Validation and Approval of Credit Score Models
| Published date | 21 December 2018 |
| Record Number | 2018-27565 |
| Court | Federal Housing Finance Agency |
Federal Register, Volume 83 Issue 245 (Friday, December 21, 2018)
[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: http://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 http://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\ http://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,
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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.
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\13\ 12 U.S.C. 1454(d)(8) and 1717(b)(7)(H).
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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.
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\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\
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\15\ 12 CFR 1002.2(p), 1002.9(b)(2).
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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.
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\18\ The Hand and Adam (2014) study is a simplified study in
contrast to the complicated underwriting and purchase process at the
Enterprises.
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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
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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
