Federal Housing Administration (FHA) Single Family Lender Insurance Process: Eligibility, Indemnification, and Termination, 3598-3605 [2012-1508]

Agencies

• DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

[Federal Register Volume 77, Number 16 (Wednesday, January 25, 2012)]
[Rules and Regulations]
[Pages 3598-3605]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-1508]


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DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

24 CFR Part 203

[Docket No. FR-5156-F-02]
RIN 2502-AI58


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

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

ACTION: Final rule.

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SUMMARY: This final rule updates and enhances the Lender Insurance 
process, through which the majority of Federal Housing Administration 
(FHA)-insured mortgages are endorsed for insurance. These changes also 
further HUD efforts to improve and expand the risk management 
activities of the FHA. This final rule follows the publication of an 
October 8, 2010, proposed rule, and takes into consideration public 
comments received in response to it.

DATES: Effective Date: February 24, 2012.

FOR FURTHER INFORMATION CONTACT: Karin Hill, 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) 708-4308 (this is not a toll-free 
number). Persons with hearing or speech impairments may access these

[[Page 3599]]

numbers through TTY by calling the toll-free Federal Relay Service at 
(800) 877-8339.

SUPPLEMENTARY INFORMATION:

I. Background

    On October 8, 2010, at 75 FR 62335, HUD published for public 
comment a proposed rule to update and enhance the Federal Housing 
Administration (FHA) Lender Insurance Process. FHA-insured single 
family mortgages are originated and underwritten through the Direct 
Endorsement process. A majority of FHA-insured mortgages that are 
originated and underwritten under the Direct Endorsement process are 
endorsed for insurance by mortgagees through the Lender Insurance 
process. Under Direct Endorsement, the mortgagee first determines that 
the proposed mortgage is eligible for insurance under applicable 
regulations, and then submits the required documents to FHA for a pre-
endorsement review. Direct Endorsement mortgagees that meet the 
requirements may be approved for Lender Insurance. The Lender Insurance 
process enables mortgagees approved for the Direct Endorsement process 
to insure single family mortgages originated and underwritten through 
the Direct Endorsement process without first submitting documents to 
FHA. Under the Lender Insurance process, a mortgagee conducts its own 
pre-insurance review and insures the mortgage without a pre-endorsement 
review by FHA. In order to be eligible to participate in the FHA single 
family programs as a Lender Insurance mortgagee, a mortgagee must be an 
unconditionally approved Direct Endorsement mortgagee that is high 
performing. 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 
Insurance processes are codified at 24 CFR part 203 (entitled Single 
Family Mortgage Insurance).
    The October 8, 2010, proposed rule furthered HUD efforts to improve 
and expand the risk management activities of the FHA. The proposed 
regulatory changes were designed to update and enhances the Lender 
Insurance process, through which the majority of FHA-insured mortgages 
are endorsed for insurance. Most significantly, the proposed rule 
provided 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. Other 
proposed regulatory changes addressed the frequency and methodology of 
HUD's review of mortgagee Lender Insurance performance, and the 
approval process for Lender Insurance mortgagees that have undergone a 
corporate restructuring. The Department also took the opportunity 
afforded by the proposed rule to solicit public comment on whether FHA 
mortgagees should be required to submit mortgage loan case binders to 
HUD electronically. Interested readers should refer to the preamble to 
the October 8, 2010, proposed rule for additional information on the 
proposed regulatory changes to the Lender Insurance process.

II. This Final Rule; Changes to the October 8, 2010, Proposed Rule

    This final rule follows publication of the October 8, 2010, 
proposed rule and takes into consideration the public comments received 
on it. The public comment period on the proposed rule closed on 
December 7, 2010, and HUD received a total of 13 public comments. 
Comments were submitted by mortgagees, mortgage lending associations, 
and private citizens. Most of the public comments pertained to the 
provisions of the proposed rule concerning indemnification.
    After careful consideration of the issues raised by the commenters, 
HUD has decided to adopt an amended version of the proposed rule. 
Specifically, HUD has made the following changes to the October 8, 
2010, proposed rule:
    1. Frequency of HUD review. This final rule clarifies that, 
consistent with reviews of mortgagee performance under the Credit Watch 
Termination Initiative, HUD will review Lender Insurance mortgagee 
performance on an ongoing (as opposed to ``continual'' basis).
    2. Scope of termination. The final rule clarifies that the 
automatic termination of a mortgagee's Lender Insurance authority under 
Sec.  203.4(d)(3) is limited to actions taken at the institution level 
of the mortgagee, as opposed to its branches.
    3. Knowing standard for indemnification in the case of fraud or 
misrepresentation. The final rule provides that a mortgagee shall 
indemnify HUD for an insurance claim if the mortgagee ``knew or should 
have known'' that fraud or misrepresentation was involved.
    4. Reinstatement process. The final rule provides that mortgagees 
whose Lender Insurance authority has been terminated may apply for 
reinstatement in accordance with procedures closely modeled on the 
existing procedures for a mortgagee seeking reinstatement following 
termination of its origination approval agreement or Direct Endorsement 
authority.
    As already noted, the October 8, 2010, proposed rule invited public 
comment on whether FHA mortgagees should be required to submit mortgage 
loan case binders to HUD electronically. This final rule does not 
revise the FHA recordkeeping and reporting requirements, but HUD will 
consider the comments received on this issue on any future rulemaking 
addressing the electronic submission of case binders.

III. Discussion of Public Comments Received on the October 8, 2010, 
Proposed Rule

    The following section of the preamble presents a summary of the 
significant issues raised by the public comments in response to the 
October 8, 2010, proposed rule, and HUD's responses to these issues.

A. Lender Indemnification for Insurance Claims

    Comment: A 5-year indemnification period starting with insurance 
endorsement is too long for indemnifications demanded for serious and 
material violations of FHA origination requirements. Several commenters 
wrote that the proposed 5-year period for indemnification should be 
shortened. Commenters wrote that problems occurring more than 2 or 3 
years after origination are most commonly due to life events such as 
loss of employment, divorce, or death, rather than decisions made at 
origination. The majority of commenters who proposed a shortened time 
frame suggested a period of 2-to-3 years after insurance endorsement. 
Commenters wrote that based on their experience, the 2-year time frame 
would be sufficient to identify serious or material issues occurring in 
the origination of mortgage loans, to identify defects stemming from 
the underwriting of mortgage loans, and to determine whether lender 
error occurred. One commenter wrote that HUD's origination guidelines 
in Handbook 4155.1 instruct lenders to establish income analysis on 
continuance for 3 years. The commenter wrote that lenders should not be 
held culpable beyond HUD's own established credit policy.
    HUD Response. HUD has not amended the rule based on these comments. 
Indemnification for 5 years

[[Page 3600]]

from the date of insurance endorsement is the current standard practice 
for indemnification in connection with other serious mortgagee program 
violations, and the adoption of a lesser standard for Lender Insurance 
would be inconsistent with proper risk management practices. HUD 
continues to believe that the 5-year period is consistent with the twin 
policy objectives of providing HUD sufficient opportunity to determine 
whether there was a serious and material noncompliance issue that 
rendered the loan ineligible for insurance, while at the same time 
ensuring that mortgagees are not burdened with the possibility of 
indemnification due to noncompliance for a mortgage loan endorsed more 
than 5 years ago.
    Comment: Indemnification should be limited to those cases where 
origination deficiencies caused default. Several commenters wrote that 
HUD should seek indemnification only in circumstances where an 
origination deficiency directly caused the default. Commenters 
expressed concern that FHA may seek indemnification due to small or 
irrelevant deficiencies in origination if a clear causation standard is 
not in place. Commenters wrote that a civil money penalty would be a 
more appropriate penalty than indemnification for loan origination 
deficiencies not directly related to the mortgage default.
    HUD Response. HUD has not amended the rule based on these comments. 
Current standard practice for indemnification requests is not based on 
causation connection between the violation and the default, and the 
adoption of a lesser standard for Lender Insurance would be 
inconsistent with proper risk management practices. Furthermore, HUD 
has made it clear that indemnification will be demanded only in cases 
of serious and material violations of HUD requirements. HUD intends to 
demand indemnification for loans where fraud, misrepresentation, or 
serious and material noncompliance are such that the loans were 
ineligible for insurance. Creating a causation standard (connecting the 
default to the violation) is unnecessary since FHA should not have 
incurred the insurance obligation in the first place.
    Comment: Proposed bases for indemnification are overly broad. 
Several commenters wrote that the bases by which HUD may seek 
indemnification described by the proposed rule are overly broad. The 
commenters wrote that the proposed bases are subjective and may deter 
mortgagees from participating in the FHA program or may increase the 
costs and fees to consumers, because mortgagees absorb the potential 
for future increased liability. Commenters requested that HUD provide 
more specific examples illustrating the scenarios under which 
indemnification may be sought.
    HUD Response. HUD has not amended the rule based on these comments. 
HUD believes that the regulatory language is clear, consistent with 
current standard practice, and covers the types of violations that are 
considered serious and material (i.e., ones where the mortgage never 
should have been endorsed by the lender because FHA would not have 
insured the mortgage under the Direct Endorsement process). HUD will 
issue additional guidance regarding the bases for indemnification 
should it determine such clarification is necessary.
    Comment: An indemnification appeals process is necessary. Several 
commenters wrote that mortgagees should be provided an opportunity to 
appeal HUD demands for indemnification. Commenters wrote that 
mortgagees should be afforded the opportunity to present to HUD 
information and clarifications that may not have been available at the 
time for indemnification was issued.
    HUD Response. HUD has not amended the rule in response to these 
comments. HUD notes that the means by which fraud or misrepresentation, 
or serious and material violations of FHA requirements for purposes of 
the new regulatory indemnification requirements will be identified in 
accordance with current standard practice; namely, post endorsement 
technical reviews, quality assurance monitoring reviews, lender self-
reports, Office of Inspector General audits, and investigations, etc. 
These processes afford mortgagees ample opportunities for meaningful 
discussion and the submission of additional information.
    Comment: HUD should clarify the rule's effect on purchasers and 
servicers of FHA loans. One commenter requested that HUD provide 
additional clarification of the term ``origination,'' by assuring that 
purchasers or servicers of FHA-insured loans will not be impacted by 
the proposed indemnification changes. The commenter also requested that 
HUD make clear the effective date of the indemnification provisions.
    HUD Response. Purchasers or servicers of FHA-insured loans will not 
be impacted by the indemnification changes. As with existing standard 
practice for indemnification agreements, FHA will pay insurance 
benefits to the servicer or holder of the mortgage, as long as they are 
not the same entity that was named in the indemnification agreement. 
The indemnification provisions will apply to all demands for 
indemnification issued on or after the effective date of this final 
rule.
    Comment: Causation and materiality standards for indemnification 
based on fraud and misrepresentation may be unequal. Several commenters 
wrote that mortgagees should not be held to a higher standard for fraud 
or misrepresentation than for serious and material origination 
violations. These commenters urged HUD to limit the indemnification 
requirement regarding fraud or misrepresentation to instances where the 
mortgagee knew, or should have known, of the fraud or 
misrepresentation. The commenters also suggested that HUD limit the 
indemnification requirement to those instances involving ``material'' 
misrepresentation.
    HUD Response: HUD has amended the rule based on this comment, and 
to conform to HUD's existing practice regarding indemnification 
agreements. As with existing standard practice, the final rule reflects 
that HUD will demand indemnification for cases where the mortgagee knew 
or should have known of the fraud or misrepresentation.
    Comment: FHA mortgage loans receiving an Accept/Approve 
recommendation from FHA's TOTAL Scorecard should not be subject to 
indemnification. Several commenters wrote that loans receiving an 
Accept/Approve recommendation from FHA's TOTAL Scorecard should be 
excluded from the indemnification provisions. These commenters wrote 
that, in the case of loans approved by this system, the mortgagee is 
responsible only for data integrity and not for the creditworthiness of 
the mortgage loan.
    HUD Response. HUD has not amended this rule based on this comment. 
HUD's current regulations provide that mortgagees are responsible for 
verifying a borrower's creditworthiness, irrespective of the results 
derived from the use of TOTAL. Specifically, CFR 203.254(t) provides 
that ``TOTAL is a tool to assist the mortgagee in managing its workflow 
and expediting the endorsement process, and is not a substitute for the 
mortgagee's reasonable consideration of risk and credit worthiness. 
Direct Endorsement mortgagees using TOTAL remain solely responsible for 
the underwriting decision'' (emphasis added). The indemnification 
provisions of this final rule merely emphasize a lender's existing 
responsibility for verifying a borrower's creditworthiness. In 
particular, Sec.  203.255(g)(3)(i) of this

[[Page 3601]]

final rule (adopted without change from the proposed rule) provides 
that it is a serious and material violation for a lender to fail to 
verify the creditworthiness, income, and/or employment of the mortgagor 
in accordance with FHA requirements.
    Receiving an Approve/Accept risk recommendation from TOTAL does not 
absolve mortgagees of their responsibility to consider information 
beyond that considered by TOTAL, as well as their responsibility for 
the decisions to approve and close loans or to endorse loans through 
the Lender Insurance process. Regardless of the risk assessment 
provided, the mortgagee remains accountable for compliance with FHA 
regulations, guidelines, and eligibility requirements, as well as for 
any credit, capacity, and documentation requirements described in the 
current version of HUD Handbook 4155.1, Mortgage Credit Analysis, and 
applicable mortgagee letters and other policy directives.

B. Acceptable Claim and Default Rate for Lender Insurance Mortgagees

    Comment: Clarify the impact of the methodology of claim and default 
rate for national lenders and those operating in multiple states. 
Several commenters requested that HUD address the impact of the 
revision to the methodology used to determine Lender Insurance 
eligibility on mortgagees operating on a nationwide basis. 
Specifically, the commenters requested clarification as to whether the 
claim and default rate of national mortgagees would be judged solely 
against those of other national mortgagees and if a nationwide 
mortgagee's claim and default rate in a particular geographic region or 
state would be compared to the claim and default rates of other 
mortgagees in that region or state. The commenters recommended that a 
national mortgagee be eligible for Lender Insurance authority if it 
maintains a claim and default rate at or below 150 percent of the FHA 
national program average.
    Other commenters requested that HUD address how the claim and 
default rate of a mortgagee operating in more than one state, but not 
nationwide, will be compared. Commenters requested that HUD describe 
whether the rate will be compared on a state-by-state basis or using a 
weighted average. Several commenters suggested that HUD use a state-by-
state comparison, which would consider only those states where the 
mortgagee has originated a meaningful number of loans in the past 2 
years in proportion to the mortgagee's total number of originations. 
Such a process, they wrote, would prevent an unfair denial or loss of 
Lender Insurance approval based on a small number of loans and defaults 
originated in one state. Commenters further suggested that HUD 
eliminate from consideration any state in which the total number of 
originations made in the past 2 years is equal to, or less than, 5 
percent of the mortgagee's total originations.
    HUD Response. HUD has not amended the rule based on these comments. 
To be eligible to participate in the Lender Insurance program, a 
mortgagee must have a claim and default rate at or below 150 percent of 
the average rate for all of the states in which it does business. In 
determining eligibility for Lender Insurance, HUD will compare the 
percentage of all claims and defaults on loans underwritten by that 
mortgagee to the percentage of claims and defaults for all loans 
underwritten in the states in which that mortgagee does business.
    Comment: Request for clarification regarding applicable comparison 
ratios. One commenter requested clarification that the comparison ratio 
used will be the 2-year default and claim ratio, rather than the one-
year ratio. The commenter requested further clarification as to which 
ratio, among those available through the Neighborhood Watch system, 
will be utilized in the comparison.
    HUD Response. HUD is using the 2-year period for determining the 
claim and default compare ratio, which is the standard used for 
determining ongoing eligibility to participate in FHA programs. As in 
the current process, HUD will consider those endorsed loans 
underwritten by the lender with a beginning amortization date within 
the 2-year period of analysis. Further, HUD will also analyze these 
loans to determine claims and defaulted loans from the total number of 
loans underwritten.
    Comment: Concerns regarding maintaining acceptable claim and 
default rates for Lender Insurance mortgagees. Several commenters 
expressed concern regarding the proposed requirement that mortgagees 
maintain the initial claim and default rate necessary for Lender 
Insurance approval to retain eligibility for Lender Insurance. 
Commenters wrote that the proposed standard fails to recognize the 
current volatility of the housing market, and could negatively impact 
mortgagees approved during periods of exceptional economic and industry 
performance. Commenters requested that HUD consider several different 
proposals. These commenter suggestions included a proposal that 
national mortgagees remain eligible for Lender Insurance if they 
maintain claim and default rates at or below 150 percent of the FHA 
national program averages. Another proposal would establish default 
rate goals rather than comparison ratios. Other commenters suggested 
that HUD establish separate standards based on borrower or loan 
characteristics that would enable mortgagees to responsibly lend to all 
segments of the population. One commenter wrote that Lender Insurance 
status should not be jeopardized by a short period of noncompliance 
that could result from a statistical anomaly.
    HUD Response. HUD has not amended the rule based on these comments. 
HUD believes that mortgagees should maintain the claim and default rate 
needed for eligibility and that setting a more lenient standard for 
retaining Lender Insurance authority is not acceptable from a risk 
management perspective. HUD also believes that comparing each 
mortgagee's claim and default rate only to that of those states where 
it does business will prevent the kind of statistical anomalies of 
concern to the commenters. Currently, the option to obtain the compare 
ratio for all states in which a mortgagee does business is available in 
Neighborhood Watch. Mortgagees are able to compare their claim and 
default rate for all states in which they do business to the overall 
claim and default rate for those same states. HUD's Lender Insurance 
Guide will be updated to provide further clarification and to describe 
any enhancements to Neighborhood Watch necessary to accomplish this 
comparison. The Lender Insurance Guide is available for download at 
https://portal.hud.gov/hudportal/documents/huddoc?id=DOC_12648.pdf.
    Comment: Requested clarification of ``continual'' HUD review of 
acceptable claim and default rates. Several commenters wrote that HUD's 
proposed ``continual'' review standard is vague due to the failure to 
describe the time period of review. One commenter noted that data is 
refreshed on a monthly basis, and asked if this implies that HUD would 
evaluate mortgagee claim and default rates on a monthly basis. 
Commenters also wrote that the proposed standard does not provide 
mortgagees with the opportunity to make self-imposed corrections to 
rectify problems identified by their own monitoring systems, or provide 
them with a cure period to correct deficiencies identified by HUD. Some 
commenters recommended that FHA maintain its current policy of yearly 
review. Many commenters requested that HUD define ``continual'' to 
enable

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mortgagees to plan appropriately for any resulting additional costs and 
staffing requirements.
    HUD Response. HUD has not revised the substance of this provision 
in response to the comments. HUD reserves the right to monitor the 
performance of Lender Insurance mortgagees on a continual basis. HUD 
must be able to respond quickly to poor mortgagee performance in order 
to fulfill its statutory obligation to safeguard the FHA mortgage 
insurance funds. Moreover, such ongoing review is consistent with the 
wording of the Department's regulations for the monitoring of mortgagee 
performance under the FHA Credit Watch Termination Initiative (see 24 
CFR 202.3(c)(2), which states that HUD will review the performance of 
mortgagees ``on an ongoing basis''). That said, this final rule makes 
one minor change to the wording of this provision for the sake of 
consistency with the Credit Watch Termination Initiative. It adopts the 
language used in Sec.  202.3(c) by referring to monitoring on an 
``ongoing basis.''

C. Other Proposed Rule Changes

    Comment: Concerns regarding termination of Lender Insurance 
authority. Several commenters expressed concern about the proposed 
regulatory changes pertaining to the termination of Lender Insurance 
authority. The commenters requested that HUD provide specific grounds 
that would trigger termination, and clarify that FHA will repeal a 
mortgagee's Lender Insurance authority only for material adverse 
actions. The commenters requested that HUD remove the word ``any'' when 
describing the specific grounds for terminations. Commenters wrote that 
use of the word ``any'' could imply that a lender's authority could be 
terminated for a minor or trivial action. Commenters also suggested 
that mortgagees be provided an opportunity for an informal conference 
prior to issuance of a termination notice. Commenters further wrote 
that mortgagees be provided a cure period for offenses that could 
jeopardize a mortgagee's Lender Insurance authority.
    HUD Response. HUD agrees with the commenters that examples and 
guidance can be particularly helpful in regard to the policies and 
procedures affecting the termination and reinstatement of Lender 
Insurance authority. To that end, HUD has issued its Lender Insurance 
Guide to assist lenders, HUD staff, and contractors who participate in 
the pre-insurance review, post endorsement technical review, and 
appraisal review processes. The Lender Insurance Guide, which is 
available for download at https://portal.hud.gov/hudportal/documents/huddoc?id=DOC_12648.pdf, also provides examples of actions that will 
trigger termination.
    Moreover, and as noted above in this preamble, this final rule 
brings additional clarity to the Lender Insurance process by codifying 
a process for the reinstatement of mortgagees who have had their Lender 
Insurance process terminated. The reinstatement procedures are closely 
modeled on the existing reinstatement process for a mortgagee seeking 
reinstatement following termination of its origination approval 
agreement or Direct Endorsement authority codified at 24 CFR 202.3(e). 
The use of the existing process has the benefit of already being 
familiar to lenders and HUD staff, and obviates the need for meeting 
new paperwork and other regulatory requirements.
    Consistent with the current reinstatement process at 24 CFR 
202.3(e)(1)(i), this final rule provides that a mortgagee whose Lender 
Insurance authority is terminated must wait at least 6 months following 
termination to apply for reinstatement. In addition to addressing the 
criteria for Lender Insurance approval specified in Sec.  203.4, the 
application for reinstatement must be accompanied by a corrective 
action plan addressing the issues resulting in the termination of the 
mortgagee's Lender Insurance authority, along with evidence that the 
mortgagee has implemented the corrective action plan. The requirement 
for a corrective action plan tracks the similar requirement for 
reinstatement of Direct Endorsement and origination approval at 24 CFR 
202.3(e)(2)(iii). HUD may grant the mortgagee's application for 
reinstatement if the mortgagee's application is complete and HUD 
determines that the underlying causes for the termination have been 
satisfactorily remedied. Mortgagees are reminded that the Lender 
Insurance Program is a process for endorsing loans for insurance only. 
Termination of this authority does not impact a mortgagee's ability to 
seek insurance for a loan originated in accordance with FHA guidelines.
    Comment: Procedures governing Lender Insurance approval in 
instances of merger, acquisition, or restructuring. Commenters welcomed 
the proposed provisions regarding merged, acquired, or restructured 
mortgagees. Several commenters also requested that HUD reconsider 
regulatory waivers as a means to address situations where a newly 
reorganized corporate entity may merit Lender Insurance approval but 
not meet the proposed regulatory standards.
    HUD Response. HUD appreciates the support of commenters on this 
issue. HUD notes that the phrase ``merger, acquisition, or 
reorganization'' would include changes among parent companies and their 
subsidiaries. As noted in the preamble to the proposed rule, HUD's goal 
in crafting the regulatory language is to limit the need for regulatory 
waivers.

D. Mandatory Electronic Submission of Case Binders

    Comment: Use of mandatory electronic submission of case binders. 
Several commenters supported the electronic submission of case binders, 
writing that the proposed requirement will make the FHA insurance 
process more efficient. Commenters, however, wrote that electronic 
submission of case files should include only those files selected for 
technical review at HUD's request rather than for all files related to 
FHA-insured loans. The commenters wrote that requiring submission of 
all loan files would be costly and would provide FHA with more 
information than it could substantively review. Some of the commenters 
were particularly concerned about the impact on smaller mortgage banks 
and correspondents. These commenters wrote that HUD should consider the 
readiness of the industry to implement the requirement prior to setting 
a specific implementation date.
    HUD Response. While HUD appreciates the comments received on this 
issue, this final rule does not revise the FHA recordkeeping and 
submission requirements. HUD is further considering the issue of 
electronic submission of case binders, including the concerns expressed 
by the commenters. As noted earlier, these comments will be addressed 
in any future rulemaking regarding electronic case binder submission.

IV. 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 an economically 
significant regulatory action, as provided under section 3(f)(1) of the 
Order). This final rule modifies 3 existing areas affecting FHA-
approved lenders. First, this rule imposes

[[Page 3603]]

indemnification provisions on all approved mortgagees with Lender 
Insurance authority. Second, this rule amends the methodology and 
requirements for determining an acceptable claim and default rate. 
Lastly, this final rule amends the 2-year historical performance 
requirement for mortgagees resulting from merger, acquisition, or 
reorganization. Other provisions of this rule describe clarifying or 
technical changes that would not produce an economic impact. HUD's 
analysis indicates that these regulatory amendments will not have an 
economic effect of greater than $100 million and thus do not require a 
regulatory impact analysis. The findings of HUD's analysis are 
summarized below:
    1. Indemnification requirements. With regard to indemnification, 
this final rule contains much of the existing practice and 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. There 
will be marginal change for those lenders with ineffective risk 
management practices and those lenders that have refused to execute an 
indemnification agreement; such lenders may elect instead to attempt to 
negotiate a settlement with HUD's Mortgagee Review Board.
    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, along with eliminating 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 final rule. On the other 
hand, the elimination of the lender's option to challenge the 
indemnification before the Mortgage Review Board could lead to greater 
expenses for those cases that would have been dismissed under the 
current practice.
    The average over the last 7 years is 1,282 indemnification 
agreements annually. Refusals to execute an indemnification agreement 
are rare. If the average negotiation costs are 2 percent of loan amount 
for both FHA and lender (approximately $140,000 is the average FHA-
insured mortgage amount), then the transaction costs to avoid or delay 
the indemnification would be $2,800 per loan. Over an average of 1,300 
indemnifications, and assuming that 5 percent initially refuse to 
indemnify, the aggregate transaction costs saved by this rule would be 
$182,000.
    2. Acceptable Claim and Default Rate. The final rule makes two 
changes regarding acceptable claim and default rates for Lender 
Insurance mortgagees. First, the rule 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 rule also 
clarifies that, in order to retain their Lender Insurance authority, 
mortgagees must maintain the acceptable claim and default rate required 
of them when they were initially delegated such authority.
    These regulatory changes will accurately evaluate a mortgagee's 
performance record by basing the claim and default rate comparison on 
the mortgagee's actual area of operations. This will likely lead to an 
increase in opportunity for some lenders but may lead to a decrease for 
others. It is difficult to know what the net effect of these regulatory 
changes on lenders will be. Some will be excluded and others will be 
included, depending upon where they operate. To simulate the regulatory 
changes, we turn to data on active direct endorsement lenders.
    Using active Direct Endorsement lenders as a base, 18 are included 
through this provision. The change in the performance analysis 
requirement (maintaining an acceptable default and claim rate) appears 
to reduce the number of direct endorsement lenders that meet the 
requirement (113 active direct endorsement lenders). The combined 
effect of the two changes in eligibility is to exclude direct 
endorsement lenders currently participating in lender insurance (a 
reduction of 54).
    In the short run, this effect can be thought of as a transfer 
between lenders of different regions. In the long 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 that can meet the eligibility criteria will eventually assume 
the business of those that could not meet the new eligibility criteria. 
The benefits of a clearer and fairer methodology are expected to 
endure.
    3. 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.
    The full economic analysis is available for review at 
www.regulations.gov. The docket file for this rule 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 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.
    As more fully discussed in the ``Regulatory Flexibility Act'' 
section of the preamble to the October 8, 2010, proposed rule, the 
amendments made by this final rule do not add any new regulatory 
burdens on FHA-approved mortgagees. Rather, the final rule codifies 
much of existing practice regarding indemnification. HUD is also 
revising the methodology for determining acceptable claim and default 
rates, and making several other changes designed to provide additional 
flexibility and to better reflect changing market conditions. These 
changes will have an overall beneficial economic impact on small 
business mortgagees. To the extent that the changes have any negative 
impact, it will be as a consequence of the mortgagee's inability to 
maintain acceptable risk management practices, and not as a result of a 
HUD regulatory mandate. Interested readers are referred to the analysis 
provided in the ``Regulatory Flexibility Act'' section

[[Page 3604]]

of the preamble to the proposed rule, commencing at 75 FR 62340.
    For the above reasons, the undersigned certifies that this rule 
will not have a significant economic impact on a substantial number of 
small entities.

Environmental Impact

    A Finding of No Significant Impact (FONSI) with respect to the 
environment was made at the proposed rule stage, in accordance with HUD 
regulations at 24 CFR part 50, which implement section 102(2)(C) of the 
National Environmental Policy Act of 1969 (42 U.S.C. 4332(2)(C)). The 
Finding of No Significant Impact remains applicable to this final rule 
and 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. Due to security measures at the HUD 
Headquarters building, please schedule an appointment to review the 
FONSI 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 Federal Relay Service at 
(800) 877-8339.

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 final rule does not 
impose any Federal mandates on any state, local, or tribal governments, 
or on the private sector, within the meaning of UMRA.

Paperwork Reduction Act

    The information collection requirements for this final 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 amends 
24 CFR part 203 to read as follows:

PART 203--SINGLE FAMILY MORTGAGE INSURANCE

0
1. Revise the authority citation for part 203 to read as follows:

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


0
2. In Sec.  203.4, revise the reference in paragraph (a) to ``Sec.  
203.5'' to read ``Sec.  203.3'', revise paragraphs (b), (c), and (d), 
and add paragraph (e) 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 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 that had Lender Insurance approval at 
the time of 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 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 an ongoing 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 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

[[Page 3605]]

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) Lender Insurance authority is automatically terminated for a 
mortgagee whose nationwide Direct Endorsement approval under Sec.  
203.3(d)(2) is terminated, without imposing any further requirement on 
the mortgagee 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.
    (e) Reinstatement. A mortgagee whose Lender Insurance authority is 
terminated under this section may apply for reinstatement if the Lender 
Insurance authority for the mortgagee has been terminated for at least 
6 months. In addition to addressing the criteria for Lender Insurance 
approval specified in paragraphs (a) and (b) of this section, the 
application for reinstatement must be accompanied by a corrective 
action plan addressing the issues resulting in the termination of the 
mortgagee's Lender Insurance authority, along with evidence that the 
mortgagee has implemented the corrective action plan. HUD may grant the 
mortgagee's application for reinstatement if the mortgagee's 
application is complete and HUD determines that the underlying causes 
for the termination have been satisfactorily remedied.

0
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 the mortgagee knew or should have known that 
fraud or misrepresentation was involved in connection with the 
origination of the mortgage, regardless of whether the fraud or 
misrepresentation caused the mortgage default and regardless of when an 
insurance claim is filed.
    (5) Demand for indemnification. The demand for indemnification will 
be made by either the Secretary or the Mortgagee Review Board. Under 
indemnification, 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: January 18, 2012.
Carole J. Galante,
Acting Assistant Secretary for Housing, Federal Housing Commissioner.
[FR Doc. 2012-1508 Filed 1-24-12; 8:45 am]
BILLING CODE 4210-67-P