Validation and Approval of Credit Score Models, 65575-65592 [2018-27565]

Agencies

• FEDERAL HOUSING FINANCE AGENCY

[Federal Register Volume 83, Number 245 (Friday, December 21, 2018)]
[Proposed Rules]
[Pages 65575-65592]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-27565]


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Proposed Rules
                                                Federal Register
________________________________________________________________________

This section of the FEDERAL REGISTER contains notices to the public of 
the proposed issuance of rules and regulations. The purpose of these 
notices is to give interested persons an opportunity to participate in 
the rule making prior to the adoption of the final rules.

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Federal Register / Vol. 83, No. 245 / Friday, December 21, 2018 / 
Proposed Rules

[[Page 65575]]



FEDERAL HOUSING FINANCE AGENCY

12 CFR Part 1254

RIN 2590-AA98


Validation and Approval of Credit Score Models

AGENCY: Federal Housing Finance Agency.

ACTION: Proposed rule.

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SUMMARY: The Federal Housing Finance Agency (FHFA) is proposing a rule 
on the process for validation and approval of credit score models by 
the Federal National Mortgage Association (Fannie Mae) and the Federal 
Home Loan Mortgage Corporation (Freddie Mac) (together, the 
Enterprises. FHFA requests public comment on all aspects of this 
proposed rule.

DATES: FHFA will accept written comments on the proposed rule on or 
before March 21, 2019.

ADDRESSES: You may submit your comments on the proposed rule, 
identified by regulatory information number (RIN) 2590-AA98, by any one 
of the following methods:
     Agency website: www.fhfa.gov/open-for-comment-or-input.
     Federal eRulemaking Portal: https://www.regulations.gov. 
Follow the instructions for submitting comments. If you submit your 
comment to the Federal eRulemaking Portal, please also send it by email 
to FHFA at RegComments@fhfa.gov to ensure timely receipt by FHFA. 
Include the following information in the subject line of your 
submission: Comments/RIN 2590-AA98.
     Hand Delivered/Courier: The hand delivery address is: 
Alfred M. Pollard, General Counsel, Attention: Comments/RIN 2590-AA98, 
Federal Housing Finance Agency, Eighth Floor, 400 Seventh Street SW, 
Washington, DC 20219. Deliver the package at the Seventh Street 
entrance Guard Desk, First Floor, on business days between 9 a.m. and 5 
p.m.
     U.S. Mail, United Parcel Service, Federal Express, or 
Other Mail Service: The mailing address for comments is: Alfred M. 
Pollard, General Counsel, Attention: Comments/RIN 2590-AA98, Federal 
Housing Finance Agency, Eighth Floor, 400 Seventh Street SW, 
Washington, DC 20219. Please note that all mail sent to FHFA via U.S. 
Mail is routed through a national irradiation facility, a process that 
may delay delivery by approximately two weeks.

FOR FURTHER INFORMATION CONTACT: Beth Spring, Senior Policy Analyst, 
Housing & Regulatory Policy, Division of Housing Mission and Goals, at 
(202) 649-3327, Elizabeth.Spring@fhfa.gov, or Kevin Sheehan, Associate 
General Counsel, (202) 649-3086, Kevin.Sheehan@fhfa.gov. These are not 
toll-free numbers. The mailing address is: Federal Housing Finance 
Agency, 400 Seventh Street SW, Washington, DC 20219. The telephone 
number for the Telecommunications Device for the Deaf is (800) 877-
8339.

SUPPLEMENTARY INFORMATION:

I. Comments

    FHFA invites comments on all aspects of the proposed rule and will 
take all comments into consideration before issuing a final rule. 
Copies of all comments will be posted without change, and will include 
any personal information you provide such as your name, address, email 
address, and telephone number, on the FHFA website at https://www.fhfa.gov. In addition, copies of all comments received will be 
available for examination by the public through the electronic 
rulemaking docket for this proposed rule also located on the FHFA 
website.
    Commenters are encouraged to review and comment on all aspects of 
the proposed rule, including the definition of a complete application, 
the timelines for submitting applications, and the standards and 
criteria for validation and approval of credit score models.

II. Background

A. Statutory Requirement for Validation and Approval of Credit Score 
Models

    Section 310 of the Economic Growth, Regulatory Relief, and Consumer 
Protection Act of 2018 (Pub. L. 115-174, section 310) amended the 
Fannie Mae and Freddie Mac charter acts and the Federal Housing 
Enterprises Financial Safety and Soundness Act of 1992 (Safety and 
Soundness Act) to establish requirements for the validation and 
approval of third party credit score models by Fannie Mae and Freddie 
Mac.\1\ Section 310 does not require an Enterprise to use third party 
credit scores as part of its business operations or purchase decisions. 
Instead, it provides that if an Enterprise elects to condition the 
purchase of a mortgage loan on the provision of a borrower's credit 
score, that credit score must be produced by a model that has been 
validated and approved.\2\
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    \1\ Section 310 defines ``credit score'' as, in relevant part, 
``a numerical value or a categorization created by a third party 
derived from a statistical tool or modeling system.'' See 12 U.S.C. 
1454(d)(1) and 1717(b)(7)(A)(i). The proposed rule would define this 
to mean that the statistical tool or modeling system was created by 
the third party.
    \2\ The Enterprises use credit scores derived from credit score 
models. However, the validation and approval process would apply to 
the credit score model rather than the credit scores derived from 
the model.
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    Section 310 imposes separate requirements on FHFA and the 
Enterprises. FHFA must first issue regulations establishing standards 
and criteria for the validation and approval of credit score models by 
the Enterprises. Each Enterprise must then publish a description of a 
validation and approval process that it will use to evaluate 
applications from credit score model developers, consistent with the 
standards and criteria established by FHFA regulation. Section 310 sets 
forth several factors that must be considered in the validation and 
approval process, including the credit score model's integrity, 
reliability and accuracy, its historical record of predicting borrower 
credit behaviors (such as default), and consistency of any model with 
Enterprise safety and soundness. This proposed rule establishes 
criteria for the validation and approval process consistent with 
section 310.

B. Current Enterprise Use of Credit Scores

    The Enterprises currently use credit scores in four primary ways. 
First, some Enterprise loan purchase programs require a minimum credit 
score as part of determining eligibility. Second, the Enterprises use 
credit scores within their automated underwriting systems (AUS).\3\ 
Freddie Mac uses credit scores

[[Page 65576]]

as part of the risk assessment within its AUS, while Fannie Mae uses 
credit scores as a minimum threshold in its AUS. Third, the Enterprises 
publish grids that disclose price adjustments known as Loan Level Price 
Adjustments (LLPAs) for Fannie Mae, and Post-Settlement Delivery Fees 
(Delivery Fees) for Freddie Mac. LLPAs and Delivery Fees are based on a 
combination of the borrower's representative credit score (currently 
Classic FICO) and the original loan-to-value (LTV) ratio.\4\ Finally, 
the Enterprises disclose credit scores to investors of Enterprise 
securities, to Credit Risk Transfer (CRT) investors, and in Securities 
and Exchange Commission (SEC) corporate filings.
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    \3\ An Enterprise automated underwriting system (AUS) is a 
proprietary system made available to other parties (e.g., lenders 
and loan originators) to help them assess whether a loan is eligible 
for purchase by an Enterprise.
    \4\ The Enterprises have required the use of FICO 5 from 
Equifax, FICO 4 from TransUnion, and FICO Score from Experian, which 
are collectively referred to as ``Classic FICO,'' since 2004.
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    Where appropriate, the proposed rule would require an Enterprise to 
consider how credit scores are used in its systems as part of its 
evaluation of credit score models (e.g., consideration of LLPAs and 
Delivery Fees and potential impact on eligibility). However, the 
proposed rule would not require an Enterprise to use a credit score in 
any particular system, nor would it require an Enterprise to use a 
credit score in a particular way. While the Enterprises currently use 
credit scores in four primary ways, the Enterprises may change how they 
use credit scores in the future.
    For example, Freddie Mac currently uses a third party credit score 
(if available) combined with borrower attributes and credit attributes 
supplied by the nationwide consumer reporting agencies (CRAs) within 
its AUS. Fannie Mae uses borrower attributes and credit attributes from 
the nationwide CRAs. Fannie Mae also uses a third party credit score as 
an eligibility threshold for its AUS (currently, Classic FICO 620 if 
available). The proposed rule would not require an Enterprise to use a 
credit score in a particular way in its AUS, or in any other system 
that uses a credit score. In addition, if an Enterprise does not 
currently use a third party credit score in a particular purchase 
system, the proposed rule would not require an Enterprise to 
incorporate a third party credit score into that system.
    Credit scores are only one factor considered by the Enterprises in 
determining whether to purchase a loan. Because an Enterprise AUS can 
consider borrower-related data independent of the consumer credit data 
from the consumer reporting agencies (e.g., income and assets) as well 
as additional information about the loan and property (e.g., LTV 
ratio), an Enterprise AUS will always be more accurate than any third 
party credit score model, used alone, at rank ordering loans by 
likelihood of borrower default.

C. Conservatorship Scorecard Project To Assess Updating Enterprise 
Credit Score Requirements

    One of the strategic goals established by FHFA as conservator of 
the Enterprises has been to maintain credit availability for new and 
refinanced mortgages to foster liquid, efficient, competitive, and 
resilient national housing finance markets.\5\ One element of that 
strategic goal has been the consideration of possible changes to the 
credit score model required by the Enterprises.\6\ Although Classic 
FICO remains adequate for Enterprise purposes, FHFA has acknowledged 
potential benefits of the Enterprises using more recently developed 
credit score models. From 2015 to 2018, FHFA has engaged with the 
Enterprises, market participants and other interested parties on 
possible changes to the Enterprise credit score requirements, including 
understanding the operational challenges and hurdles of various updated 
credit score proposals.
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    \5\ https://www.fhfa.gov/AboutUs/Reports/ReportDocuments/2014StrategicPlan05132014Final.pdf. This goal aligns with the 
purposes stated in the Safety and Soundness Act and the Enterprises' 
charter acts.
    \6\ Since 2013, FHFA has issued an annual Conservatorship 
Scorecard that sets forth expectations for activities to be 
undertaken by the Enterprises to further FHFA's strategic goals as 
conservator. Beginning in 2015, each Conservatorship Scorecard has 
called for the Enterprises to increase access to mortgage credit for 
creditworthy borrowers. This includes assessing the feasibility of 
updating the credit score requirements consistent with the 
Enterprises' risk-management practices.
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    In response to FHFA's 2015 Conservatorship Scorecard, the 
Enterprises began assessing the feasibility of updating their credit 
score requirements, including the potential impact of a change on 
Enterprise operations and systems, and whether updating the 
requirements would generate additional access to mortgage credit for 
creditworthy borrowers while maintaining consistency with Enterprise 
credit requirements and risk-management practices.
    The 2015 assessment began by defining the scope of potential credit 
score models to review. FHFA and the Enterprises conducted an in-depth 
review of three models: Classic FICO, FICO 9, and VantageScore 3.0. 
While there were other credit score models available at that time, FHFA 
and the Enterprises limited the evaluation to credit score models that 
had nationwide coverage and that could produce credit scores based on 
data from all three nationwide CRAs.\7\ FHFA and the Enterprises 
determined it would not be practical to build and estimate Enterprise 
internal models for every credit score model available.
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    \7\ Currently, there are three nationwide CRAs--Equifax, 
Experian, and TransUnion. These companies gather, store, and sell 
consumer credit data, including credit scores that are produced by 
algorithms developed by other companies (e.g., FICO or VantageScore 
LLC) supplied with consumer credit data from a CRA.
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    In 2016, FHFA and the Enterprises met with lenders, consumer 
groups, investors, trade associations, and other market participants to 
discuss the possible impacts of changing the Enterprises' credit score 
model requirements. FHFA was focused on better understanding how the 
industry uses credit scores and possible impacts to industry if the 
Enterprises were to make a change to their credit score model 
requirements. In addition, FHFA was focused on how long it might take 
the mortgage finance industry to adopt such a change. The independent 
outreach FHFA conducted in 2016 informed the four proposals in the 2017 
Credit Score Request for Input (RFI).
    As part of the industry feedback, most market participants stated 
that they would need a significant period of time, approximately 18-24 
months, to implement a credit score change after an announcement from 
the Enterprises.

D. Credit Score Request for Input

    In 2017, FHFA determined that it would be useful to solicit input 
publicly. In December of 2017, FHFA issued an RFI on possible updates 
to the Enterprise credit score model requirements. The RFI was based on 
FHFA's review of the operational impact of any credit score change and 
growing concerns about how competition should factor into the decision 
to update the credit score model. FHFA publicly communicated its intent 
to make a decision about the Enterprise credit score model requirements 
in 2018, upon finishing review of responses to the RFI.
    The RFI was focused on four proposals: (1) Maintain a single credit 
score; (2) adopt an optional waterfall of credit scores; (3) require 
multiple credit scores; or (4) let the lender choose the credit score. 
The RFI sought public input on the concerns market participants had 
expressed to FHFA, including concerns about the potential costs and 
benefits of updating the Enterprise credit score requirements.

[[Page 65577]]

FHFA encouraged all parties to provide as much information and insight 
as possible in response to the RFI.
    FHFA received over 100 responses to the RFI.\8\ The responses came 
from all parts of the mortgage finance industry including consumers, 
mortgage lenders, mortgage insurers, and non-profit housing agencies. A 
central theme from RFI respondents was that the operational challenges 
of implementing a multi-credit score approach would outweigh any 
benefits. As one RFI respondent noted, ``changes to Enterprise credit 
score requirements could have widely-felt implications for borrower 
access to credit, origination costs in the primary mortgage market, the 
ability to fully analyze and properly price mortgage credit risk, and 
liquidity in the secondary mortgage market.''
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    \8\ RFI responses are available online on FHFA's website at 
https://www.fhfa.gov/AboutUs/Contact/Pages/input-submissions.aspx 
(select ``Credit Score'' in the menu).
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E. Effect of the Act on the Conservatorship Scorecard Project

    FHFA was in the process of making a determination on updating the 
Enterprise credit score requirements when the Economic Growth, 
Regulatory Relief, and Consumer Protection Act was enacted on May 24, 
2018. Although FHFA had announced its intent to make a decision about 
the Enterprise credit score model requirements in 2018, FHFA announced 
in July 2018 that it was shifting its focus to development of notice 
and comment rulemaking to implement the credit score requirements 
consistent with section 310. FHFA stated that it would not make a 
decision on updating the credit score required by the Enterprises until 
after the credit score model validation and approval process required 
by section 310 has been established.

F. Assessment of Borrowers Without Credit Scores

    Each Enterprise has updated its respective AUS in recent years to 
process loans for borrowers who lack a credit score. In September 2016, 
Fannie Mae upgraded Desktop Underwriter (DU) with the capability to 
underwrite loan applications where both the borrower and co-borrower 
lack a credit score.\9\ In June 2017, Freddie Mac updated Loan Product 
Advisor (LPA) with the same capability to underwrite both borrower and 
co-borrowers who lack a credit score.\10\ Development of the ``no score 
AUS'' reduces the significance of third party credit scores within each 
Enterprise's AUS. The Enterprises' guidance to lenders related to 
borrowers who lack a credit score now provides that if a borrower has 
other housing-related tradelines (such as demonstrated rental payments 
or utility payments), those borrowers can be evaluated through the AUS. 
The ability of an Enterprise AUS to assess borrowers who lack a credit 
score is an additional consideration in assessing the impact of the use 
of any credit score model on access to credit.
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    \9\ Desktop Originator/Desktop Underwriter Release Notes, DU 
Version 10.0, Fannie Mae (Last Updated June 20, 2016) https://www.fanniemae.com/content/release_notes/du-do-release-notes-06252016.pdf.
    \10\ https://freddiemac.mwnewsroom.com/press-releases/freddie-mac-loan-advisor-suite-sm-to-cut-mortgage-otcqb-fmcc-1282556.
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G. Development of Proposed Rule Reflects Public Input Received

    In developing the proposed rule, FHFA has given careful 
consideration to all aspects of the 2015, 2016, and 2017 Scorecard 
projects and related work. The proposed rule also has been informed by 
responses to the RFI. For example, FHFA considered feedback received 
from the industry related to some of the operational and implementation 
concerns in determining how often it would be feasible for the 
Enterprises to update their credit score requirements.
    Based on research and analysis conducted for the past three years, 
a primary consideration in FHFA's analysis has been weighing the costs 
of adopting a newer credit score model against the potential benefits. 
The significant costs and complexity for the Enterprises and industry 
in making a change to the required credit score were weighed against 
potential improvements in accuracy and borrower access to credit. More 
recently developed credit score models capture post-crisis borrower 
behavior, which more accurately reflects today's borrowers than older 
models, and also include rental payment data, when available. While a 
newer credit score model would likely be more accurate than an existing 
credit score model, a borrower's credit score is not the only factor 
used by an Enterprise AUS to make a purchase decision, reducing the 
significance of any improvement in accuracy.
    The proposed rule reflects FHFA's balancing of these costs and 
benefits and is based on both the requirements of section 310 and 
multiple years of public outreach and empirical research by FHFA and 
the Enterprises.

III. Features of the Proposed Rule

A. Enterprise Validation and Approval Process

    The proposed rule would establish a four-phase validation and 
approval process: (1) Solicitation of applications from credit score 
model developers, (2) an initial review of submitted applications, (3) 
Credit Score Assessment, and (4) Enterprise Business Assessment. In 
addition, the proposed rule would set the minimum standards and 
criteria for each step in the process.
    As part of the solicitation phase of the process, each Enterprise 
would publish a Credit Score Solicitation that would include the 
opening and closing dates of the solicitation time period during which 
the Enterprise would accept applications from credit score model 
developers. It would include a description of the information that must 
be submitted with the application; instructions for submitting the 
application; a description of the Enterprise process for obtaining data 
for testing; a description of the Enterprise's process and criteria for 
conducting a Credit Score Assessment and an Enterprise Business 
Assessment; and other content as determined by an Enterprise.
    As part of the application review phase of the process, an 
Enterprise would determine whether each application submitted by a 
credit score model developer is complete. An Enterprise could request 
additional information if necessary. An application would be complete 
only after the Enterprise has received all required fees and 
information, including any necessary data from a third party. An 
Enterprise would not be obligated to conduct an assessment of a credit 
score model if an Enterprise is not in receipt of a complete 
application within the timeframes in this proposed rule.
    During the Credit Score Assessment phase of the process, each 
credit score model would be assessed for accuracy, reliability and 
integrity, independent of the use of the credit score in the 
Enterprise's systems, as well as any other requirements established by 
the Enterprise. A credit score model must pass the Credit Score 
Assessment to be reviewed by an Enterprise during the Business 
Assessment phase.
    During an Enterprise Business Assessment phase, which is the fourth 
and final phase of the process, an Enterprise would assess the credit 
score model in conjunction with the Enterprise's business systems. The 
Enterprise must assess the accuracy and reliability of credit scores 
where used within the Enterprise's systems,

[[Page 65578]]

possible impacts on fair lending and impact on the Enterprise's 
operations and risk management. An Enterprise also must consider 
impacts on the mortgage finance industry, assess competitive effects, 
conduct a third party vendor review, and perform any other evaluations 
established by the Enterprise as part of the Enterprise Business 
Assessment. A credit score model may be approved by an Enterprise 
during the Business Assessment phase, and only then would the credit 
score model be considered validated and approved for purposes of 
section 310.
    The Credit Score Assessment and Enterprise Business Assessment 
steps may not necessarily happen sequentially. However, in order for a 
credit score model to be approved for use, the credit score model would 
have to pass both a Credit Score Assessment and an Enterprise Business 
Assessment. The proposed rule would require that an Enterprise update 
its credit score requirements to reflect the outcome of the validation 
and approval process. However, the proposed rule does not address how 
an Enterprise's credit score requirements would be updated should a new 
credit score model be approved. How approved credit score model(s) are 
implemented, including the timeframe for the Enterprises to transition 
from one credit score to another score or scores, would be best 
addressed through direction that will be provided by FHFA outside of 
the final rule but consistent with FHFA statutory obligations.
    FHFA requests comment on any operational impacts or considerations 
that should be addressed in implementing any newly approved credit 
score models, including timing between approval of any new credit score 
model and required delivery of the new score(s) to an Enterprise or 
whether there are issues related to implementation that are not covered 
by the proposed rule.

B. Timeframes for Enterprise Application Determinations

    A key consideration in structuring the process in four phases is to 
address the statutory requirements of section 310, which references 
solicitation, application, validation, and approval. Section 310 also 
requires the Enterprises to make ``a determination with respect to any 
application submitted'' and provide notice of that determination no 
later than 180 days after the date on which an application is 
submitted, subject to two 30-day extensions.
    The proposed rule would require each Enterprise to complete the 
Credit Score Assessment in no more than 180 days, with the possibility 
of no more than two 30-day extensions. The proposed rule would 
establish a separate 240-day maximum time period for the Enterprises to 
conduct the Enterprise Business Assessment. As discussed above, the 
Credit Score Assessment and Enterprise Business Assessment could 
overlap. However, the maximum, combined time for these two parts of the 
process could be as much as approximately 16 months depending on 
whether FHFA granted any extensions for the Credit Score Assessment. 
This proposal aligns with FHFA's knowledge of the time needed to 
conduct testing similar to the testing proposed for the Credit Score 
Assessments. Based on FHFA and Enterprise experience assessing credit 
score models and the process outlined in this proposed rule, FHFA 
determined 180 days, or even 240 days, would not give an Enterprise 
sufficient time to conduct both the Credit Score Assessment and the 
Enterprise Business Assessment for all possible applications submitted 
during the solicitation period.
    By taking this approach, the proposed rule would establish 
reasonable and realistic deadlines for each phase of the process--
solicitation period, application review, Credit Score Assessment, and 
Enterprise Business Assessment. The proposed rule would establish a 
time period for application submission that includes a review for 
completeness and notification to an applicant to address deficiencies, 
before the solicitation period ends and the Credit Score Assessment 
begins. An Enterprise would be required to notify an applicant of its 
determination under the Credit Score Assessment within 180 days from 
the start of the Credit Score Assessment, with up to two extensions of 
30 days each, consistent with section 310. These timeframes may be 
adjusted based on future public notice and comment as FHFA and the 
Enterprises gain experience with the validation and approval process.
    Under the proposed rule, the determination that a credit score 
model passes the Credit Score Assessment would be separate from the 
determination that a credit score model meets the criteria of an 
Enterprise Business Assessment resulting in Enterprise approval. A 
credit score model would only be approved if an Enterprise determines 
that it meets the criteria under both the Credit Score Assessment and 
an Enterprise Business Assessment. The Enterprise Business Assessment 
would allow an Enterprise to complete a comprehensive assessment of the 
impact of a new credit score when used in an Enterprise's proprietary 
systems, fair lending impact, impact on Enterprise operations, 
Enterprise risk management and impact to industry, as well as any other 
criteria evaluated by an Enterprise. The proposed rule would provide an 
Enterprise 240 days to complete the Enterprise Business Assessment. 
This would be in addition to the maximum 240 days (including 
extensions) to complete the Credit Score Assessment phase.

C. Alignment of Enterprises

    FHFA may direct the Enterprises to align their assessment processes 
or the decisions on approved credit score model(s) under FHFA's 
authority as regulator or conservator of the Enterprises. For example, 
FHFA may determine as regulator that it is necessary to align the 
Enterprises on approved credit score model(s) to help maintain 
efficiency and liquidity in the secondary mortgage market, a core 
purpose of the Safety and Soundness Act and the charter acts. Or FHFA 
may determine that alignment is necessary to facilitate the Enterprise 
credit risk transfer (CRT) programs or the development and 
implementation of the Uniform Mortgage-Backed Security (UMBS).\11\
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    \11\ See, e.g., Uniform Mortgage-Backed Security proposed rule, 
83 FR 46889 (Sept. 17, 2018).
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    While the Enterprises remain in conservatorship, on the same basis 
FHFA could use its authority as conservator of the Enterprises to 
direct the Enterprises to adopt aligned validation and approval 
processes or outcomes. FHFA may also use its existing authority as 
regulator or conservator to establish other credit score requirements 
for the Enterprises. For example, FHFA may require the Enterprises to 
continue to require lenders to deliver loans with a single credit 
score, or FHFA may require the Enterprises to allow use of more than 
one credit score for delivery of loans.
    The proposed rule would require the Enterprises to provide FHFA 
with prior notice of a determination to approve an application. Such 
prior notice would provide FHFA with an opportunity, if appropriate, to 
require the Enterprises to adopt aligned determinations on some or all 
applications. However, the proposed rule itself would not require 
alignment of the Enterprises. The proposed rule would allow the 
Enterprises to adopt independent and distinct validation and approval 
processes, to conduct separate evaluations of any application received 
and to reach different decisions about

[[Page 65579]]

which credit score models are validated and approved for use.
    FHFA expects that the Enterprises will regularly consult with FHFA, 
in the Agency's role as regulator or as conservator. FHFA would retain 
its ability, in its role as regulator or conservator, to provide the 
Enterprises with guidance on alignment and the use of one credit score 
model or multiple credit score models at any point in the Enterprises' 
solicitation and review process. However, the proposed rule would not 
address how multiple credit score models, if approved, would be 
implemented and/or required by an Enterprise. These decisions could be 
handled through FHFA's authority as regulator or as conservator.
    FHFA requests comments on the approaches described above. In 
addition, FHFA requests comments on whether the Agency should consider 
alternatives to these approaches.

D. Credit Score Model Developer Independence

    The proposed rule would prohibit an Enterprise from approving any 
credit score model developed by a company that is related to a consumer 
data provider through any common ownership or control, of any type or 
amount. The proposed rule would also require the Enterprises to 
consider competitive impacts more generally in assessing applications 
from credit score model developers. In developing this approach, FHFA 
has considered and worked to balance a number of policy concerns, 
including potential conflicts of interest, potential competitive 
effects (positive and negative), and burdens on prospective applicants 
and the Enterprises.
    The Credit Score RFI, as discussed earlier, sought input on credit 
score competition and consolidation in the credit score marketplace. 
Feedback indicated concerns with the competitive position of 
VantageScore, LLC when compared to other credit score model developers, 
by virtue of its joint ownership by three nationwide consumer reporting 
agencies (CRAs). The CRAs own the data that both VantageScore, LLC and 
its competitors use to build their credit score models. They also set 
the prices for the different credit scores, subject to any license fees 
charged by the credit score model developer. Each CRA has the ability 
to set the prices for its own use, or an affiliated company's use, of 
the consumer credit data that is reported to that CRA. Vertical 
integration with a credit score model developer could, in theory or 
practice, permit the CRA to sell credit scores constructed from data 
(including the scoring algorithm) that the CRA owns more cheaply.
    Given these considerations, FHFA believes it is appropriate to 
propose prohibiting common ownership or control of the credit score 
model developer and the owner of consumer credit data. To implement 
this prohibition, the proposed rule would require each application to 
include a certification that no owner of consumer data necessary to 
construct the credit score model is related to the credit score model 
developer through common ownership or control. Establishing a clear 
threshold requirement in the application process will put an applicant 
on notice that, unless it can make that certification, its application 
will not be approved. This approach is intended to avoid a party with a 
prohibited relationship expending time and money to complete and submit 
an application with associated fees that an Enterprise ultimately would 
not validate and approve.
    The proposed rule seeks to avoid a possible negative impact on 
competition among credit score models, for example if pricing of credit 
scores and consumer credit reports were used to reduce competition and, 
thereafter, to increase prices. Although the proposed prohibition could 
limit the number of possible credit score model developers that would 
be able to submit an application, it would ensure that any approved 
credit score model would not unfairly benefit the institution that 
developed the credit score model. To date, FHFA has not identified a 
degree of common ownership or control that would clearly avoid its 
concerns. Therefore, even a minority ownership interest would be 
subject to the prohibition. FHFA requests comment on whether there are 
examples of common ownership or control by type or amount that would 
not reasonably give rise to anti-competitive concerns or if there are 
other safeguards that could address or avoid such concerns.
    FHFA also believes changing or using a new credit score model could 
have other competitive effects, or give rise to other conflicts of 
interest, that should be considered by an Enterprise in determining 
whether to approve a model. While feedback on the Credit Score RFI 
focused on competition concerns related to the joint-ownership 
structure of VantageScore, LLC, the proposed rule would require the 
Enterprises to consider competition concerns more broadly. FHFA has 
previously stated that its ``objective is not to help any particular 
company sell more credit scores, but to determine how to appropriately 
balance the safety and soundness of the Enterprises while maintaining 
liquidity in the housing finance market,'' and this remains the 
case.\12\
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    \12\ https://www.fhfa.gov/Media/PublicAffairs/PublicAffairsDocuments/CreditScore_RFI-2017.pdf, pg. 19.
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    The proposed rule would require an Enterprise to consider potential 
conflicts of interest and competitive effects in assessing the costs 
and benefits of approving any credit score model in the Enterprise 
Business Assessment. An applicant would be required to provide 
information on any business relationship with any other party that may 
give rise to a conflict of interest beyond the upfront application 
certification of whether it is related to a data provider (including 
information about the credit score model developer's corporate and 
governance structure, and any ownership, control, or relationship to 
any other institution). An Enterprise also would be required to 
consider other potential effects on competition, including positive 
effects.
    FHFA requests comment on the proposed approach of requiring an 
upfront certification in addition to an assessment of competitive 
effects in the Enterprise Business Assessment. FHFA also requests 
comment on any alternative approaches for assessing and evaluating 
conflicts of interest and other competitive effects.

IV. Summary of the Proposed Rule

A. No Required Use of Credit Scores; No Expectation of Continued Use

    The proposed rule would set forth requirements and limitations on 
how the Enterprises validate and approve credit score models. Section 
310 does not require the Enterprises to use a credit score for any 
purpose. It does require, however, that if an Enterprise elects to 
condition its purchase of mortgages on provision of a credit score, 
that score must be derived from a model that has been validated and 
approved in accordance with statutory and regulatory requirements. 
Likewise, if an Enterprise elects to condition its purchase of 
mortgages on provision of a credit score, it also must use the 
validated and approved credit score in all of its purchase-related 
systems and procedures that currently use a credit score. The proposed 
rule would incorporate these statutory provisions and would address 
several related situations.
    First, the proposed rule would expressly state that an Enterprise 
is not required to use a third party credit score. For example, if an 
Enterprise in the future no longer uses a third party

[[Page 65580]]

credit score in any purchase-related systems or procedures, the 
Enterprise would not be subject to the requirements of this proposed 
rule. However, if an Enterprise continues to price loans based on 
credit score and LTV ratios (LLPAs and Delivery fees), the Enterprise 
would still be subject to the requirements of this proposed rule, even 
if the Enterprise no longer used credit scores in any other manner.
    Second, the proposed rule would expressly state that an Enterprise 
is permitted either to replace an existing credit score model with a 
newly approved credit score model or to continue to use the existing 
credit score model along with the newly approved credit score model. 
For example, if an Enterprise is using a validated and approved score, 
and in response to a new solicitation validates and approves a new 
credit score, an Enterprise could ``retire'' the existing validated and 
approved credit score. This would be considered replacement of an 
existing model. Alternatively, an Enterprise would have the option to 
use both the existing validated and approved credit score model and the 
new validated and approved credit score model. Section 310 expressly 
permits replacement of one validated and approved credit score model 
with another validated and approved model, and it does not establish 
any standard for replacement, other than that the models must be 
validated and approved.
    Finally, the proposed rule would expressly state that the use of a 
credit score by an Enterprise does not create any right or expectation 
to continued use of that credit score. Section 310 does not require an 
Enterprise to continue to use previously validated and approved credit 
score models. Section 310 does not create, and FHFA does not recognize, 
any right or expectation of a party with an interest in a credit score 
model used by an Enterprise to its continued or continuing use. Under 
the statute and under the proposed rule, an Enterprise would have the 
option to stop using a previously approved credit score model, with no 
obligation or liability of any kind.

B. Enterprise Solicitation of Applications From Credit Score Model 
Developers

1. Overview
    The proposed rule would permit FHFA periodically to require the 
Enterprises to solicit applications from credit score model developers. 
The proposed rule addresses the solicitation process, the required 
content of an Enterprise solicitation, and the review of Enterprise 
proposed solicitations by FHFA prior to Enterprise publication.
    FHFA would establish the need for an Enterprise solicitation by 
notice to the Enterprises. Because assessing a credit score model is 
time-consuming and requires the acquisition of significant amounts of 
consumer credit data, and because of the potentially significant 
implementation costs to industry, it would not be efficient or cost 
effective (for an Enterprise, an applicant, or other market 
participants) to require that an Enterprise consider applications for 
validation and approval submitted at any time. Instead, the proposed 
rule would allow FHFA to establish a periodic solicitation process.
    Under the proposed rule, an Enterprise would not be required to 
consider any application that is not received in response to a 
particular solicitation. An Enterprise could review and conduct 
preliminary empirical analysis on any application received outside of a 
particular solicitation. However, an Enterprise would not be permitted 
to approve any application not submitted in response to a solicitation. 
Outside of the periodic solicitations required by FHFA, there would be 
periods of time during which an Enterprise would not be expected or 
required to solicit applications and during which any credit score it 
is then using would not be subject to change. The proposed rule 
addresses timing requirements for the first solicitation for 
applications, while also creating a framework for setting similar 
deadlines for future solicitations.
    The proposed rule would require FHFA to review and approve each 
Credit Score Solicitation from an Enterprise. The proposed rule would 
require that, after an Enterprise receives notification from FHFA, the 
Enterprise publish the description of its validation and approval 
process prior to, and in conjunction with, soliciting applications. 
This approach would ensure that potential applicants and the public are 
provided with information about regulatory and Enterprise requirements 
and considerations. Thus, the Enterprise description, which the 
proposed rule refers to as a ``Credit Score Solicitation,'' would cover 
the Enterprise's validation and approval process as well as 
requirements that an application, and the applicant, must meet in order 
for a credit score model to be considered by an Enterprise. The 
publication of the Enterprise Credit Score Solicitation would satisfy 
section 310's requirement that an Enterprise ``make publicly 
available'' a description of its validation and approval process.
    Under the proposed rule, the solicitation process would involve: 
(1) A notice from FHFA to the Enterprises informing the Enterprises 
that FHFA has determined that a review of new credit score models is 
timely; (2) development of a Credit Score Solicitation by each 
Enterprise; (3) review of each Solicitation by FHFA; (4) publication of 
the Solicitation by each Enterprise; and (5) a time period, determined 
by FHFA and communicated through the Enterprises to the public, during 
which the Enterprises will accept applications for validation and 
approval of credit score models. These steps are addressed below.
2. FHFA Notice to the Enterprises To Solicit Applications
    The proposed rule states FHFA's authority to determine when an 
Enterprise is required to solicit applications from credit score model 
developers. An Enterprise would not be permitted to solicit 
applications except in response to a notice from FHFA. In general, FHFA 
would provide notice to an Enterprise establishing when the Enterprise 
must begin soliciting applications, the length of time the solicitation 
period is open and applications will be accepted, and the deadline for 
an Enterprise to submit its proposed Credit Score Solicitation to FHFA 
for review.
    To establish a reasonable expectation of when an Enterprise would 
be required to initiate a validation and approval process, the proposed 
rule would provide that FHFA require a solicitation every seven years, 
determined from the date of the preceding solicitation, except as 
otherwise determined by FHFA. Requiring a solicitation any more 
frequently would lessen the likelihood that the benefits of 
transitioning to a new score would outweigh its costs, including costs 
to applicants and the Enterprises to assess a proposed new model. In 
proposing seven years, FHFA has attempted to balance those concerns and 
establish a realistic timeframe not only for the Enterprises but for 
the rest of the mortgage finance industry. FHFA is seeking comment on 
whether the proposed seven year solicitation of applications from 
credit score model developers is too frequent or not frequent enough.
    The proposed rule also would permit FHFA to require the Enterprises 
to solicit applications either sooner or later than seven years, in 
appropriate circumstances. For example, FHFA may determine not to 
initiate a solicitation within seven years, and thus that a credit 
score in use in the future should

[[Page 65581]]

continue to be used, because the cost to industry of changing from one 
score to another could be avoided and any intended benefit of a new 
score could be achieved by an enhancement to an Enterprise AUS instead. 
In proposing a very flexible approach to determining the time between 
Enterprise solicitations, FHFA is seeking to balance the value of a 
reasonable public expectation that the Enterprises will periodically 
review updated credit scores, with the ability to act when 
circumstances indicate that the regulatory time period is either too 
long or too short.
    The proposed rule would require that the process for the initial 
solicitation begin within 60 days of the effective date of the final 
rule. The initial solicitation time period would begin on a date 
determined by FHFA and would extend for 120 days.
3. Enterprise Development of a Credit Score Solicitation and Content
    For solicitations after the initial solicitation, each Enterprise 
must develop a Credit Score Solicitation after receiving a notice from 
FHFA. The Credit Score Solicitation would describe the Enterprise 
validation and approval process, which must be in accordance with the 
minimum standards and criteria of the regulation.
    The Credit Score Solicitation also would address the Enterprise 
process for assessing credit score models, as well as standards or 
criteria for accuracy, reliability, and integrity, and any method of 
demonstrating that the credit score has a historical record of 
measuring and predicting credit behaviors, including default rates, 
consistent with section 310. The proposed rule would establish minimum 
standards and criteria for validation and approval of credit score 
models. An Enterprise may have valid business reasons for imposing 
additional standards and criteria. Section 310 and the proposed rule 
both permit additional standards to be imposed by an Enterprise and 
such additional standards, criteria, or requirements would be addressed 
in the Credit Score Solicitation.
4. FHFA Review of Enterprise Solicitation
    The proposed rule would require an Enterprise to submit a Credit 
Score Solicitation to FHFA for review prior to the start of any 
solicitation period. FHFA review will allow the Agency to object to any 
additional Enterprise standards, criteria or requirements or to impose 
any terms, conditions or limitations that FHFA determines appropriate. 
The proposed rule would establish a 45-day period for FHFA review, 
which may be extended by FHFA if necessary.
    Because a notice from FHFA requiring a new solicitation would 
require each Enterprise to submit a current Credit Score Solicitation 
to FHFA for review, the review also would meet the statutory 
requirement that FHFA ``periodically'' review the Enterprise's 
validation and approval process to ensure the process remains 
appropriate, adequate, and in compliance with applicable FHFA 
regulations and requirements.\13\ This does not mean, however, that 
FHFA could not review the Enterprise's approval and validation process 
as part of its usual supervisory processes, including examinations. 
Further, FHFA review and approval of an Enterprise Credit Score 
Solicitation would not prevent FHFA from taking any subsequent 
appropriate supervisory action.
---------------------------------------------------------------------------

    \13\ 12 U.S.C. 1454(d)(8) and 1717(b)(7)(H).
---------------------------------------------------------------------------

5. Timeframes for Solicitation
    The proposed rule would provide that each Enterprise make publicly 
available its Credit Score Solicitation for at least 90 days prior to 
the start of the solicitation period. In order to ensure that the 
Enterprises are accepting applications during the same time period, 
FHFA expects to require each Enterprise to publish its Credit Score 
Solicitation on the same date. Once the initial solicitation period 
begins, it would extend for 120 days. For subsequent solicitations, 
FHFA would determine both the frequency of the solicitations and the 
length of a particular solicitation period. FHFA recognizes that for 
subsequent solicitation periods, 120 days may not be suitable and 
therefore builds into the regulation the flexibility to allow for a 
longer or shorter timeframe that would better serve applicants and the 
housing industry. The timeframes for the initial solicitation are 
illustrated in Figure 1.
[GRAPHIC] [TIFF OMITTED] TP21DE18.002

    These timeframes ensure that the Credit Score Solicitation is 
handled in an expeditious manner while providing applicants sufficient 
time to review the fees and the information required for a complete 
application prior to expending resources to submit an application. The 
proposed timeframes are consistent with timeframes in practice between 
FHFA and the Enterprises for reviewing and responding to proposals.

C. Enterprise Initial Review of Submitted Applications

1. Overview
    The proposed rule would establish the criteria an application must 
meet to be considered complete. Each applicant would be required to 
submit: (1) An application fee; (2) a fair lending certification; (3) 
information to demonstrate use of the model by industry; (4) a 
conflicts-of-interest certification and other information on credit 
score model developer qualifications; and (5) any other information 
required by an Enterprise in the Credit Score Solicitation. An 
application would not be considered complete until an Enterprise has 
obtained any data necessary for testing. An application would be 
complete when an Enterprise determines that the

[[Page 65582]]

required information has been received from the applicant and any third 
party (i.e., any data requested from a third party on behalf of the 
applicant).
    Under the proposed rule, an Enterprise would have no obligation to 
assess any incomplete application. As required by section 310, each 
applicant would receive an application status notice informing the 
applicant of any additional information needed in conjunction with an 
application. If an Enterprise determines that an application is 
incomplete, or has questions about information provided, the applicant 
would have the opportunity to respond within the 120-day solicitation 
period. FHFA recognizes that information required from a third party, 
such as consumer credit data, may be beyond the control of the 
applicant. The proposed rule would allow third parties to deliver 
information to an Enterprise within a reasonable time period that may 
extend beyond the 120-day solicitation period.
2. Application Fees and Assessment for Costs
    The proposed rule would require each applicant to be responsible 
for the costs associated with validating and approving its credit score 
model. It is typical for the Enterprises to assess a fee for reviewing 
and approving counterparties and/or vendors seeking a business 
relationship with them. Therefore, the proposed rule would permit an 
Enterprise to require each applicant to pay an application fee 
established by the Enterprise to cover reasonable costs, including 
expenses incurred as part of the application review process. The 
proposed rule also would permit an Enterprise to assess applicants for 
the costs associated with acquiring third party data and credit scores, 
either in addition to or instead of an up-front application fee.
3. Fair Lending Compliance and Certification
    The proposed rule would require each applicant to provide a 
certification that addresses compliance with federal fair lending 
requirements. The certification would address protected classifications 
under the Equal Credit Opportunity Act (ECOA), the Fair Housing Act, 
and the Safety and Soundness Act.\14\ Because an Enterprise would not 
necessarily have access to the factors used in the development of the 
credit score model or used by the credit score model to produce credit 
scores, the fair lending certification would provide assurances that 
the credit score model is not based on any protected classifications. 
The certification would be required to state that no characteristic 
that is based directly on or is highly correlated with such a protected 
classification was used in the development of the credit score model or 
is used by the credit score model to produce credit scores.
---------------------------------------------------------------------------

    \14\ 15 U.S.C. 1691(a) (ECOA); 42 U.S.C. 3605(a) (Fair Housing 
Act); 12 U.S.C. 4545(1) (Safety and Soundness Act).
---------------------------------------------------------------------------

    The proposed rule also would require each applicant to address 
compliance of the credit score model and credit scores produced by it 
with federal fair lending requirements, including information on any 
fair lending testing and evaluation of the model. Statements about 
compliance with consumer regulatory standards that do not relate to the 
model's compliance with federal fair lending requirements related to 
protected classifications would be insufficient to satisfy this 
requirement. For example, statements about the ability to satisfy 
standards relating to generating reasons for adverse action or 
satisfying the standard for an empirically derived, demonstrably and 
statistically sound credit scoring system would not be sufficient.\15\
---------------------------------------------------------------------------

    \15\ 12 CFR 1002.2(p), 1002.9(b)(2).
---------------------------------------------------------------------------

4. Demonstrated Use
    In addition to the fair lending certification, the proposed rule 
would require the application to demonstrate use of the credit score by 
creditors to make credit decisions. This requirement would ensure that 
the credit score model is employed by creditors. To demonstrate use, 
the application could include testimonials by non-mortgage and/or 
mortgage lenders or bank validation reports that show the applicant's 
credit scores were used in underwriting credit.
    While FHFA generally believes that the Enterprises should not 
validate and approve credit scores that have not been used by a 
creditor in some capacity, FHFA recognizes that limiting applications 
to those credit score models that have been used to make credit 
decisions may impede innovation and potential market acceptance of new 
credit score models. In other words, it may be difficult for credit 
score model developers to demonstrate the viability of their credit 
scores to creditors without entities like the Enterprises engaging them 
in ``test and learn'' pilots. The provisions related to pilot programs 
are discussed in more detail below.
5. Conflicts of Interest Certification and Qualification of Credit 
Score Model Developer
    The last application criterion in the proposed rule involves the 
credit score model developer's qualifications. To implement the 
conflicts of interest prohibition discussed above, FHFA is proposing to 
require each applicant to certify that no owner of consumer data 
necessary to construct or test the credit score model is related to the 
credit score model developer through any degree of common ownership or 
control. In addition, the proposed rule would require the application 
to demonstrate the credit score model developer's experience and 
financial capacity. This would include a detailed description of the 
developer's corporate and governance structure, including any common 
ownership or control with an entity that owns, prices, and provides 
access to consumer data. An application also would be required to 
provide information about the past financial performance of the credit 
score model developer, including audited financial statements for the 
preceding three years. This information provided by the applicant would 
allow an Enterprise to evaluate the experience and financial capacity 
of the credit score model developer as well as the basis for the 
conflicts of interest certification.
    As a general prudential standard, each Enterprise is required to 
manage its counterparty and vendor risk.\16\ In this context, if an 
Enterprise chooses to require provision of a borrower's credit score as 
a condition of purchasing a mortgage, the Enterprise must be reasonably 
assured that the type of credit score it specifies will be available 
within the market, and thus that the credit score model developer is, 
and will remain, financially viable. To understand the credit score 
model developer as a potential counterparty, the proposed rule would 
require each application to address the applicant-developer's corporate 
structure, governance structure, and financial performance, including 
audited financial statements for the three full years preceding the 
year of application. An Enterprise may require an applicant to certify 
that there has been no material change to information submitted on the 
developer's qualifications prior to approving a credit score model.
---------------------------------------------------------------------------

    \16\ See generally, 12 U.S.C. 4513b; see also 12 CFR parts 1236 
and 1239.
---------------------------------------------------------------------------

6. Additional Enterprise Standards and Criteria
    The proposed rule would permit the Enterprises to establish 
additional

[[Page 65583]]

requirements for the application. The Enterprise would be required to 
include any additional requirements in its Credit Score Solicitation, 
and those requirements would be subject to FHFA review and approval as 
discussed above.
7. Data Acquisition
    The proposed rule would permit an Enterprise to acquire any data 
that it may require to conduct the Credit Score Assessment. Such data 
would typically include historical credit scores on a test set of 
existing Enterprise loans at origination. For example, in the 2015 
assessment conducted by FHFA and the Enterprises, the Enterprises each 
purchased Classic FICO, VantageScore 3.0, and FICO 9 scores from one of 
the nationwide CRAs. Each application must include a reasonable process 
for the Enterprise to acquire the applicant credit score and data on 
existing loans and future loans. Applicants whose credit scores 
incorporate multiple sources of consumer credit information (e.g., 
credit scores based on information from the nationwide CRAs yet 
augmented with data outside of the three nationwide CRAs) will need to 
work with the Enterprises on a process to acquire the applicant's 
credit scores on existing Enterprise loans.
8. Timing and Notices
    The proposed rule would require an Enterprise to provide certain 
notices to an applicant, including an application status notice and a 
notice of whether an applicant's application is complete. The notices 
are intended to keep the applicant informed about the status of its 
application and provide an opportunity to identify and address 
questions or deficiencies. Section 310 requires that an Enterprise 
provide an applicant with a status notice no later than 60 days from 
the date the application is submitted to an Enterprise. The proposed 
rule would require an Enterprise to include any information about the 
application, specifically if there is any missing or additional 
required information. The Credit Score Assessment and the Business 
Assessment of the validation and approval process also require 
notifications to the applicant. FHFA is seeking comment on the number 
of notifications, and whether the proposed notifications are the 
appropriate notifications for the applicant to be kept abreast of its 
application throughout the validation and approval process.
    Once an Enterprise makes a determination of completeness of an 
application, the proposed rule would require an Enterprise to notify 
the applicant that its application is complete. As noted earlier, 
applications would be considered complete once an Enterprise has all 
the information needed to begin the Credit Score Assessment, including 
any information from the applicant as well as any data that may be 
obtained from a third party.

D. Credit Score Assessment

1. Overview
    The proposed rule would require Fannie Mae and Freddie Mac to 
undertake a Credit Score Assessment of each credit score model for 
which it has received a complete application. The Credit Score 
Assessment would include an evaluation of the accuracy and reliability 
of credit scores on a stand-alone basis (outside of an Enterprise's 
internal systems and procedures), along with an assessment of the 
integrity of the scores produced by the model. The tests for accuracy 
and reliability of credit scores within an Enterprise's internal 
systems and procedures would be considered after the Credit Score 
Assessment phase, as part of an Enterprise Business Assessment.
    The proposed rule would permit an Enterprise to conduct its own 
testing for the Credit Score Assessment or to contract with a third 
party to test each credit score model. Because the Credit Score 
Assessment considers accuracy and reliability of the credit score 
outside of the Enterprise systems, FHFA requests comment on whether the 
Credit Score Assessment could be conducted jointly by the Enterprises 
for each application. If so, an applicant could submit an application 
to each Enterprise, but the Enterprises would work together to conduct 
a single Credit Score Assessment for each application.
    The proposed rule would establish standards for accuracy, 
reliability and integrity and would require that an application pass 
the Credit Score Assessment in order to be considered in the next phase 
of the process (Enterprise Business Assessment).\17\ A credit score 
model that does not pass the Credit Score Assessment would not be 
eligible to be approved by an Enterprise under the Enterprise Business 
Assessment.
---------------------------------------------------------------------------

    \17\ Section 310 requires an Enterprise to establish a process 
pursuant to which an Enterprise will not validate and approve a 
credit score model that does not ``satisf[y] minimum requirements of 
integrity, reliability, and accuracy.'' 12 U.S.C. 1454(d)(3)(A) and 
1717(b)(7)(C)(i). Elsewhere, section 310 states that the credit 
score model must ``compl[y] with any standards and criteria 
established by'' FHFA. Id., 1454(d)(3)(D) and 1717(b)(7)(C)(iv).
---------------------------------------------------------------------------

2. Standards or Criteria for Accuracy
    A credit score model is accurate if it produces credit scores that 
appropriately reflect a borrower's propensity to repay a mortgage loan 
in accordance with its terms. This permits a credit score user to 
correctly rank order the risk that the borrower will not repay the 
obligation in accordance with its terms relative to other borrowers. 
FHFA has considered several options for assessing the accuracy test 
results. Under each of the options being considered by FHFA, which are 
discussed further below, the Enterprises would conduct substantially 
the same statistical tests for credit score accuracy yet the outcome of 
the accuracy testing would be determined by the assessment option. This 
section first describes the statistical tests that would be conducted 
and then describes each of the four options under consideration.
a. Testing for Accuracy
    Conceptually, statistical tests of credit score accuracy measure 
the separation between the credit score distribution of the defaulted 
loans with the credit score distribution of the non-defaulted loans. 
The Kolmogorov-Smirnov statistic (K-S), divergence, and Gini 
coefficient are common statistical measures used to measure the ability 
of a credit score model to separate defaulted borrowers from non-
defaulted borrowers. Beyond the common set of tests, the Enterprises 
are encouraged to explore additional score performance measures and 
statistical tests.
    The proposed rule would not define specific parameters for the 
testing that would be conducted by an Enterprise. The proposed rule 
would require that testing utilize one or more industry standard 
statistical tests for demonstrating divergence among borrowers' 
propensity to repay, applied to mortgages purchased by an Enterprise. 
Although the proposed rule allows flexibility for the Enterprises to 
define the specific parameters of testing, FHFA expects that the 
Enterprise testing requirements would include a definition of default.
    Critical to accuracy testing of a credit score is the definition of 
default, which includes two parts, the occurrence of an event (e.g., 
delinquency) and a time horizon (e.g., 24 months since origination). 
Currently, the generally accepted definition of default is a 90-day 
delinquency during a two year period. FHFA expects that the Enterprises 
will use the generally accepted definition of default and FHFA is 
seeking comment, with supporting information, on any additional default 
definitions.
    The proposed rule would include a requirement that the Enterprise 
test accuracy on subgroups of loans. The loan sets obtained for testing 
would

[[Page 65584]]

have to contain sufficient observations to perform the accuracy tests 
on subgroups. It is unlikely that the accuracy of a credit score is 
constant across the entire credit score distribution. Subgroup testing 
could be applied to loan to value groups, credit score groups, thin 
credit file loans at origination, new credit files, and files with a 
past delinquency. It is expected that credit score accuracy will 
decline when applied to thin, stale and new credit files, yet credit 
score models' accuracy is critically important to borrowers and 
investors in these challenging cases because the credit scores will be 
in close proximity to critical thresholds.
b. Options for Evaluating Test Results
    FHFA has considered four options for evaluating test results: A 
comparison-based approach, a champion-challenger approach, a benchmark-
based approach, and a transitional approach. The proposed rule language 
is based on the comparison-based approach, but FHFA may adopt any of 
the four approaches in the final rule or consider other options 
suggested in the comments. Each of the four approaches is discussed in 
more detail below.
    Each of the four options under consideration would include a 
minimum standard that a credit score model must meet, in that ``it 
produces a credit score that appropriately reflects a borrower's 
propensity to repay a mortgage loan in accordance with its terms, 
permitting a credit score user to rank order the risk that the borrower 
will not repay the obligation in accordance with its terms relative to 
other borrowers.'' The standard is measured by statistical testing. 
However, the four options reflect different approaches for comparing 
the statistical results from the credit score models being evaluated to 
each other.
    FHFA is considering four options for evaluating test results in 
part to address potential concerns about the continued use of Classic 
FICO. Section 310 requires an Enterprise to use a validated and 
approved score at a defined point in the future. One way to ensure that 
a validated and approved score is available before that defined point 
would be to approve Classic FICO. This would not require any additional 
time to implement because Classic FICO is already in use. Continuing to 
use Classic FICO could be beneficial to the Enterprises and other 
market participants in smoothing the transition away from using a 
credit score from a model that has not been validated and approved to 
an environment in which an Enterprise must only use credit scores from 
models that have been validated and approved.
i. Comparison-Based Approach
    The first option under consideration is a comparison-based 
approach. This is the option reflected in the proposed rule text. Under 
this approach, an Enterprise would test the credit scores under 
consideration for accuracy and would be required to evaluate whether 
the new model produced credit scores that are more accurate than any 
credit score the Enterprise is then using. While an Enterprise would be 
required to assess accuracy on a comparative basis, the proposed rule 
would not establish a bright-line test for minimum accuracy that a 
credit score model would have to meet to pass the Credit Score 
Assessment.
    The comparison-based approach would allow flexibility for an 
Enterprise to make any determination based on the results of the 
comparison. For example, an Enterprise could determine that a 
particular credit score model did not meet the Credit Score Assessment 
based on the comparison if the credit score model performed 
substantially worse than other credit score models in measuring 
accuracy. An Enterprise would be permitted to determine that a credit 
score model met the accuracy standard if it performed substantially as 
well as other credit score models being tested. Because the comparison-
based approach would not include a bright-line test for minimum 
accuracy, an Enterprise would be permitted to make a determination on 
this aspect of the Credit Score Assessment even if there were no 
relevant comparison available for the credit score model being tested. 
In that case, the accuracy standard would be successful rank-ordering 
of borrowers, as stated in proposed Sec.  1254.7(b)(1).
    The flexibility of a comparison-based approach without a bright-
line test could raise certain challenges. Among these are concerns that 
the accuracy standard itself would not inform the public and applicants 
as to how an Enterprise would make its determination of accuracy. These 
transparency concerns would be mitigated by the proposed requirement 
that an Enterprise provide an explanation of the reasons for 
disapproval of an application to the applicant. Even so, a requirement 
that an Enterprise explain after making its decision how it considered 
and applied the accuracy standard would not inform the public or 
prospective applicants about how the Enterprise would consider and 
apply criteria in future decisions.
ii. Champion-Challenger Approach
    As another possible standard, the second option under consideration 
is a champion-challenger approach that would require that the 
applicant's credit score(s) be more accurate than the existing credit 
score in use at the Enterprises, as demonstrated by appropriate 
testing. Score accuracy directly benefits borrowers and investors since 
an Enterprise relies on credit risk measures generated from its AUS. 
Accepting a less accurate credit score model would negatively impact 
borrowers and investors.
    Newer credit score models should statistically outperform legacy 
credit score models for several reasons. First, newer credit score 
models incorporate borrower information that was not available when the 
legacy credit score models were designed and estimated. Second, newer 
credit score models are estimated (or ``trained'') on more recent 
borrower credit histories. More recent historical borrower behaviors 
better represent current borrower behaviors than older credit 
histories. In addition, overlap between the estimation (or 
``training'') data and the accuracy testing data should benefit the 
credit score model with the greatest time period overlap. Lastly, when 
comparing accuracy tests on old and new credit scores with loans that 
were originated with the old credit score, studies, such as Hand and 
Adams (2014), show that a component of the newer credit score's 
improved accuracy is an artifact of the biased testing sample.\18\ 
Although the amount of bias may be small, the bias makes the new credit 
score appear more accurate than the old credit score. Therefore a new 
score is not as accurate as the old score if the new score tests only 
as accurate as the old score. With expectations that the accuracy 
results for newer credit score models prove stronger than those for the 
older credit score model, the standard that a new credit score be more 
accurate than the existing credit score could be a reasonable minimum 
standard.
---------------------------------------------------------------------------

    \18\ The Hand and Adam (2014) study is a simplified study in 
contrast to the complicated underwriting and purchase process at the 
Enterprises.
---------------------------------------------------------------------------

    One drawback to requiring as the standard for accuracy that the new 
score perform better than the old score is that it does not provide a 
standard for assessing the accuracy of the old score. Thus, this 
standard could effectively prevent an Enterprise from continuing to use 
an ``old'' score. For example, adoption and application of a ``must 
perform better than'' comparative standard could result in the 
Enterprises

[[Page 65585]]

not validating and approving Classic FICO. This could have negative 
consequences. For example, an Enterprise may determine Classic FICO to 
be sufficient to meet the business needs of the Enterprise, such that 
costs and disruptions of changing to a new score are not justified. The 
champion-challenger approach could prevent the Enterprise from 
continuing to use Classic FICO in that situation.
    To address concerns of a ``more accurate than'' comparative 
standard, FHFA has considered establishing a standard that any new 
score must perform ``as well as'' the old score to pass the Credit 
Score Assessment. Based on the bias described above, however, FHFA has 
concerns that such a standard may not be appropriate.
iii. Benchmark-Based Approach
    To avoid the concerns of either the comparison-based approach or 
the champion-challenger approach, FHFA is also considering a third 
option, which would establish an absolute statistical standard and 
would require all scores to meet a benchmark. FHFA could either adopt 
the benchmark level as part of this rulemaking or FHFA could determine 
the benchmark level and publish it through an order issued in 
conjunction with any notice to an Enterprise at the time of opening a 
solicitation period. Based on credit score model testing undertaken for 
the Conservatorship Scorecard project, FHFA believes an appropriate 
statistical standard would be to define a test statistic (K-S, Gini, or 
equivalent) as the threshold. All complete applications would be tested 
for accuracy and the results compared to the threshold test statistic. 
FHFA also recognizes that other statistical measures could be 
supported, and for that reason considered whether a K-S range would be 
another option for measuring accuracy. In this case, however, 
establishing a range would present the same issues as selecting a 
single threshold because the lowest end of the range would operate as 
the binding accuracy measure.
    This approach would permit all scores under consideration, and any 
score then in use, to be measured against the same benchmark. Both a 
score then in use and any new score being considered could pass or fail 
the benchmark. Defining a specific regulatory benchmark could present 
other issues, however. For example, if a specific benchmark is known in 
advance, applicants or testers could engineer scores or testing methods 
to meet it. In addition, requiring that a score meet a regulatory 
benchmark may excessively value that consideration (i.e., accuracy) 
among other considerations for which there are not regulatory 
benchmarks.
iv. Transitional Approach
    FHFA is also considering a transitional approach, whereby one 
standard for accuracy would be applied for purposes of the first Credit 
Score Assessment undertaken by an Enterprise, and another standard 
applied for subsequent Assessments in response to a future 
solicitation. This approach would apply the same standard to all 
applications received in response to the initial solicitation in 
addition to the existing credit score model currently in use. This 
could permit an Enterprise to validate and approve Classic FICO pending 
a determination on any other applications received by the Enterprise. 
This may be necessary to meet statutory timeframes for an Enterprise to 
be using a validated and approved credit score model.
    Under this approach, FHFA would permit an Enterprise to validate 
and approve the score currently in use while continuing to consider 
whether to validate and approve other scores for which it received 
applications in response to the same Credit Score Solicitation. If, 
shortly after validating and approving the score currently in use, an 
Enterprise validated and approved another score, section 310 would 
permit the Enterprise to replace the first validated and approved score 
with any other validated and approved score.
    If a transitional approach is adopted, FHFA is considering a method 
for determining accuracy for the initial Credit Score Assessment that 
could be applied to all ``new'' credit scores and the credit score 
currently in use (Classic FICO). Because of issues that arise with a 
champion-challenger approach as applied to a score currently in use, 
FHFA anticipates that the transitional approach would entail either a 
benchmark-based approach (meaning, selection of a statistical benchmark 
that all scores, including the ``old'' score, must meet in order to 
pass the Credit Score Assessment) or a comparison-based approach. 
Further, if a transitional approach were adopted, FHFA would establish 
a standard for determining accuracy for subsequent Credit Score 
Solicitations in the same rulemaking. That standard could be any that 
is discussed above (i.e., a comparison-based approach, champion-
challenger approach, or a benchmark-based approach) or could be a 
different approach, taking into consideration comments received.
v. Request for Comment on Specific Options
    As discussed above, FHFA sees value in and has concerns with each 
approach described. FHFA may adopt any of these options in the final 
rule or may revise any of the options after considering public 
comments.
    If FHFA adopts a comparison-based approach, the final rule would 
include a requirement that an Enterprise evaluate accuracy based on a 
comparison of each credit score model to any other credit score model 
under consideration, including the model that produces the score 
currently in use by an Enterprise. This approach for assessing the 
accuracy of a new score is reflected in the proposed rule text set 
forth below. The comparison-based approach would not include a bright-
line test regarding the outcome of the comparison.
    If FHFA adopts a champion-challenger approach, the final rule would 
include a relative measure under which each model under consideration 
would be compared to the others, and would include a bright-line test 
regarding the outcome of the comparison.
    If FHFA adopts a benchmark-based approach, the final rule would 
include a bright-line test that a credit score model, or the credit 
scores produced from it, must meet in order to pass the Credit Score 
Assessment. The final rule could either include an absolute statistical 
cutoff to which each model's accuracy test would be compared, or 
provide that the specific statistical cutoff would be established by 
FHFA order.
    If FHFA adopts a transitional approach, the final rule would 
include one measure that a credit score model, or the credit scores 
produced from it, must meet in order to pass the initial Credit Score 
Assessment, and a different measure that must be met by later 
applicants in response to subsequent Credit Score Solicitations.
    FHFA welcomes comment on all approaches and all standards described 
above, and in particular on whether there is a basis on which one 
should be preferred to others or another.
3. Reliability Standard
    The proposed rule would establish a reliability standard that must 
be met as part of the Credit Score Assessment. Under the reliability 
standard, a credit score model is reliable if it produces credit scores 
that maintain accuracy through the economic cycle. The proposed rule 
would require that an Enterprise evaluate whether a new

[[Page 65586]]

credit score model produces credit scores that are at least as reliable 
as the credit scores produced by a credit score model that the 
Enterprise is then using, as demonstrated by appropriate testing. 
Delinquency rates increase and decrease over the economic cycle; 
however, the rank ordering ability of the credit score should remain 
over the cycle.
    The proposed rule would require that the Enterprises test at least 
two sets of Enterprise loans to evaluate credit score reliability. The 
first group of loans would represent recently underwritten loans with 
sufficient performance history consistent with the definition of 
default. The second set of loans would be selected from a period 
earlier than the estimation data used to develop the new credit scores 
and at a point in the economic cycle different from the first loan 
group. The Enterprises would define the loan sets conditional on 
origination period (or acquisition period) and include all single-
family loans within the specified periods.
    The proposed rule would ensure that new credit score models are not 
``over-fitted'' to recent loan quality and borrower credit behavior. 
``Over-fitting'' is a characterization of a model where the model 
predicts exceptionally well on the two years of credit records used to 
estimate the model, yet predicts poorly outside of those two years. 
Testing credit score accuracy at a minimum of two points in the 
economic cycle should also ensure the credit score models retain the 
ability to rank order credit risk over the economic cycle.
4. Integrity Standard
    The proposed rule would establish a standard for integrity that 
must be met as part of the Credit Score Assessment. Under the integrity 
standard, a credit score model has integrity if, when producing a 
credit score, it uses relevant data observed by the developer that 
reasonably encompasses the borrower's credit history and financial 
performance. To be validated, a credit score model applicant would be 
required to demonstrate to the Enterprise that the model has integrity, 
based on appropriate evaluations or requirements identified by the 
Enterprise (which may address, for example, the level of aggregation of 
data or observable data that may not be omitted or discounted when 
constructing a credit score).
    The proposed integrity standard would be evaluated subjectively, 
but consistently, in the Credit Score Assessment. The goal of the 
standard is to ensure that the credit score model developer utilized 
available data elements that are relevant and legally permissible. 
Today, the most common credit score models are developed on consumer 
credit files owned by the nationwide CRAs. In the future, credit score 
model developers may use consumer credit information outside of the 
CRAs or the CRAs may expand the breadth of consumer credit information 
collected. Improvements in the range of consumer information available 
to credit score model developers may improve credit score accuracy. The 
proposed integrity standard is designed to encourage credit score model 
developers to innovate.
5. Additional Enterprise Standards and Criteria
    The proposed rule would permit the Enterprises to establish 
additional requirements for the Credit Score Assessment. The Enterprise 
would be required to include any additional requirements in its Credit 
Score Solicitation, and those requirements would be subject to FHFA 
review and approval as discussed above.
6. Timing and Notices
    The proposed rule would require an Enterprise to provide a notice 
to each applicant that has submitted a complete application of when an 
Enterprise will commence the Credit Score Assessment phase. For reasons 
discussed previously, an Enterprise would have the flexibility to 
assess applications as they are completed or to assess all applications 
once an Enterprise has made a determination on complete applications 
submitted during the solicitation period. The proposed rule would 
provide that the Credit Score Assessment phase could begin no earlier 
than the close of the solicitation time period. The proposed rule would 
require the Credit Score Assessment period to extend for 180 days. The 
proposed rule would permit the Director to authorize not more than two 
extensions of the Credit Score Assessment period that shall not exceed 
30 days each, upon a written request and showing of good cause by an 
Enterprise in accordance with section 310. The timeframes for the 
Credit Score Assessment are illustrated in Figure 2.
[GRAPHIC] [TIFF OMITTED] TP21DE18.003

    The proposed rule would require that a Credit Score Assessment 
determination notice be provided to the applicant indicating whether 
the applicant's score meets the criteria of the Credit Score Assessment 
no later than 270 days from the beginning of the Credit Score 
Assessment. The proposed rule would require that this notification be 
provided no later than 30 days after the Enterprise makes a 
determination. If an applicant does not pass the Credit Score 
Assessment, the notice must include a description of the reason(s) why 
the applicant did not pass the Credit Score Assessment.

[[Page 65587]]

E. Enterprise Business Assessment

1. Overview
    The proposed rule would require Fannie Mae and Freddie Mac to 
undertake an Enterprise Business Assessment of each credit score model 
that the Enterprise determines has met the Credit Score Assessment. The 
proposed Enterprise Business Assessment would be broader than the 
Credit Score Assessment. The Enterprise Business Assessment would 
include an evaluation in at least five areas: (1) An assessment of the 
accuracy and reliability of credit scores within the Enterprise 
underwriting and other systems; (2) an assessment of possible fair 
lending impacts; (3) an assessment of potential impacts on Enterprise 
operations and risk management, and impact on industry; (4) an 
assessment of possible competitive effects from using a particular 
credit score model; (5) an assessment of the credit score model 
provider as a potential third-party vendor; and (6) any other 
Enterprise standards and criteria. The proposed rule would allow each 
Enterprise to include, subject to FHFA review and approval, any 
additional assessment necessary to make a business case decision. The 
considerations in the Enterprise Business Assessment would not be new 
to the Enterprises and are generally part of the current course of 
business for the Enterprises.
    In addition to the minimum requirements of accuracy, reliability, 
and integrity, section 310 requires that a credit score model must be 
``consistent with the safe and sound operation of the [Enterprise]'' in 
order for an Enterprise to validate and approve the model. Several 
assessment criteria relate to Enterprise safety and soundness, and the 
use of a credit score model in the Enterprise systems. Because the 
Enterprises operate different systems, different business models, and 
different credit tolerances, the Enterprise Business Assessment would 
allow each Enterprise to assess credit scores based on its specific 
business needs.
2. Assessment of Credit Scores With Enterprise Proprietary Systems
    The proposed rule would require an Enterprise to include an 
assessment of the accuracy and reliability of the credit score when 
used within its systems that use credit scores. An Enterprise Business 
Assessment would not consider a credit score's integrity, because the 
integrity of a score would be established in the Credit Score 
Assessment phase and would not change by use in an Enterprise's 
systems.
    The assessment of accuracy and reliability would include 
statistical testing that would be similar to the tests used in the 
Credit Score Assessment. However, instead of testing the performance of 
a credit score model independent of Enterprise systems based on its 
ability to rank-order applicants, an Enterprise Business Assessment 
would consider the performance of a credit score model when used in the 
Enterprise systems that use credit scores, for example as a purchase 
threshold or as an input to the Enterprise's underwriting systems.
3. Fair Lending Assessment
    The proposed rule would require each Enterprise to evaluate the 
fair lending risk and the fair lending impact of the credit score model 
in accordance with standards and requirements related to the Equal 
Credit Opportunity Act (15 U.S.C. 1691(a)(1)), the Fair Housing Act (42 
U.S.C. 3605(a)), and the Safety and Soundness Act (12 U.S.C. 4545(1)) 
(including identification of potential impact, comparison of the new 
credit score model with any credit score model currently in use, and 
consideration of potential methods of using the new credit score model) 
as part of the Enterprise Business Assessment. The Enterprises 
currently conduct fair lending analyses when making credit policy 
changes. FHFA requests comment on whether the fair lending assessment 
should go beyond traditional fair lending risk and compliance testing 
to consider, in addition, whether the credit score model has the 
potential to promote access to mortgage credit for creditworthy 
applicants across all protected classifications. FHFA requests comment 
on how any such additional analysis under the Enterprise Business 
Assessment should be defined or conducted.
4. Assessment of Impact on Enterprise Operations and Risk Management, 
and Impact on Industry
    The proposed rule would require the Enterprise Business Assessment 
to consider operational impacts to the Enterprises, such as 
implementation timing, and potential impacts on Enterprise risk 
management. The Enterprise Business Assessment also would consider 
potential impacts across the entire mortgage industry of an updated 
credit score model or models.
    In response to the RFI, many market participants indicated that 
updating to the newest version of FICO would be less operationally 
complex than updating systems to handle multiple models. Respondents 
were concerned about impacts to liquidity in the secondary markets if 
the Enterprises permitted lenders to submit either credit score. 
Maintaining a single score requirement yet updating the credit score 
would initiate a series of changes and adoption costs throughout the 
mortgage industry. Lenders would have to update loan-pricing models and 
any lender overlays, while mortgage insurers would have to update and 
submit their premium rate sheets to state insurance regulators for 
approval. Mortgage Backed Securities (MBS) and Credit Risk Transfer 
(CRT) investors would have to re-estimate mortgage performance and 
valuation models. In light of these responses to the RFI, the proposed 
rule would require an Enterprise to consider impacts of a new credit 
score model or models and the impacts that updating may have on the 
entire mortgage finance industry.
    The proposed rule also would require the Enterprise Business 
Assessment to include consideration of potential impacts on eligibility 
criteria and Enterprise pricing for loan purchases as part of any 
assessment. The Enterprise Business Assessment also would require each 
Enterprise to evaluate other possible impacts of a new credit score 
model. For example, the Enterprises currently use credit score 
thresholds as eligibility criteria for certain loan purchases. 
Similarly, the Enterprises currently establish loan delivery fees for 
loans based on the original credit score and LTV ratio. Switching to a 
new credit score model could require an Enterprise to adjust its 
eligibility criteria and loan pricing such that credit risk on new 
business is unchanged. Changing a credit score model could require 
updating credit score thresholds in order to maintain Enterprise credit 
risk tolerances.
    The proposed rule would address these business considerations in 
terms of the impact, benefits, and costs of adopting or changing a 
credit score model on market participants, market liquidity, and the 
cost and availability of credit. FHFA believes these are important 
considerations, as the cost and other impacts of changing a credit 
score model could be significant. Likewise, FHFA recognizes that it may 
be difficult to quantify the benefits to borrowers in terms of the cost 
and availability of credit. FHFA requests comments on these 
considerations, including whether there are impacts, costs, or benefits 
that the Enterprises should specifically consider, and whether the 
impacted parties or areas--market participants (including borrowers, 
lenders, investors, and the Enterprises), market liquidity, and

[[Page 65588]]

availability of credit--are appropriate or should be supplemented.
5. Competitive Effects
    The Enterprise Business Assessment must evaluate whether using the 
credit score model could have an impact on competition in the industry. 
This evaluation must consider whether use of a particular credit score 
model could have an impact on competition due to any ownership or other 
business relationship between the credit score model developer and any 
other institution.
6. Third-Party Vendor Review
    The proposed rule would require the Enterprise Business Assessment 
to include a comprehensive vendor review for all applicants. FHFA 
expects an Enterprise, as part of its oversight of third-party vendors, 
to maintain a third-party vendor risk management program that assesses 
and manages risks associated with third-party vendor relationships. The 
Enterprise Business Assessment would address any financial, 
operational, compliance, legal, and reputational risks associated with 
the third party. The third-party vendor review in an Enterprise 
Business Assessment would evaluate the third party under any policies, 
procedures, and internal standards of the Enterprise, consistent with 
any Advisory Bulletins in effect at the time the Enterprise submits its 
Credit Score Solicitation to FHFA for approval. The Enterprise must 
follow its policies and procedures for approval and management of 
vendors and other third-party service providers.\19\
---------------------------------------------------------------------------

    \19\ See 12 CFR part 1236 (Prudential Management and Operations 
Standards); Advisory Bulletin 2018-08, ``Oversight of Third-Party 
Provider Relationships,'' Sept. 28, 2018.
---------------------------------------------------------------------------

7. Enterprise Standards and Criteria
    The proposed rule would permit the Enterprises to establish 
additional requirements for the Enterprise Business Assessment. The 
Enterprise would be required to include any additional requirements in 
its Credit Score Solicitation, and those requirements would be subject 
to FHFA review and approval as discussed above.
8. Timing and Notices
    The proposed rule would require that an Enterprise complete the 
Enterprise Business Assessment within 240 days as depicted in Figure 3. 
Section 310 does not address a timeframe for industry adoption of a new 
credit score model. Based on feedback from the Credit Score RFI, which 
indicated that it will take the industry approximately 18-24 months to 
adopt a new credit score model, the proposed rule would require an 
Enterprise to provide notice to the industry about expected timing of 
changing any credit score model requirements. Whether multiple credit 
score models are approved for use may impact the implementation timing 
required by an Enterprise. The timeframes for the Enterprise Business 
Assessment are illustrated in Figure 3.
[GRAPHIC] [TIFF OMITTED] TP21DE18.004

9. Enterprise Business Assessment Approval Determination
    The proposed rule would require that if an Enterprise made an 
approval determination at the end of the Enterprise Business 
Assessment, the Enterprise would have to implement each credit score 
model that it approves in its mortgage purchase systems that use a 
credit score. As discussed above, the proposed rule does not address 
how approved scores will be implemented (e.g., waterfall approach or 
require all approved credit scores for every loan). FHFA expects that 
the Enterprise would develop a plan to update their requirements of 
approved score(s) in a timely manner taking into account the timeframes 
necessary for any system updates and industry concerns on adequate time 
for implementation in an orderly fashion.

F. Enterprise Actions on Applications

1. Overview
    The proposed rule would require an Enterprise to make a 
determination on each application that it determines to be complete. An 
Enterprise could determine that an application should be approved or 
disapproved. The proposed rule would permit an applicant to withdraw 
its application at any time during the validation and approval process.
2. Enterprise Determinations
    The proposed rule would permit an Enterprise to approve an 
application after it completes the Enterprise Business Assessment.
    The proposed rule would permit an Enterprise to disapprove an 
application at any point in the validation and approval process. An 
application could be disapproved based on any of the criteria 
identified in the Credit Score Solicitation, including any of the 
application requirements (for example, if an application did not 
include a required certification) or any of the criteria under the 
Credit Score Assessment or the Enterprise Business Assessment. If an 
Enterprise determines that an application should be disapproved, the 
proposed rule would require an Enterprise to provide the applicant with 
a notice of disapproval no later than 30 days after a determination is 
made. If an Enterprise disapproves an application, the Enterprise would 
be required to provide a description of the reason(s) for disapproval, 
as provided in section 310. If an application is approved, the 
Enterprise would be required to make its approval determination public.
3. FHFA Review of Enterprise Determination
    The proposed rule would require an Enterprise to provide notice to 
FHFA

[[Page 65589]]

once an Enterprise has made a decision to approve or disapprove an 
application at least 45 calendar days prior to notifying the applicant 
and/or the public. This 45-day notice would be required for any 
decision to approve or disapprove an application. In all cases, the 
proposed rule would require that FHFA be notified prior to an 
Enterprise notifying an applicant or the public of its decision. Prior 
notice to FHFA would ensure that FHFA has had an opportunity to 
determine how to handle future changes, updates to, or replacement of, 
any credit score model(s). Prior notice would permit FHFA to take any 
steps appropriate in FHFA's capacity as conservator or as safety and 
soundness regulator of the Enterprises. FHFA's review of the Enterprise 
determinations would be consistent with FHFA's expectations that all 
Enterprise initiatives be conducted in a safe and sound manner.
4. Withdrawal of Application
    The proposed rule would permit an applicant to withdraw its 
application at any time by notifying the Enterprise. This would allow 
an applicant to terminate the evaluation process for any reason after 
providing notice to the Enterprise. However, because an Enterprise may 
have already devoted considerable resources to the evaluation of the 
application, the proposed rule would not require the Enterprise to 
return any application fee paid by the applicant. In appropriate 
circumstances, an Enterprise may determine that some portion of the 
application fee should be refunded to the applicant or used to offset 
the application fee if the applicant submits a new application. 
However, any decision to return a portion of an application fee or 
apply it toward a new application would be in the sole discretion of 
the Enterprise.

G. Pilot Programs

1. Overview
    The proposed rule would allow FHFA to approve pilot programs for 
the use of credit scores. Section 310 does not address pilot programs 
explicitly but requires that the Enterprises use a validated and 
approved score model in all automated underwriting systems that use a 
credit score and in any other mortgage purchase procedures and systems 
that use a credit score. It also requires that if an Enterprise 
conditions the purchase of mortgages on a credit score, the credit 
score model must be validated and approved. In addition, section 310 
requires that a credit score model have a historical record of 
measuring and predicting default rates and other credit behaviors.
    One way to gain performance history is to allow an Enterprise to 
collect an application from model developers and make a business 
assessment for the use of credit score(s) for pilot programs. If an 
applicant's credit score lacks usage by industry to underwrite consumer 
credit, it may be approved initially for a pilot program only.
    The proposed rule is seeking feedback on whether an Enterprise 
should conduct a pilot with a new credit score model, and on how such 
pilots should be addressed under the regulation. For example, a pilot 
may be useful in augmenting the Enterprise no-score AUS. While both 
Enterprises have the capability to review loans that lack credit 
scores, the addition of a ``supplemental'' score could enhance the no-
score AUS.
    A pilot may also assist an Enterprise in determining the 
appropriate standards and criteria for the Credit Score Solicitation, 
including the requirements for the application. In order to test 
various standards and criteria for the Credit Score Solicitation, the 
pilot or testing initiative would itself need to be exempt from the 
requirements of this regulation.
    Any pilot needs to be of limited duration and of limited scope. In 
addition, the proposed rule would require a pilot to be reviewed and 
approved by FHFA, which may also require changes to the program. FHFA 
is seeking comment on all aspects of the proposed approach on credit 
score pilot programs.

V. Paperwork Reduction Act

    The proposed rule would not contain any information collection 
requirement that would require the approval of the Office of Management 
and Budget (OMB) under the Paperwork Reduction Act (44 U.S.C. 3501 et 
seq.). Therefore, FHFA has not submitted any information to OMB for 
review.

VI. Regulatory Flexibility Act

    The Regulatory Flexibility Act (5 U.S.C. 601 et seq.) requires that 
a regulation that has a significant economic impact on a substantial 
number of small entities, small businesses, or small organizations must 
include an initial regulatory flexibility analysis describing the 
regulation's impact on small entities. Such an analysis need not be 
undertaken if the agency has certified that the regulation will not 
have a significant economic impact on a substantial number of small 
entities. 5 U.S.C. 605(b). FHFA has considered the impact of the 
proposed rule under the Regulatory Flexibility Act. The General Counsel 
of FHFA certifies that the proposed rule, if adopted as a final rule, 
will not have a significant economic impact on a substantial number of 
small entities because the regulation applies only to Fannie Mae and 
Freddie Mac, which are not small entities for purposes of the 
Regulatory Flexibility Act.

List of Subjects in 12 CFR Part 1254

    Mortgages.

Authority and Issuance

    For the reasons stated in Preamble, under the authority of 12 
U.S.C. 4511, 4513, 4526 and Public Law 115-174, section 310, 132 Stat. 
1296, FHFA proposes to amend subchapter C of Chapter XII of Title 12 of 
the Code of Federal Regulations as follows:

CHAPTER XII--FEDERAL HOUSING FINANCE AGENCY

SUBCHAPTER C--ENTERPRISES

0
1. Add part 1254 to subchapter C to read as follows:

PART 1254--VALIDATION AND APPROVAL OF CREDIT SCORE MODELS

Sec.
1254.1 Purpose and Scope.
1254.2 Definitions.
1254.3 Computation of time.
1254.4 Requirements for use of a credit score.
1254.5 Solicitation of applications.
1254.6 Submission of applications.
1254.7 Credit Score Assessment.
1254.8 Enterprise Business Assessment.
1254.9 Enterprise actions on applications.
1254.10 Withdrawal of application.
1254.11 Pilots.

    Authority: 12 U.S.C. 4511, 4513, 4526 and Sec. 310, Pub. L. 115-
174, 132 Stat. 1296.


Sec.  1254.1   Purpose and Scope.

    (a) The purpose of this part is to set forth standards and criteria 
for the process an Enterprise must establish to validate and approve 
any credit score model that produces any credit score that the 
Enterprise requires in its mortgage purchase procedures and systems.
    (b) The validation and approval process for a credit score model 
includes the following phases: Solicitation of applications, submission 
of applications, Credit Score Assessment, and Enterprise Business 
Assessment.


Sec.  1254.2   Definitions.

    For purposes of this part, the following definitions apply. 
Definitions of other terms may be found in 12 CFR part 1201, General 
Definitions Applying

[[Page 65590]]

to All Federal Housing Finance Agency Regulations:
    Credit score means a numerical value or a categorization created by 
a third party derived from a statistical tool or modeling system used 
by a person who makes or arranges a loan to predict the likelihood of 
certain credit behaviors, including default.
    Credit score model means a statistical tool or algorithm created by 
a third party used to produce a numerical value or categorization to 
predict the likelihood of certain credit behaviors.
    Credit score model developer means any person with ownership rights 
in the intellectual property of a credit score model.
    Days means calendar days.
    Mortgage means a residential mortgage as that term is defined at 12 
U.S.C. 1451(h).
    Nationwide consumer reporting agency means a consumer reporting 
agency that compiles and maintains files on consumers on a nationwide 
basis as defined in section 603 of the Fair Credit Reporting Act (15 
U.S.C. 1681a).
    Person means an individual, sole proprietor, partnership, 
corporation, unincorporated association, trust, joint venture, pool, 
syndicate, organization, or other legal entity.


Sec.  1254.3   Computation of time.

    For purposes of this part, each time period begins on the day after 
the relevant event occurs (e.g. the day after a submission is made) and 
continues through the last day of the relevant period. When the last 
day is a Saturday, Sunday or federal holiday, the period runs until the 
end of the next business day.


Sec.  1254.4   Requirements for use of a credit score.

    (a) Enterprise use of a credit score. An Enterprise is not required 
to use a credit score for any business purpose. However, if an 
Enterprise conditions its purchase of a mortgage on the provision of a 
credit score for the borrower, the Enterprise must:
    (1) Require that the credit score be derived from a credit score 
model that has been approved by the Enterprise in accordance with this 
part; and
    (2) Provide for the use of the credit score by any automated 
underwriting system that uses a credit score and any other procedures 
and systems used by the Enterprise that use a credit score for mortgage 
purchases.
    (b) Replacement of credit score model. An Enterprise may at its 
discretion continue to use or replace any credit score model then in 
use after a new credit score model has been approved in accordance with 
this part.
    (c) No right to continuing use. Enterprise use of a particular 
credit score model does not create any right to or expectation of 
continuing, future, or permanent use of that credit score model by an 
Enterprise.


Sec.  1254.5   Solicitation of applications.

    (a) Required solicitations. FHFA periodically will require the 
Enterprises to solicit applications from credit score model developers. 
FHFA will require solicitation to occur at least every seven (7) years, 
unless FHFA determines that a solicitation should occur more or less 
frequently. FHFA will establish the solicitation requirement by notice 
to the Enterprises, which will include:
    (1) A requirement to submit a Credit Score Solicitation to FHFA for 
review;
    (2) A deadline for submission of the Credit Score Solicitation; and
    (3) A timeframe for the solicitation period.
    (b) Credit Score Solicitation. In connection with each required 
solicitation, an Enterprise must submit to FHFA a Credit Score 
Solicitation including:
    (1) The opening and closing dates of the solicitation time period 
during which the Enterprise will accept applications from credit score 
model developers;
    (2) A description of the information that must be submitted with an 
application;
    (3) A description of the process by which the Enterprise will 
obtain data for the assessment of the credit score model;
    (4) A description of the process for the Credit Score Assessment 
and the Enterprise Business Assessment; and
    (5) Any other requirements as determined by an Enterprise.
    (c) Review by FHFA. Within 45 days of an Enterprise submission of 
its Credit Score Solicitation to FHFA, FHFA will either approve or 
disapprove the Enterprise's Credit Score Solicitation. FHFA may extend 
the time period for its review as needed. FHFA may impose such terms, 
conditions, or limitations on the approval of a Credit Score 
Solicitation as FHFA determines to be appropriate.
    (d) Publication. Upon approval by FHFA, the Enterprise must publish 
the Credit Score Solicitation on its website for at least 90 days prior 
to the start of the solicitation time period.
    (e) Initial solicitation. Each Enterprise must submit its initial 
Credit Score Solicitation to FHFA within 60 days of the effective date 
of this regulation. The initial solicitation time period will begin on 
a date determined by FHFA and will extend for 120 days.


Sec.  1254.6   Submission of applications.

    (a) Application requirements. Each application submitted in 
response to a Credit Score Solicitation must meet the requirements set 
forth in the Credit Score Solicitation to which it responds. Each 
application must include the following elements, and any additional 
requirements that may be set forth in the Credit Score Solicitation:
    (1) Application fee. Each application must include an application 
fee established by the Enterprise. An Enterprise may address conditions 
for refunding a portion of a fee in the Credit Score Solicitation. The 
application fee is intended to cover the direct costs to the Enterprise 
of conducting the Credit Score Assessment.
    (2) Fair lending compliance and certification. Each application 
must address compliance of the credit score model and credit scores 
produced by it with federal fair lending requirements, including 
information on any fair lending testing and evaluation of the model 
conducted. Each application must include a certification that no 
characteristic that is based directly on or is highly correlated solely 
with a classification prohibited under the Equal Credit Opportunity Act 
(15 U.S.C. 1691(a)(1)), the Fair Housing Act (42 U.S.C. 3605(a)), or 
the Safety and Soundness Act (12 U.S.C. 4545(1)) was used in the 
development of the credit score model or is used as a factor in the 
credit score model to produce credit scores.
    (3) Use of model by industry. Each application must demonstrate use 
of the credit score by creditors to make a decision whether to extend 
credit to a prospective borrower. An Enterprise may address criteria 
for such demonstration in the Credit Score Solicitation. An Enterprise 
may permit such demonstration of use to include submission of 
testimonials by creditors (mortgage or nonmortgage) who use the 
applicant's score when making a determination to approve the extension 
of credit.
    (4) Conflict of interest certification and qualification of credit 
score model developer. Each application must include a certification 
that no owner of consumer data necessary to construct the credit score 
model is related to the credit score model developer through any degree 
of common ownership or control. Each application must also include any 
information that an Enterprise may require to evaluate the credit score 
model developer (i.e., relevant experience and financial

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capacity). Such information must include a detailed description of the 
credit score model developer's:
    (i) Corporate structure, including any business relationship to any 
other person through any degree of common ownership or control;
    (ii) Governance structure; and
    (iii) Past financial performance, including audited financial 
statements for the preceding three years.
    (5) Other requirements. Each application must include any other 
information an Enterprise may require.
    (b) Historical consumer credit data. An Enterprise may obtain any 
historical consumer credit data necessary for the Enterprise to test a 
credit score model's historical record of measuring and predicting 
default rates and other credit behaviors. An Enterprise may assess the 
applicant for any costs associated with obtaining or receiving such 
data unless such costs were included in the up-front application fee.
    (c) Acceptance of applications. Each application submitted in 
response to a Credit Score Solicitation within the solicitation time 
period must be reviewed for acceptance by the Enterprise.
    (1) Notice of status. Within 60 days of an applicant's submission, 
the Enterprise must provide an applicant with an Application Status 
Notice, which will indicate whether the application requires additional 
information to be provided by the applicant. An applicant may submit 
additional information through the end of the solicitation period.
    (2) Complete application. Completeness of an application will be 
determined by the Enterprise. An application is complete when an 
Enterprise determines that required information has been received by 
the Enterprise from the applicant and from any third party. Information 
from a third party for a specific application may be received by the 
Enterprise after the solicitation period closes. The Enterprise must 
notify the applicant upon determining that the application is complete 
with a Complete Application Notice.


Sec.  1254.7  Credit Score Assessment.

    (a) Requirement for Credit Score Assessment. An Enterprise will 
undertake a Credit Score Assessment of each application that the 
Enterprise determines to be complete. An Enterprise must determine 
whether an application passes the Credit Score Assessment.
    (b) Criteria for Credit Score Assessment. The Credit Score 
Assessment is based on the following criteria:
    (1) Testing for accuracy. A credit score model is accurate if it 
produces a credit score that appropriately reflects a borrower's 
propensity to repay a mortgage loan in accordance with its terms, 
permitting a credit score user to rank order the risk that the borrower 
will not repay the obligation in accordance with its terms relative to 
other borrowers. The Credit Score Assessment must evaluate whether a 
new credit score model produces credit scores that are more accurate 
than the credit scores produced by any credit score model that the 
Enterprise is then using, as demonstrated by appropriate testing. 
Testing is appropriate if it utilizes one or more industry standard 
statistical tests for demonstrating divergence among borrowers' 
propensity to repay, applied to mortgages purchased by an Enterprise 
(including subgroups), as identified by the Enterprise.
    (2) Testing for reliability. A credit score model is reliable if it 
produces credit scores that maintain accuracy through the economic 
cycle. The Credit Score Assessment must evaluate whether a new credit 
score model produces credit scores that are at least as reliable as the 
credit scores produced by any credit score model that the Enterprise is 
then using, as demonstrated by appropriate testing. Testing is 
appropriate if it utilizes one or more industry standard statistical 
tests for demonstrating accuracy using the industry standard definition 
of default, and demonstrates accuracy at a minimum of two points in the 
economic cycle when applied to mortgages purchased by an Enterprise 
(including subgroups), as identified by the Enterprise.
    (3) Testing for integrity. A credit score model has integrity if, 
when producing a credit score, it uses relevant data that reasonably 
encompasses the borrower's credit history and financial performance. 
The Credit Score Assessment must evaluate whether a credit score model 
applicant has demonstrated that the model has integrity, based on 
appropriate testing or requirements identified by the Enterprise (which 
may address, for example, the level of aggregation of data or whether 
observable data has been omitted or discounted when producing a credit 
score).
    (4) Other requirements. An Enterprise may establish requirements 
for the Credit Score Assessment in addition to the criteria established 
by FHFA.
    (c) Third-party testing. Testing required for the Credit Score 
Assessment may be conducted by:
    (1) An Enterprise; or
    (2) An independent third party selected or approved by an 
Enterprise.
    (d) Timing of Credit Score Assessment. (1) An Enterprise must 
notify the applicant when the Enterprise begins the Credit Score 
Assessment. The Credit Score Assessment will begin no earlier than the 
close of the solicitation time period and will extend for 180 days. 
FHFA may authorize not more than two extensions of time for the Credit 
Score Assessment, which shall not exceed 30 days each, upon a written 
request and showing of good cause by the Enterprise.
    (2) The Enterprise must provide notice to the applicant within 30 
days of the determination of whether the application has passed the 
Credit Score Assessment.


Sec.  1254.8  Enterprise Business Assessment.

    (a) Requirement for Enterprise Business Assessment. An Enterprise 
will undertake an Enterprise Business Assessment of each application 
that the Enterprise determines to have passed the Credit Score 
Assessment. An Enterprise must determine whether an application passes 
the Enterprise Business Assessment.
    (b) Criteria for Enterprise Business Assessment. The Enterprise 
Business Assessment is based on the following criteria:
    (1) Accuracy; reliability. The Enterprise Business Assessment must 
evaluate whether a new credit score model produces credit scores that 
are more accurate than and at least as reliable as credit scores 
produced by any credit score model currently in use by the Enterprise. 
This evaluation must consider credit scores as used by the Enterprise 
within its systems or processes that use a credit score for mortgage 
purchases.
    (2) Fair lending assessment. The Enterprise Business Assessment 
must evaluate the fair lending risk and fair lending impact of the 
credit score model in accordance with standards and requirements 
related to the Equal Credit Opportunity Act (15 U.S.C. 1691(a)(1)), the 
Fair Housing Act (42 U.S.C. 3605(a)), and the Safety and Soundness Act 
(12 U.S.C. 4545(1)) (including identification of potential impact, 
comparison of the new credit score model with any credit score model 
currently in use, and consideration of potential methods of using the 
new credit score model). This evaluation must consider credit scores as 
used by the Enterprise within its systems or

[[Page 65592]]

processes that use a credit score for mortgage purchases.
    (3) Impact on Enterprise operations and risk management, and impact 
on industry. The Enterprise Business Assessment must evaluate the 
impact using the credit score model would have on Enterprise operations 
(including any impact on purchase eligibility criteria and loan 
pricing) and risk management (including counterparty risk management) 
in accordance with standards and requirements related to prudential 
management and operations and governance set forth at parts 1236 and 
1239 of this chapter. This evaluation must consider whether the 
benefits of using credit scores produced by that model can reasonably 
be expected to exceed the adoption and ongoing costs of using such 
credit scores, considering projected benefits and costs to the 
Enterprises. The Enterprise Business Assessment must evaluate the 
impact of using the credit score model on industry operations and 
mortgage market liquidity, including costs associated with 
implementation of a newly approved credit score. This evaluation must 
consider whether the benefits of using credit scores produced by that 
model can reasonably be expected to exceed the adoption and ongoing 
costs of using such credit scores, considering projected benefits and 
costs to the Enterprises and borrowers, including market liquidity and 
cost and availability of credit.
    (4) Competitive effects. The Enterprise Business Assessment must 
evaluate whether using the credit score model could have an impact on 
competition in the industry. This evaluation must consider whether use 
of a credit score model could have an impact on competition due to any 
ownership or other business relationship between the credit score model 
developer and any other institution.
    (5) Third-Party Vendor Review. The Enterprise Business Assessment 
must evaluate the credit score model developer under the Enterprise 
standards for approval of third-party service providers.
    (6) Other requirements. An Enterprise may establish requirements 
for the Enterprise Business Assessment in addition to the criteria 
established by FHFA.
    (c) Timing of Enterprise Business Assessment. The Enterprise 
Business Assessment must be completed within 240 days.
    (d) Enterprise Business Assessment Determination. If an Enterprise 
approves an application for a credit score model, the Enterprise must 
implement the credit score model in its mortgage purchase systems that 
use a credit score for mortgage purchases.


Sec.  1254.9  Enterprise actions on applications.

    (a) Types of actions. An Enterprise must approve or disapprove each 
application.
    (b) Approval of a credit score model. An Enterprise may approve an 
application upon completion of the Enterprise Business Assessment. An 
Enterprise must notify the applicant and the public of the approval of 
an application.
    (c) Disapproval of a credit score model. An Enterprise may 
disapprove an application at any time during the validation and 
approval process based on any of the criteria identified in the Credit 
Score Solicitation. If an Enterprise disapproves an application at any 
time, the Enterprise must provide written notice to the applicant 
within 30 days of the disapproval determination, and the notice must 
provide a description of the reasons for disapproval.
    (d) Prior notice to FHFA. An Enterprise must notify FHFA of any 
decision to approve or disapprove an application at least 45 days prior 
to an Enterprise's notification to an applicant or the public of its 
decision.


Sec.  1254.10  Withdrawal of application.

    At any time during the validation and approval process, an 
applicant may withdraw its application by notifying an Enterprise. The 
Enterprise may, in its sole discretion, determine whether to return any 
portion of the application fee paid by the applicant.


Sec.  1254.11  Pilots.

    (a) Pilots permitted. An Enterprise may undertake pilots or testing 
initiatives for a credit score model. If a pilot or testing initiative 
involves the use of a credit score model not in current use by the 
Enterprises, that credit score model is not required to be approved 
under this part.
    (b) Prior notice to FHFA. Before commencing a pilot or testing 
initiative, an Enterprise must submit the pilot or testing initiative 
to FHFA for review and approval. The Enterprise's submission must 
include a complete and specific description of the pilot or testing 
initiative, including its purpose. FHFA may impose such terms, 
conditions, or limitations on the pilot or testing initiative as FHFA 
determines to be appropriate.

    Dated: December 12, 2018.
Melvin L. Watt,
Director, Federal Housing Finance Agency.
[FR Doc. 2018-27565 Filed 12-20-18; 8:45 am]
 BILLING CODE 8070-01-P