Validation and Approval of Credit Score Models
| Citation | 84 FR 41886 |
| Record Number | 2019-17633 |
| Published date | 16 August 2019 |
| Section | Rules and Regulations |
| Court | Federal Housing Finance Agency |
Federal Register, Volume 84 Issue 159 (Friday, August 16, 2019)
[Federal Register Volume 84, Number 159 (Friday, August 16, 2019)]
[Rules and Regulations]
[Pages 41886-41908]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-17633]
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FEDERAL HOUSING FINANCE AGENCY
12 CFR Part 1254
RIN 2590-AA98
Validation and Approval of Credit Score Models
AGENCY: Federal Housing Finance Agency.
ACTION: Final rule.
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SUMMARY: The Federal Housing Finance Agency (FHFA) is issuing a final
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). The final rule defines a four-phase process for an
Enterprise to validate and approve credit score models. The process
begins with the Credit Score Solicitation (a solicitation by the
Enterprises of applications from credit score model developers),
followed by the Submission and Initial Review of Applications (an
initial review by the Enterprise of submitted applications). The third
phase is a Credit Score Assessment by the Enterprise, and the fourth
phase is an Enterprise Business Assessment. The final rule establishes
criteria for each of the four phases and includes required timing and
notices for Enterprise decisions under the process.
DATES: This rule is effective: October 15, 2019.
FOR FURTHER INFORMATION CONTACT: Beth Spring, Senior Policy Analyst,
Housing & Regulatory Policy, Division of Housing Mission and Goals, at
(202) 649-3327, [email protected], or Kevin Sheehan, Associate
General Counsel, (202) 649-3086, [email protected]. These are not
toll-free numbers. The telephone number for the Telecommunications
Device for the Deaf is (800) 877-8339.
SUPPLEMENTARY INFORMATION:
I. Background
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.
Section 310 provides that if an Enterprise elects to condition the
purchase of a mortgage loan on the delivery of a borrower's credit
score, that credit score must be produced by a model that has been
validated and approved by the Enterprise. Section 310 imposes separate
requirements on FHFA and the Enterprises. FHFA must first issue a
regulation establishing standards and criteria for the validation and
approval of credit score models by the Enterprises. Then, each
Enterprise must publish a description of its validation and approval
process that an Enterprise will use to evaluate applications from
credit score model developers, consistent with the FHFA issued
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
measuring and
[[Page 41887]]
predicting borrower credit behaviors (such as default rates), and
consistency of the credit score model with the safe and sound operation
of the Enterprises. The validation and approval process established by
the final rule addresses each of the statutory factors, as well as
additional standards and criteria consistent with section 310.
On December 21, 2018, FHFA published in the Federal Register a
notice of proposed rulemaking on the ``Validation and Approval of
Credit Score Models.'' See 83 FR 65575. FHFA requested public comment
on the proposed rule, including the standards and criteria for the
validation and approval of credit score models by the Enterprises. FHFA
received 60 comment letters on the proposed rule. FHFA reviewed and
considered all comments received in response to the proposed rule. The
final rule reflects adoption, clarifications, or changes based on the
comments received. A full discussion of the adoption of certain
provisions, clarifications, and changes to provisions are in the
subsequent sections.
II. Major Provisions of the Final Rule
A. Validation and Approval Process
The final rule generally adopts the validation and approval process
set forth in the proposed rule. The validation and approval process
outlines how an Enterprise will solicit applications from credit score
model developers and assess credit score models for use. An Enterprise
must publish a ``Credit Score Solicitation'' describing the
requirements for credit score model developers to submit applications
and the criteria under which the Enterprises will evaluate the
applications.
Following the ``Submission and Initial Review of Applications,'' in
order for a credit score model to be approved for use, an Enterprise
must complete two separate assessments. The first assessment is a
``Credit Score Assessment,'' under which an Enterprise will evaluate
the credit score model for accuracy, reliability and integrity. During
the Credit Score Assessment, an Enterprise will evaluate the credit
score model on a standalone basis, outside the Enterprise business
systems and processes.
The second assessment is an ``Enterprise Business Assessment,''
under which an Enterprise will evaluate the potential impact of using
the credit score model within the Enterprise's proprietary business
systems and processes. The Enterprise Business Assessment is a
comprehensive evaluation of the potential impacts that using each
credit score model could have on an Enterprise and the mortgage finance
industry. The assessment will consider several factors leading to a
decision for use by an Enterprise. Because the Enterprises' automated
underwriting systems (AUS) treat credit scores differently, and because
they have different risk tolerances, the Enterprise Business Assessment
is designed to consider the credit score model's impact on an
Enterprise's proprietary business use and risk management needs.
The final rule clarifies that an Enterprise will submit a proposed
approve or disapprove determination for each application to FHFA for
review, and FHFA will make its determination taking into account the
information provided by the Enterprise along with any other factors
that FHFA determines appropriate.
B. Certification of Conflicts-of-Interest
The final rule does not adopt the proposed conflict-of-interest
certification requirement. The proposed rule would have required credit
score model developers to demonstrate, upon applying for consideration,
that there was no common ownership with a consumer data provider that
has control over the data used to construct and test the credit score
model.
Under the final rule, any credit score model developer is able to
submit an application in response to a Credit Score Solicitation,
provided it meets the other requirements for applicants set forth in
the Credit Score Solicitation.
While the final rule permits credit score model developers that
meet solicitation requirements to submit applications, the Enterprises
will consider market and competition impacts as part of the Enterprise
Business Assessment. This may include market or competition impacts
related to the ownership structure of the credit score model developer
and its relationship to other market participants. The Enterprise's
consideration of market and competition impacts is consistent with the
normal risk assessment and evaluation that an Enterprise would conduct
with respect to other potential third-party providers or
counterparties.
C. No Required Use of Credit Scores
The final rule provides that an Enterprise is not required to use
third-party credit scores for any business purpose. Section 310 does
not require an Enterprise to use a third-party credit score model for
any part of its business operations or purchase decisions. However, if
an Enterprise conditions its purchase of mortgages on the provision of
a credit score, section 310 requires that the score must be derived
from a model that has been validated and approved in accordance with
section 310 and this final rule. The validated and approved credit
score must be used in all of the Enterprise's purchase-related systems
and procedures that use a credit score.
The final rule contemplates that if in the future an Enterprise no
longer uses third-party credit scores in any purchase-related systems
or procedures, the Enterprise would not be subject to the requirements
in the final rule. Conversely, if an Enterprise uses credit scores as a
consideration in setting the price for loans it purchases, for example
by using Loan Level Price Adjustments (LLPAs) or Delivery Fees based on
credit score and loan-to-value (LTV) ratios, the Enterprise is subject
to the requirements of the final rule, even if the Enterprise no longer
uses credit scores in any other manner.
If a new credit score model is approved, the final rule permits an
Enterprise to replace the existing credit score model or to continue to
use the existing credit score model in addition to a newly approved
credit score model. Section 310 expressly permits replacement of one
validated and approved credit score model with another validated and
approved credit score model, and does not establish any standard for
replacement, other than the models must be validated and approved.
Neither section 310 nor the final rule creates any right to or
expectation of continued, future, or permanent use of any credit score
model by an Enterprise, even if the model has been validated and
approved.
D. Current Credit Score Model in Use
Fannie Mae and Freddie Mac currently require lenders to provide
credit scores derived from the Classic FICO credit score model for each
loan delivered to the Enterprises.\1\ The final rule clarifies how
Classic FICO will be evaluated under the validation and approval
process. The final rule establishes criteria for the initial Credit
Score Assessment that permit an Enterprise to evaluate Classic FICO on
an expedited basis, if necessary, to meet statutory timeframes. This
approach allows an Enterprise to complete the validation and approval
process for the credit score model currently in use by the Enterprises
and the mortgage
[[Page 41888]]
finance industry (Classic FICO). This evaluation may occur prior to a
determination on any other application(s) received in response to the
initial Credit Score Solicitation.
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\1\ The Enterprises require delivery of FICO 5 from Equifax,
FICO 4 from TransUnion, and FICO Score 2 from Experian, which are
collectively referred to as ``Classic FICO.''
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While the final rule makes no predetermination of which
applications will be approved, FHFA expects that Classic FICO is likely
to meet the applicable testing criteria based on its history of use.
However, FHFA acknowledges that approving a credit score model in use
for the past decade would not satisfy the intent of section 310 that
the Enterprises consider credit score models developed after Classic
FICO. FHFA expects that the Enterprises will also evaluate applications
received in response to the initial Credit Score Solicitation and that
the Enterprises may submit to FHFA a proposed determination to approve
one or more of those credit score models for use, either to replace
Classic FICO or in addition to Classic FICO.
III. Summary of Comments Received and FHFA Responses
In response to the proposed rule, FHFA received 60 comment letters
during the 90-day comment period.\2\ Comments were received from all
segments of the mortgage industry, including: Mortgage insurers,
mortgage originators, Mortgage Backed Securities (MBS) and Credit Risk
Transfer (CRT) investors, technology vendors, housing advocates,
industry trade groups, Congressional members, and other interested
stakeholders. FHFA considered all comments received in response to the
proposed rule. While the final rule adopts most of the provisions from
the proposed rule, FHFA has incorporated a number of changes. A
discussion of FHFA's rationale for all components of the final rule,
including responses to significant issues raised by comment letters, is
set forth below.
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\2\ https://www.fhfa.gov/SupervisionRegulation/Rules/Pages/Validation-and-Approval-of-Credit-Score-Models.aspx.
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A. Validation and Approval Process and Timelines
FHFA proposed that the validation and approval process have four
phases, with the first phase being a solicitation for applications from
credit score model developers, the second phase being the submission
and initial review of applications, the third phase being a Credit
Score Assessment, and the last phase being an Enterprise Business
Assessment. The final rule adopts these four phases as proposed and
establishes minimum standards and criteria for each phase. Consistent
with section 310 and the proposed rule, the final rule permits an
Enterprise to add to the standards and criteria for all four phases of
the process. In general, comments received on the four phases in the
proposed rule were supportive of this approach.
The proposed rule also set out timelines for the completion of each
phase of the validation and approval process. Section 310 requires that
an Enterprise provide notice of a ``determination'' to an applicant
within 180 days from receipt of a complete application, with two
possible 30-day extensions. While recognizing that statutory provision,
the proposed rule set forth timelines that reflect the length of time
FHFA believes, based on similar analysis conducted in 2015, is
necessary for an Enterprise to complete the acquisition of consumer
credit data for testing of each credit score model and the empirical
and business analysis of each credit score. FHFA received a few comment
letters that supported the need to separate the Credit Score Assessment
from the Enterprise Business Assessment. Commenters were split on the
length of time proposed for each phase. Some commenters stated that the
maximum total time allowed for completion of the process was too long.
The final rule adopts the four phases and the associated timeframes
as proposed. Specifics of the four phases are explained in more detail
below.
1. Proposed and Final Rule
Under both the proposed rule and the final rule, each Enterprise
must publish a Credit Score Solicitation as part of the solicitation
phase of the process. The Credit Score Solicitation will specify the
opening and closing dates of the solicitation time period during which
the Enterprise will accept applications from credit score model
developers. FHFA expects that the Credit Score Solicitation will
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/criteria for conducting the
Credit Score Assessment and the Enterprise Business Assessment; and
other requirements established by the Enterprise consistent with
section 310.
In the Submission and Initial Review of Applications phase, the
Enterprise will determine whether each application submitted by a
credit score model developer is complete. An application would be
complete only after the Enterprise has received all required fees and
information from the applicant as well as any data that must be
obtained from a third party. If an application is not complete, the
Enterprise must notify the applicant and provide an opportunity for the
applicant to submit any information that the Enterprise determines
necessary for the evaluation of the application.
During the Credit Score Assessment phase of the process, each
credit score model will be assessed for accuracy, reliability, and
integrity, independent of the use of the credit score in the
Enterprise's systems. The Credit Score Assessment will also include any
other requirements established by the Enterprise.
During the Enterprise Business Assessment phase, which is the
fourth and final phase of the process, an Enterprise will assess the
credit score model in conjunction with the Enterprise's business
systems and processes. The Enterprise must assess the accuracy and
reliability of credit scores when used within the Enterprise's systems.
The Enterprise must assess possible impacts on fair lending and 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 provider review, and perform any other
evaluations established by the Enterprise as part of the Enterprise
Business Assessment.
2. Comments Received and Final Rule Rationale
Commenters were generally supportive of the proposed four phases,
and the final rule adopts this approach. Based on the comments received
and prior work related to analyzing credit score models, the four-phase
approach is operationally practical. The four-phase approach is also
consistent with the statutory requirements of section 310.
Some commenters stated that the proposed timeline for the
solicitation, review and assessment of applications was too long. One
commenter stated that the ``long, drawn out process does not encourage
the competition contemplated by Sec. 310.'' On the other hand, the
Enterprises commented that they support the four-phased approach, and
the timelines outlined in the proposed rule. The timelines in the
proposed rule were informed by the work related to assessing credit
score models conducted by FHFA and the Enterprises from 2015 to 2018
pursuant to FHFA's Conservatorship Scorecards. The final rule adopts
the proposed timelines associated with completion of each phase of the
process because they
[[Page 41889]]
appropriately allow for completion of the provisions required by
section 310. The timelines allow the Enterprises an appropriate amount
of time to process applications, and they reasonably reflect prior FHFA
and Enterprise experience regarding the amount of time needed to test
and evaluate credit score models. The timelines adopted in the final
rule reflect the maximum number of days allowable to complete the
entire process, and in FHFA's judgment, are necessary to reasonably
achieve the objectives of the statute.
The timeframes set out in the final rule do not address the time it
will take the industry to prepare for a change in credit score
requirements. One commenter stated consideration of any credit score
model should include ``the time, effort, complexity, uncertainty, and
costs (direct and indirect) to the mortgage industry of alternative
decisions.'' As discussed in the proposed rule, implementation timing
is not addressed in section 310. Implementation of any change to
existing credit score requirements will have significant operational
and cost implications for the Enterprises and the mortgage finance
industry. FHFA expects that full implementation of any change to the
Enterprise credit score requirements will take the industry as long as
24 months after a new credit score model is approved. The final rule
does not address how an Enterprise's credit score requirements might
change following the approval of a new credit score model. How an
approved credit score model(s) is implemented, including the timeframe
for the Enterprises to transition from one credit score to another
score or scores, is best addressed outside of the final rule. FHFA will
provide direction to the Enterprises on implementation issues
consistent with applicable law.
Some comment letters stated that the validation and approval phases
should be done simultaneously. Under the final rule, the Credit Score
Assessment and Enterprise Business Assessment phases may be conducted
sequentially, or in unusual or unique circumstances such as the initial
solicitation, simultaneously. In some cases, an Enterprise may want to
have the results of the Credit Score Assessment before initiating the
Enterprise Business Assessment. In other cases, an Enterprise may
conduct some or all of the Enterprise Business Assessment at the same
time it is conducting the Credit Score Assessment. In all cases, 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. As discussed in more detail below, the
final rule clarifies that FHFA's review of a proposed determination by
an Enterprise must include a decision by FHFA to either approve or
disapprove the proposed determination. Under the final rule, if an
Enterprise finds that an application should be approved, the Enterprise
must submit a proposed determination recommending approval of a credit
score model to FHFA at the conclusion of the Enterprise Business
Assessment phase. However, the credit score model will only be
considered validated and approved for purposes of the regulation and
section 310 if an Enterprise makes a final determination to approve the
credit score model after FHFA has completed its review.
With regard to communication with applicants during the Enterprise
review process, one commenter noted the possible need for additional
interaction with applicants concerning issues in their applications. As
noted above, the final rule provides for an Enterprise to request
supplemental information from the applicant if necessary, which will
allow the Enterprises to have those additional interactions.
Several comments were in favor of the Enterprises conducting a
joint Credit Score Assessment. The comments that supported a joint
assessment indicated that it is likely to lead to a more efficient
process. The final rule does not prohibit the Enterprises from
conducting a joint Credit Score Solicitation and/or Credit Score
Assessment. The Enterprises may choose to issue a joint Credit Score
Solicitation and to collaborate on the Credit Score Assessment of
credit score models outside of their automated underwriting systems. A
joint approach may minimize costs and operational burdens with these
phases. However, the Enterprises will have to consider each credit
score model that passes the Credit Score Assessment in an independent
Enterprise Business Assessment because of differences in their
respective business systems and processes.
B. Alignment of Enterprises
The preamble to the proposed rule stated that FHFA may direct the
Enterprises to align their assessment processes or their decisions on
which credit score models to approve. The final rule includes three
separate provisions that FHFA may use to direct the Enterprises at
different stages of the validation and approval process. The final rule
does not itself require the Enterprises to align their processes or
outcome decisions. This approach is consistent with the proposed rule
in providing flexibility for FHFA and the Enterprises to ensure that
the Enterprises are able to respond appropriately to the primary market
and to their own business requirements and objectives, as well as to
manage their operations in a manner that is safe and sound.
1. Proposed Rule
The proposed rule provided for FHFA review at two points in the
validation and approval process. First, the proposed rule required each
Enterprise to submit its Credit Score Solicitation for FHFA review
before making it publicly available. The proposed rule stated that FHFA
could approve or disapprove the Credit Score Solicitation, and may
impose any appropriate terms, conditions, or limitations on its
approval. Second, the proposed rule would have required each Enterprise
to notify FHFA of any decision to approve or disapprove a credit score
model application prior to an Enterprise's notification to the
applicant or the public. The preamble to the proposed rule indicated
that this notice requirement would provide FHFA with an opportunity to
make any determinations or take any steps appropriate in FHFA's
capacity as conservator or as safety and soundness regulator with
respect to changes, updates to, or replacement of any credit score
model, including alignment of outcomes.
2. Comments Received
FHFA received several comments that either supported alignment of
the Enterprises or expressed concern that the rule would permit the
Enterprises to approve for use different credit score models. For
example, one commenter stated that it is necessary and appropriate for
FHFA to align Enterprise usage of credit scores to ensure that Fannie
Mae and Freddie Mac securities are as homogeneous as possible. Other
commenters emphasized the potential cost and operational impacts if the
Enterprises do not align on which credit scores they require.
FHFA also received comments on the impact that alignment of the
Enterprise credit score requirements could have on FHFA regulations
such as the Enterprise capital requirements (Conservatorship Capital
Framework) and other Enterprise policies, such as the Private Mortgage
Insurer Eligibility Requirements (PMIERs). For example, one commenter
noted that credit scores are used by the mortgage insurance industry
``in a variety of ways, including to determine borrower eligibility,
pricing, and to calculate the amount of
[[Page 41890]]
capital required to comply with the Enterprises' capital and
operational standards for [private mortgage insurers].'' Two commenters
raised a concern about the Enterprises using different credit score
models to assess the creditworthiness of borrowers, which they stated
could raise the risk of a divergence in the performance of loans
collateralizing their mortgage backed securities, potentially causing
prepayment speeds to differ in the Uniform Mortgage Backed Security
(UMBS). Commenters also noted that any change in the credit score model
would require other policies and requirements such as PMIERs and the
Enterprise capital requirements to be recalibrated based on the new
credit score model.
3. Rationale for Final Rule
While the final rule does not require the Enterprises to align on
processes or outcomes related to validation and approval of credit
score models, the final rule permits FHFA to require alignment of the
Enterprises on any aspects of the validation and approval process,
including which credit score model or models would be approved for use.
Based on the comments received and FHFA's own assessment of potential
impacts, it is likely that FHFA would have to consider whether the
Enterprises should align their credit score requirements, whether the
Enterprises remain in conservatorship or not. The final rule expands on
the proposed rule provisions for FHFA review at different stages of the
validation and approval process to provide clarity for applicants and
the Enterprises on how FHFA, as conservator or regulator, may require
alignment of the Enterprises.
As stated above, the final rule expands on three provisions FHFA
may use to direct the Enterprises at different stages of the validation
and approval process to address alignment. First, the final rule
maintains the proposed provision for FHFA review of the Enterprise
Credit Score Solicitation. As in the proposed rule, the final rule
states explicitly that FHFA may approve or disapprove the Credit Score
Solicitation and may impose any terms, conditions, or limitations on
its approval. This will allow FHFA to require an Enterprise to make any
changes that FHFA determines appropriate, including any changes that
may be necessary to align the respective Enterprise processes.
Second, the final rule adds a new provision for FHFA to undertake
an evaluation concurrent with the 240-day Enterprise Business
Assessment phase. FHFA's evaluation during the Enterprise Business
Assessment phase will focus on potential impacts on other regulations
and aligned Enterprise policies. This evaluation could include how the
Enterprise use of credit scores may impact the PMIERs, the UMBS
regulation, CRT transactions, and the Enterprise capital requirements.
For example, under the PMIERs, the risk-based required asset amounts
for mortgage insurers are based on factors including the original LTV
ratio of the insured loan, the original credit score for the loan, the
loan vintage, and other factors. A change to the credit score
requirements of the Enterprises would require an update to the PMIERs
requirements to reflect a new credit score model.
FHFA's evaluation during the Enterprise Business Assessment will
provide an opportunity for FHFA to determine the feasibility of
implementing multiple credit score models. FHFA may make this decision
in its capacity as conservator under existing FHFA authorities or as
safety and soundness regulator under the approval authority provided by
this final rule. For example, FHFA may consider the impact on
Enterprise loan pricing if the Enterprises permit the use of more than
one credit score model by lenders. FHFA may require the Enterprises to
maintain a single credit score model if the secondary market liquidity
were expected to decline if multiple credit score models were
permitted, or if FHFA determines there are other policies or
regulations that require alignment on credit score model requirements.
Finally, the final rule revises the proposed provision regarding
prior notice to FHFA of an Enterprise determination based on the
Enterprise Business Assessment. The proposed rule provided for 45-day
prior notice to FHFA of any determination by an Enterprise on an
application. This would have required an Enterprise to make an approval
determination and submit that approval determination to FHFA for
review. The preamble to the proposed rule indicated that FHFA could
take appropriate steps in FHFA's capacity as conservator or as safety
and soundness regulator in response to the prior notice, but the
proposed rule did not explicitly state that FHFA could approve or
disapprove the Enterprise determination at this stage.
The final rule provides that an Enterprise must submit a proposed
determination to FHFA. FHFA will review the Enterprise proposal and
either approve it or disapprove the proposed determination. The final
rule provides that FHFA must approve or disapprove the Enterprise's
proposed determination during the 45-day prior notice period. The
requirement for FHFA approval or disapproval will provide a mechanism
for FHFA to ensure that the Enterprises reach aligned decisions on
which credit score model or models to approve, if FHFA determines that
alignment of the Enterprises is appropriate.
FHFA acknowledges the concerns raised by commenters about the
potential costs and complexity that may arise if the Enterprises follow
different processes, apply different criteria, or reach different
decisions on which credit score model(s) to use and how they would be
used. However, the final rule is flexible enough to allow FHFA to
require alignment in areas where FHFA determines alignment is
appropriate, and to allow the Enterprises to be different in other
areas. For example, Fannie Mae and Freddie Mac currently treat credit
scores in different ways in their respective AUSs. Fannie Mae uses
credit scores as an eligibility threshold for its AUS, while Freddie
Mac uses credit scores as one factor in the risk assessment for its
AUS. As a result, in implementing the final rule, the Enterprises may
consider different factors in their respective Enterprise Business
Assessments based on how they each use credit scores in their own
business systems.
The final rule does not require the Enterprises to use identical
processes for evaluating credit score models, and the final rule does
not require the Enterprises to reach identical decisions on which
credit score models to approve through the validation and approval
process.
However, the final rule provides for several points at which FHFA
may consider whether a greater or lesser degree of alignment is needed
to address the needs of the mortgage market or the statutory mission of
the Enterprises, including to promote access to mortgage credit
throughout the Nation. For example, FHFA may exercise this discretion
to enhance processing efficiency in the mortgage market, to enhance the
safety and soundness of the Enterprises, or to reduce costs for
lenders, borrowers, and others.
C. No Requirement for Conflicts-of-Interest Certification
The proposed rule would have required each applicant to provide a
certification regarding conflicts of interest as part of its
application. The final rule does not adopt this requirement and instead
permits credit score model developers to submit applications to the
Enterprises in
[[Page 41891]]
response to a Credit Score Solicitation, regardless of the ownership
structure of the credit score model developer. However, the final rule
permits consideration of conflicts of interests as part of a
comprehensive Enterprise Business Assessment.
1. Proposed Rule
The proposed rule required that a credit score model developer
certify in its application that the credit score model developer has no
common ownership or affiliation with the owner of data used to
construct the credit score model. This conflicts-of-interest
certification was proposed to address concerns about vertical
integration of the nationwide consumer reporting agencies (CRAs), and
to address current and potential future affiliations between data
providers and analytic companies that own algorithms used to generate
credit scores. For example, VantageScore Solutions, LLC is jointly
owned by the three nationwide CRAs. The CRAs also own, price, and
distribute consumer credit data and credit scores. This type of common
ownership could in theory negatively impact competition in the
marketplace.
The proposed rule discussed concerns that the CRAs could
potentially use their position in the marketplace in a manner that
favors VantageScore Solutions, LLC over its current and future
competitors. The proposed rule would have addressed these concerns by
prohibiting common ownership or control of a credit score model
developer and the owner of the consumer credit data that is needed to
construct the model and to generate the credit scores.
The proposed rule also required each applicant to provide
information about its market experience and financial capacity. Such
information included a detailed description of the credit score model
developer's corporate structure and business relationships, governance
structure, and past financial performance, including audited financial
statements for the preceding three years.
2. Comments Received
FHFA received numerous comments on the proposed conflicts-of-
interest certification, both supporting the proposed restriction and
opposing the proposed restriction. Commenters against the proposed
conflicts-of-interest certification raised three main arguments. First,
several commenters stated that the proposed conflicts-of-interest
certification requirement was not consistent with the spirit or letter
of section 310. One commenter stated that ``the Proposed Rule directly
conflicts with the spirit and intent of the Credit Score Competition
provisions within the Economic Recovery, Regulatory Relief and Consumer
Protection Act (S.2155); where Congress recognized that competition is
vital in commercial markets and therefore required that the FHFA allow
existing credit scoring models to compete with the incumbent scoring
company.''
Second, some commenters stated that open competition among credit
score model developers would lead to improved credit score models and
would benefit borrowers. One commenter stated that ``[f]or over a
decade, VantageScore LLC has competed and provided demonstrable value
in other lending markets without any tangible harm to its rivals, and
most importantly, consumers have benefitted from greater access to
financial opportunity.''
Third, commenters argued that the proposed conflicts-of-interest
certification is unnecessary because antitrust laws already prohibit
the types of anti-competitive behavior that the conflicts-of-interest
certification was intended to prevent. One commenter stated that
``[t]he antitrust statutes are very clearly designed to prevent exactly
the type of anticompetitive behavior the FHFA is concerned about and if
necessary, those statutes may be readily invoked to provide relief.''
FHFA also received comments supporting the proposed conflicts-of-
interest certification. These comments expressed concerns about the
potential negative effects on competition that may result if the owner
of consumer credit data needed to develop competing credit score models
and distribute credit scores into the marketplace also owns or controls
a credit score model developer. One comment stated that ``[t]he
Enterprises must be required and allowed to judge competing scoring
approaches and their effects on reliability and performance based
solely on the merits, without the inevitable distortions brought about
by data owners' simultaneous control of the data, the credit score
model, and the means of credit score distribution.''
Another commenter indicated that the proposed independence
requirement is needed to promote open and fair competition among credit
score developers, stating that the proposed certification requirement
``shows serious consideration for ensuring open and fair competition in
the submission and evaluation of new credit scoring models that is
welcome and needed.'' Another commenter suggested that the competitive
concerns about common ownership could be mitigated if the CRAs
transferred their contractual control of the credit score distribution
channel and pricing. Commenters supporting independence of credit score
model developers also argued that there is the potential for
competitive harm resulting from vertical integration of credit score
model developers and the CRAs that own the data used to construct and
test such models.
Although not addressed in the proposed rule, some commenters
expressed support for other changes that could foster competition. For
example, some commenters supported an approach that would allow lenders
to choose among multiple validated and approved credit scores. Opposing
this view were commenters expressing concerns about adverse selection
and impact on investors if lenders were permitted to select the credit
score used to underwrite a borrowers mortgage.
A number of commenters also noted that increased competition and
improvements to credit score models may result from adopting newer data
types and sources. For example, some commenters supported the use of
data outside of the CRAs, such as rental and telecommunications data.
While FHFA believes there are other consumer data sources that could
potentially be useful, the proposed and final rule do not address, or
create any provision related to, required use of alternative data
consistent with section 310.
3. Rationale for Final Rule
The final rule does not include the proposed conflicts-of-interest
certification requirement. Instead, the final rule permits credit score
model developers to submit applications for consideration by the
Enterprises, without having to demonstrate that there is no affiliation
or common ownership of the credit score model developer with data
provider(s). The independence requirement was intended to encourage
additional credit score developers to enter the mortgage marketplace.
The proposed rule reflected concerns that the CRAs lacked an incentive
to support new entrants because of their ownership of VantageScore
Solutions, LLC. However, FHFA recognizes that there are many other
factors that may affect the potential entrance of new credit scoring
companies into the industry.
Despite the concerns raised by some commenters about potential
impacts on competition, FHFA has concluded that allowing all credit
score model developers to submit applications is more consistent with
section 310, which does not prevent any credit score model
[[Page 41892]]
from being considered for potential use in the mortgage market.
Therefore, the final rule does not require a credit score model
developer to provide a conflicts-of-interest certification with its
application.
While all credit score model developers are permitted to apply for
consideration regardless of ownership structure, the final rule adopts
the proposed requirement that a credit score model developer provide
all information necessary for an Enterprise to evaluate the credit
score model developer. Such information may include relevant experience
of the applicant and financial capacity of the applicant. The final
rule requires, as part of the Enterprise Business Assessment,
evaluating whether use of a credit score model could have an impact on
competition in the industry. The Enterprise must consider whether such
impact is due to any ownership or other business relationship between
the credit score model developer and any other institution. The
assessment of competitive effects is discussed in more detail below.
D. Frequency of Solicitation of Applications
The proposed rule provided that FHFA would require the Enterprises
to solicit applications from credit score model developers at a minimum
once every seven years, unless FHFA determined that a solicitation
should occur more or less frequently. The proposed minimum frequency
for solicitations was based on prior feedback from the industry on the
significant cost and operational complexity of updating the credit
score required by the Enterprises. For example, responding to FHFA's
December 2017 Request for Information (RFI), representatives from the
mortgage insurance industry requested 24 months to transition from the
current credit score to a new credit score.\3\ However, several
comments on the proposed rule stated that seven years is too long, and
that the seven years would not align with the rate of innovation or
advances in technology and data.
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\3\ https://www.fhfa.gov/PolicyProgramsResearch/Policy/Pages/Credit-Scores.aspx.
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The final rule provides that FHFA will require the Enterprises to
open a solicitation period as FHFA determines necessary. FHFA may
require a new solicitation on its own initiative or in response to a
request from any party, including an Enterprise. The final rule
requires FHFA to make a determination on whether it is necessary for
the Enterprises to open a solicitation for credit score model
developers to apply for consideration.
1. Proposed Rule
The proposed rule stated that FHFA would require the Enterprises to
solicit applications from credit score model developers at least once
every seven years, unless FHFA determined that a solicitation should
occur more or less frequently. FHFA would establish the solicitation
requirement by notice to the Enterprises, which would include: (1) A
requirement for the Enterprises to submit a Credit Score Solicitation
to FHFA for review; (2) a deadline for submission of the Credit Score
Solicitation to FHFA; and (3) a timeframe for the solicitation period
in which the Enterprises would accept applications.
In connection with each required solicitation, the proposed rule
would have required an Enterprise to 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 would 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 the
Enterprise.
2. Comments Received
FHFA received comments expressing a range of views on the
appropriate frequency for solicitation of new credit score models. One
commenter stated that ``[w]ith respect to the frequency of the
validation and approval process, the proposed rule contemplates FHFA
requiring Enterprise solicitation of new credit score models every
seven years. This cycle allows sufficient time for the completion of
each validation and approval process, though it may not allow the
Enterprises to be as responsive as possible when new technologies or
data sources emerge.'' The commenter therefore recommended that ``FHFA
more frequently evaluate whether a new solicitation would provide
significant benefits to the market, such that it is prepared to begin
the process earlier than the seven year threshold if warranted.''
However, another commenter cautioned that ``frequent and radical
changes to credit score models may raise the cost and complicate
implementation even more . . .''
3. Rationale for Final Rule
The final rule provides that FHFA will determine the frequency of
credit score solicitations in its discretion. FHFA may initiate a
solicitation at its own initiative or in response to a request
submitted to FHFA by any person, including an Enterprise. While the
final rule does not include the proposed baseline frequency of once
every seven years, the final rule approach is consistent with the
proposed rule, which would have allowed FHFA to require a solicitation
either more or less frequently.
Recognizing that comments on the proposed rule encouraged FHFA to
consider opening solicitations more frequently, the final rule does not
include a seven-year solicitation cycle. Instead, the final rule allows
FHFA to establish the frequency of the solicitation in response to the
need and justification from either the industry or an Enterprise. FHFA
can open the solicitation window as frequently or as infrequently as
necessary, assuming there is reasonable justification to do so.
The final rule strikes a balance between the comments concerned
about the potential cost and impact of frequent solicitations and the
comments concerned that infrequent solicitations would not be
responsive to advances in technology and data. The validation and
approval process is potentially time-consuming and costly, and the
implementation of any changes to the credit score model in use by the
Enterprise and the industry would entail substantial time, cost, and
effort by many parties. For that reason, it would be impractical and
too costly to require the Enterprise to solicit applications on a
rolling or annual basis. At the same time, FHFA recognizes that a
seven-year cycle may be too long to take into account innovations and
advances in technology and data. FHFA may initiate solicitations more
or less frequently depending on technology, improved data, or other
compelling reasons to do so.
E. Fair Lending Compliance and Certification
The proposed rule included fair lending compliance provisions in
two phases of the credit score model validation and approval process.
First, the proposed rule would have required a certification by the
credit score model developer in the application phase. Second, the
proposed rule would have required the Enterprises to assess fair
lending impacts during the Enterprise Business Assessment. The final
rule
[[Page 41893]]
retains both of these fair lending provisions. The final rule also adds
a requirement that the Enterprises evaluate the potential impact of
using a particular credit score model on access to credit.
1. Proposed Rule
The proposed rule included two provisions related to fair lending.
First, in the application phase, the credit score model developer would
have been required to certify 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)), and the Safety
and Soundness Act (12 U.S.C. 4545(1)) was used in the development of
the credit score model or was used as a factor in the credit score
model to produce credit scores. The proposed rule would have required
the credit score model developer to provide information in its
application on any fair lending testing and evaluation of the model
conducted. Second, in the Enterprise Business Assessment phase, the
Enterprises would have been required to evaluate the fair lending risk
and fair lending impact of the credit score model and credit scores
produced by it in accordance with standards and requirements related to
federal fair lending laws.
2. Comments Received and Final Rule Rationale
Comments on the proposed fair lending provisions were generally
supportive of both the proposed certification requirement in the
application phase and the proposed fair lending assessment in the
Enterprise Business Assessment. Some commenters recommended that FHFA
expand the fair lending requirements to include additional requirements
for fair lending testing. Commenters also supported adding as part of
the Enterprise Business Assessment a requirement to assess potential
impacts on access to credit from any change to the credit score model
requirements of the Enterprises.
The final rule retains fair lending compliance provisions in both
the application and Enterprise Business Assessment phases and adds a
requirement that the Enterprises consider potential impacts on access
to credit in response to feedback received in the comments.
The compliance and certification requirements in the application
phase of the final rule are the same as the proposed rule. Some
commenters suggested requiring fair lending testing by the credit score
model developer in the application's fair lending certification.
The final rule requires each application to include a certification
that no characteristic used in the development of the credit score
model or as a factor in the credit score model to produce credit scores
is based directly on or is highly correlated solely with a prohibited
classification. In the final rule, each application must address
compliance of the credit score model and credit scores produced by it
with federal fair lending requirements and provide information on any
fair lending testing and evaluation of the model conducted. FHFA
expects credit score model developers to have a sufficient basis for
making the certification and addressing the application requirement,
but the final rule does not prescribe or require any particular method
of evaluation or testing.
Some commenters proposed inserting ``current'' before ``federal
fair lending requirements'' out of a concern that federal fair lending
requirements may change due to rulemakings, acts of Congress, and court
decisions. FHFA recognizes that applicable legal standards, including
the Fair Housing Act, Equal Credit Opportunity Act, and Safety and
Soundness Act, may change over time. The proposed rule was not limited
to federal fair lending requirements as of a particular date, and the
final rule does not include any change on this point.
The final rule includes the proposed fair lending assessment
requirements in the Enterprise Business Assessment phase. Commenters
supported the fair lending compliance component in the Enterprise
Business Assessment. One commenter recommended including disparate
impact testing in the fair lending assessment. The final rule refers to
the standards and requirements of applicable fair lending authorities.
The final rule itself does not describe the compliance standards for
those authorities. However, the rule does require an evaluation of the
fair lending risk and fair lending impact associated with those fair
lending authorities, 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.
The proposed rule also requested comments on whether the Enterprise
Business Assessment should consider whether the credit score model may
have any impact on access to mortgage credit. Commenters were
supportive of requiring this analysis. Some commenters stated that
access to mortgage credit is a critical component of building wealth
that has historically been limited on the basis of protected factors.
The final rule requires an Enterprise to consider possible impacts on
access to credit as part of the Enterprise Business Assessment.
F. Qualifications of Credit Score Model Developer
The proposed rule would have required that the Enterprises review,
in accordance with their third-party provider management policies and
procedures, the corporate structure, governance structure, and past
financial performance of the credit score model developer, including
three years of audited financial statements to demonstrate financial
strength of the credit score model developer. As discussed previously,
the final rule includes the proposed requirements on the evaluation of
the financial strength of the credit score model developer, but the
final rule does not include the proposed application requirement for
three years of audited financial statements. FHFA expects that the
Enterprises will consider any guidance that FHFA has issued in its
supervisory capacity to the regulated entities on the oversight of
third-party provider relationships.
1. Proposed Rule
The proposed rule would have required that each application include
any information that an Enterprise may require to evaluate the credit
score model developer (i.e., relevant experience and financial
capacity). Such information would 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.
2. Comments Received
Several commenters opposed the proposed requirement that applicants
provide audited financial statements for the preceding three years,
stating that such a requirement was arbitrary or unreasonable and the
Enterprises should manage their vendor risk through their existing
third-party management process. Several commenters raised concerns
about the burden associated with providing three years of audited
financial statements.
[[Page 41894]]
One commenter stated that ``since credit score model developers are not
counterparties, there is no need to require an assessment of developers
at the rigorous level proposed.''
3. Rationale for Final Rule
The final rule does not adopt the proposed three year audited
financial statements requirement. The final rule is less prescriptive
than the proposed rule in establishing criteria for assessing the
financial strength of credit score model developers. The final rule
requires an applicant to submit information related to its organization
and financial strength in its application, and the final rule requires
an Enterprise to assess the financial strength of the credit score
model developer as part of the Enterprise Business Assessment. However,
the final rule does not include the proposed requirement that a credit
score model developer provide three years of audited financial
statements. This change will provide more flexibility for an Enterprise
to determine what information is necessary for its review and
potentially more flexibility to applicants submitting such information.
FHFA has provided supervisory guidance to the Enterprises on
managing risks associated with third-party providers. The guidance
describes FHFA's supervisory expectations, including that an Enterprise
review audited financial statements, equivalent financial information,
or other evidence of creditworthiness and financial viability. This
review should consider whether the third-party provider will be able to
continue to perform its role for the foreseeable future. The level of
review, and documentation required, will vary depending on the
financial risk to an Enterprise and/or the viable alternatives to the
third-party provider.
Effective risk management of third-party provider relationships is
essential to the safe and sound operations of the Enterprises. It is
not necessary for the final rule to reference guidance that is already
applicable to the Enterprises or to impose specific requirements
related to third-party provider financial information. FHFA expects the
Enterprises to consider applicants in accordance with any applicable
FHFA guidance on the financial strength of third-party providers that
is in effect at the time of the relevant Credit Score Solicitation.
The final rule also permits the Enterprises to establish additional
requirements for qualifications of credit score model developers. The
Enterprises are required to include any such additional requirements in
the Credit Score Solicitation, and those requirements are subject to
FHFA review and approval as discussed above.
G. Demonstrated Use
The proposed rule would have required an applicant to demonstrate
use of the credit score by creditors to make lending decisions. The
proposed rule would not have established a standard for meeting the
demonstrated use component, but permits an Enterprise to address
criteria for demonstrating use in its Credit Score Solicitation. The
final rule adopts the same approach.
1. Proposed Rule
The proposed rule would have required the applicant to demonstrate
use of its credit score model by creditors to make credit decisions.
The requirement was designed to ensure that all credit score models
considered by an Enterprise are used or employed by lenders. The
proposed rule discussed various options for how an applicant might
demonstrate use (e.g., testimonials by non-mortgage and/or mortgage
lenders).
2. Comments Received
Most commenters supported the proposed requirement that applicants
demonstrate use of the credit score by creditors to make credit
decisions. One commenter suggested that this requirement could be
expanded to require ``substantial use in originating and securitizing
consumer credit products of the same credit quality as the
conventional, conforming mortgage loans that the Enterprises purchase
and securitize.'' In addition, commenters encouraged FHFA to include in
the final rule an ``objective and quantifiable standard of substantial
use.'' One commenter stated that while the demonstrated use requirement
``may impede innovation,'' the Enterprise pilot programs could engage
``untested'' credit scores.
3. Rationale for Final Rule
The final rule requires an applicant to demonstrate use of the
credit score by creditors to make credit decisions. The final rule does
not establish a standard for meeting the demonstrated use component,
but permits an Enterprise to address criteria for demonstrating use in
its Credit Score Solicitation. FHFA acknowledges that requiring credit
score models to demonstrate use in making credit decisions may limit
the number of applications submitted to the Enterprises. This concern
is partially addressed by the final rule provision permitting pilot
programs. The availability of pilot programs will be an essential
vehicle for new credit scores to demonstrate their performance history.
The provisions related to pilot programs are discussed in more detail
below.
H. Options for Evaluating Accuracy Test Results
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 accuracy
standard is measured by statistical testing. The final rule adopts a
transitional approach to evaluating the results of the statistical
testing.
Under the transitional approach, one standard for accuracy would be
applied to the initial Credit Score Assessment undertaken by an
Enterprise, and another standard would be applied to subsequent Credit
Score Assessments in response to a future solicitation. The
transitional approach will require the Enterprises to apply the same
standard to all applications received in response to the initial
solicitation. This transitional approach will permit an Enterprise to
assess the score currently in use, Classic FICO, pending a
determination on any other applications received by the Enterprise in
response to the initial Credit Score Solicitation.
1. Proposed Rule
FHFA proposed four options for evaluating credit score accuracy
test results in the Credit Score Assessment: A comparison approach, a
champion-challenger approach, a benchmark-based approach, and a
transitional approach. The four options reflect different approaches
for comparing the statistical results from the credit score models
being evaluated. The comparison approach would require an Enterprise to
consider the credit score accuracy results of the new model(s) but
would not establish a bright-line standard. The champion-challenger
approach would require that the accuracy of the new credit score exceed
the accuracy of the credit score(s) that are in use by the Enterprises.
The benchmark approach would require all applicants to meet or exceed a
benchmark established by regulation or by FHFA notice. The transitional
approach would apply one of the above approaches to the initial
solicitation and apply a different approach to subsequent evaluations.
[[Page 41895]]
2. Comments Received
A majority of the commenters who addressed the four options in the
proposed rule supported some variation of the transitional approach.
The primary rationale provided by commenters to support the
transitional approach was that the transitional approach would allow
for the validation and approval of Classic FICO in the initial Credit
Score Assessment. Some commenters recommended that the Enterprises
immediately validate and approve Classic FICO, while one commenter
stated that Classic FICO should be reviewed under the same process used
for any other credit score model.
Some commenters noted that Classic FICO has been tested by virtue
of its use across the industry and within Enterprise systems for many
years. These commenters stated that the Enterprises should be able to
validate and approve Classic FICO consistent with this final rule on an
expedited basis. One commenter stated that ``regardless of the option
that is adopted in the final rule, FHFA and the Enterprises should
validate and approve Classic FICO immediately rather than require the
model to undergo the lengthy process envisioned in the proposed rule.
Such a step would significantly reduce transition uncertainty for
market participants and ensure that there are no market disruptions
prior to the approval of any new models (including new models developed
by FICO).''
Most of the commenters that addressed the other options in the
proposed rule recommended that they be used in combination with the
transitional approach. A few commenters supported a standalone
champion-challenger approach, stating that it would provide a clear
standard for approval. Some commenters supported the comparison
approach as a means of ensuring that the credit score models currently
in use could meet the standard. Several other commenters opposed the
comparison approach, stating that it would provide too much discretion
and therefore would lack transparency. Similarly, most of the
commenters that addressed the benchmark approach opposed it due to
uncertainty about how the benchmark would be set.
3. Rationale for Final Rule
FHFA agrees that there are benefits to the industry to validate and
approve the score currently in use, Classic FICO, while also applying a
fair and rigorous validation and approval process for all credit score
model applications. The final rule provides that all credit score
models must meet the same criteria for validation and approval.
However, FHFA recognizes that the long use and widespread industry
acceptance of Classic FICO may allow an Enterprise to accelerate the
validation and approval process for this model.
The final rule adopts the transitional approach because it offers
the smoothest transition from the current use of Classic FICO to any
new credit score model. Section 310 permits an Enterprise to continue
to use the current credit score model until November 20, 2020. The
transitional approach will abate the risk of the Enterprises failing to
validate and approve a credit score model under the final rule before
this date.
Under the transitional approach, the standard for accuracy in the
initial Credit Score Assessment will be different from the standard for
accuracy in subsequent Credit Score Assessments. For the initial Credit
Score Assessment, a champion-challenger approach would be problematic
due to the lack of a validated and approved credit score to serve as
the champion. Multiple commenters suggested instead setting a benchmark
threshold based on the performance of Classic FICO for the initial
Credit Score Assessment.
The final rule requires the Enterprises to establish a credit score
accuracy benchmark for the initial Credit Score Assessment. FHFA
expects that the accuracy benchmark for the initial Credit Score
Assessment will be informed by the accuracy of the credit score model
currently used by the Enterprises, Classic FICO. Establishing a
benchmark informed by Classic FICO is appropriate because the model has
been used by the Enterprises and the mortgage finance industry for more
than 12 years. In addition, FHFA has found the Classic FICO score to be
a reasonable measure of default risk for the Enterprises' internal
purposes. The Enterprises will publish the accuracy benchmark for the
initial Credit Score Assessment in the initial Credit Score
Solicitation.
This approach to setting an accuracy benchmark for the initial
Credit Score Assessment will permit an Enterprise to validate and
approve Classic FICO while continuing to evaluate other credit score
models for which it receives applications in response to the initial
Credit Score Solicitation. If an Enterprise validates and approves
Classic FICO and then validates and approves another credit score
model, the Enterprise may replace Classic FICO with the newly validated
and approved credit score model.
The final rule adopts a credit score accuracy standard for Credit
Score Assessments in response to future solicitations that will be
based on the validated and approved credit score model(s) in use at
that time. This is equivalent to the champion-challenger approach where
the applicant's ``challenger'' credit score model must be more accurate
than the ``champion'' credit score model that is in use. One commenter
suggested adding an accuracy improvement margin such that the
applicant's credit score would have to be more accurate than the
existing credit score by a threshold.
Considering the implementation costs associated with introducing a
new credit score into the mortgage marketplace, requiring an
improvement in accuracy is reasonable. However, establishing such a
threshold in the final rule could provide less flexibility to the
Enterprises. An Enterprise may consider the relative accuracy of
different credit score models as part of the Enterprise Business
Assessment, including whether any improvement is sufficient to justify
the costs and benefits associated with adoption of a new credit score
requirement.
Several commenters mentioned the known testing bias where new
credit scores will seem more accurate than legacy credit scores, when
in fact they are not more accurate. In the absence of a simple solution
to abate the statistical bias, some commenters recommended requiring
new credit score models exceed the accuracy of the existing credit
score model. An alternative viewpoint expressed by two commenters was
that requiring an applicant's credit score to be equally as accurate as
the current credit score model in use would enable more credit score
models to pass the Credit Score Assessment and be evaluated in the
Enterprise Business Assessment phase.
One commenter stated that credit score models that pass the Credit
Score Assessment may have greater credibility in the market. However,
it is important to note that the Credit Score Assessment is only one
step of the overall validation and approval process. When an
application passes the Credit Score Assessment, an Enterprise has
determined that a credit score meets the minimum testing criteria for
the limited purpose of the Credit Score Assessment. The statistical
results of the Credit Score Assessment should not be extrapolated
beyond these minimum testing criteria. The Credit Score Assessment does
not evaluate the appropriateness of a credit score model for any other
purposes, and
[[Page 41896]]
an Enterprise determination as part of the Credit Score Assessment
should not be viewed as an endorsement of the credit score model.
I. Assessment of Impact on Enterprise Operations and Risk Management,
and Impact on Industry
The proposed rule would have required that the Enterprise Business
Assessment include a cost-benefit analysis of the potential operational
impact on industry and borrowers of using a particular credit score
model. FHFA received a number of comments raising concerns with the
potential cost and time required for an extensive cost-benefit
analysis, with some commenters concerned that the cost of this analysis
would be shifted to applicants through excessive upfront or assessed
fees. The final rule does not make any change to the proposed
provisions on application fees or cost-benefit analysis. Under the
final rule, the Enterprise is responsible for conducting the Enterprise
Business Assessment, which includes a cost-benefit analysis. The final
rule does not permit an Enterprise to assess an applicant for the costs
of this analysis beyond the upfront application fee and any assessment
for third-party data acquisition costs. The final rule also provides
that the cost-benefit analysis must be completed within the 240 days
allotted for completing the Enterprise Business Assessment.
1. Proposed Rule
Under the proposed rule, the Enterprise Business Assessment
included an evaluation of the impact that using the applicant's 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 in other FHFA regulations.\4\
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\4\ See 12 CFR part 1236 and 1239.
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The Enterprise Business Assessment would evaluate the impact of
using the applicant's credit score model on mortgage industry
operations and mortgage market liquidity, including costs associated
with implementation of a newly approved credit score model. This
evaluation also would consider whether the benefits of using credit
scores produced by that model can reasonably be expected to exceed the
costs. Consideration of the costs and benefits would include
implementation and ongoing costs, projected benefits and costs to the
Enterprises and borrowers, as well as potential impacts on market
liquidity and the cost and availability of credit.
2. Comments Received
Many commenters addressed the cost-benefit analysis in the
Enterprise Business Assessment. Commenters generally were in favor of
the proposed cost-benefit analysis in the Enterprise Business
Assessment. Several commenters cited the importance of this provision
as part of prudent decision-making practices. Other commenters
supported the provision but suggested changes, stating that the
provision was too vague and should explicitly require engagement with
industry stakeholders to seek input on industry costs.
Some commenters were concerned that the Enterprises would have an
unlimited amount of time to conduct the cost-benefit analysis and that
the costs of such an analysis would be borne by the applicant. One
commenter suggested that the cost-benefit analysis should be made
public, either through making the raw data from the Enterprises'
analysis available or in the form of an Enterprise white paper.
Several commenters, including associations representing smaller
lenders, expressed concern that replacement of a credit score model, or
the use of multiple credit score models at the same time, would present
significant lender implementation costs which might especially impact
smaller lenders. The commenters noted that those costs may not be worth
the benefits of a new credit score model, especially given the higher
expected costs associated with the use of multiple credit score models.
3. Rationale for Final Rule
The proposed rule included the requirement for a cost-benefit
analysis in the Enterprise Business Assessment, which was limited in
time and scope. The final rule adopts the cost-benefit analysis
provision as proposed. The final rule requires the cost-benefit
analysis to 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.
Because the cost-benefit analysis is one element of the overall
Enterprise Business Assessment, the cost-benefit analysis must be
conducted within the 240-day timeframe for completing the Enterprise
Business Assessment.
The final rule provides that each applicant must pay an up-front
application fee established by the Enterprise. This application fee is
intended to cover the direct costs to the Enterprise of conducting the
Credit Score Assessment. An Enterprise also may assess an applicant for
the cost of obtaining third-party data and credit scores necessary for
testing purposes. The Enterprises are responsible for any costs
associated with the Enterprise Business Assessment.
Finally, the final rule does not make changes in response to
comments recommending that the rule be more explicit about engaging
with industry stakeholders. FHFA expects that the Enterprises will
engage with industry stakeholders if necessary to complete the cost-
benefit analysis. For example, an Enterprise may consider the need for
mortgage insurers to update and submit their premium rate sheets to
state insurance regulators for approval, as well as the need for MBS
and CRT investors to re-estimate mortgage performance and valuation
models.
J. Competitive Effects
As discussed above, the final rule does not include the proposed
conflicts-of-interest certification, which would have required
independence of a credit score model developer from any data provider.
However, the final rule still includes an evaluation of competitive
effects as one component of the Enterprise Business Assessment. This
will allow an Enterprise to consider whether using a particular model
would promote or discourage competition in the industry.
1. Proposed Rule
The proposed rule would have required the Enterprise Business
Assessment to include an evaluation of whether using the applicant's
credit score model could have an impact on competition in the industry.
This evaluation would 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.
2. Comments Received
FHFA received numerous comments on the proposed competition
provisions. As previously discussed, many commenters opposed the
conflicts-of-interest certification requirement in the application, and
FHFA is eliminating the requirement for an applicant to certify its
independence as a component of the application. However, many
commenters also suggested that it is appropriate for an Enterprise to
consider whether using a particular credit score
[[Page 41897]]
model may have competitive effects on the industry--positive or
negative--during an Enterprise Business Assessment.
These commenters supported addressing competition as part of the
rulemaking and the Enterprise evaluations, with some commenters
believing that ``that increased market competition in the credit-score
industry could be beneficial to both consumers and lenders because it
can improve efficiency, decrease pricing, and potentially expand the
market of consumers for mortgage products.'' Other commenters expressed
concerns about vertical integration and about the lack of other
participants in the credit score market.
3. Rationale for Final Rule
The final rule adopts the provision requiring the Enterprise
Business Assessment to include consideration of the potential impact
selection of a credit score could have on competition. An Enterprise
may consider whether using a particular credit score model would
contribute to consolidation or vertical integration. This type of
evaluation is not unusual for the Enterprises. In the normal course of
business, an Enterprise may consider the potential impact on
consolidation as part of its review of third-party providers. For
example, the Enterprises consider consolidation risk when doing
business with servicers, sub-servicers, counterparties, vendors, and
third-party providers. A similar evaluation is appropriate for the
review of competitive effects in the market for credit score model
developers.
An assessment of competitive effects is just one component of the
broader Enterprise Business Assessment. Overall, the Enterprise
Business Assessment requires the Enterprises to consider multiple
factors including, but not limited to, review of fair lending impacts,
impact on risk management, and assessment of the credit score model
developer as a third-party provider. FHFA expects that an Enterprise's
review of competitive effects will be considered in conjunction with
all other criteria established for the Enterprise Business Assessment.
K. Pilot Programs
Section 310 requires that a credit score model have a historical
record of measuring and predicting default rates and other credit
behaviors. This could pose a challenge for newer credit scores. The
proposed rule would have allowed for the Enterprises to use pilot
programs for credit scores as a way for the Enterprises to evaluate and
track performance of potential new credit scores with minimal
disruption. Comments were supportive of the proposed provision on pilot
programs, which the final rule adopts, with some clarifications.
1. Proposed Rule
The proposed rule would have permitted the Enterprises to engage in
pilot programs to learn about credit score models. Such pilot programs
would balance the section 310 requirement that a credit score model
have ``a historical record of measuring and predicting default rates
and other credit behaviors'' with desirable innovation in credit score
models. A pilot program could assist an Enterprise in determining the
appropriate standards and criteria for a Credit Score Solicitation,
including requirements for applications from credit score model
developers.
The proposed rule would have required FHFA to review and approve
any credit score pilot of an Enterprise, and the proposed rule would
have permitted FHFA to impose terms, conditions, and limitations as it
deemed appropriate. Pilot programs generally would be of limited
duration and scope. This would reinforce the ``test and learn'' nature
of a pilot program and would ensure consistency with section 310's
requirement that any score used by an Enterprise be validated and
approved.
2. Comments Received
All of the commenters that addressed pilot programs supported
allowing the Enterprises to engage in pilot programs and other testing
initiatives. One commenter stated that ``[t]his is perhaps the most
important provision in the proposed rule. And it will be the provision
with the most long-lasting impact in terms of encouraging innovation
and progress,'' if new scoring models are able to help ``thin'' or
``no-file'' consumers and expand access to mortgage credit without
increasing risk. Another commenter stated that ``[t]he pilot program
process that [FHFA proposed] for new scoring models in the rule is
exactly the right approach to encourage and promote innovation,
competition and the use of true alternative data and alternative
methods,'' and that pilots should be encouraged rather than just
permitted. Other commenters agreed that pilots would be consistent with
the intent of section 310, which they described as encouraging
competition among and innovation by credit score model developers.
Several commenters noted that pilots could be helpful in advancing the
use of alternative data such as rental, utility, and telecommunications
data, as well as consumer-permissioned data such as depository data.
Several commenters suggested types of pilots that might be
beneficial. One commenter suggested that the Enterprises could conduct
a pilot on ``a subset of borrowers that did not have a credit score and
were manually underwritten by the Enterprises to assess how well a new
credit score predicts the propensity of these borrower to repay their
mortgages.'' Another commenter suggested pilot programs ``for new
models that go beyond conventional minimum scoring criteria'' to score
consumers new to credit (those whose credit files show no accounts that
have been opened for six or more months), consumers who may be
``involuntarily inactive'' and have derogatory information such as a
past delinquency on file, and consumers who are voluntarily inactive.
Pilot programs for credit score models that use alternative data could
demonstrate whether future models using such data would be able to
accurately and inclusively score a larger portion of the population.
Several commenters suggested that the final rule provide for
transparency and public awareness of pilot programs. One commenter
suggested FHFA publicly report on new pilots and the results of pilots
while another suggested FHFA ``maximize'' transparency by regularly
informing the public of approved pilots, publicly sharing the results
from pilots, and providing the public information about Enterprise and
FHFA actions that follow pilots. Similarly, another commenter suggested
that the terms of pilots should be transparent, limitations on duration
and scope should be made publicly available, and that the public should
be provided information on the types of institutions participating in
the pilot and the qualitative and quantitative metrics for evaluating
pilots.
One commenter suggested that requirements for implementing a pilot
be less restrictive and time intensive than the proposed credit score
model validation and approval process. Another commenter suggested that
all pilot program applicants be assessed and compared against each
other, considering that there would be no incumbent or benchmark credit
score model to use for comparison. That commenter also noted that
pilots should include model testing across the populations and market
conditions they are intended to address.
[[Page 41898]]
Some commenters also addressed transitioning from a pilot program
to wider use of a validated and approved credit score, with one
commenter suggesting that a model that successfully completes a pilot
program then be eligible to undergo a Credit Score Assessment and
another suggesting that FHFA provide clear guidance about how a credit
score model would transition from a pilot program to the full
validation and approval process to full implementation by the
Enterprises.
3. Rationale for Final Rule
To promote public awareness and transparency, FHFA intends to apply
as much of the credit score validation and approval process established
by this final rule as is appropriate, considering the nature of any
pilot programs that may be considered by an Enterprise. For example,
FHFA anticipates that the Enterprises may solicit applications for
pilot programs. A solicitation for pilot programs would include much of
the same information as a Credit Score Solicitation. Because of the
potentially wide variation among pilot programs, the final rule does
not restrict the ability of FHFA or the Enterprises to vary the
requirements for a pilot program solicitation based on the specific
pilot program in question.
The final rule requires that an Enterprise must submit any pilot
program to FHFA for review and approval. An Enterprise may submit a
proposed pilot program at any time, regardless of whether FHFA has
initiated a solicitation period for all applicants. FHFA may impose
terms, conditions, or limitations on the pilot program to ensure that
it clearly addresses any regulatory requirements that a pilot applicant
is required to meet and any other Enterprise standards and criteria.
To address concerns that pilots might be perceived as
``exceptions'' to the full regulatory validation and approval process,
the final rule provides that each pilot program will be subject to
limits on the duration and scope of the pilot. The final rule allows
FHFA to extend the duration of a pilot for good cause shown.
FHFA acknowledges the interest commenters expressed in making
information about pilots publicly available. FHFA expects to assess
publication of information about pilot programs in the context of the
review and approval process for pilots.
IV. Other Comments Received
This section addresses comments on other significant topics,
including themes outside the scope of this rulemaking.
A. Lender Choice
Some commenters suggested that the final rule permit lenders to
select the credit score used to underwrite a mortgage for delivery to
an Enterprise. While the concept of lender choice was one of four
approaches on which FHFA requested input from the public in the 2017
Credit Score RFI, this issue is outside the scope of this rulemaking.
As stated previously, the final rule does not address how multiple
approved credit score models would be implemented.
B. Tri-Merged Credit Report
The Enterprises have long required a tri-merged credit report,
pursuant to which lenders are required to purchase credit scores and
credit reports from all three CRAs. Several commenters noted that
competition could be encouraged among the CRAs if the Enterprise
requirement for a tri-merged report was eliminated. While FHFA stated
in the 2017 Credit Score RFI that changes to the tri-merged report are
under consideration, the tri-merged report requirement is outside the
scope of this rulemaking.
While FHFA may at some point review and evaluate changing the
requirement of lenders to purchase credit reports and scores from all
three CRAs, FHFA and the Enterprises would need to fully understand the
costs and benefits before making any change to the tri-merge
requirement. FHFA aims to simplify and reduce costs associated with
mortgage origination and the acquisition process, while ensuring the
Enterprises manage their credit risk exposure appropriately.
C. Encourage New Credit Data Repositories
One commenter stated that FHFA should encourage the creation of
additional credit data repositories. The commenter suggested that one
mechanism for encouraging such new entrants would be to require the
Enterprises to sell mortgage payment data to any new credit data
repositories. While FHFA supports competition in the credit data and
credit score industry generally, the specific steps recommended by the
commenter are outside the scope of this rulemaking.
D. Use of Nontraditional Consumer Credit Data
Several commenters supported the use of consumer credit data that
is not traditionally found in the CRAs. FHFA agrees with commenters on
the potential benefits of using nontraditional data, such as data on
payment of rent, utility data, or telecommunications data. The
Enterprises currently consider alternative housing-related data such as
rental payments or utility payments where available. However, the use
of nontraditional consumer credit data is outside the scope of this
rulemaking.
E. Transparency/Release of Information
Several commenters suggested that FHFA or the Enterprises make
additional disclosures of information if and when a new credit score
model is to be implemented. These commenters requested that FHFA or the
Enterprises disclose the criteria for, and the results of, any cost-
benefit analysis of a new credit score model, and also that
comprehensive data be disclosed so the market can understand the impact
of a new credit score model. The commenters stated that this type of
transparency will increase confidence in the new credit score model.
Although a discussion of implementation is outside the scope of
this rulemaking, FHFA acknowledges the importance of public
understanding of the impact of, and confidence in, any new credit score
model. FHFA and the Enterprises will consider how to facilitate public
understanding of any new credit score model, including the potential
sharing of non-proprietary information, at the time a new credit score
model is approved.
F. Request for Enterprises To Provide Raw Credit Score Data
Some commenters requested that the Enterprises provide access to
the historical loan-level data and credit scores used for the empirical
testing of credit scores conducted by FHFA and the Enterprises from
2015 to 2018 pursuant to FHFA's Conservatorship Scorecards. FHFA
received similar requests in response to the 2017 Credit Score RFI.
While the data used for that empirical testing has not been made
public, Enterprises make available to the public several other loan-
level data sets that include credit scores.
The final rule does not require the Enterprises to make data
available to industry or the public for parallel testing. The data used
for empirical testing of credit scores is generally proprietary data
that may be costly to obtain and may be subject to restrictions on
further sharing. Industry participants are encouraged to work with the
credit score model developers and CRAs to acquire any data needed to
update their internal models or to conduct parallel testing of credit
score models.
[[Page 41899]]
G. Consider Enterprise Mission
While several commenters noted the Enterprises' public mission, one
commenter requested that FHFA revise its proposal on the Enterprise
Business Assessment to require consideration of the positive effect a
model could have on expanding the universe of creditworthy borrowers
and potential homebuyers, as an offsetting factor to the cost of
adopting and implementing that model. FHFA believes this sentiment is
already reflected in the final rule, which requires the Enterprises to
consider potential benefits to borrowers, including benefits related to
cost and availability of credit. FHFA also interprets its regulations,
and expects the Enterprise to implement them, with full awareness of
other statutory duties that may be implicated, including duties related
to Enterprise safety and soundness, acting consistently with the public
interest, support of mortgages for low- and moderate-income families,
and compliance with fair lending laws. Consequently, FHFA does not
believe the requested change is necessary.
H. Consider Eliminating LLPAs and Delivery Fees
Some commenters noted that consumers with lower credit scores are
more likely to be subject to higher LLPAs and Delivery Fees and thus
may pay more for credit. One commenter noted that consumers with lower
credit scores are disproportionately likely to have low or moderate
incomes or to be minorities. The commenter stated that LLPAs and
Delivery Fees could reduce access to credit for such consumers and
suggested eliminating LLPAs and Delivery Fees on that basis.
LLPAs and Delivery Fees are used by the Enterprises to compensate
for the credit risk of a mortgage loan. To the extent that credit
scores are used in setting the LLPAs and Delivery Fees, the final rule
requires that the credit scores be produced from validated and approved
models. As other commenters have expressed, innovation in credit score
models could result in improved understanding of borrower
creditworthiness that may result in reduced cost of credit for some
borrowers. However, the question of establishing specific requirements
for Enterprise loan pricing (including LLPAs and Delivery Fees) is
outside the scope of this rulemaking.
I. Discontinue the Rulemaking
One commenter stated that the proposed rule is a waste of taxpayer
dollars. The commenter urged FHFA to discontinue the rulemaking process
and to go back to Congress to gain additional guidance. However,
section 310 requires FHFA to establish standards and criteria for the
validation and approval of credit score models. This final rule meets
that statutory obligation.
V. Section-by-Section Analysis of Final Rule
A. Purpose and Scope, Definitions, and Computation of Time--Sec. Sec.
1254.1, 1254.2 and 1254.3
Section 1254.1 of the final rule sets out the purpose of the final
rule, to establish the standards and criteria that an Enterprise must
satisfy in creating a process for the validation and approval of credit
score models. Section 1254.1 of the final rule also describes the four
major components of the validation and approval process.
Section 1254.2 of the final rule defines key terms used in the
regulation. The definitions distinguish between a ``credit score'' and
a ``credit score model.'' As defined in the final rule, a ``credit
score'' is a numerical value that is derived from a statistical tool or
model, while a ``credit score model'' is the statistical tool or model
itself. Consistent with section 310, the definition of ``credit score
model'' is limited to models created by third parties. In other words,
``credit score model'' does not include any statistical tool or model
created by an Enterprise, such as an AUS. The final rule defines a
``credit score model developer'' as any person with ownership rights in
the intellectual property of a credit score model.
The proposed rule would have defined ``nationwide consumer
reporting agency'' consistent with the definition in the Fair Credit
Reporting Act (15 U.S.C. 1681a). The final rule omits this definition
because the term is not used in the regulation.
Section 1254.3 of the final rule clarifies how time periods will be
measured for the various requirements and deadlines set forth in the
final rule.
B. Enterprise Use of Credit Scores--Sec. 1254.4
Section 1254.4 of the final rule provides that an Enterprise is not
required to use a credit score for any business purpose. However, if an
Enterprise requires a credit score as a condition of purchasing a
mortgage, the credit score must be produced by a credit score model
that has been validated and approved in accordance with the final rule.
As discussed in more detail above, the final rule permits an Enterprise
to use credit scores that are subject to a limited pilot program being
conducted by the Enterprise in accordance with the final rule.
Section 1254.4 of the final rule also provides that an Enterprise
may replace any validated and approved credit score with any other
validated and approved credit score. The proposed rule would have
provided that such replacement was at the discretion of the Enterprise.
However, as discussed in more detail above, the final rule provides
that an Enterprise must submit any proposed determination to FHFA for
review and approval. This prior approval requirement applies to any
proposed determination to replace one credit score model with another,
and so the final rule omits the phrase indicating that replacement is
at an Enterprise's discretion. However, the final rule still provides
that use of a credit score model by an Enterprise does not create any
expectation of or right to continued use of that credit score model.
C. Enterprise Solicitation of Applications From Credit Score Model
Developers--Sec. 1254.5
The final rule addresses the solicitation process, the minimum
required contents of an Enterprise solicitation, and details and timing
of the review of Enterprise proposed solicitations by FHFA prior to
Enterprise publication. The final rule establishes that the
solicitation process involves: (1) A notice from FHFA to the
Enterprises that FHFA has determined that the Enterprises must
undertake a solicitation; (2) development of a Credit Score
Solicitation by each Enterprise; (3) review and approval of the Credit
Score Solicitation by FHFA; (4) publication of the Credit Score
Solicitation by the Enterprise; and (5) the time period during which
the Enterprises will accept applications for validation and approval of
credit score models. Each step is addressed below.
1. Solicitation Process Initiated by FHFA
Section 1254.5(a) of the final rule permits FHFA to require the
Enterprises to solicit applications from credit score model developers
for the review and approval of the credit score model by an Enterprise.
FHFA will determine in its discretion whether to open a solicitation
for credit score model developers to apply for consideration.
FHFA may open a solicitation at its own initiative or based on a
request from an Enterprise or any other party. Such requests may be
based on a reasonable belief on the part of an Enterprise or interested
party that a new score has the potential to be materially
[[Page 41900]]
beneficial to the mortgage market and merits earlier consideration. In
determining the need for future solicitations, FHFA will consider
potential benefits of updating the credit score model requirements and
the costs to industry of changing from one credit score model to
another, and whether an update to the credit score model could be
achieved by an enhancement to an Enterprise AUS. For example, FHFA may
determine there is no need to open a solicitation in the future because
an Enterprise no longer conditions mortgage purchases on the provision
of a credit score.
Section 1254.5(a) of the final rule also provides that FHFA will
notify an Enterprise of the requirement to solicit applications. The
notice will state when the Enterprise must begin soliciting
applications, the deadline for an Enterprise to submit its proposed
Credit Score Solicitation to FHFA, and the length of time the
solicitation period is open. Each Enterprise is required to submit a
``Credit Score Solicitation'' to FHFA for review and approval in
response to an FHFA initiated solicitation.
The final rule does not require an Enterprise to consider any
application that is received outside of a solicitation established by
FHFA. An Enterprise could review and conduct preliminary empirical
analysis if an application is received outside of a particular
solicitation, and this analysis could prompt an Enterprise to request
that FHFA open a solicitation. However, an Enterprise would not be
permitted to approve an application that was not submitted in response
to a solicitation.
2. Required Content of a Credit Score Solicitation
Section 1254.5(b) of the final rule requires that a ``Credit Score
Solicitation'' must cover the Enterprise's validation and approval
process, including the requirements that an application must meet in
order for a credit score model to be considered by an Enterprise. The
final rule permits the Enterprises to establish requirements in
addition to those set forth in the rule.
Specifically, the final rule requires each Credit Score
Solicitation to provide the opening and closing dates of the period
during which applications will be accepted, describe information that
must be included in each application, and describe the process by which
the Enterprise will obtain data for assessing applicants' credit score
models. The Credit Score Solicitation must describe the Enterprise
validation and approval process, including the processes for the Credit
Score Assessment and the Enterprise Business Assessment. The process
must be in accordance with the minimum standards and criteria of
section 310 and the final rule. For example, the Credit Score
Solicitation must address the 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, as required by section 310.
The final rule establishes 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 final rule both permit additional standards and
criteria to be imposed by an Enterprise. Any additional standards,
criteria, or requirements must be included in the Credit Score
Solicitation, and are subject to FHFA review and approval.
3. FHFA Review of Enterprise Solicitation
Section 1254.5(c) of the final rule requires FHFA to review and
approve or disapprove each Credit Score Solicitation submitted by an
Enterprise, including any Credit Score Solicitations submitted jointly
by the Enterprises. The final rule requires an Enterprise to submit a
Credit Score Solicitation for FHFA review prior to the start of the
solicitation period. FHFA may object to any additional Enterprise
standards, criteria, or requirements, or impose any terms, conditions,
or limitations that FHFA determines appropriate. The final rule
establishes a 45-day period for FHFA to complete its review, which may
be extended by FHFA if necessary.
Because the Credit Score Solicitation must describe the Enterprise
validation and approval process, FHFA's review of each Credit Score
Solicitation meets the statutory requirement that FHFA ``periodically''
review the Enterprise validation and approval process.\5\ This review
does not prevent FHFA from reviewing an Enterprise's validation and
approval process as part of its usual supervisory processes, including
examinations.
---------------------------------------------------------------------------
\5\ 12 U.S.C. 1454(d)(8) and 1717(b)(7)(H).
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4. Publication of Credit Score Solicitation
Section 1254.5(d) of the final rule provides that after receiving
approval of the Credit Score Solicitation from FHFA, the Enterprise
must make publicly available the Credit Score Solicitation for at least
90 days prior to the start of the solicitation time period. This will
provide prospective applicants time to consider whether to submit an
application for review. In particular, the 90-day publication period
will provide applicants a reasonable period to review the fees and the
information required to complete an application prior to expending
resources to submit an application. The publication of the Enterprise
Credit Score Solicitation satisfies section 310's requirement that an
Enterprise ``make publicly available'' a description of its validation
and approval process.
5. Timeframes for Solicitation
Section 1254.5(a) provides that the solicitation period will be
determined by FHFA. Based on comments received, FHFA wants to ensure
that the Enterprises are accepting applications concurrently.
Therefore, FHFA expects to require each Enterprise to publish its
Credit Score Solicitation on the same date. Section 1254.5(e) of the
final rule requires that each Enterprise submit its Credit Score
Solicitation for the initial solicitation within 60 days of the
effective date of the final rule. The initial solicitation time period
will begin on a date determined by FHFA and will extend for 120 days.
For future solicitation time periods, FHFA will review the Credit Score
Solicitations submitted by the Enterprises and consider the appropriate
length of time the solicitation window should be open.
D. Submission and Initial Review of Applications--Sec. 1254.6
1. Overview
Section 1254.6 of the final rule establishes the minimum criteria
an application must meet to be considered complete, including: (1) An
application fee; (2) a fair lending certification; (3) information to
demonstrate use of the credit score model by the lending industry; (4)
information on the qualifications of the credit score model developer;
and (5) any other information required by an Enterprise in the Credit
Score Solicitation. The final rule also addresses submission of
applications, Enterprise determination of each application's
completeness, notice to applicants of the status of the application as
complete, and acquisition of historical consumer credit data by an
Enterprise. Finally, the final rule establishes that an Enterprise is
not required to evaluate any application that is not complete.
2. Application Fees and Enterprise Assessment for Costs
Section 1254.6(a)(1) of the final rule requires each applicant to
pay an
[[Page 41901]]
application fee that is intended to cover the direct cost to the
Enterprise of the Credit Score Assessment. The final rule also permits
an Enterprise to address conditions under which it would refund a
portion of the application fee. Section 1254.6(b) of the final rule
also permits 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 Certification and Compliance
Section 1254.6(a)(2) of the final rule requires each applicant to
address compliance of the credit score model and the credit scores it
produces with federal fair lending requirements, and to certify that no
characteristic used in the development of the credit score model or as
a factor in the credit score model to produce credit scores is based
directly on or is highly correlated solely with prohibited
classifications, as defined by 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)).
4. Demonstrated Use
Section 1254.6(a)(3) of the final rule requires an applicant to
demonstrate use of the credit score by creditors to make lending
decisions. The final rule does not establish a standard for meeting the
demonstrated use component, but permits an Enterprise to address
criteria for demonstrating use in its Credit Score Solicitation.
Enterprise criteria may include, for example, submissions of
testimonials by lenders who use the applicant's credit score for
underwriting credit.
5. Qualifications of Credit Score Model Developer
Section 1254.6(a)(4) of the final rule requires each applicant to
provide information on the qualifications of the credit score model
developer, including a description of the developer's relevant
experience, financial capacity, corporate structure (including
relationships through common control or ownership), governance
structure, and past financial performance. Each Credit Score
Solicitation may also set forth other required information related to
qualifications, in the Enterprise's discretion.
6. Additional Enterprise Standards and Criteria
Section 1254.6(a)(5) of the final rule permits the Enterprises to
establish additional requirements for applicants. Each Enterprise must
include all application requirements in its Credit Score Solicitation,
including requirements established by the Enterprise in addition to
those established by the final rule.
7. Data Acquisition
Section 1254.6(b) of the final rule permits an Enterprise to
acquire any historical consumer credit data necessary to test the
credit score model's record of measuring default rates and other credit
behaviors. Such data typically include historical credit scores on a
test set of existing Enterprise loans at origination. Applicants whose
credit scores incorporate multiple sources of consumer credit
information (e.g., credit scores based on information from the
nationwide CRAs augmented with data outside of the three nationwide
CRAs) will be required to work with the Enterprises on a process to
obtain the applicant's credit scores on existing Enterprise loans. FHFA
recognizes that information required from a third party, such as
consumer credit data, may be beyond the control of the applicant. The
final rule permits third parties to deliver information to an
Enterprise within a reasonable time period that may extend beyond the
120-day solicitation period. However, an application is not complete
unless and until an Enterprise has received all the necessary data
needed to undertake a Credit Score Assessment.
As stated above, the final rule also permits an Enterprise to
assess applicants for reasonable costs associated with the acquisition
of third-party data and credit scores.
8. Completeness of Applications
Section 1254.6(c) of the final rule requires the Enterprises to
review each application that is submitted within the solicitation
period. Within 60 days after the date of submission, the Enterprise
must provide the applicant a status notice of the application. Each
applicant will be responsible for submitting the documentation required
within the timeframe imposed by the final rule. If the applicant needs
to provide additional information in order for the application to be
complete, the deadline for submitting that information is the close of
the solicitation period. Required information from a third party, such
as consumer credit data, may be submitted to an Enterprise after the
close of the solicitation period.
The final rule provides that an application is complete when an
Enterprise determines that the 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 for use by the Enterprise).
The final rule establishes that an Enterprise has no obligation to
assess any incomplete application. As required by section 310, each
applicant will 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, the applicant would have the opportunity to respond within
the designated 120-day solicitation period.
The final rule does not require an Enterprise to consider any
application that is received outside of a solicitation established by
FHFA. An Enterprise could review and conduct preliminary empirical
analysis if an application is received outside of a particular
solicitation, and this analysis could prompt an Enterprise to request
that FHFA open a solicitation. However, an Enterprise would not be
permitted to approve an application that was not submitted in response
to a solicitation.
E. Credit Score Assessment--Sec. 1254.7
1. Overview
Section 1254.7 of the final rule requires each Enterprise to
undertake a Credit Score Assessment of each credit score model for
which it has received a complete application. The Credit Score
Assessment includes an evaluation of the accuracy, reliability, and
integrity of credit scores on a stand-alone basis (outside of an
Enterprise's internal systems and procedures). The final rule addresses
the standards or criteria for accuracy, reliability, and integrity for
this purpose, and sets forth an accuracy standard for the initial
Credit Score Solicitation to facilitate the transition to validated and
approved credit score models. The final rule also addresses who may
conduct such evaluations, and the timeframe in which the Credit Score
Assessment must be completed.
2. Testing for Accuracy and Reliability
Section 1254.7(b) of the final rule requires that the Enterprises
conduct statistical testing that uses one or more industry standard
statistical tests for demonstrating divergence among borrowers'
propensity to repay, applied to mortgages purchased by an Enterprise.
The final rule does not define specific parameters for the testing that
would be conducted by an Enterprise for accuracy testing. Although the
final rule allows flexibility for the Enterprises to define the
specific parameters of testing, FHFA requires
[[Page 41902]]
that the Enterprise testing requirements include a common definition of
default.
The definition of default is critical to accuracy and reliability
testing of a credit score. A definition of default 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 during the Credit Score Assessment. However, FHFA
encourages the Enterprises to consider testing using other definitions
in addition to the testing using the generally-accepted definition.
FHFA requested comment on any additional default definitions.
Commenters generally supported the proposed language and mentioned the
benefits of the Enterprises using an aligned definition of default. One
commenter indicated that the definition of default should be longer
given that mortgages have long maturities. The predictive power of
credit scores at origination declines as the mortgage ages beyond two
years, while other factors like payment history and home equity (or
LTV) increase in predictive power. While the aligned definition of
default is reasonable, consistent with industry standard and consistent
with how the Enterprises use credit scores, the Enterprises are
encouraged to test longer performance windows.
The final rule includes a requirement that the Enterprise test
accuracy and reliability on subgroups of loans. The loan sets obtained
for testing would have to contain sufficient observations to perform
the 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,
and thin credit file loans at origination, as well as 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 the accuracy of credit score models is critically important
to borrowers and investors for thin files because such credit scores
will likely be close to current underwriting thresholds.
3. Accuracy Standard
Section 1254.7(c)(1) of the final rule provides that 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. An accurate credit score 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.
The final rule requires an Enterprise to establish a credit score
accuracy cutoff as a benchmark for the initial Credit Score Assessment.
Applicants' credit scores must be as accurate as the benchmark in order
to pass the Credit Score Assessment. FHFA expects that the benchmark
for the initial Credit Score Assessment will be informed by the
accuracy of the credit score in use today, Classic FICO.
The final rule establishes that future Credit Score Assessments
must use the validated and approved credit score models in use at the
time the testing is conducted as the accuracy standard. Basing the
benchmark on the most accurate validated and approved score in use at
that time is equivalent to the champion-challenger approach where the
applicant's credit score model (the ``challenger'') must be more
accurate than the existing credit score model in use (the
``champion'').
4. Reliability Standard
Section 1254.7(c)(2) of the final rule establishes the 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 final rule requires that an Enterprise evaluate whether a
new 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.
The final rule requires an Enterprise to 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.
5. Integrity Standard
Section 1254.7(c)(3) of the final rule establishes 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 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).
One commenter recommended that the integrity standard in proposed
Sec. 1254.7(b)(3) also provide that ``No credit score model may be
eliminated from consideration based solely on the test for integrity,
unless it clearly fails to meet the criteria set out by the Enterprise,
but performance on this test may be considered as one factor in the
overall Credit Score Assessment.'' FHFA recognizes that the integrity
standard in the final rule is more subjective than the accuracy and
reliability standards, which are based on statistical testing. However,
determining whether particular data elements are relevant to the
borrower's credit history and financial performance is necessarily a
subjective determination. The additional language recommended by this
commenter would not change the subjective nature of the determination
and therefore the final rule does not include the suggested language.
FHFA expects the Enterprises to apply the integrity standard based on
their reasonable judgment of which data elements are necessary for a
credit score model to consider.
The integrity standard should 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. Improvements
in the range of consumer information available to credit score model
developers may improve credit score accuracy. The integrity standard is
designed to permit credit score model developers to innovate.
6. Additional Enterprise Standards and Criteria
Section 1254.7(c)(4) of the final rule permits an Enterprise 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.
[[Page 41903]]
7. Required Testing
Section 1254.7(c) of the final rule permits 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. In addition, the
Enterprises are permitted to jointly conduct the Credit Score
Assessment for all complete applications received in response to a
solicitation.
8. Timing and Notices
Section 1254.7(d) of the final rule requires an Enterprise to
provide a notice to each applicant that has submitted a complete
application when an Enterprise will begin the Credit Score Assessment.
The final rule provides that the Credit Score Assessment will begin no
earlier than the close of the solicitation period unless FHFA
determines that the assessment should begin on an earlier date. For
example, FHFA may permit an Enterprise to begin a Credit Score
Assessment prior to the close of the solicitation period if an
Enterprise has concluded the application is complete, and the
Enterprise has all the necessary data to begin a Credit Score
Assessment.
The final rule requires an Enterprise to complete the Credit Score
Assessment period within 180 days. The final rule permits FHFA 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.
Section 1254.7(d) of the final rule also requires that an
Enterprise notify an applicant if the application has passed the Credit
Score Assessment. The final rule requires that this notification be
provided no later than 30 days after the Enterprise has determined that
the application has passed the Credit Score Assessment. If an
application does not pass the Credit Score Assessment, the Enterprise
would submit a proposed determination to FHFA as described in section
1254.9.
F. Enterprise Business Assessment--Sec. 1254.8
1. Overview
Section 1254.8 of the final rule requires Fannie Mae and Freddie
Mac to independently undertake an Enterprise Business Assessment for
each credit score model that the Enterprise determines has passed the
Credit Score Assessment. The Enterprise Business Assessment must
include: (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 of using the credit score
within the Enterprise systems and processes that use credit scores; (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 provider; and (6) any other Enterprise standards and criteria.
Because the Enterprises operate different systems, different business
models, and different credit tolerances, the Enterprise Business
Assessment requires each Enterprise to assess credit scores based on
its specific business needs.
2. Accuracy and Reliability of Credit Scores Within Enterprise Systems
Section 1254.8(b)(1) of the final rule requires an Enterprise to
evaluate the accuracy and reliability of the credit score model when
used within the Enterprise systems and processes. This evaluation must
consider whether the credit score produced by an applicant's model is
more accurate than, and at least as reliable as, the credit score that
is then in use by the Enterprise. The Enterprise Business Assessment
does not require an Enterprise to consider a credit score model's
integrity, because the integrity of a credit score model would be
established in the Credit Score Assessment phase and would not change
when used in an Enterprise system or process.
3. Fair Lending Assessment
Section 1254.8(b)(2) of the final rule requires an Enterprise to
evaluate the fair lending risk and fair lending impact of using the
applicant's credit score model, in accordance with standards and
requirements of federal fair lending laws. The fair lending assessment
must also consider any impact on access to credit related to use of
that credit score model.
4. Assessment of Impact on Enterprise Operations and Risk Management,
and Impact on Industry
Section 1254.8(b)(3) of the final rule requires an Enterprise to
consider operational impacts to the Enterprises of using the credit
score produced by the applicant's credit score model, such as
implementation timing and potential impacts on Enterprise risk
management. That evaluation must consider whether the benefits of using
the applicant's credit score can reasonably be expected to exceed the
adoption and ongoing costs of using that credit score, considering
costs and benefits to the Enterprises. The Enterprise also must
consider potential costs and benefits across the entire mortgage
industry--origination, servicing, and securitization--of adopting a
newly validated and approved credit score model. The final rule also
requires an Enterprise to consider potential impacts on mortgage
eligibility criteria and Enterprise pricing for loan purchases as part
of any assessment.
5. Competitive Effects
Section 1254.8(b)(4) of the final rule requires an Enterprise to
evaluate whether using the applicant's credit score model could have an
impact on competition in the credit reporting and credit scoring
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 Provider Review
Section 1254.8(b)(5) of the final rule requires an Enterprise to
conduct a comprehensive third-party provider review for all applicants,
consistent with the Enterprise's standards for approval of third-party
providers. This review should address any financial, governance,
operational, compliance, legal, and reputational risks associated with
the third party.
7. Enterprise Standards and Criteria
Section 1254.8(b)(6) of the final rule permits an Enterprise to
establish additional requirements for the Enterprise Business
Assessment. An Enterprise is required to include any additional
requirements in its Credit Score Solicitation, and those requirements
are subject to FHFA review and approval as previously discussed.
8. Timing
Section 1254.8(c) of the final rule requires that an Enterprise
complete its Enterprise Business Assessment within 240 days.
9. FHFA Evaluation
Section 1254.8(d) of the final rule provides that FHFA will conduct
an independent analysis of the potential impacts of any change to an
Enterprise's credit score model. This analysis will be conducted at the
same time as the Enterprise Business Assessment. The analysis will
provide a mechanism for FHFA to make determinations in its capacity as
safety and soundness
[[Page 41904]]
regulator of the Enterprises with respect to the Enterprise use of
credit scores. Under the final rule, the FHFA evaluation could result
in a requirement that an Enterprise conduct additional analysis or
reporting related to credit scores. The FHFA evaluation would also
permit FHFA to determine whether the Enterprises will continue to use a
single credit score or will permit the use of multiple credit scores,
or to require other changes. Such determination by FHFA may impact an
Enterprise Business Assessment.
G. Determinations on Applications--Sec. 1254.9
Section 1254.9(a) of the final rule requires an Enterprise to
submit to FHFA a proposed determination of approval or disapproval for
each application. The final rule requires an Enterprise to submit to
FHFA a proposed determination of approval if an application passes both
the Credit Score Assessment and the Enterprise Business Assessment. The
final rule requires an Enterprise to submit to FHFA a proposed
determination of disapproval of an application if the Enterprise finds
at any point in the validation and approval process that the
application should be disapproved. The final rule permits an Enterprise
to propose disapproval of an application based on any of the criteria
identified in the Credit Score Solicitation, including any of the
application requirements or any of the criteria under the Credit Score
Assessment or the Enterprise Business Assessment.
FHFA will make its decision on approval or disapproval after
considering the Enterprise proposal and any other information that FHFA
determines appropriate. The final rule provides a 45-day review period,
which FHFA may extend as needed. FHFA's review and approval of a
proposed Enterprise determination must be completed before the
Enterprise notifies that applicant. The final rule clarifies that the
30-day period for any approval or disapproval notification by an
Enterprise to the applicant begins when FHFA has notified the
Enterprise of its decision on the proposed Enterprise determination.
FHFA may impose any appropriate terms, conditions, or limitations on
its approval or disapproval of the Enterprise proposed determination.
1. Approval of a Credit Score Model
Section 1254.9(b) of the final rule provides if an Enterprise
approves an application for a credit score model following FHFA review
of its proposed determination, the Enterprise must implement the credit
score model in its mortgage purchase systems that use a credit score
for mortgage purchases. If an application is approved, the Enterprise
will notify the applicant and the public of the approval of such
application within 30 days after FHFA completes its review.
2. Disapproval of a Credit Score Model
Section 1254.9(c) of the final rule provides that, if an
application is disapproved, an Enterprise must provide an applicant
with a notice of disapproval no later than 30 days after FHFA completes
its review. The Enterprise must provide a description of the reason(s)
for disapproval in its notice to the applicant.
H. Withdrawal of Application--Sec. 1254.10
Section 1254.10 of the final rule permits an applicant to withdraw
its application at any time during the validation and approval process
by notifying the Enterprise. This allows 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 final
rule does 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.
I. Pilot Programs--Sec. 1254.11
Section 1254.11(a) of the final rule permits an Enterprise to
conduct credit score pilot programs. A pilot program will allow an
Enterprise to use a credit score model that has not been validated and
approved under this rule for the limited purpose of evaluating the
performance of the credit score model.
Section 1254.11(b) of the final rule requires that an Enterprise
must submit any proposed pilot program to FHFA for review and approval.
The Enterprise must provide a complete description of the pilot
program, including the purpose, duration, and scope of the pilot
program. This will allow FHFA to ensure that the pilot program
addresses any requirements that FHFA determines appropriate. For
example, FHFA may require that an Enterprise publish a solicitation for
applicants to participate in a pilot program, or FHFA may add other
terms or limitations as appropriate.
FHFA expects regulatory notice and timing requirements to apply to
pilot program applications, even though the credit score model
considered for a pilot program will not be subject to the full
regulatory validation and approval process. FHFA believes it would be
valuable to obtain from the model developer any available information
that is responsive to the regulatory requirements, such as information
about the ownership structure and business qualifications of the
applicant.
VI. Regulatory Determinations
A. Paperwork Reduction Act
The final rule does 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.
B. 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 must include an 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 final
rule under the Regulatory Flexibility Act. The General Counsel of FHFA
certifies that this final rule will not have a significant economic
impact on a substantial number of small entities because the regulation
applies only to the Enterprises, which are not small entities for
purposes of the Regulatory Flexibility Act.
C. Congressional Review Act
In accordance with the Congressional Review Act (5 U.S.C. 801 et
seq.), FHFA has determined that this final rule is a major rule and has
verified this determination with the Office of Information and
Regulatory Affairs of the OMB.
List of Subjects in 12 CFR Part 1254
Mortgages.
Authority and Issuance
0
Accordingly, for the reasons stated in the preamble, and under the
authority of 12 U.S.C. 4511, 4513, 4526, and Public Law 115-174,
section 310, 132 Stat.
[[Page 41905]]
1296, FHFA amends subchapter C of chapter XII of Title 12 of the Code
of Federal Regulations by adding part 1254 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 and initial review of applications.
1254.7 Credit Score Assessment.
1254.8 Enterprise Business Assessment.
1254.9 Determinations on applications.
1254.10 Withdrawal of application.
1254.11 Pilot programs.
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 and Initial Review, 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 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).
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:
(1) The credit score must be derived from a credit score model that
has been approved by the Enterprise in accordance with this part; and
(2) The Enterprise must 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 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 determine whether a solicitation should be initiated. FHFA
will establish the solicitation requirement by notice to the
Enterprises, which will include:
(1) The 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 the 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 and initial review 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 certification and compliance. 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
[[Page 41906]]
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 non-mortgage) who use the
applicant's credit score when making a determination to approve the
extension of credit.
(4) Qualification of credit score model developer. Each application
must include any information that an Enterprise may require to evaluate
the credit score model developer (i.e., relevant experience and
financial 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.
(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 the 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) Testing for Credit Score Assessment. An Enterprise must conduct
statistical tests for accuracy and reliability that use one or more
industry standard statistical tests for demonstrating divergence among
borrowers' propensity to repay using the industry standard definition
of default, applied to mortgages purchased by an Enterprise (including
subgroups), as identified by the Enterprise.
(c) 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.
(i) Initial Credit Score Assessment. For the Credit Score
Assessment of applications submitted in response to the initial
solicitation under Sec. 1254.5(e), a credit score model meets the test
for accuracy if it produces credit scores that meet a benchmark
established by the Enterprise in the initial Credit Score Solicitation,
as demonstrated by appropriate testing.
(ii) Subsequent Credit Score Assessments. For the Credit Score
Assessment of applications submitted in response to any later
solicitation under this part, a credit score model meets the test for
accuracy if it produces credit scores that are more accurate than the
credit scores produced by any credit score model that is required by
the Enterprise at the time the test is conducted, as demonstrated by
appropriate testing.
(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 is required by
the Enterprise at the time the test is conducted, as demonstrated by
appropriate testing. Testing for reliability must demonstrate 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, unless FHFA has determined that
an Enterprise should begin a Credit Score Assessment sooner. The Credit
Score Assessment 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) An Enterprise must provide notice to the applicant within 30
days of a determination that the application has passed the Credit
Score Assessment.
[[Page 41907]]
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 processes that use a
credit score for mortgage purchases. The fair lending assessment must
also consider any impact on access to credit related to the use of a
particular credit score model.
(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 Provider Review. The Enterprise Business Assessment
must evaluate the credit score model developer under the Enterprise
standards for approval of third-party 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) FHFA Evaluation. FHFA will conduct an independent analysis of
the potential impacts of any change to an Enterprise's credit score
model. FHFA will initiate its analysis no later than the beginning of
the Enterprise Business Assessment. Based on its analysis, FHFA may:
(1) Require an Enterprise to undertake additional analysis,
monitoring, or reporting to further the purposes of this part;
(2) Require an Enterprise to permit the use of a single credit
score model or multiple credit score models; or
(3) Require any other change to an Enterprise program, policy, or
practice related to the Enterprise's use of credit scores.
Sec. 1254.9 Determinations on applications.
(a) Enterprise determinations subject to prior review and approval
by FHFA. An Enterprise must submit to FHFA a proposed determination of
approval or disapproval for each application. Within 45 days of an
Enterprise submission, FHFA must approve or disapprove the Enterprise's
proposed determination. FHFA may extend the time period for its review
as needed. FHFA may impose such terms, conditions, or limitations on
the approval or disapproval of the Enterprise's proposed determination
as FHFA determines to be appropriate.
(b) Approval of a credit score model. If an Enterprise approves an
application for a credit score model following FHFA review of its
proposed determination, the Enterprise must implement the credit score
model in its mortgage purchase systems that use a credit score for
mortgage purchases. The Enterprise must provide written notice to the
applicant and the public within 30 days after the FHFA decision on the
proposed determination.
(c) Disapproval of a credit score model. If an Enterprise
disapproves an application for a credit score model following FHFA
review of its proposed determination, the Enterprise must provide
written notice to the applicant within 30 days after the FHFA decision
on the proposed determination. An application may be disapproved under
this section at any time during the validation and approval process
based on any of the criteria identified in the Credit Score
Solicitation. The notice to the applicant must provide a description of
the reasons for disapproval.
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 Pilot programs.
(a) Pilots permitted; duration of pilots. An Enterprise may
undertake pilot programs to evaluate credit score models. If a pilot
program involves a credit score model not in current use by an
Enterprise, the credit score model is not required to be approved under
this part.
(b) Prior notice to FHFA. Before commencing a pilot program, an
Enterprise must submit the proposed pilot program to FHFA for review
and approval. The Enterprise's submission to FHFA must include a
complete and specific description of the pilot program, including its
purpose, duration, and scope. FHFA may impose such terms, conditions,
or limitations on the pilot program as FHFA determines to be
appropriate.
[[Page 41908]]
Dated: August 13, 2019.
Mark A. Calabria,
Director, Federal Housing Finance Agency.
[FR Doc. 2019-17633 Filed 8-15-19; 8:45 am]
BILLING CODE 8070-01-P
