    (4) Any termination instituted under this section is distinct from 
withdrawal of mortgagee approval by the Mortgagee Review Board under 24 
CFR part 25.
    3. In Sec.  203.255, revise paragraph (f)(1), remove paragraph 
(f)(4), and add paragraph (g) to read as follows:


Sec.  203.255  Insurance of mortgage.

* * * * *
    (f) Lender Insurance. (1) Pre-insurance review. For applications 
for insurance involving mortgages originated under the Lender Insurance 
program under Sec.  203.6, the mortgagee is responsible for performing 
a pre-insurance review that would otherwise be performed by HUD under 
Sec.  203.255(c) on the documents that would otherwise be submitted to 
HUD under Sec.  203.255(b). The mortgagee's staff that performs the 
pre-insurance review must not be the same staff that originated the 
mortgage or underwrote the mortgage for insurance.
* * * * *
    (g) Indemnification. (1) General. By insuring the mortgage, a 
Lender Insurance mortgagee agrees to indemnify HUD, in accordance with 
this paragraph.
    (2) Definition of origination. For purposes of indemnification 
under this paragraph, the term ``origination'' means the process of 
creating a mortgage, starting with the taking of the initial 
application, continuing with the processing and underwriting, and 
ending with the mortgagee endorsing the mortgage note for FHA 
insurance.
    (3) Serious and material violation. The mortgagee shall indemnify 
HUD for an FHA insurance claim paid within 5 years of mortgage 
insurance endorsement, if the mortgagee knew or should have known of a 
serious and material violation of FHA origination requirements, such 
that the mortgage loan should not have been approved and endorsed by 
the mortgagee and irrespective of whether the violation caused the 
mortgage default. Such a serious and material violation of FHA 
requirements in the origination of the mortgage may occur if the 
mortgagee failed to, among other actions:
    (i) Verify the creditworthiness, income, and/or employment of the 
mortgagor in accordance with FHA requirements;
    (ii) Verify the assets brought by the mortgagor for payment of the 
required down payment and/or closing costs in accordance with FHA 
requirements; or
    (iii) Address property deficiencies identified in the appraisal 
affecting the health and safety of the occupants or the structural 
integrity of the property in accordance with FHA requirements, or
    (iv) Ensure that the appraisal of the property serving as security 
for the mortgage loan satisfies FHA appraisal requirements, in 
accordance with Sec.  203.5(e).
    (4) Fraud or misrepresentation. The mortgagee shall indemnify HUD 
for an insurance claim if fraud or misrepresentation was involved in 
connection with the origination of the mortgage, regardless of when the 
mortgage was endorsed for insurance and irrespective of whether the 
fraud or misrepresentation caused the mortgage default.
    (5) Demand for indemnification. The demand for indemnification will 
be made by either the Secretary or the Mortgagee Review Board. Under an 
indemnification agreement, the Lender Insurance mortgagee agrees to 
either abstain from filing an insurance claim, or reimburse FHA if a 
subsequent holder of the mortgage files an insurance claim and FHA 
suffers a financial loss.

    Dated: September 16, 2010.
David H. Stevens,
Assistant Secretary for Housing--Federal Housing Commissioner.
[FR Doc. 2010-25441 Filed 10-7-10; 8:45 am]
BILLING CODE 4210-67-P