HUD's Regulation of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac)

Federal RegisterOct 31, 2000

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DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

24 CFR Part 81

[Docket No. FR-4494-F-02]

RIN 2501-AC60

HUD's Regulation of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac)

AGENCY:

Office of the Assistant Secretary for Housing “ Federal Housing Commissioner, HUD.

ACTION:

Final rule.

SUMMARY:

This final rule establishes new housing goal levels for the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) (collectively, the “Government Sponsored Enterprises,” or the “GSEs”) for the years 2001 through 2003. The new housing goal levels are established in accordance with the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (FHEFSSA), and govern the purchase by Fannie Mae and Freddie Mac of mortgages financing low- and moderate-income housing, special affordable housing, and housing in central cities, rural areas and other underserved areas. Specifically, the final rule increases the Low- and Moderate-Income Housing Goal to 50 percent, the Geographically Targeted Goal to 31 percent, and the Special Affordable Housing Goal to 20 percent of units backing each GSE's annual eligible mortgage transactions. The Special Affordable Multifamily Subgoal increases to one percent of each GSE's average annual total dollar mortgage purchases in 1997 through 1999. This rule also establishes new provisions and clarifies certain other provisions of HUD's rules for counting different types of mortgage purchases towards the goals, including provisions regarding the use of bonus points for mortgages that are secured by certain single family rental properties and small multifamily properties; and the disallowance of goals credit for mortgage loans with predatory characteristics.

While Fannie Mae and Freddie Mac have been successful in providing stability and liquidity in the market for certain types of mortgages, their share of the affordable housing market is substantially smaller than their share of the total conventional, conforming mortgage market. There are several reasons for these disparities, related to the GSEs' purchase and underwriting guidelines; and to their relatively low level of activity in specific mortgage markets that provide financing for housing serving low- and moderate-income families, including small multifamily rental properties, single family owner-occupied rental properties, manufactured housing, and markets for seasoned mortgages on properties with affordable housing. As the GSEs continue to grow their businesses, the new goals will provide strong incentives for the two enterprises to more fully address the housing finance needs for very low-, low- and moderate-income families and residents of underserved areas and, thus, more fully realize their public purposes.

In addition, as government sponsored enterprises and market leaders, Fannie Mae and Freddie Mac have a public responsibility to help eliminate predatory mortgage lending practices which are inimical to the home financing and homeownership objectives that the GSEs were established to serve. Fannie Mae and Freddie Mac have adopted policies stating that they will not purchase mortgage loans with certain predatory characteristics. This final rule affirms the GSEs' actions by disallowing housing goals credit for mortgages having features that the GSEs themselves have identified as unacceptable.

EFFECTIVE DATE:

January 1, 2001.

FOR FURTHER INFORMATION CONTACT:

Director, Office of Government Sponsored Enterprises Oversight, Office of Housing, Room 6182, telephone 202-708-2224. For questions on data or methodology, contact John L. Gardner, Director, Financial Institutions Regulation Division, Office of Policy Development and Research, Room 8234, telephone (202) 708-1464. For legal questions, contact Kenneth A. Markison, Assistant General Counsel for Government Sponsored Enterprises/RESPA, Office of the General Counsel, Room 9262, telephone 202-708-3137. The address for all of these persons is Department of Housing and Urban Development, 451 Seventh Street, SW., Washington, DC 20410. Persons with hearing and speech impairments may access the phone numbers via TTY by calling the Federal Information Relay Service at (800) 877-8399.

SUPPLEMENTARY INFORMATION

I. General

A. Purpose

This final rule revises existing regulations implementing the Department of Housing and Urban Development's (the “Department” or “HUD”) authority to regulate the GSEs. The authority exercised by the Department is established under:

(1) The Federal National Mortgage Association Charter Act (“Fannie Mae Charter Act”), which is Title III of the National Housing Act, section 301

et seq.

(12 U.S.C. 1716

et seq.

);

(2) The Federal Home Loan Mortgage Corporation Act (“Freddie Mac Act”), which is Title III of the Emergency Home Finance Act of 1970, section 301

et seq.

(12 U.S.C. 1451

et seq.

); and

(3) FHEFSSA, enacted as Title XIII of the Housing and Community Development Act of 1992 (Pub. L. 102-550, approved October 28, 1992) (12 U.S.C. 4501-4641).

(4) Section 7(d) of the Department of Housing and Urban Development Act (42 U.S.C. 3535(d)), which provides that the Secretary may make such rules and regulations as may be necessary to carry out his functions, powers, and duties, and may delegate and authorize successive redelegations of such functions, powers, and duties to officers and employees of the Department.

FHEFSSA substantially changed the Department's regulatory authorities governing the GSEs by establishing a separate safety and soundness regulator within the Department and clarified and expanded the Department's regulation of the GSEs' missions. Regulations first implementing the Department's authorities with respect to the GSEs' missions under FHEFSSA were issued on December 1, 1995 (24 CFR part 81).

This rule revises certain portions of those regulations concerning the GSEs' affordable housing goals and provisions related to how mortgage loans are treated in the calculation of performance under the housing goals. The remaining part of the preamble contains several endnotes. These endnotes appear at the end of the preamble.

B. Background

1. Fannie Mae and Freddie Mac

Fannie Mae and Freddie Mac engage in two principal businesses: investing in residential mortgages and guaranteeing securities backed by residential mortgages. Fannie Mae and Freddie Mac are chartered by Congress as Government Sponsored Enterprises to: (1) Provide stability in the secondary market for residential mortgages; (2) respond appropriately to the private capital market; (3) provide ongoing assistance to the secondary market for residential mortgages (including activities relating to mortgages on housing for low- and moderate-income families involving a reasonable

economic return that may be less than the return earned on other activities) by increasing the liquidity of mortgage investments and improving the distribution of investment capital available for residential mortgage financing; and (4) promote access to mortgage credit throughout the nation (including central cities, rural areas, and other underserved areas) by increasing the liquidity of mortgage investments and improving the distribution of investment capital available for residential mortgage financing.

Fannie Mae and Freddie Mac receive significant explicit benefits through their status as GSEs that are not enjoyed by any other shareholder-owned corporations in the mortgage market. These benefits include: (1) Conditional access to a $2.25 billion line of credit from the U.S. Treasury;

(2) exemption from the securities registration requirements of the Securities and Exchange Commission and the States;

and (3) exemption from all State and local taxes except property taxes.

Additionally, although the securities the GSEs guarantee and the debt instruments they issue are not backed by the full faith and credit of the United States, and nothing in this final rule should be construed otherwise, such securities and instruments trade at yields only a few basis points over those of U.S. Treasury securities and at yields lower than those for securities issued by comparable firms that are fully private but may be higher capitalized. The market prices for GSE debt and mortgage-backed securities, and the fact that the market does not require that those securities be rated by a national rating agency, suggest that investors perceive that the government implicitly backs the GSEs' debt and securities. This perception evidently arises from the GSEs' relationship to the Federal Government, including their public purposes, their Congressional charters, their potential direct access to U.S. Department of Treasury funds, and the statutory exemptions of their debt and mortgage-backed securities (MBS) from otherwise mandatory security laws. Consequently, each GSE enjoys a significant implicit benefit—its cost of doing business is significantly less than that of other firms in the mortgage market. According to a U.S. Department of Treasury 1996 study, the benefits of federal sponsorship are worth almost $6 billion annually to Fannie Mae and Freddie Mac. Of this amount, reduced operating costs (

i.e.,

exemption from SEC filing fees and from state and local income taxes) represent approximately $500 million annually. These estimates are broadly consistent with estimates by the Congressional Budget Office and General Accounting Office. According to the Department of the Treasury, Fannie Mae and Freddie Mac appear to pass through part of these benefits to consumers through reduced mortgage costs and retain part for their own stockholders.

The GSEs have achieved an important part of their mission: providing stability and liquidity to large segments of the housing finance markets. As a result of the GSEs' activities, many home buyers have benefited from lower interest rates and increased access to capital, contributing, in part, to a record national homeownership rate of 66.8 percent in 1999. While the GSEs have been successful in providing stability and liquidity to certain portions of the mortgage market, the GSEs must further utilize their entrepreneurial talents and power in the marketplace and “lead the mortgage finance industry” to “ensure that citizens throughout the country enjoy access to the public benefits provided by these federally related entities.”

Despite the record national homeownership rate in 1999, lower homeownership rates have prevailed for certain minorities, especially for African-American households (46.3 percent) and Hispanics (45.5 percent). These gaps are only partly explained by differences in income, age, and other socioeconomic factors. Disparities in mortgage lending are a contributing factor to lower homeownership rates and are reflected in loan denial rates of minority groups when compared to white applicants. Denial rates for conventional (non-government-backed) home purchase mortgage loans in 1998 were 54 percent for African Americans, 53 percent for Native American applicants, 39 percent for Hispanic applicants, 26 percent for White applicants, and 12 percent for Asian applicants.

Despite strong economic growth, low unemployment, low mortgage interest rates, and relatively stable home prices, housing problems continue to persist for low-income families and certain minorities.

In addition to disparities across racial groups, populations who live in certain types of housing have not benefited to the same degree as have others from the advantages and efficiencies provided by Fannie Mae and Freddie Mac. The GSEs have been much less active in purchasing mortgages in markets where there is a need for additional financing to address persistent housing needs including financing for small multifamily rental properties, manufactured housing, single family owner-occupied rental properties, seasoned affordable housing mortgages, and older housing in need of rehabilitation.

While HUD recognizes that the GSEs have played a significant role in the mortgage finance industry by providing a secondary market and liquidity for mortgage financing for certain segments of the mortgage market, it is this recognition of their ability, along with HUD's comprehensive analyses of the size of the mortgage market and the opportunities available, America's unmet housing needs, identified credit gaps, and HUD's consideration of the statutory factors under FHEFSSA that causes HUD to increase the level of the housing goals so that as the GSEs grow their businesses so they will address new markets and persistent housing finance needs.

2. Regulation of the GSEs

In 1968, Congress assigned HUD general regulatory authority over Fannie Mae,

and in 1989, Congress granted the Department essentially identical regulatory authority over Freddie Mac.

Under the 1968 law, HUD was authorized to require that a portion of Fannie Mae's mortgage purchases be related to the national goal of providing adequate housing for low- and moderate-income families. Accordingly, the Department established two housing goals—a goal for mortgages on low- and moderate-income housing and a goal for mortgages on housing located in central cities—by regulation, for Fannie Mae in 1978.

Each goal was established at the level of 30 percent of mortgage purchases. Similar housing goals for Freddie Mac were proposed by the Department in 1991 but were not finalized before October 1992, when Congress revised the Department's GSE regulatory authorities including requirements for new housing goals.

In 1992, Congress enacted the Federal Housing Enterprises Financial Safety and Soundness Act (FHEFSSA) as Title XIII of the Housing and Community Development Act of 1992 (Pub. L. 102-550, approved October 28, 1992) (12 U.S.C. 4501-4641), which established the Office of Federal Housing Enterprise Oversight (OFHEO) as the GSEs' safety and soundness regulator and affirmed, clarified and expanded the Secretary of Housing and Urban Development's responsibilities for GSE mission regulation. FHEFSSA provided that, except for the specific authority of the Director of OFHEO, the Secretary retained general regulatory power over the GSEs.

FHEFSSA also detailed and expanded the Department's specific

powers and authorities, including the power to establish, monitor, and enforce housing goals for the GSEs' purchases of mortgages that finance housing for low-and moderate-income families; housing located in central cities, rural areas, and other underserved areas; and special affordable housing, affordable to very low-income families and low-income families in low-income areas.

The Department is required to establish each of the goals after consideration of certain prescribed factors relevant to the particular goal.

11. Sec. 1321.

12. See generally secs. 1331-34.

13. Secs. 1332(b), 1333(a)(2), 1334(b).

FHEFSSA provided for a transition period during 1993 and 1994 and required HUD to establish interim goals for the transition period (58 FR 53048; October 13, 1993) (59 FR 61504; November 30, 1994). In November 1994, HUD extended the interim goals established for 1994 for both GSEs through 1995 while the Department completed its development of post transition goals.

The Department issued proposed and final rules in 1995 establishing and implementing the housing goals for the years 1996 through 1999. The rule provided that the housing goals for 1999 would continue beyond 1999 if the Department did not change the goals, and further provided that HUD may change the level of the goals for the years 2000 and beyond based upon HUD's experience and in accordance with HUD's statutory authority and responsibility.

In addition to establishing the level of the housing goals, the 1995 final rule included counting requirements for purposes of calculating performance under the housing goals. The new regulations also prohibited the GSEs from discriminating in any manner on any prohibited basis in their mortgage purchases, implemented procedures by which HUD exercises its authority to review new programs of the GSEs, required reports from the GSEs, established a public use data base on the GSEs' mortgage purchase activities while providing protections for confidential and proprietary information, and established enforcement procedures under FHEFSSA.

C. The Proposed Rule

On March 9, 2000,

HUD published a rule proposing new housing goal levels for Fannie Mae and Freddie Mac. The rule proposed to increase the level of the housing goals for the purchase by Fannie Mae and Freddie Mac of mortgages financing low- and moderate-income housing, special affordable housing, and housing in central cities, rural areas, and other underserved areas. The rule also proposed to clarify HUD's guidelines for counting different types of mortgage purchases under the housing goals, including treatment of missing affordability data and purchases of seasoned mortgage loans; use of bonus points for goals credit for purchases of mortgages secured by single family rental and small multifamily properties; and providing greater public access to certain types of mortgage data on the GSEs' mortgage purchases in HUD's public use database. The rule also solicited public comments on several other issues related to the housing goals including the appropriate role of credit enhancements in furthering affordable housing lending and whether the use of credit enhancements should be considered in calculating housing goal performance.

14. 65 FR 12632-12816

D. This Final Rule

In response to the proposed rule, HUD received over 250 comments. The comments came from the GSEs; individuals; representatives of lending institutions; non-profit organizations; community, consumer groups and civil rights organizations; local and State governments; and others. Following full consideration of the comments, HUD developed this final rule. The final rule is consistent with the approach announced in the proposed rule but does include some revisions adopted in light of the comments received. The final rule: (1) Increases the level of the housing goals for the years 2001 through 2003 as a result of HUD's review of the statutory factors under FHEFSSA to ensure that the GSEs continue and strengthen their efforts to carry out Congress' intent that the GSEs provide the benefits of the secondary market to families throughout the nation—the Low- and Moderate-Income Housing Goal increases to 50 percent, the Geographically Targeted Goal increases to 31 percent, the Special Affordable Housing Goal increases to 20 percent; and the Special Affordable Multifamily Subgoal increases to the respective average of one percent of each GSE's total mortgage purchases over 1997 through 1999; (2) establishes the use of bonus points for small multifamily properties with 5 to 50 units and for single family owner-occupied rental properties for the years 2001 through 2003; (3) establishes a temporary adjustment factor for Freddie Mac's multifamily mortgage purchases for the years 2001 through 2003; (4) prohibits the counting of high cost mortgage loans with predatory features for goals credit; (5) provides or clarifies counting rules for the treatment of missing affordability data, purchases of seasoned mortgage loans, purchases of federally insured mortgage loans and purchases of mortgage loans on properties with expiring assistance contracts; (6) provides for HUD's review of transactions to determine appropriate goal treatment; and (7) includes certain definitional and technical corrections to the regulations issued in 1995.

Specific changes included in the Final Rule from the provisions included in the Proposed Rule are as follows:

(1) The period covered by the housing goals is 2001 through 2003 and there is no transition year. The proposed rule had suggested the goals cover the period from 2000 through 2003 with 2000 serving as a transition year.

(2) The Special Affordable Multifamily Subgoal uses the average of 1997 through 1999 as the base period for establishing the level of the goal over the 2001 through 2003 period, rather than 1998 as the base period, as proposed. The subgoal remains a fixed dollar amount for each year of the period covered by the housing goals base equal to one percent of each GSE's average total mortgage purchases in 1997 through 1999.

(3) The final rule does not allow goals credit for predatory mortgage loans, and the rule describes specific characteristics, in addition to the HOEPA definition suggested in the proposed rule, to determine what types of loans are considered predatory. The final rule also identifies good lending practices with which mortgages should conform in order to count towards goals credit.

(4) The proposed provisions for the treatment of missing affordability data are retained but the final rule includes a five percent ceiling on the use of estimated affordability information for multifamily units.

(5) The guidance provided on how to determine if seasoned mortgage loan purchases meet the recycling requirements of the Special Affordable Housing Goal was expanded to (1) include additional types of lending organizations with affordable housing missions that are presumed to meet the recycling requirements; (2) adjust the Community Reinvestment Act (CRA) examination requirement for Federally regulated financial institutions to one “Satisfactory” rating for financial institutions with assets of $250 million or less to accommodate a less frequent examination schedule; and (3) specify requirements that a seller must meet for purposes of evaluating whether the seller meets the recycling requirements of 12 U.S.C. 4563(b)(1)(B).

(6) The final rule does not make changes to the definition of underserved

area other than the inclusion of tribal lands in underserved areas and does not address the public availability of mortgage data in the public use data base. As explained below, HUD will publish a decision on which data elements will be accorded proprietary and non-proprietary treatment by separate Order following publication of this final rule.

The analysis of Fannie Mae's and Freddie Mac's affordable housing performance, which is the basis for many of the changes in the final rule, is primarily based on data from 1997, 1998 and 1999. The GSEs' actual performance is presented through 1999. However, Home Mortgage Disclosure Act (HMDA) data which provides data on the conventional, conforming market was not available for 1999 at the time HUD prepared its analysis supporting this final rule. As HMDA data for 1999 were not available, comparisons between the GSEs and the market as a whole for that year are not possible. Further, as 1998 was a year with a large percentage of refinance mortgage transactions, at times 1997 data is utilized as it presents a more normal year in terms of home purchase mortgage transactions.

In finalizing these regulations, the Department is guided by and affirms the following principles established in the 1995 rulemaking:

(1) To fulfill the intent of FHEFSSA, the GSEs should lead the industry in ensuring that access to mortgage credit is made available for very low-, low- and moderate-income families and residents of underserved areas. HUD recognizes that, to lead the mortgage industry over time, the GSEs will have to stretch to reach certain goals and close the gap between the secondary mortgage market and the primary mortgage market. This approach is consistent with Congress' recognition that “the enterprises will need to stretch their efforts to achieve” the goals.

5. U.S. Department of Treasury, Government Sponsorship of the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation (1996), page 3.

(2) The Department's role as a regulator is to set broad performance standards for the GSEs through the housing goals, but not to dictate the specific products or delivery mechanisms the GSEs will use to achieve a goal. Regulating two exceedingly large financial enterprises in a dynamic market requires that HUD provide the GSEs with sufficient latitude to use their innovative capacities to determine how best to develop products to carry out their respective missions. HUD's regulations should allow the GSEs to maintain their flexibility and their ability to respond quickly to market opportunities. At the same time, the Department must ensure that the GSEs' strategies serve families in underserved markets and address unmet credit needs. The addition of bonus points to the regulatory structure provides an additional means of encouraging the GSEs' affordable housing activities to address identified, persistent credit needs while leaving the specific approaches to meeting these needs to the GSEs.

(3) Discrimination in lending—albeit sometimes subtle and unintentional—has denied racial and ethnic minorities the same access to credit to purchase a home that has been available to similarly situated non-minorities. The GSEs have a central role and responsibility to promote access to capital for minorities and other identified groups and to demonstrate the benefits of such lending to industry and borrowers alike. The GSEs also have an integral role in eliminating mortgage lending practices that are predatory.

(4) In addition to the GSEs' purchases of single family home loans, the GSEs also must continue to assist in the creation of an active secondary market for multifamily loans. Affordable rental housing is essential for those families who cannot afford or choose not to become homeowners. The GSEs must assist in making capital available to assure the continued development of rental housing.

II. Discussion of Public Comments

A. Overview

1. Public Comment

Of the over 250 comments received, by far the most detailed were the submissions of the two directly affected GSEs—Fannie Mae and Freddie Mac. Each GSE's comments were in large measure supportive of the overall goal structure proposed by the Department. The GSEs, however, did provide extensive appendices questioning the Department's methodology in determining market share for the three affordable housing goals, a key component for establishing the appropriate level of the housing goals.

Other commenters included national and regional industry related groups, non-profit organizations, state and local government officials, lenders, and individuals. In large measure, these commenters were also supportive of the Department's proposal to increase the affordable housing goals and the related provisions designed to streamline the counting rules used to calculate performance under the housing goals.

Other than the goals framework, the areas generating the largest response from commenters were the treatment of high cost mortgages, the role of credit enhancements in affordable lending transactions, and the availability of data on the public use data base. It should be noted that in evaluating these comments a large number of comments were received that included substantially similar responses, in both language and tone, to those submitted by Fannie Mae.

In addressing the appropriate goals treatment for high cost mortgages, one group of commenters, comprised primarily of non-profit and housing advocacy groups, felt the provisions included in the proposed rule disallowing credit for loans that meet the HOEPA definition should be strengthened. Other commenters, consistent with the comments provided by Fannie Mae, opposed any limitation of goals credit for predatory mortgage loans.

With regard to credit enhancements, a substantial majority of commenters noted that credit enhancements are a critical component of many affordable housing transactions. There was little support for limiting goals credit for affordable housing transactions that include credit enhancements without a better understanding of how to ensure that there are not negative implications for affordable housing transactions.

The Department received comments supporting both increased data availability and limited availability of data. One group of commenters, including non-profit organizations and academic researchers, felt the provisions included in the proposed rule should be adopted and, in some instances, expanded in order to fully understand and challenge the GSEs on their affordable housing activities. Again, another group of commenters, consistent with the comments provided by Fannie Mae, opposed the availability of additional data on the public use data base. This group of commenters included both lenders and non-profit organizations which felt the additional data would release confidential business information and could compromise the privacy of individuals, respectively. This final rule does not, however, address the availability of data on the public use data base.

A discussion of the general and specific comments on the rule follows in subsequent sections. While comments are summarized, not all of the comments are addressed explicitly in this preamble. HUD fully considered all of the comments and HUD's response is either explicit in this final rule or implicit in the general discussion of the rule or other comments. HUD is appreciative of the full range of public comments received and acknowledges the value of all of the comments

submitted in response to the proposed rule.

2. Other Public Input

As part of the public comment process, the Department conducted extensive outreach to educate and inform interested parties of the nature and extent of the GSEs' affordable housing activities. The outreach was undertaken in order to encourage comments on the proposed rule from a wide range of individuals, organizations and businesses that are interested in or are affected by Congress' charge to the GSEs to further the financing needs of underserved families and neighborhoods. The Department's outreach in this regard included two forums, three subject matter meetings, and meetings with various industry trade groups and non-profit organizations to discuss the provisions of the proposed rule. These sessions are described below. Further, additional information on these meetings is contained in the public docket file of this rule in Room 10276 at HUD Headquarters.

a. Forums.

The Department conducted two forums designed to give participants an in-depth look at how well the GSEs are supporting affordable housing activities in local communities. One forum was held in Hartford, Connecticut and the other in Durham, North Carolina. Each forum had approximately 125 participants. In addition to sessions held at both forums that reviewed the GSEs' progress in meeting the affordable housing needs in the respective region, each forum had a session that addressed issues and needs specific to the region. In Hartford, a session was held on the role of multifamily housing in meeting affordable housing needs. Research was presented on how small multifamily properties disproportionately serve low- income families and data was provided on the extent of the GSEs' purchases of mortgages on small multifamily properties. Panel members discussed the unique problems of financing small multifamily properties and how Fannie Mae and Freddie Mac can better serve these markets. In Durham, a session was held on predatory lending. Panel members identified abusive practices and discussed the impacts that predatory lenders were having particularly on the elderly and in minority neighborhoods. Serious questions were raised as to whether Fannie Mae and Freddie Mac should be involved in this market.

b. Subject Matter Meetings.

HUD also held three smaller discussion group sessions designed to address specific subject matters included in the proposed rule. Subject matter meetings were held on the availability of data on the public use data base, issues related to identifying and meeting the credit needs of non-metropolitan areas, and the role of credit enhancements in affordable housing lending.

c. Other Meetings.

In addition to the meetings described above, the Department met with various industry trade groups and non-profit organizations to present the changes suggested in the proposed rule and the rationale for the changes. HUD also met with Fannie Mae and Freddie Mac to discuss their concerns regarding the proposed rule.

B. Subpart A—General

HUD proposed to revise the definitions of “median income,” “metropolitan area,” and “underserved area” in order to provide greater clarity, consistency and technical guidance. The few comments received on these definitions were supportive of the proposed technical changes. HUD also proposed certain changes to several aspects of the definition of underserved area to solicit public input on how best to identify the areas that are underserved by the mortgage credit markets.

1. Median Income

HUD proposed to change the definition of “median income” to require the GSEs to use HUD estimates of median family income to further clarify the appropriate process for the GSEs' determination of area incomes. HUD has implemented this change in this final rule. As part of this change to the definition of “median income,” HUD will provide the GSEs, on an annual basis, information specifying how HUD's published median family income estimates are to be applied. This change is needed because, in some cases, HUD publishes area median family income estimates for portions of areas rather than whole metropolitan statistical areas (MSAs) or primary metropolitan statistical areas (PMSAs).

2. Metropolitan Area

HUD proposed to clarify the definition of “metropolitan area” by revising the description of the relevant area for determining median incomes to eliminate the reference in § 81.2 to consolidated metropolitan statistical areas (CMSAs). HUD has implemented this change in the final rule. “Metropolitan area” was defined in § 81.2 under the 1995 final rule as an MSA, a PMSA, or a CMSA, designated by the Office of Management and Budget of the Executive Office of the President. This definition raised questions as to the definition of “underserved area” and the denominator of the affordability ratio used to compute the Low- and Moderate-Income Housing Goal and the Special Affordable Housing Goal regarding whether to use the median income of the CMSA or the PMSA. HUD has consistently relied upon median incomes of PMSAs in defining underserved areas and determining denominators for the other goals and this final rule clarifies this point.

3. Underserved Area

a. Technical Definition.

HUD proposed to revise the definition of “underserved area” to clarify the parameters of rural underserved areas. The definition under HUD's 1995 final rule omitted the requirement for a comparison between the “greater of the State non-metropolitan median income or nationwide non-metropolitan median income” from the “income/minority” provision even though it had provided for this comparison when qualifying mortgage purchases under the “income-only” provision. HUD proposed to add the comparative language to the “income/minority” provision for rural underserved areas. The revision applies the same median income standard to both the “income-only” and the “income/minority” definitions. HUD has implemented this change in § 81.2 of this final rule. (HUD also proposed other changes to the definition of “underserved areas.” These are discussed in Subpart B—Housing Goals.)

b. Other Changes Proposed and/or Comments Requested.

The proposed rule described additional changes to the definition of underserved area relating to tribal lands and requested comments on possible changes to the income and minority requirements of the definition.

(1) Tribal Lands.

HUD proposed to revise the definition of “underserved areas” in § 81.2 to designate all qualifying Indian reservations and trust lands as underserved areas.

c. Summary of Comments.

Fannie Mae stated that it is “particularly appropriate” to include these lands in the definition of underserved areas. Fannie Mae added that it “does not think it is feasible, practical, or appropriate to split trust lands between served and underserved designations, depending on the designation of the surrounding tracts or counties.” Fannie Mae further commented that HUD's proposal could lead to “split or proportional treatment of any one trust land,” and that such areas should be

included as underserved areas “without regard to income or minority status.” Fannie Mae added that HUD should consider postponing this change until “the new boundary files and data files” become available from the 2000 Census. Fannie Mae further stated that HUD's proposal to define some underserved areas in terms of income and minority composition for the balance of a county or census tract excluding the area within any Federal or State American Indian reservation or tribal or individual trust land “raises operational issues that will be difficult to overcome.”

Freddie Mac stated that “In principal [sic], Freddie Mac has no objection to treating an American Indian Reservation or tribal land as a geographic whole” for determining underserved areas. It added, however, that “adoption of a definition that would involve geocoding rural loans at the subcounty level could present formidable practical problems.” Freddie Mac recommended that HUD “designate entire tracts in metropolitan areas and entire counties in nonmetropolitan areas that contain qualifying reservations and trust lands as underserved.”

Other commenters were generally supportive of the Department's proposal. One commenter called for an expansion of the proposal to include tribal service areas and urban living Native Americans.

d. HUD's Determination.

HUD believes that treating tribal lands as separate geographic entities implies that the balance of counties or tracts excluding such areas would logically be treated as separate entities, but it recognizes Fannie Mae's argument that this could raise “operational issues.” HUD will issue operational guidance on this matter prior to the effective date of this Final Rule.

HUD evaluated Fannie Mae's recommendation to classify all American Indian and Alaskan Native (AIAN) areas as underserved areas, without regard to income or minority status, in light of the problems involved in obtaining a mortgage on even the very few higher-income (or low minority) tribal lands. HUD analyzed data on 1989 median incomes and minority concentrations for AIAN areas provided by the U.S. Bureau of the Census. HUD's analysis showed that, out of 248 AIAN areas with sufficient population to determine an area median family income, 19 areas, or 6.7 percent, would be classified as served and 265 areas, or 93.3 percent, as underserved. The 19 areas include some with very low minority concentrations and some with very high median incomes. HUD concludes that implementation of Fannie Mae's recommendation would, in a small but significant number of instances, substantially breach the principle that underserved areas are areas with low median incomes and/or high minority concentrations, as established in the 1995 Final Rule. Accordingly, HUD has not implemented Fannie Mae's recommendation.

HUD believes that designating entire tracts or counties that contain qualifying tribal lands as underserved areas is not appropriate. The purpose of the definitional change in underserved areas to include all tribal lands is to focus attention on the mortgage financing needs of Native American communities. By designating the entire county or census tract as underserved by virtue of the presence of tribal lands in a portion of it, this focus is lost. HUD believes that any geocoding problems arising from this proposal can be resolved. HUD will issue operational guidance on this matter prior to the effective date of this final rule.

HUD believes that underserved areas must have relatively fixed definitions—tribal service areas are evolving over time. The underserved areas goal is defined broadly by both geographic and area wide demographic features so that borrowers living in underserved areas benefit from the increased attention paid to lending in such areas as a result of HUD's geographic goal.

(2) Enhanced Tract Definition.

In the proposed rule, comments were sought on possible changes to the current metropolitan underserved areas definition to better target underserved areas with higher mortgage denial rates and thereby promote better access to mortgage credit for these areas. Specifically, HUD proposed changing the current tract income ratio to an “enhanced” tract income ratio requiring that for tracts to qualify as underserved they must have a tract income ratio at or below the maximum of 80 percent of area median income or 80 percent of U.S. median income in metropolitan areas. The proposed change would make the underserved areas definition used by the GSEs consistent with the requirements of Federally insured depository institutions under the Community Reinvestment Act (CRA). The Department believes the concept has substantial merit, and there was a sizeable group of commenters that supported the concept, at least in part. However, there were a number of commenters, including the GSEs, that said that since the redesignation of census tracts as underserved would be based on data from the 1990 Census, and since data from the 2000 Census would not be available for a few years, it would not be appropriate to make such a change at this time. Rather, they suggested that the Department wait until updated information from the 2000 Census is available to analyze. The Department agrees that, with more current information to become available from the 2000 Census in the near future, the timing is not optimal to make a change in the underserved areas designation. Once information from the 2000 Census is available, the Department will determine whether this proposal merits consideration.

(3) Minority Composition.

Similarly, the proposed rule requested comment on another approach to target high mortgage denial rate areas. The alternative approach would be to increase the minority component required to identify an area as underserved by increasing the requirement from 30 percent to 50 percent minority. Several commenters noted that increasing the minority component of a census tract to qualify as underserved would have a disproportionately negative impact on the Hispanic population. Commenters observed that Hispanic residential living patterns are not as concentrated as those of other minority groups. In addition, comments were provided suggesting that any changes in this area be considered once data from the 2000 Census is available before making a final determination in this regard. The Department has determined that it will obtain and analyze 2000 Census data and consider various minority population patterns and their relationship to the availability of mortgage credit before deciding whether this proposal continues to merit consideration.

(4) Rural Areas.

The proposed rule requested comments on how best to define underserved rural areas, posing questions on whether the underserved rural areas should be identified by census tract or by county. HUD received comments that supported both approaches. Again, the commenters raised the issue of the 2000 Census. Consistent with the Department's other determinations regarding significant changes to the definition of underserved areas, HUD will not make any changes at this time in defining underserved rural areas and will wait for the opportunity to analyze the data from the 2000 Census.

C. Subpart B—Housing Goals

1. Overview

Comments received overwhelmingly supported the Department's proposal to increase the level of the affordable

housing goals. Both GSEs commented that, while meeting these goals will be a challenge (particularly the Underserved Areas Goal), they are committed to doing so. While some commenters, including the GSEs, expressed concern that the market scenarios used by HUD did not adequately consider an economic downturn, those commenters still felt that higher goals levels were appropriate. This section of the final rule reviews the statutory factors the Department must consider in setting the level of the housing goals, specific comments on the housing goals including the market methodology, and the determination made with regard to the level for each of the housing goals.

2. Statutory Considerations in Setting the Level of the Housing Goals

In establishing the housing goals, FHEFSSA requires the Department to consider six factors—national housing needs; economic, housing and demographic conditions; performance and effort of the GSEs toward achieving the goal in previous years; size of the conventional mortgage market serving the targeted population or areas, relative to the size of the overall conventional mortgage market; ability of the GSEs to lead the industry in making mortgage credit available for the targeted population or areas; and the need to maintain the sound financial condition of the GSEs. These factors are discussed in more detail in the following sections of this preamble and in the Appendices to this rule. A summary of HUD's findings relative to each factor follows:

a. National Housing Needs.

Analysis and research by HUD and others in the housing industry indicate that there are, and will continue to be in the foreseeable future, substantial unmet housing needs among lower-income and minority families. Data from the American Housing Surveys demonstrate that there are substantial unmet housing needs among lower-income families. Many households are burdened by high homeownership costs or rent payments and will likely continue to face serious housing problems, given the dim prospects for earnings growth in entry-level occupations. According to HUD's “Worst Case Housing Needs” report, 21 percent of owner households faced a moderate or severe cost burden in 1997. Affordability problems were even more common among renters, with 40 percent paying more than 30 percent of their income for rent in 1997.

Despite the growth during the 1990s in affordable housing lending, disparities in the mortgage market remain, with certain minorities, particularly African-American and Hispanic families, lagging the overall market in rate of homeownership. In addition, there is evidence that the aging stocks of single family rental properties and small multifamily properties with 5-50 units, which play a key role in lower-income housing, have experienced difficulties in obtaining financing. The ability of the nation to maintain the quality and availability of the existing affordable housing stock and to stabilize neighborhoods depends on an adequate supply of affordable credit to rehabilitate and repair older units.

(1) Single Family Mortgage Market.

Many younger, minority, and lower-income families did not become homeowners during the 1980s due to the slow growth of earnings, high real interest rates, and continued house price increases. Over the past several years, economic expansion, accompanied by low interest rates and increased outreach on the part of the mortgage industry, has improved affordability conditions for lower-income families. Between 1994 and 1999, record numbers of lower-income and minority families purchased homes. First time homeowners have become a major driving force in the home purchase market over the past five years. Thus, the 1990s have seen the development of a strong affordable lending market. Despite the growth of lending to minorities, disparities in the mortgage market remain. For example, African-American applicants are still twice as likely to be denied a loan as white applicants, even after controlling for income.

(2) Multifamily Mortgage Market.

Since the early 1990s, the multifamily mortgage market has become more closely integrated with global capital markets, although not to the same degree as the single family mortgage market. Loans on multifamily properties are still viewed as riskier by some than mortgages on single family properties. Property values, vacancy rates, and market rents of multifamily properties appear to be highly correlated with local job market conditions, creating greater sensitivity of loan performance to economic conditions than may be experienced for single family mortgages.

There is a need for an on-going GSE presence in the multifamily secondary market both to increase liquidity and to further affordable housing efforts. The potential for an increased GSE presence is enhanced by the fact that an increasing proportion of multifamily mortgages are now originated in accordance with secondary market standards.

The GSEs can play a role in promoting liquidity for multifamily mortgages and increasing the availability of long-term, fixed rate financing for these properties. Increased GSE presence would provide greater liquidity to lenders,

i.e.

, a viable “exit strategy,” that in turn would serve to increase their lending. It appears that the financing of small multifamily rental properties with 5-50 units, where a substantial portion of the nation's affordable housing stock is concentrated, have been adversely affected by excessive borrowing costs. Multifamily properties with significant rehabilitation needs also appear to have experienced difficulty gaining access to mortgage financing. Moreover, the flow of capital into multifamily housing for seniors has been historically characterized by a great deal of volatility.

b. Economic, Housing, and Demographic Conditions.

Studies indicate that changing population demographics will result in a need for the mortgage market to meet nontraditional credit needs and to respond to diverse housing preferences. The U.S. population is expected to grow by an average of 2.4 million persons per year over the next 20 years, resulting in 1.1 to 1.2 million new households per year. In particular, the continued influx of immigrants will increase the demand for rental housing while those who immigrated during the 1980s will be in the market to purchase owner-occupied housing. The aging of the baby-boom generation and the entry of the small baby-bust generation into prime home buying age is expected, however, to result in a lessening of housing demand. Non-traditional households have, and will, become more important as overall household formation rates slow down. With later marriages, divorce, and non-traditional living arrangements, the fastest growing household groups have been single parent and single person households. With continued house price appreciation and favorable mortgage terms, “trade-up buyers” will also increase their role in the housing market. There will also be increased credit needs from new and expanding market sectors, such as manufactured housing and housing for senior citizens. These demographic trends will lead to greater diversity in the homebuying market, which, in turn, will require greater adaptation by the primary and secondary mortgage markets.

As a result of the above demographic forces, housing starts are expected to average 1.5 million units annually between 2000 and 2003, essentially the same as in 1996-99.

Refinancing of

existing mortgages, which accounted for 50 percent of originations in 1998 and 34 percent in 1999, is expected to return to lower levels during 2000. The mortgage market remained strong with $1.3 trillion dollars in originations during 1999. A lower number of originations is expected in 2000 with approximately $962 billion in originations being projected by the Mortgage Bankers Association of America.

c. Performance and Effort of the GSEs Toward Achieving the Goal in Previous Years.

Both Fannie Mae and Freddie Mac have improved their affordable housing loan performance since the enactment of FHEFSSA in 1992 and HUD's establishment of housing goals under the law. However, the GSEs' mortgage purchases continue to lag the overall market in providing financing for affordable housing to low- and moderate-income families, underserved borrowers and their neighborhoods, indicating that there is more that the GSEs can do to improve their performance. In addition, a large percentage of the lower-income loans purchased by the GSEs have relatively high down payments, which raises questions about whether the GSEs are adequately meeting the needs of those lower-income families who have little cash for making large down payments but can fully meet their monthly payment obligations. The discussion of the performance and effort of the GSEs toward achieving the housing goals in previous years is specific to each of the three housing goals. This topic is discussed below and further details are provided in the Appendices to this rule.

d. Size of the Mortgage Market Serving the Targeted Population or Areas, Relative to the Size of the Overall Conventional, Conforming Mortgage Market.

The Department's analyses indicate that the size of the conventional, conforming market relative to each housing goal is greater than earlier estimates (based mainly on HMDA data for 1992 through 1994) used in establishing the 1996-1999 housing goals. The discussion of the size of the conventional mortgage market serving targeted populations or areas relative to the size of the overall conventional, conforming mortgage market is specific to each of the three housing goals. The Department's estimate of the size of the conventional mortgage market is discussed below and further details are provided in the Appendices to this rule.

e. Ability of the GSEs To Lead the Industry in Making Mortgage Credit Available for the Targeted Population or Areas.

Research concludes that the GSEs have generally not been leading the market, but have lagged behind the primary market in financing housing for lower-income families and housing in underserved areas. However, the GSEs' state-of-the-art technology, staff resources, share of the total conventional, conforming market, and their financial strength suggest that the GSEs have the ability to lead the industry in making mortgage credit available for lower-income families and underserved neighborhoods.

The legislative history of FHEFSSA indicates Congress's strong concern that the GSEs need to do more to benefit low- and moderate-income families and residents of underserved areas that lack access to credit.

The Senate Report on FHEFSSA emphasized that the GSEs should “lead the mortgage finance industry in making mortgage credit available for low- and moderate-income families.”

FHEFSSA, therefore, specifically required that HUD consider the ability of the GSEs to lead the industry in establishing the level of the housing goals. FHEFSSA also clarified the GSEs' responsibility to complement the requirements of the Community Reinvestment Act

and fair lending laws

in order to expand access to capital to those historically underserved by the housing finance market.

While leadership may be exhibited through the GSEs' introduction of innovative products, technology, and processes and through establishing partnerships and alliances with local communities and community groups, leadership must always involve increasing the availability of financing for homeownership and affordable rental housing. Thus, the GSEs' obligation to lead the industry entails leadership in facilitating access to affordable credit in the primary market for borrowers at different income levels and housing needs, as well as for underserved urban and rural areas.

While the GSEs cannot be expected to solve all of the nation's housing problems, the efforts of Fannie Mae and Freddie Mac have not matched the opportunities that are available in the primary mortgage market. Although the GSEs were directed by Congress to lead the mortgage finance industry in making mortgage credit available for low- and moderate-income families, depository and other lending institutions have been more successful than the GSEs in providing affordable loans to lower-income borrowers and in historically underserved neighborhoods. In 1998 for example, very low-income borrowers accounted for 9.9 percent of Freddie Mac's acquisitions of home purchase mortgage loans, 11.4 percent of Fannie Mae's acquisitions, 15.2 percent of such mortgage loans originated and retained by depository institutions, and 13.3 percent of such mortgage loans originated in the overall conventional, conforming market. Similarly, mortgage purchases on properties located in underserved areas accounted for 20.0 percent and 22.5 percent of Freddie Mac's and Fannie Mae's purchases of home purchase loans, respectively, 26.1 percent of home purchase mortgages originated and retained by depository institutions and 24.6 percent of home purchase mortgages originated in the overall conventional, conforming market.

Between 1993 and 1998, Fannie Mae improved its affordable lending performance and made progress toward closing the gap between its performance and that of the overall mortgage market. During that period Freddie Mac showed less improvement and, as a result, did not make as much progress in closing the gap between its performance and that of the overall market for home loans. However, during 1999, Freddie Mac's purchases of goals qualifying home loans increased significantly relative to Fannie Mae's purchases and, as a result Freddie Mac now matches or out-performs Fannie Mae in several affordable lending categories. For example, during 1999, very low-income borrowers accounted for 11.0 percent of Freddie Mac's purchases of home loans in metropolitan areas, compared with 10.8 percent of Fannie Mae's. Similarly, mortgages on properties in underserved census tracts accounted for 21.2 percent of Freddie Mac's acquisitions of home purchase mortgage loans in metropolitan areas, compared with 20.6 percent of Fannie Mae's. The extent to which Freddie Mac has closed its performance gap relative to depositories and the overall market will be clarified once HUD has the opportunity to analyze 1999 HMDA data for metropolitan areas.

The Department estimates the GSEs provided financing for 55 percent of units financed by conventional, conforming mortgages in 1998.

However, the GSEs' mortgage market presence varies significantly by property type. While the GSEs accounted for about 68 percent of the owner-occupied units financed in the primary market in that year, their role was much less in the market for mortgages on rental properties. Specifically, HUD estimates that Fannie Mae and Freddie Mac accounted for only about 24 percent of rental units financed in 1998. Thus, the GSEs' presence in the rental mortgage market was well under half their presence in the market for mortgages on

single family owner-occupied properties.

Within the rental category, GSE purchases have accounted for 29 percent of the multifamily dwelling units that were financed in 1998. The GSEs have yet to play a major role in financing mortgages for rental units in single family rental properties (those with at least one rental unit and no more than four units in total), where their market share was only 19 percent.

As noted above, the GSEs continue to lag the overall conforming, conventional market in providing affordable home purchase loans to lower-income families and for properties in underserved neighborhoods. Additionally, a large percentage of the lower-income loans purchased by both GSEs have relatively high down payments, which raises questions about whether the GSEs are adequately meeting the needs of those lower-income families who find it difficult to raise enough cash for a large down payment. Also, while rental properties are an important source of low- and moderate-income rental housing, they represent only a small portion of the GSEs' business.

The appendices to this rule provide more information on HUD's analysis of the extent to which the GSEs have lagged the mortgage industry in funding loans to underserved borrowers and neighborhoods. From this analysis of the GSEs' performance in comparison with the primary mortgage market and with other participants in the mortgage markets, it is clear that the GSEs need to improve their performance relative to the primary market of conventional, conforming mortgage lending. The need for improvements in the GSEs' performance is especially apparent with respect to the single family and multifamily rental markets.

f. Need To Maintain the Sound Financial Condition of the GSEs.

Based on HUD's economic analysis and discussions with the Office of Federal Housing Enterprise Oversight, HUD has concluded that the level of the goals as proposed would not adversely affect the sound financial condition of the GSEs. Further discussion of this issue is found in Appendix A.

3. Determinations Regarding the Level of the Housing Goals

There are several reasons the Department, having considered all the statutory factors, is increasing the level of the housing goals.

a. Market Needs and Opportunities.

First, the GSEs appear to have substantial room for growth in serving the affordable housing mortgage market. For example, as discussed above, the Department estimates that the two GSEs' mortgage purchases accounted for 55 percent of the total (single family and multifamily) conventional, conforming mortgage market during 1998. In contrast, GSE purchases comprised only 44 percent of the low- and moderate-income mortgage market in 1998, 46 percent of the underserved areas market, and, a still smaller, 33 percent of the special affordable market. As discussed above, the GSE presence in mortgage markets for rental properties, where much of the nation's affordable housing is concentrated, is far below that in the single family owner-occupied market.

The GSEs' role in the mortgage market varies somewhat from year to year in response to changes in interest rates, mortgage product types, and a variety of other factors. Underlying market trends, however, show a clear and significant increase in the GSEs' role. Specifically, OFHEO estimates that the share (in dollars) of single family mortgages outstanding accounted for by mortgage-backed securities issued by the GSEs and by mortgages held in the GSEs' portfolios has risen from 31 percent in 1990 to 42 percent in 1999. In absolute terms, the GSEs' presence has grown even more sharply, as the total volume of single family mortgage debt outstanding has increased rapidly over this period.

The GSEs have indicated that they expect their role in the mortgage market to continue to increase in the future, as they develop new products, refine existing products, and enter markets where they have not played a major role in the past. The Department's housing goals for the GSEs also anticipate that their involvement in the mortgage market will continue to increase.

There are a number of segments of the multifamily, single family owner, and single family rental markets that the GSEs have not tapped in which the GSEs might play an enhanced role thereby increasing their shares of targeted loans and their performance under the housing goals. Six such areas are discussed below.

(1) Small Multifamily Properties.

One sector of the multifamily mortgage market where the GSEs could play an enhanced role involves loans on small multifamily properties—those containing 5-50 units. These loans account for 39 percent of the units in recently mortgaged multifamily properties, according to the 1991 Survey of Residential Finance. However, the GSEs typically purchase relatively few of these loans. HUD estimates that the GSEs acquired loans financing only three percent of units in small multifamily properties originated during 1998. This is substantially less than the GSEs' presence in the overall multifamily mortgage market, which the Department estimates was 29 percent in 1998.

Increased purchases of small multifamily mortgages would make a significant contribution to performance under the goals, since the percentages of these units qualifying for the income-based housing goals are high—in 1999, 95 percent of units backing Fannie Mae's multifamily mortgage transactions qualified for the Low- and Moderate-Income Housing Goal, with a corresponding figure of 90 percent for Freddie Mac. That year, 43 percent of units backing Freddie Mac's multifamily transactions qualified for the Special Affordable Housing Goal, with a corresponding figure of 56 percent for Fannie Mae.

(2) Multifamily Rehabilitation Loans.

Another multifamily market segment holding potential for expanded GSE presence involves properties with significant rehabilitation needs. Properties that are more than 10 years old are typically classified as “C” or “D” properties, and are considered less attractive than newer properties by many lenders and investors. Multifamily rehabilitation loans accounted for only 0.5 percent of units backing Fannie Mae's 1998 mortgage purchases and for 1.6 percent in 1999. These loans accounted for 1.9 percent of Freddie Mac's 1998 multifamily mortgage purchase total (with none indicated in 1999).

(3) Single Family Rental Properties.

Studies show that single family rental properties are a major source of affordable housing for lower-income families, yet these properties are only a small portion of the GSEs' overall business.

HUD estimates that approximately 203,000 mortgages were originated on owner-occupied single family rental properties in 1998. These mortgages financed a total of 458,000 units—the owners' units plus an additional 254,000 rental units.

Data submitted to HUD by the GSEs indicate that, in 1998, together the GSEs acquired mortgages backed by 188,000 such units, 41 percent of the number of units financed in the primary market, well below the GSEs' overall 1998 market share of 55 percent.

There is ample room for an enhanced GSE role in this goal-rich market. For the GSEs combined, 65 percent of the units in these properties qualified for the Low- and Moderate-Income Housing Goal in 1999, 32 percent qualified for the Special Affordable Housing Goal, and 54 percent qualified for the

Geographically Targeted Goal. Thus, significant gains could be made in performance on all of the goals if Fannie Mae and Freddie Mac played a larger role in the market for mortgages on single family owner-occupied rental properties (two to four units).

(4) Manufactured Homes.

The Manufactured Housing Institute, in its Annual Survey of Manufactured Home Financing, reported that 116 reporting institutions originated $15.6 billion in consumer loans on manufactured homes in 1998, and that, with an average loan amount of about $30,000, approximately 520,000 loans were originated.

While the GSEs have traditionally played a minimal role in financing manufactured housing, they have recently stepped up their activity in this market. However, even with their increased level of activity, the GSEs' purchases probably accounted for less than 15 percent of total loans on manufactured homes in 1998—a figure well below their overall market presence of 55 percent.

There is ample room for an enhanced GSE role in this market, with its high concentration of goals qualifying mortgage loans. In 1998, for loans reported by 21 manufactured housing lenders (that are required by HMDA to report loan data), 76 percent qualified for the Low- and Moderate-Income Housing Goal in 1998, 42 percent qualified for the Special Affordable Housing Goal, and 47 percent qualified for the Geographically Targeted Goal. Thus, manufactured housing has significantly higher shares of goal qualifying loans than all single family owner-occupied properties, though purchases of these loans are not quite as goal-rich as loans on multifamily properties. In general, goal performance could be enhanced substantially if the GSEs were to play an increased role in the manufactured housing mortgage market.

(5) A-minus Loans.

Industry sources estimate that subprime mortgage originations amounted to about $160 billion in 1999, and that these loans are divided evenly between the more creditworthy (“A-minus”) borrowers and less creditworthy (“B,” “C,” and “D”) borrowers. Based on HMDA data for 200 subprime lenders, the Department estimates that 58 percent of the units financed by subprime loans qualified for the Low- and Moderate-Income Housing Goal in 1998, 29 percent qualified for the Special Affordable Housing Goal, and 45 percent qualified for the Geographically Targeted Goal.

Freddie Mac has estimated that 10 to 30 percent of subprime borrowers would qualify for a prime conventional loan. Fannie Mae Chairman Franklin Raines has stated that half of all mortgages in the high cost subprime market are candidates for purchase by Fannie Mae. Both Fannie Mae and Freddie Mac recently introduced programs aimed at borrowers with past credit problems that would lower the interest rates for those borrowers that were timely on their mortgage payments. Freddie Mac has also purchased subprime loans through structured transactions that limit Freddie Mac's risk to the “A” piece of a senior-subordinated transaction.

However, there may be ample room for further enhancement of both GSEs' roles in the A-minus market. A larger role by the GSEs might help standardize mortgage terms in this market, possibly leading to lower interest rates.

(6) Seasoned Mortgages.

Over the past five years, depository institutions (banks and thrifts) have been expanding their affordable loan programs and, as a result, have originated substantial numbers of loans to low-income and minority borrowers and to low-income and predominantly minority neighborhoods, under the incentive of the Community Reinvestment Act (CRA),

which requires many depository institutions to help meet the credit needs of their communities. As the GSEs noted in their comments, some of these loans, when originated, may not have met the GSEs' underwriting guidelines. A large number of the “CRA-type” loans that have been recently originated remain in thrift and bank portfolios; selling these loans on the secondary market would free up capital for depositories to originate new CRA loans. Given its enormous size, the CRA market segment provides an opportunity for Fannie Mae and Freddie Mac to expand their affordable housing financing programs. The Department recognizes that purchasing these loans may present some challenges for the GSEs. However, it appears these loans are beginning to be purchased by GSEs after the loans have seasoned and through various structured transactions. As explained in Appendix A, Fannie Mae's purchases of seasoned loans improved its performance on the housing goals in 1997 and 1998. Seasoned loan purchases did not have a similar impact in 1999. Freddie Mac, on the other hand, has not been as active as Fannie Mae in purchasing seasoned CRA type loans. With billions of dollars worth of CRA loans in bank portfolios, the early experience of Fannie Mae suggests that purchasing these loans could be an important strategy for reaching the housing goals and provide needed liquidity for a market that is serving the needs of low-income and minority homeowners.

(7) Lending to Minority Borrowers.

The GSEs have an opportunity to play a leadership role in making mortgage credit more widely available to African American and other minority borrowers, who represent yet another underserved market. In 1998, for example, African American borrowers accounted for five percent of conventional, conforming single family mortgage loans originated in metropolitan areas, as shown in Appendix A.

By contrast, African American borrowers accounted for only 3.1 percent of Fannie Mae's metropolitan area mortgage purchases and three percent of Freddie Mac's mortgage purchases. Hispanic borrowers accounted for 5.2 percent of the metropolitan area conventional, conforming mortgage market in 1998, 4.8 percent of Fannie Mae's mortgage purchases and 4.4 percent of Freddie Mac's mortgage purchases.

b. Market Share Higher than Goal Levels.

The shares of the mortgage markets that would qualify for each of the housing goals are higher than the goal levels as they were set through 1999. Specifically, the Low- and Moderate-Income Housing Goal for 1997 through 1999 was 42 percent, but the market share for low- and moderate-income mortgages has been estimated at 50-55 percent. The Geographically Targeted Goal for 1997 through 1999 was 24 percent, but the estimated market share of geographically targeted mortgages has been estimated at 29-32 percent. The Special Affordable Housing Goal for 1997 through 1999 was 14 percent, but the estimated special affordable market share is 23-26 percent.

Thus, the increases in the housing goals implemented in this final rule and described below will significantly reduce the disparities that existed between the previous housing goals and HUD's market estimates. HUD's analysis indicates that the goal levels established in the final rule are reasonable and feasible and that its market estimates reflect significantly more adverse economic environments than have recently existed. Reasons for the remaining disparity between the GSE housing goals established in this final rule and the respective shares of the overall mortgage market qualifying for each of the housing goals are discussed below. See Appendix D for further discussion of these issues.

28. The low-and moderate-income market share is the estimated proportion of newly mortgaged units in the market serving low-and moderate-income families. The two other shares are similarly defined. HUD's conservative range of estimates (such as 50-55 percent) reflects uncertainty about future market conditions.

c. Need for Increased Affordable Single Family Mortgage Purchases.

Higher housing goals are needed to assure that both Fannie Mae and Freddie Mac increase their purchases of

single family mortgages for lower-income families. The GSEs lag behind depository institutions and other lenders in the conventional, conforming market in providing mortgage funds for underserved families and their neighborhoods. Numerous studies have concluded that Fannie Mae and Freddie Mac have room to increase their purchases of affordable loans originated by primary lenders. The single family affordable market, which had only begun to grow when HUD set housing goals in 1995, has now established itself with seven straight years (1993-1999) of solid performance. Current projections suggest that the demand for affordable housing by minorities, immigrants, and non-traditional households will be maintained in the post-1999 period, leading to additional opportunities for the GSEs to support mortgage lending benefiting families targeted by the housing goals.

d. Market Disparities.

Despite the recent growth in affordable lending, there are many groups who continue to face problems obtaining mortgage credit and who would benefit from a more active and targeted secondary market. Homeownership rates for lower-income families, certain minorities, and central city residents are substantially below those of other families, and the disparities cannot simply be attributed to differences in income. Immigrants represent a ready supply of potential first-time home buyers and need access to mortgage credit. Special needs in the market, such as rehabilitation of older two- to four-unit properties, could be helped by new mortgage products and more flexibility in underwriting and appraisal guidelines. The GSEs, along with primary lenders and private mortgage insurers, have been making efforts to reach out to these underserved portions of the markets. However, more needs to be done, and the proposed increases in the housing goals are intended to encourage additional efforts by Fannie Mae and Freddie Mac.

e. Impact of Multifamily Mortgage Purchases.

When the 1996-99 goals were established in December 1995, Freddie Mac had only recently reentered the multifamily mortgage market, after an absence from the market in the early 1990s. Freddie Mac has made progress in rebuilding its multifamily mortgage purchase program, with its purchases of these loans rising from $191 million in 1993 to $7.6 billion in 1999. Freddie Mac's limited role in the multifamily market was a significant constraint when HUD set the level of the housing goals for 1996 through 1999. While Freddie Mac has made progress in recent years in significantly increasing its multifamily mortgage purchases, Freddie Mac's smaller multifamily portfolio relative to that of Fannie Mae has meant fewer refinance opportunities from within its portfolio. Accordingly, the Department is providing Freddie Mac with a temporary adjustment factor for purchases of mortgages in multifamily properties with more than 50 units under the 2001-2003 goals as it continues to increase its multifamily mortgage purchases, as discussed in more detail, below.

f. Financial Capacity to Support Affordable Housing Lending.

A wide variety of quantitative and qualitative indicators demonstrate that the GSEs' have ample, indeed robust, financial strength to improve their affordable lending performance. For example, the combined net income of the GSEs has risen steadily over the last decade, from $677 million in 1987 to over six billion dollars in 1999. This financial strength provides the GSEs with the resources to lead the industry in making mortgage financing available for families and neighborhoods targeted by the housing goals.

g. Closing the Gap Between the GSEs and the Market.

This section discusses the relationship between the housing goals, the GSEs' performance and HUD's market estimates; and identifies key segments of the affordable market in which the GSEs have had only a weak presence. To lay the groundwork for this discussion, the following table summarizes the Department's findings regarding GSE performance under the 1997-2000 goals and the new goal levels for 2001-2003 as compared to HUD's estimates for 1995-1998 markets as well as HUD's projected market estimates for 2001-2003:

ER31OC00.000

It is evident from this table that the new goal levels for the Low- and Moderate-Income Housing Goal and Special Affordable Housing Goal are below HUD's projected market estimate for the years covered by the new housing goals. One reason for this disparity can be discerned by disaggregating GSE purchases by property type, which shows that the GSEs have little presence in some important segments of the affordable housing market. For example, as shown in Figure 1, in 1998, the GSEs purchased loans representing only 19 percent of rental units in single family rental properties, and only three percent of units in small multifamily properties mortgaged that year. Figure 2 provides additional detail providing unit data comparing the GSEs' with the conventional, conforming market. Typically, about 90 percent of rental units in single family rental and small multifamily properties qualify for the Low- and Moderate-Income Housing Goal. One reason that the GSEs' performance under the Low- and Moderate-Income Housing Goal falls short of HUD's market estimate is that the GSEs have had only a weak and inconsistent presence in financing these important sources of affordable housing, notwithstanding that these market segments are important components in the market estimate. In the overall conventional, conforming mortgage market, rental units in single family properties and in small multifamily properties are expected to represent approximately 21 percent of the overall mortgage market, and 33 percent of units backing mortgages qualifying for the Low- and Moderate-Income Housing Goal. Yet in 1999, units in such properties accounted for 6.6 percent of the GSEs' overall purchases, and only 11.5 percent of the GSEs' purchases meeting the Low- and Moderate-Income Housing Goal. The continuing weakness in GSE purchases of mortgages on single

family rental and small multifamily properties is a major factor explaining the shortfall between GSE performance and that of the primary mortgage market.

For a variety of reasons, the GSEs have historically viewed the single family rental and small multifamily market segments as more difficult for them to penetrate than the single family owner-occupied mortgage market. In order to provide the GSEs with an incentive to enter these markets and to provide this housing the benefits of greater financing through the secondary market, HUD is proposing to award “bonus points” for the GSEs' purchases of mortgages on owner-occupied single family rental properties and small multifamily properties in calculating credit toward the housing goals. The bonus points will make the Department's increased housing goals easier for the GSEs to attain if they devote resources to affordable market segments where their past role has been limited and there are significant needs for greater secondary market involvement.

BILLING CODE 4210-27-P

ER31OC00.001

ER31OC00.002

4. Summary of Comments on HUD's Analysis of Statutory Factors

HUD received several comments on the factors for determining the goal levels. Fannie Mae and Freddie Mac provided numerous technical comments on HUD's analyses in the appendices to the proposed rule. Most of the comments focused on two related topics concerning HUD's market methodology: (a) HUD's model for the determining the market size for each of the three housing goals; and (b) HUD's analysis of the GSEs' performance in the single family owner-occupied portion of the conventional, conforming mortgage market. Section A of Appendices A, B and C and Section B of Appendix D provide a more extensive discussion of HUD's response to the various questions raised by the GSEs about the factors for determining the housing goals.

a. Market Share Methodology.

In Appendix D, HUD estimates the following market shares for the three housing goals during 2001-2003: 50-55 percent for the Low-Mod Goal, 23-26 percent for the Special Affordable Goal, and 29-32 percent for the Geographically Targeted Goal. Neither GSE objected to HUD's basic approach to calculating these market shares, which involves estimating (1) the share of the market (in dwelling units) by type of property (single family owner-occupied, single family rental, and multifamily), (2) the proportion of dwelling units financed by mortgages for each type of property meeting each goal, and (3) projecting the size of the total market by weighting each such goal share by the corresponding market share. In fact, both Fannie Mae and Freddie Mac stated that HUD's market share model was a reasonable approach

for estimating the goals qualifying shares of the mortgage market. Freddie Mac stated that the Department took the correct approach in estimating the size of the conventional, conforming market by examining several different data sets, using alternative methodologies, and conducting sensitivity analyses. Fannie Mae expressed similar sentiments asserting that HUD's model for assessing the size of the affordable housing market is reasonable.

Both GSEs were critical, however, of HUD's implementation of its market methodology. Their major comments on the market methodology fall into two general areas. First, the GSEs expressed concern about HUD's assumptions and use of specific data elements both in constructing the distribution of property shares among single family owner-occupied, single family rental, and multifamily properties and in estimating the goals qualifying shares for each property type. The GSEs contended that HUD chose assumptions and data sources that resulted in an overstatement of the market estimate for each of the housing goals. In particular, the GSEs claimed that HUD overstated the importance of rental properties (both single family and multifamily) in its market model and overstated the Low-and Moderate-Income, Special Affordable, and Geographically Targeted shares of the single family owner market. Second, both GSEs argued that HUD's market estimates depended heavily on a continuation of recent conditions of economic expansion and low interest rates. According to the GSEs, HUD's range of market estimates did not include periods of adverse economic and affordability conditions such as those which existed in the early 1990s.

b. GSEs' Performance in Single Family Owner-Occupied Market.

Both GSEs differed with HUD's conclusions that they lag the conventional, conforming market in funding mortgages for the goals qualifying segments of the single family owner-occupied market. Rather, the GSEs hold strongly that they have led the mortgage market, from both quantitative and qualitative perspectives. The GSEs expressed concern about HUD's assumptions and treatment of HMDA data in estimating the goals qualifying shares for single family owner-occupied mortgages. The GSEs assert that certain portions of the conforming mortgage market (such as manufactured housing loans and selected CRA loans)—those market segments where they have not been very active—should be excluded from HUD's definition of the owner market. From their own analysis that excludes these markets from HMDA data, the GSEs conclude that they match or exceed the market in funding affordable loans.

It should be noted that the GSEs extend their criticism to other researchers that have examined this issue of their leading the market with HMDA and related data. Appendix A summarizes findings of several research studies that have reached the same conclusion as HUD—that the GSEs have lagged the market in affordable lending

c. Volatility of the Mortgage Market.

Both GSEs claimed that HUD had not adequately considered the impact that changes in the national economy could have on the size of the affordable lending market and that HUD should significantly lower its market estimates to reflect adverse economic conditions. The GSEs commented that HUD based its market estimates on the unusually favorable economic and housing market conditions that have existed since 1995. The GSEs relied on a Freddie Mac funded study by PriceWaterhouse-Coopers (PWC) which concluded that the low- and moderate-income share of the mortgage market was heavily influenced by interest rate movements and changes in the rate of economic growth.

PWC claims that the low-mod share of the market ranged from 35 percent to 56 percent during the 1990s, with a mean of 46 percent. HUD's analysis, on the other hand, finds that the low- and moderate-income share of the market averaged 53 percent during the 1990s.

In HUD's view, a major shortcoming of the PWC report is that it underestimates the size of the multifamily mortgage market by relying on multifamily originations reported in HMDA data. While HMDA is for many purposes a preeminent data source on single family lending, its usefulness as a multifamily data source is much more limited due to severe underreporting of loan originations. Indeed, HMDA is not widely used as a multifamily data source in published works by highly regarded independent researchers, nor by Fannie Mae in its comments submitted in response to HUD's proposed rule.

The discussion of single family lending in the PWC document initially appears to contradict HUD's analysis in Appendix D of the proposed rule, but this is mainly because HUD's analysis is based upon the conforming, conventional mortgage market, whereas PWC includes FHA loans and loans above the conforming loan limit, at least in the same years.

Because the GSEs are prohibited from purchasing loans above the conforming limit, and because HUD is directed by statute to focus on the conventional market in setting the housing goals, it is necessary to restrict analyses of the mortgage market to the conventional, conforming market for purposes of establishing the housing goals.

As explained in Appendices A and D, HUD is aware that the mortgage market is dynamic in character and susceptible to significant changes in conditions that would affect the overall level of affordable lending to lower-income families. In response to concerns expressed about the volatility of the mortgage markets over time, HUD has estimated a range of market shares for each of the housing goals for the years 2001-2003 of 50-55 percent for the Low- and Moderate-Income Housing Goal, 23-26 percent for the Special Affordable Housing Goal, and 29-32 percent for the Geographically Targeted Goal—that reflect economic environments significantly more adverse than those which existed during the period between 1995 and 1998, when the units financed in the conventional, conforming market meeting the Low- and Moderate-Income Housing Goal averaged 56 percent, the Special Affordable Housing Goal, 28 percent, and the Geographically Targeted Goal, 33 percent.

HUD conducted detailed sensitivity analyses for each of the housing goals to reflect affordability conditions that are less conducive to lower-income homeownership than those that existed during the mid- to late-1990s. For example, the low- and moderate-income percentage for single family home purchase loans can fall to as low as 34 percent—or four-fifths of its 1995-98 average of over 42 percent—before the projected low- and moderate-income share of the overall market would fall below 50 percent. Additional sensitivity analyses examining recession and proportionately higher refinance scenarios and varying other key assumptions, such as the size of the multifamily market, show that HUD's market estimates consider a range of mortgage market and affordability conditions and provide a sound basis for setting housing goals for the years 2001-03.

HUD recognizes that under certain adverse circumstances, the goals qualifying market shares could fall below its estimates. However, as HUD stated in its 1995 GSE Rule, while the housing goals must be feasible, setting goals so that they can be met even under the very worst of circumstances is unreasonable. As HUD stated in its 1995 Final GSE Rule, policy should not be based on market estimates that include the worst possible economic scenarios.

HUD believes that the range for the market shares should be broad enough to reflect the likely scenarios including an expected range of volatility in the mortgage market over the period during which the new housing goals will be in effect.

FHEFSSA and HUD recognize that conditions could change in ways that would require revised expectations. Thus, HUD is given the statutory discretion to revise the goals if the need arises. Further, current regulations require that, if a GSE fails or if there is a substantial probability that a GSE will fail one or more of the housing goals, notice be provided to the GSE and an opportunity provided for the GSE to explain the reason for the failure, or potential failure, and to provide information as to the feasibility of achieving the housing goal. The Department then makes a determination, taking into consideration market and economic conditions and the financial condition of the GSE, as to whether the goal was feasible. If the goal is determined not to be feasible, no further action is taken. If the goal is determined to be feasible, the GSE is given the opportunity to submit, for HUD's approval, a housing plan demonstrating how the goal will be achieved in the future. Thus, there are adequate protections for the GSEs if they are unable to achieve one or more of their housing goals due to a dramatic downturn in the market.

d. Shortcomings of Mortgage Market Data Bases.

Major mortgage market data bases such as HMDA and the American Housing Survey (AHS) are used to implement HUD's market share model. The GSEs made extensive criticisms of these data bases, concluding from their critiques that the ranges for the estimates of the goals-qualifying market shares should be wider to reflect uncertainty due to inadequate data. Examples of problems asserted by the GSEs include: overstating of low-income loans in HMDA data; inability of HMDA data to identify important segments of the market (such as subprime lenders); underreporting of multifamily mortgages in HMDA data and generally unreliable reporting of rental mortgages in other data bases; underreporting of income in the AHS; and the fact that some important mortgage market data bases such as the 1991 Residential Mortgage Finance Survey are dated.

HUD agrees that a single comprehensive source of information on mortgage markets is not available. Nevertheless, HUD considered and analyzed a number of data sources for the purpose of estimating market size, since no single source could provide all the data elements needed for its market model. In the appendices, HUD carefully defines the range of uncertainty associated with each data source, pulls together estimates of important market parameters from independent sources, and conducts sensitivity analyses to show the effects of various assumptions. In fact, Freddie Mac noted that “We support the Department's approach for addressing the empirical challenges of setting the goals by examining several different data sets, using alternative methodologies, and conducting sensitivity analysis.”

While HUD recognizes the shortcomings of the various data and the inability to derive precise point estimates of various market parameters, HUD does not believe that these limitations call for expanding the range of the market estimates, as suggested by the GSEs. One purpose of the appendices is to demonstrate that careful consideration of independent data sources can lead to reliable ranges of estimates for the goals-qualifying shares of the mortgage market. HUD demonstrates the robustness of its market estimates by reporting the results of numerous sensitivity analyses that examine a range of assumptions about the existing data on the rental and owner markets. It should also be emphasized that while there are some problems with existing mortgage market data, there is a wealth of information on important components of the market. For example, HMDA data provide wide coverage of the single family owner market in metropolitan areas, yielding important information on the borrower income and census tract (underserved area) characteristics of that market, and thus providing useful information on the affordability characteristics of the single family rental and multifamily housing stock.

HUD's specific responses to the GSEs' comments on data are included mainly in Section A of Appendices A, B and C and Section B of Appendix D. For example, as noted there, HUD disagrees with the GSEs' assertions regarding the seriousness of the bias problem (

i.e.

, overstating low-income loans) in HMDA data. HUD does not rely heavily on some of the data bases that the GSEs criticize (

e.g.

, the borrower income data from the AHS and the 1991 Residential Finance Survey).

e. Size of the Multifamily Market.

Because a high proportion of multifamily units qualify for the housing goals (

e.g.

, 90 percent typically qualify for the Low- and Moderate-Income Housing Goal and about 50 percent for the Special Affordable Goal), the size of the multifamily market is an important determinant of the overall market shares for the housing goals, as estimated by HUD's model. Both GSEs commented that HUD overstated the role of multifamily financing, which they asserted led to HUD's overstated estimated market shares. Freddie Mac and PriceWaterhouseCoopers, in particular, advocated the use of HMDA data for measuring the size of the multifamily market.

As explained in Appendix D, HUD disagrees with Freddie Mac's and PWC's analysis of the multifamily market. That appendix contains a detailed discussion of the size of the multifamily mortgage market that considers a number of alternative data sources providing ample evidence on multifamily origination volume over the years 1990 to 1999. HUD finds that newly mortgaged multifamily units represent an average of 16-17 percent of units financed during the 1990s. HUD's estimated multifamily market shares exceed estimates prepared by PWC (averaging 8.7 percent for 1991-1998); Appendix D outlines what HUD regards as errors in the PWC study that led to its unrealistically low estimates of the multifamily origination market. The three multifamily market shares—13.5 percent, 15 percent, and 16.5 percent—that HUD emphasizes in its market share model accommodates the possibility of a recession or heavy refinance year.

f. GSEs' Affordable Lending Performance—Defining the Relevant Market.

As noted earlier, HUD uses HMDA data to show that even though the GSEs have improved their performance since 1993, they have lagged depositories and others in the conventional, conforming market in funding affordable loans, both since 1993 and particularly during the more recent 1996-98 period when the new housing goals were in effect. In their analyses, the GSEs reach the opposite conclusion—each concludes that they already match or even lead the market, depending on the affordable category being considered. The GSEs obtain this result by adjusting HMDA market data to exclude single family loans that they perceive as not being available for them to purchase.

Both GSEs provided numerous comments concerning the types of mortgages that HUD should exclude from the definition of the single family owner market. Fannie Mae states that it “can only purchase or securitize mortgages that primary market lenders are willing to sell” and that “HUD fails to adjust for those housing markets that are not fully available to Fannie Mae

and Freddie Mac.” Freddie Mac states that it “has not achieved, and is unlikely to achieve in the near term, the same penetration in the subprime and manufactured housing segments of the market as it has achieved in the conventional, conforming market” and, therefore, HUD should not include these segments in its market definition. According to the GSEs, markets that are “not available” to them or where they are not a “full participant” should be excluded from HUD's market definition. In addition to the subprime and manufactured housing markets, examples of market segments mentioned by the GSEs for exclusion consisted of the following: low-down payment mortgages (those with loan-to-value ratios greater than 80 percent) without private mortgage insurance or some other credit enhancement; loans financed through state and local housing finance agencies; below-market-interest-rate mortgages; specialized CRA mortgages; and portions of depository portfolios that are not available for purchase by the GSEs at the time of mortgage origination.

HUD disagrees with the comments offered by the GSEs advocating exclusion of those market segments that they have not yet been able to penetrate. The conventional, conforming market represents the appropriate benchmark for evaluating GSE performance as discussed previously, even if this is not the market that the GSEs perceive as available for them to purchase. However, with respect to the subprime market, HUD believes that the risky, B&C portion of that market should be excluded from the market estimates for each of the housing goals. Thus, HUD includes only the A-minus portion of the subprime market in its overall estimates of the goals-qualifying market shares.

Excluding other important segments of the mortgage market as the GSEs recommend would render the resulting market benchmark useless for evaluating the GSEs' performance. The loans that the GSEs would exclude are important sources of goals credit and, in fact, are the very loans the GSEs are supposed to be reaching out to finance. A recent report by the Department of Treasury demonstrated the targeting of CRA-type loans to lower-income and minority families. Numerous studies have shown that the manufactured home sector is an important source of low-income housing. In many of these markets, a more active secondary market could encourage lending to traditionally underserved borrowers. While HUD recognizes that some segments of the market may be more challenging for the GSEs to enter than others, the data reported in Figure 2 of this Appendix show that the GSEs have ample opportunities to purchase goals-qualifying mortgages. Furthermore, HUD recognizes the challenge of reaching segments of these markets by not setting each goal at the very top of its market estimate range.

Finally, it should also be noted that the GSEs' purchases under the housing goals are not limited to new mortgages that are originated in the current calendar year. The GSEs can purchase loans from the substantial, existing stock of affordable loans—after these loans have seasoned and the GSEs have had the opportunity to observe their payment performance.

g. HUD's Determination.

HUD carefully examined the comments on its analysis of the statutory factors used to determine the appropriate level of the housing goals, particularly the methodology used to establish the market share for each of the goals. Based on that evaluation, as well as HUD's additional analysis of its estimates, HUD determined that its basic methodology is a reasonable and valid approach to estimating market share and that the percentage ranges for each of the three market share estimates do not need to be adjusted from those provided in the proposed rule. While a number of technical changes have been made in this final rule in response to the comments, the approach for determining market size has not been modified substantially. The detailed evaluations show that the methodology, as modified, produces conservative estimates of the market share for each goal. HUD recognizes the uncertainty regarding some of these estimates, which has led the Department to undertake a number of sensitivity and other analyses to reduce this uncertainty and also to provide a range of market estimates (rather than precise point estimates) for each of the housing goals.

5. Period Covered by the Housing Goals

This final rule establishes housing goals for the years 2001 through 2003. The proposed rule would have established housing goals for the GSEs for the year 2000 as well as 2001-2003, with higher housing goals than currently required for 2000, a transition year, and still higher goals for 2001-2003.

The GSEs commented that since the proposed rule would have set transitional goals for 2000, if the goals are established later in 2000, then 2001 should become the transition year.

HUD has considered the issue and concluded that while it could establish higher “transitional” goals for 2000 as were proposed late in the year, and require that the GSEs perform at the new goal levels, given the publication date of this final rule, HUD will not require that the GSEs meet higher goals for 2000.

At the same time, HUD has determined that establishing 2001 as a transition year is unnecessary and unwarranted. The goal levels for the years 2001-2003, and 2000, were announced in July 1999 and formally proposed earlier this year, providing the GSEs ample notice of the goal levels expected for these years. Indeed, data indicate that the GSEs have increased their efforts in 2000 in light of the proposed 2001-2003 levels. Moreover, the Department's analysis of the statutory factors supports establishment of the goals for 2001-2003 at the levels proposed as both reasonable and feasible. Accordingly, the housing goals for 2000 shall remain at the levels previously established in accordance with §§ 81.12(c)(3), 81.13(c)(3), and 81.14(c)(3) of the regulations as they existed prior to the effectiveness of this final rule. The housing goals for 2001-2003 are established at the levels HUD proposed.

The Department believes the new goal levels established by this rule to be appropriate based upon consideration of the statutory factors and comments received. Setting the goal levels for years 2001-2003 provides the GSEs with a level of predictability to enable them to develop and implement business strategies to achieve the goals.

6. Low- and Moderate-Income Housing Goal, § 81.12

This section discusses the Department's consideration of the statutory factors in arriving at and the comments received on the new housing goal level for the Low- and Moderate-Income Housing Goal, which targets mortgages on housing for families with incomes at or below the area median income. After consideration of these factors, this final rule establishes the goal for the percentage of dwelling units to be financed by each GSE's mortgage purchases for each of the years 2001-2003 that are affordable to low- and moderate-income families at 50 percent. A short discussion of the statutory factors received follows. Additional information analyzing each of the statutory factors is provided in Appendix A, “Departmental Considerations to Establish the Low- and Moderate-Income Housing Goal,” and Appendix D, “Estimating the Size of the Conventional Conforming Market for each Housing Goal.”

a. Market Estimate for the Low- and Moderate-Income Housing Goal.

The Department estimates that dwelling units serving low- and moderate-income families will account for 50-55 percent of total units financed in the overall conventional, conforming mortgage market during the period 2001 through 2003. HUD has developed a reasonable range, rather than a point estimate, that accounts for significantly more adverse economic conditions than have existed recently.

b. Past Performance of the GSEs under the Low- and Moderate-Income Housing Goal

. During the transition period from 1993 through 1995, Fannie Mae's performance under the Low- and Moderate-Income Housing Goal jumped sharply in one year, from 34.2 percent in 1993 to 44.8 percent in 1994, before declining to 42.3 percent in 1995. It then stabilized at just over 45 percent in 1996 and 1997. Fannie Mae's performance in 1998 declined to 44.1 percent due in large measure to the high volume of refinance loans that Fannie Mae funded in 1998, before rising to 45.9 percent in 1999.

During the same period, Freddie Mac demonstrated more consistent gains in performance under the Low- and Moderate-Income Housing Goal, from 29.7 percent in 1993 to 37.4 percent in 1994 and 38.9 percent in 1995. Freddie Mac then achieved 41.1 percent in 1996, and 42.6 percent and 42.9 percent in 1997 and 1998, respectively. In 1999, Freddie Mac's performance increased sharply to 46.1 percent.

The housing goals that have been in effect prior to this final rule specified that in 1996 at least 40 percent of the number of units financed by mortgage purchases of the GSEs and eligible to count toward the Low- and Moderate-Income Goal should qualify as low- and moderate-income, and at least 42 percent should qualify as such in each year from 1997 through 1999. Fannie Mae surpassed these goal levels by 5.6 percentage points in 1996, 3.7 percentage points in 1997, 2.1 percentage points in 1998, and 3.9 percentage points in 1999. Freddie Mac surpassed the goals by 1.1 percentage points, 0.6 percentage points, 0.9 percentage points and 4.1 percentage points in 1996, 1997, 1998 and 1999, respectively.

Fannie Mae's performance on the Low- and Moderate-Income Housing Goal has surpassed Freddie Mac's in every year but one, 1999, when Freddie Mac slightly outperformed Fannie Mae (46.1 percent versus 45.9 percent). However, Freddie Mac's 1999 performance represented a 55 percent increase over its 1993 level, exceeding the 34 percent increase by Fannie Mae over the same period, recognizing, however, that Fannie Mae's 1993 performance was significantly greater than Freddie Mac's.

The GSEs' performance under the Low- and Moderate-Income Housing Goal for the 1996 through 1999 period is summarized below:

Summary of GSEs' Performance Under the Low- and Moderate-Income Housing Goal 1996-1999

[In percentages]

1996

1997

1998

1999

Required Goal Level

Fannie Mae: Percent Low- and Moderate-Income

45.6

45.7

44.1

45.9

Freddie Mac: Percent Low- and Moderate-Income

41.1

42.6

42.9

46.1

Freddie Mac's improved performance since 1993 is due mainly to its increased purchases of multifamily loans as it has again become active in this market. Some housing industry observers believe that the establishment of the Low- and Moderate-Income Housing Goal has been an important factor in explaining Freddie Mac's re-entry into the multifamily market. In fact, as indicated above, multifamily mortgage purchases represent a significant component of both GSEs' activities in meeting the Low- and Moderate-Income Housing Goal, even though multifamily loans comprise a relatively small portion of the GSEs' business activities. In 1999, while Fannie Mae's multifamily purchases represented only nine percent of its total mortgage acquisition volume measured in terms of dwelling units, these purchases comprised 20 percent of units qualifying for the Low- and Moderate-Income Housing Goal. Multifamily purchases were eight percent of the units financed by Freddie Mac's 1999 mortgage purchases but represented 17 percent of the units comprising Freddie Mac's low- and moderate-income mortgage purchases.

c. Summary of Comments

. A number of commenters recommended that the Low- and Moderate-Income Housing Goal include separate goals targeting a portion of the GSEs' business to multifamily housing and a portion to single family housing. While there are distinctly different issues relevant to the single family market and the multifamily market, the Department does not believe that it is necessary or appropriate to establish separate goals for those two markets. First, the increased level of the Low- and Moderate-Income Housing Goal in this final rule will require an increase in both single family and multifamily mortgage purchases. HUD's present analysis of these markets indicates that a unitary goal will best achieve increased performance in both markets. Second, this final rule adopts a number of incentives to encourage the GSEs to move into markets with unmet needs including the financing of smaller multifamily properties. HUD will, however, continue to examine market needs and evaluate the effects of the goal structure established in this final rule on the GSEs' single family and multifamily mortgage purchase performance. Based on this ongoing review, HUD may at a future date consider separate single family and multifamily goals or subgoals under the Low- and Moderate-Income Housing Goal, as warranted.

Fannie Mae expressed no objection to the higher goal level, provided the Department retains the proposed housing goals framework, including the proposed changes to the counting rules, in the final rule. Freddie Mac supports the goal framework included in the proposed rule and is committed to meeting the new goal levels. The Department's response to the issues raised by Fannie Mae and Freddie Mac relative to HUD's market share methodologies and its analysis of the statutory factors are discussed above.

Overall, other commenters were supportive of the proposed increase in the Low- and Moderate-Income Housing Goal. One group of commenters thought that, since the GSEs are mandated to lead the market, the level of the Low- and Moderate-Income Housing Goal should be increased further. Another group of commenters supported the increased level of the goal, but felt the Department needed to be prepared to

accommodate shifts in economic conditions that may have a negative impact on the GSEs' ability to meet the housing goals.

d. HUD's Determination

. The Low- and Moderate-Income Housing Goal established in this final rule is reasonable and appropriate having considered the factors set forth in FHEFSSA. HUD set the level of the housing goal conservatively, relative to the Department's market share estimates, in order to accommodate a variety of economic scenarios. Moreover, current examination of the gaps in the mortgage markets, along with the estimated size of the market available to the GSEs, demonstrates that the number of mortgages secured by housing for low- and moderate-income families is more than sufficient for the GSEs to achieve the new goal.

Therefore, having considered all the statutory factors including housing needs, projected economic and demographic conditions for 2001 to 2003, the GSEs' past performance, the size of the market serving low- and moderate-income families, and the GSEs' ability to lead the market while maintaining a sound financial condition; HUD has determined that the annual goal for mortgage purchases qualifying under the Low- and Moderate-Income Housing Goal will be 50 percent of eligible units financed in each of the years 2001, 2002 and 2003. The new goal level will increase the GSEs' current level of performance to a level that is consistent with reasonable estimates of the low- and moderate-income housing market.

7. Central Cities, Rural Areas, and Other Underserved Areas Goal, § 81.13

This section discusses the Department's consideration of the statutory factors in arriving at and comments received on the proposed new housing goal level for the Central Cities, Rural Areas, and Other Underserved Areas Housing Goal (the Geographically Targeted Goal).

The Geographically Targeted Goal focuses on areas currently underserved by the mortgage finance system. The 1995 Final Rule provided that mortgage purchases count toward the Geographically Targeted Goal if such purchases finance properties that are located in underserved census tracts. In § 81.2, HUD defined “underserved areas” for metropolitan areas (in central cities and other underserved areas) as census tracts where either: (1) The tract median income is at or below 90 percent of the area median income (AMI); or (2) the minority population is at least 30 percent and the tract median income is at or below 120 percent of AMI. The AMI ratio is calculated by dividing the tract median income by the MSA median income. The minority percent of a tract's population is calculated by dividing the tract's minority population by its total population.

For properties in non-metropolitan (rural) areas, mortgage purchases count toward the Geographically Targeted Goal where such purchases finance properties that are located in underserved counties. These are defined as counties where either: (1) The median income in the county does not exceed 95 percent of the greater of the state or nationwide non-metropolitan median income; or (2) minorities comprise at least 30 percent of the residents and the median income in the county does not exceed 120 percent of the state non-metropolitan median income.

After analyzing the statutory factors and considering the comments, this final rule establishes the goal for the percentage of dwelling units financed by each GSE's mortgage purchases on properties that are located in underserved areas for each of the years 2001-2003 be 31 percent. A short discussion of the statutory factors follows. Additional information analyzing each of the statutory factors is provided in Appendix B, “Departmental Considerations to Establish the Central Cities, Rural Areas, and Other Underserved Areas Goal,” and Appendix D, “Estimating the Size of the Conventional Conforming Market for Each Housing Goal.”

a. Market Estimate for the Geographically Targeted Goal.

The Department estimates that dwelling units in underserved areas will account for 29-32 percent of total units financed in the overall conventional, conforming mortgage market during the period 2001 through 2003. HUD has developed a reasonable range, rather than a point estimate, that accounts for significantly more adverse economic conditions than have existed recently.

Past Performance of the GSEs under the Geographically Targeted Goal

. The housing goals that have been in effect prior to this final rule required that in 1996 at least 21 percent of the units financed by the GSEs' mortgage purchases should count toward the Geographically Targeted Goal, and at least 24 percent in 1997 through 1999. Fannie Mae surpassed the goal by 7.1 percentage points in 1996, 4.8 percentage points in 1997, 3.0 percentage points in 1998, and 2.8 percentage points in 1999. Freddie Mac surpassed the goal by 4.0, 2.3, 2.1 and 3.5 percentage points in 1996, 1997, 1998, and 1999, respectively. The GSEs' performance for the 1996-99 period is summarized below:

Summary of GSE Performance Under the Geographically Targeted Goal 1996-1999

[In percentages]

1996

1997

1998

1999

Required Goal Level

Fannie Mae: Percent Geographically Targeted

28.1

28.8

27.0

26.8

Freddie Mac: Percent Geographically Targeted

25.0

26.3

26.1

27.5

Although both GSEs have improved their performance in underserved areas, on average, their mortgage purchases continue to lag the primary market in providing financing for housing in these areas. On average, during the 1996-1998 period, mortgage purchases on properties in underserved areas accounted for 19.9 percent of Freddie Mac's purchases of single family home purchase mortgages, compared with 22.9 percent of Fannie Mae's purchases, 25.8 percent of mortgages retained by portfolio lenders, and 24.9 percent of all home purchase mortgages originated in the conventional, conforming market. These figures indicate that Freddie Mac has been less likely than Fannie Mae to purchase mortgages on properties in underserved neighborhoods. Through 1998, Freddie Mac had not made progress in reducing the gap between its performance and that of the overall market. In 1992, underserved areas accounted for 18.6 percent of Freddie Mac's purchases of home purchase mortgages and for 22.2 percent of such mortgage loans originated in the conforming market, which yields a “Freddie Mac-to-Market” ratio

0.84. By 1998, the “Freddie Mac-to-Market” ratio had actually fallen to 0.81. During the same period, the “Fannie Mae-to-Market” ratio increased from 0.82 to 0.93. However, in 1999, Freddie Mac's purchase share for underserved area loans increased while Fannie Mae's declined. In 1999, underserved areas accounted for 21.2 percent of Freddie Mac's home purchase mortgage loan acquisitions, compared with 20.6 percent for Fannie Mae.

In evaluating the GSEs' past performance, it should be noted that while borrowers in underserved metropolitan areas tend to have much lower incomes than borrowers in other areas, this does not mean that GSE performance in underserved areas must be derived from mortgages on housing for lower income families. In 1999, housing for above median-income households accounted for about half of the single family owner-occupied mortgages the GSEs purchased in underserved areas.

c. Summary of Comments

. Fannie Mae expressed no objection to the higher goal level provided the Department retains the proposed housing goals framework, including the proposed changes to the counting rules, in the final rule. Freddie Mac supported the overall goal framework included in the proposed rule but recommended that the Geographically Targeted Goal be set at 30 percent. Freddie Mac noted that it was committed to stretching to meet the proposed new goal levels, but believed that the level of the Geographically Targeted Goal was set too far toward the high end of the market estimate, making it more difficult to achieve. The Department's response to the issues raised by both Fannie Mae and Freddie Mac relative to HUD's estimates of the markets and its analysis of the statutory factors used to set the level of the goals was discussed above.

Overall, other commenters were supportive of the proposed increase in the Geographically Targeted Goal. Certain commenters noted that by placing the level of the goal around the midpoint of the estimate of market size, the GSEs will be encouraged to move into a market leadership position. Another group of commenters supported the increased level of the goal, but felt the Department needed to be prepared to accommodate changes in economic circumstances that may have a negative impact on the GSEs' ability to meet the housing goals.

d. HUD's Determination

. The Geographically Targeted Goal established in this final rule is reasonable and appropriate, considering the factors set forth in FHEFSSA. The Department's market share estimates for the Geographically Targeted Goal accommodate a variety of economic scenarios. In addition, a current examination of the gaps in the mortgage markets, along with the estimated size of the market available to the GSEs, demonstrates the opportunities for the GSEs to purchase mortgages secured by housing in underserved areas of the nation.

Therefore, having considered all statutory factors including housing needs, projected economic and demographic conditions for 2001 to 2003, the GSEs' past performance, the size of the market for central cities, rural areas and other underserved areas, and the GSEs' ability to lead the market while maintaining a sound financial condition; HUD is establishing the annual goal for mortgage purchases qualifying under the Geographically Targeted Goal to be 31 percent of eligible units financed in each of the years 2001, 2002 and 2003. The new goal level will increase the GSEs' current level of performance to a level that is consistent with reasonable estimates of the housing market in underserved areas.

8. Special Affordable Housing Goal, § 81.14

This section discusses the Department's consideration of the statutory factors in arriving at, and the comments received on, the new housing goal level for the Special Affordable Housing Goal, which counts mortgages on housing for very low-income families and low-income families living in low-income areas. After consideration of these factors and the comments received, this final rule establishes the goal for the percentage of the total number of dwelling units financed by each GSE's mortgage purchases for housing affordable to very low-income families and low-income families living in low-income areas for each of the years 2001-2003 at 20 percent. A short discussion of the statutory factors follows. Additional information analyzing each of the statutory factors is provided in Appendix C, “Departmental Considerations to Establish the Special Affordable Housing Goal,” and Appendix D, “Estimating the Size of the Conventional Conforming Market for Each Housing Goal.

a. Market Estimate for the Special Affordable Housing Goal.

The Department estimates that dwelling units serving very low-income families and low-income families living in low-income areas will account for 23-26 percent of total units financed in the overall conventional, conforming mortgage market during the period 2001 through 2003. HUD has developed a reasonable range, rather than a point estimate, that accounts for significantly more adverse economic conditions than have existed recently.

b. Past Performance of the GSEs under the Special Affordable Housing Goal.

The Special Affordable Housing Goal is designed to ensure that the GSEs serve the very low- and low-income portion of the housing market. However, analysis of HMDA data shows that the shares of mortgage loans for very low-income homebuyers are smaller for the GSEs' mortgage purchases than for depository institutions and others originating mortgage loans in the conforming conventional market. HUD's analysis suggests that the GSEs should improve their performance in providing financing for the very low-income housing market.

The housing goals that have been in effect prior to this final rule specified that in 1996 at least 12 percent of the number of units eligible to count toward the Special Affordable Housing Goal should qualify as special affordable, and at least 14 percent in 1997 through 1999. As indicated below, Fannie Mae surpassed the goal by 3.4 percentage points in 1996, 3.0 percentage points in 1997, 0.3 percentage points in 1998 and 3.6 percentage points in 1999. Freddie Mac surpassed the goal by 2.0, 1.2, 1.9, and 3.2 percentage points in 1996, 1997, 1998, and 1999, respectively. The GSEs' performance for the 1996-99 period is summarized below:

Summary of GSE Performance under the Special Affordable Housing Goal 1996-1999

1996

(in percent)

1997

(in percent)

1998

(in percent)

1999

(in percent)

Required Goal Level

Fannie Mae:

Percent Low-and Moderate-Income

15.4

17.0

14.3

17.6

Freddie Mac:

Percent Low-and Moderate-Income

14.0

15.2

15.9

17.2

As noted above, HMDA and GSE data for metropolitan areas show that both GSEs lag depository institutions and other lenders in providing financing for home loans that qualify for the Special Affordable Housing Goal. Special affordable loans, which include loans for very low-income borrowers and low-income borrowers living in low-income areas, accounted for 9.8 percent of Freddie Mac's purchases of home purchase mortgages during 1996-98, 11.9 percent of Fannie Mae's purchases, 16.7 percent of newly originated loans retained by depository institutions, and 15.3 percent of all new originations in the conventional, conforming market. While Freddie Mac has improved its special affordable lending since the housing goals were put in place in 1993, up until 1999 it had not made as much progress as Fannie Mae in closing the gap with depository institutions and other lenders in the home loan market. In 1998, Freddie Mac's special affordable performance was 73 percent of the primary market proportion of home loans that would qualify under the Special Affordable Housing Goal, compared to Fannie Mae's performance of 85 percent during the same period. In 1999, Freddie Mac did match Fannie Mae, as special affordable loans accounted for 12.5 percent of its home loan purchases versus 12.3 percent of Fannie Mae's home loan purchases. Market data for 1999 are not yet available.

The multifamily market is especially important in the establishment of the Special Affordable Housing Goal for Fannie Mae and Freddie Mac because of the relatively high percentage of multifamily units meeting the Special Affordable Housing Goal. For example, in 1999, 56 percent of units financed by Fannie Mae's multifamily mortgage purchases met the Special Affordable Housing Goal, representing 31 percent of units counted toward the Special Affordable Housing Goal, at a time when multifamily units represented only nine percent of its total purchase volume.

c. Summary of Comments.

Fannie Mae expressed no objection to the higher goal level, provided the Department retains the proposed housing goals framework, including the proposed changes to the counting rules, in the final rule. Freddie Mac supported the goal framework included in the proposed rule and is committed to stretching to meet the new goal levels. The Department's response to the issues raised by both Fannie Mae and Freddie Mac relative to HUD's market share methodologies and its analysis of the statutory factors used to set the level of the goals was discussed above.

Overall, other commenters were supportive of the proposed increase in the Special Affordable Housing Goal. One group of commenters thought that, since the GSEs are mandated to lead the market, the level of the Special Affordable Housing Goal should be increased even more, at a minimum, to the lower range of the Department's market share, at 23-24 percent. Another group of commenters supported the increased level of the goal but felt the Department needed to be prepared to accommodate changes in economic circumstances that may have a negative impact on the GSEs' ability to meet the housing goals.

d. HUD Determination.

The Special Affordable Housing Goal established in the final rule is reasonable and appropriate, considering the factors set forth in FHEFSSA. The market share estimates for this goal reflect a variety of economic scenarios significantly more adverse than have existed recently. Current examination of the gaps in the mortgage markets, along with the estimated size of the market available to the GSEs, demonstrates that the number of mortgages secured by housing for special affordable families is more than sufficient for the GSEs to achieve the goal.

Having considered all statutory factors including housing needs, projected economic and demographic conditions for 2001 to 2003, the GSEs' past performance, the size of the market serving very low-income families and low-income families living in low-income areas, and the GSEs' ability to lead the market while maintaining a sound financial condition; HUD is establishing the annual goal for mortgage purchases qualifying under the Special Affordable Housing Goal at 20 percent of eligible units financed by each GSE in each of the years 2001, 2002 and 2003. This new goal level will increase the GSEs' current level of performance to a level that is consistent with reasonable estimates of the special affordable housing market.

e. Special Affordable Housing Goal: Multifamily Subgoal.

This final rule modifies the proposed rule by implementing a multifamily subgoal based upon each GSE's respective average mortgage purchase volume for the years 1997 through 1999. The proposed rule suggested that the subgoal be established at 0.9 percent of each GSE's dollar volume of combined 1998 mortgage purchases in 2000 and at 1.0 percent of combined 1998 mortgage purchases from 2001 through 2003. In this final rule, the level of the subgoal is established at a fixed level of one percent of the average of each GSE's respective dollar volume of combined (single family and multifamily) mortgage purchases in the years 1997, 1998 and 1999. This level is $2.85 billion for Fannie Mae and $2.11 billion for Freddie Mac, in each of the years 2001 through 2003.

f. Summary of Comments.

Both Fannie Mae and Freddie Mac opposed establishing the special affordable multifamily subgoal as a percentage of their 1998 transaction volumes, stating that 1998 was in some respects an unusual year in the mortgage markets. Instead, they both recommended that the special affordable multifamily subgoal be established as a percentage of a five year average of each GSE's transactions volume. Freddie Mac commented further that HUD's proposed subgoal was unreasonably high.

Many other commenters supported the multifamily subgoal, although they questioned whether 1998 was the appropriate base year upon which to establish the subgoal. Some commenters asserted that the proposed subgoal was too high, in light of an expected decline in multifamily origination volume. Other commenters noted that the subgoal was too low, based on the needs of very low- and low-income families and those in rural areas. Yet, others agreed the subgoal should continue to be percentage based, but argued that the baseline year should move from year to year. Still other commenters felt that the multifamily subgoal should be eliminated, as it no longer appears to serve a purpose, particularly since Freddie Mac has re-entered the multifamily market.

g. HUD's Determination.

Both the multifamily mortgage market and Freddie Mac's multifamily transactions volume have grown significantly during the 1990's, indicating both increased opportunity and capacity to grow by Freddie Mac. While Freddie Mac continues to lag behind Fannie Mae somewhat in its multifamily volume, it appears to be within reach of catching up with its larger competitor with regard to the multifamily proportion of total purchases. In 1999, Fannie Mae's multifamily mortgage purchases were 9.5 percent of its total mortgage purchases and Freddie Mac's multifamily mortgage purchases were 8.3 percent of its total mortgage purchases.

Freddie Mac's multifamily special affordable transactions volume was $2.7 billion in 1998 and $2.3 billion in 1999, which demonstrates Freddie Mac's capacity to generate significant multifamily special affordable volume in a favorable market environment. However, the Department is mindful of the fact that the multifamily market conditions experienced during 1998 were very favorable and may not be fully representative of future years. HUD expects conventional multifamily volume in 2001 through 2003 to be somewhat lower than the level reached during 1998.

The Special Affordable Housing Multifamily Subgoal established in this final rule is reasonable and appropriate based on the Department's analysis of this market. The Department's decision to retain the multifamily subgoal is based on the fact that HUD's analysis indicates that multifamily housing still serves the housing needs of lower-income families and families in low-income areas to a greater extent than single family housing. By retaining the multifamily subgoal, the Department ensures that the GSEs continue their activity in this market and that they achieve, at least, a minimum level of special affordable multifamily mortgage purchases that are affordable to lower-income families. Now that more recent data is available, it is apparent that taking 1999 mortgage volume into consideration, along with that of 1997 and 1998, more accurately corresponds to the relative size and respective capabilities of the GSEs over the 2001-2003 goals period. Accordingly, as noted above, this final rule establishes each GSE's special affordable multifamily subgoal at the respective average of one percent of that GSEs' combined mortgage purchases over 1997 through 1999.

h. Multifamily Subgoal Alternatives.

In the proposed rule, HUD identified three alternative approaches for specifying multifamily subgoals for the GSEs based on a (i) minimum number of units; (ii) minimum percentage of multifamily acquisition volume; and (iii) minimum number of mortgages acquired. While some of these proposals did receive support from commenters, HUD does not see any compelling reason to alter the dollar based structure of the multifamily subgoal as established in the regulations, which can be updated and adapted to the current market environment by basing it upon recent acquisition volume. It is noteworthy that the Special Affordable Housing Goal, as a percentage of business goal based on the number of units financed, combines elements of options (i) and (iii). HUD's decision to award bonus points toward the housing goals for GSE transactions involving small multifamily properties with 5-50 units will achieve some of the intended policy objectives associated with option (iii).

9. Bonuses and Subgoals

a. Overview.

The Department proposed to introduce a system of bonus points to encourage the GSEs to increase their activity in specified underserved markets that serve low- and moderate-income families and families in underserved areas. Bonus points were specifically proposed to encourage increased involvement by the GSEs under goals established for the years 2000-2003 for purchases of mortgages financing small multifamily properties (5-50 units) and two to four unit owner-occupied properties that contain rental units. The areas for which bonus points were suggested are areas in which the GSEs' mortgage purchases have traditionally played a minor role but which provide significant sources of affordable housing and for which the need for mortgage credit persists. As a regulatory incentive to encourage the GSEs to increase their mortgage purchase activity in underserved markets, the Department proposed the use of bonus points for mortgage purchases in these important segments of the housing market. HUD also sought comments on the utility of applying bonus points and other regulatory incentives such as subgoals to other underserved segments of the market including manufactured housing, multifamily properties in need of rehabilitation, and properties in tribal areas.

This final rule incorporates the use of bonus points for small multifamily properties and owner-occupied single family rental properties as proposed for the years 2001 through 2003.

b. Summary of Comments.

Fannie Mae and Freddie Mac commented in detail on the use of bonus points and subgoals. Fannie Mae supported the use of bonus points to provide incentives to expand its presence in the markets for both the small multifamily and single family owner-occupied, 2-4 unit property. Fannie Mae opposed the use of subgoals for that purpose, however, arguing that they would result in micromanagement of its business operation. Fannie Mae added that “these two property types pose great difficulties for the secondary market to serve and will require new channels, new products, new modes of operation, and significant investments to better understand the risks.” Fannie Mae also recommended that if the Department adopts bonus points, the points should continue beyond 2003.

Freddie Mac supported using bonus points and opposed using subgoals for small multifamily and single family owner-occupied, 2-4 unit property mortgage acquisitions. As with Fannie Mae, Freddie Mac commented that subgoals would result in micromanagement of its business. Freddie Mac also recommended calculating the threshold for 2-4 unit properties based on the period from 1995-1999 instead of using a five-year rolling average. Overall, Freddie Mac commented that it would prefer bonus points to subgoals for any targeted market segments.

Other commenters were generally supportive of the use of bonus points, with many noting that bonus points were preferable to additional subgoals. This group of commenters felt that additional subgoals would result in micromanagement of the GSEs' business operations but felt that bonus points provided an incentive rather than a mandate to move into markets that were underserved.

One group of commenters was opposed to bonus points. Among many of these commenters, however, there was support for incentives for the GSEs to purchase mortgages on small rental properties, noting that the market is underserved and provides an excellent source of affordable rental housing. Specific comments regarding the use of bonus points concluded that bonus points would: (a) Allow the GSEs to meet the goals with less effort and that they might lead the GSEs to relax their single family efforts; and (b) inflate goal performance numbers. It was suggested by several commenters that subgoals would be a more appropriate vehicle to encourage the GSEs' involvement in those segments of the market as well as other segments,

e.g.,

mortgages made to

minority borrowers and home purchase mortgages. Some commenters suggested that since there was evidence that the small multifamily mortgage market is well served by community banks, thrifts and small life insurance companies, there is no need for HUD to award bonus points as an incentive for the GSEs to enter that market.

c. HUD's Determination.

This final rule adopts the two categories for bonus points that were proposed by the Department. Bonus points are a temporary incentive for the GSEs to step up their efforts to serve this particular need. Availability of bonus points for this purpose beyond 2003, therefore, will require a determination by the Department that the bonus points continue to serve this need. HUD's research and analysis indicates that there is substantial unmet need in these two areas and believes that these are markets the GSEs should serve better. While HUD has determined to establish bonus points in the two market areas proposed, HUD does not believe that either the use of subgoals, that would be unenforceable under FHEFSSA (except for the Special Affordable Housing Goal), or bonus points amounts to micromanagement of the GSEs. By utilizing bonus points the GSEs can choose whether to increase their presence in these markets, and by evaluating the impact of these incentives on the GSEs' mortgage purchase patterns, the Department can evaluate the reasonableness and effectiveness of bonus points as a tool to increase activity in specific markets.

d. Additional Bonus Points and Subgoals.

Commenters suggested a wide variety of other areas to consider for either bonus points and/or subgoals including those for which views were invited. Suggestions by commenters for subgoals included home purchase mortgages and mortgages to minority borrowers. Commenters also suggested either bonus points and/or subgoals for reverse mortgages, groups with low homeownership rates, rural multifamily housing programs, manufactured housing, and expiring Section 8 assistance contracts, among other types of transactions. While there was some support for directing bonus points for encouraging GSE financing for minorities there was, however, no consensus among the commenters for this or other specific categories that bonus points and subgoals should address. Since HUD believes that the increased goals under this rule will result in increased financing of affordable housing and increased home ownership opportunities for minorities and other families in underserved areas, HUD has determined to establish bonus points only in the two categories proposed at this time. As indicated above, HUD will, however, monitor the effectiveness of these bonus points closely, based on these results and future housing needs, may establish bonus points for other mortgage purchases in the future.

10. Temporary Adjustment Factor for Freddie Mac

a. Overview.

To overcome any lingering effects of Freddie Mac's decision to dismantle and then cautiously reestablish a multifamily mortgage purchase program in the early 1990s, the Department proposed an incentive for Freddie Mac to further expand its scope of multifamily operations through the use of a temporary adjustment factor for its multifamily mortgage purchases in calculating its performance under the Low- and Moderate-Income Housing Goal and the Special Affordable Housing Goal. In determining Freddie Mac's performance for each of these two goals, the Department proposed that each unit in a property with more than 50 units meeting either of these two housing goals would be counted as 1.2 units in the numerator of the respective housing goal percentage. The temporary adjustment factor would be limited to properties with more than 50 units to avoid overlap with the proposal to award bonus points for multifamily properties with 5-50 units. Comments were requested on whether the proposed temporary adjustment factor for Freddie Mac was set at an appropriate level and whether such an adjustment factor should be phased out prior to 2003.

This final rule incorporates the temporary adjustment factor for Freddie Mac for multifamily properties, other than those small multifamily units receiving bonus credit, as proposed for the years 2001 through 2003.

b. Summary of Comments.

Fannie Mae and Freddie Mac commented in detail on the application of a temporary adjustment factor for Freddie Mac's multifamily business. Fannie Mae opposed the application of a temporary adjustment factor for Freddie Mac's multifamily business. Fannie Mae stated that Freddie Mac made a business decision to leave the multifamily market and HUD's action would effectively punish Fannie Mae for staying in the market. Fannie Mae recommended that instead of a temporary adjustment factor, HUD should lower Freddie Mac's goals to levels that would represent a similar “stretch” as the higher goal levels that would be established for Fannie Mae.

Freddie Mac supported the idea of a temporary adjustment factor but recommended that it be set at a multiplier of 1.35 instead of 1.2. Noting that the difference in size and age between Freddie Mac's and Fannie Mae's multifamily portfolios makes goal achievement easier for Fannie Mae, Freddie Mac also recommended that the temporary adjustment factor apply to all three goals. Freddie Mac also opposed any phasing out or elimination of the adjustment factor.

Other comments on the proposal were mixed. While there were many comments in support of the proposal, a number of commenters objected to the proposal, observing that by providing the temporary adjustment factor, HUD would be rewarding Freddie Mac for leaving the multifamily mortgage market in previous years. Commenters also suggested that the same objective could be achieved through the Special Affordable Multifamily Subgoal or by establishing separate housing goals for the single family and multifamily market. Many of these commenters said that, if the temporary adjustment factor were adopted for Freddie Mac, it should be phased out over a period of time.

c. HUD's Determination.

In the period since HUD's interim housing goals took effect in January 1993, the volume of Freddie Mac's multifamily mortgage purchase transactions has grown significantly, both in absolute terms and as a proportion of its total mortgage purchases. Freddie Mac's 1993 multifamily transactions volume was only $191 million, compared with $7.6 billion in 1999. In 1999, Freddie Mac's multifamily transactions volume represented 8.3 percent of units backing its total mortgage purchases, close to the Fannie Mae proportion of 9.5 percent. Thus, while Freddie Mac continues to lag behind Fannie Mae somewhat in its multifamily volume, it appears to be within reach of catching up with Fannie Mae with regard to the multifamily proportion of total purchases.

In discussing the Department's appropriations for fiscal year 2000, the Conference Report stated in October, 1999 that “* * * the stretch affordable housing efforts required of each of Freddie Mac and Fannie Mae should be equal, so that both enterprises are similarly challenged in attaining the goals. This will require the Secretary to recognize the present composition of each enterprise's overall portfolio in order to ensure regulatory parity in the application of regulatory guidelines measuring goal compliance.”

Consistent with Congress' October 1999 guidance, HUD's analysis indicates that a 1.2 adjustment factor applied to Freddie Mac's mortgage purchases for multifamily properties of more than 50 units for purposes of the Low- and Moderate-Income and Special Affordable Housing Goals, as proposed, is sufficient both to overcome any lingering effects of Freddie Mac's decision to leave the multifamily market in the early 1990s and to “ensure regulatory parity,” taking account of the recent magnitude of difference between the GSEs' respective multifamily shares of business and the multifamily market projections detailed in Appendix D. Therefore, while the goals are set at the same levels, the Department has decided to implement the temporary adjustment factor as proposed. The temporary adjustment factor of 1.2 will be applied to the Low- and Moderate-Income Housing Goal and the Special Affordable Housing Goal. The temporary adjustment factor will terminate December 31, 2003. The temporary adjustment factor will not apply to Fannie Mae.

11. High Cost Mortgages

a. Overview.

The proposed rule requested comments on whether HUD should disallow goals credit for high cost mortgage loans, and if so, whether HUD should define high cost mortgage loans using the Home Ownership and Equity Protection Act (HOEPA)

or an alternative definition. HOEPA defines high cost mortgages as those that meet an annual percentage rate (APR) threshold (more than 10 percentage points above the yield on Treasury securities of comparable maturity; the Federal Reserve Board can adjust the threshold down to 8 percent or up to 12 percent), or a threshold for points and fees charged (exceeding the greater of 8 percent of the loan amount or $400—adjusted for inflation to $451 for the year 2000). HOEPA requires additional disclosures and restricts certain loan terms (

e.g.

, prepayment penalties, balloon payments, and negative amortization) and practices (

e.g.

failing to consider a borrower's ability to repay) for those mortgages.

The proposed rule also requested comments on the potential benefits, if any, associated with the GSEs' presence in the various higher cost mortgage markets, such as the standardization of underwriting guidelines or reductions in interest rates, as well as the potential dangers, if any, associated with the GSEs' presence in those markets. Finally, the proposed rule requested comments on what additional data would be useful for the purposes of monitoring the GSEs' activities in this area and on whether certain of these data elements should be included in the public use data base. The proposed rule noted that possible data elements that could be collected from the GSEs for monitoring include loan level data on the annual percentage rate, debt-to-income ratio, points and fees, and prepayment penalties.

b. HUD/Treasury Report.

On June 20, 2000, HUD and the Department of Treasury jointly released a report entitled “Curbing Predatory Home Mortgage Lending,” which detailed predatory or abusive lending practices in connection with higher cost loans in the subprime mortgage market. These practices include charging excessive fees, lending to borrowers without regard to their ability to repay, establishing prepayment penalties that prevent high cost borrowers from refinancing into lower cost loans, abusive terms and conditions that include packing loans with products such as single premium credit insurance, and other practices, including failing to steer borrowers to the lowest-cost product for which they qualify and incomplete reporting of borrowers' payment history to credit bureaus. The report recommended legislative and regulatory action to combat predatory lending while maintaining access to credit for low- and moderate-income borrowers. Respecting the secondary mortgage market, the report recommended that HUD restrict the GSEs from funding loans with predatory features since such loans may undermine homeownership by low- and moderate-income families. HUD and Treasury noted “while the GSEs currently play a relatively small role in the subprime market today, they are beginning to reach out with new products in this marketplace.”

Recently the GSEs have each announced corporate policies against the purchase of loans with certain features. Fannie Mae has established greater limitations than Freddie Mac, although Fannie Mae has been less involved in the subprime market to date. Fannie Mae announced that “[f]or loans delivered to Fannie Mae, the points and fees charged to a borrower should not exceed 5 percent, except where this would result in an unprofitable origination,” and that Fannie Mae will not purchase high cost mortgages as defined under HOEPA. Fannie Mae announced further that it “will not purchase or securitize any mortgage for which a prepaid single-premium credit life insurance policy was sold to the borrower,” and that it will generally only allow prepayment penalties under the terms of a negotiated contract and where the lender adheres to the following criteria: A mortgage that has a prepayment penalty should provide some benefit to the borrower (such as a rate or fee reduction for accepting the prepayment premium); the borrower also should be offered the choice of another mortgage product that does not require payment of such premium; the terms of the mortgage provision that requires a prepayment penalty should be adequately disclosed to the borrower, and the prepayment penalty should not be charged when the mortgage debt is accelerated as a result of the borrower's default in making his or her mortgage payments.

Fannie Mae also announced that it will not purchase loans from lenders who steer borrowers to higher cost products if those borrowers qualify for lower cost products. Freddie Mac announced that it will not purchase HOEPA loans, nor will it purchase mortgage loans with single-premium credit life insurance. Both GSEs have announced that they will require lenders who sell them loans to file monthly full-file credit reports on every borrower. While the GSEs' policies differ somewhat in their scope and specificity, both have publicly expressed strong concern about predatory lending practices and have adopted policies requiring them to look harder at particular loan terms and their seller/servicers' business practices, and restricting their purchases of loans originated with such terms and practices. However, the GSEs' broad guidelines describing the characteristics of loans that they intend to make ineligible for purchase lack important details and are subject to changes in corporate direction, or other changes. Therefore, HUD and Treasury recognized in the report that such corporate policies may not be sufficient and that regulations would be needed to address this issue.

c. Summary of Comments.

Many commenters on the proposed rule supported the disallowance of credit under the GSE housing goals for high cost mortgages. Some of these commenters commended the GSEs for beginning to offer quality loan products to credit-impaired borrowers. Those commenters argued, however, that restrictions on goals credit for certain loans would not prohibit the GSEs from purchasing all subprime loans but merely those that are likely to be predatory and wealth-stripping. Other commenters argued that without adequate controls, the GSEs' forays into the subprime market will not translate

into lower costs for borrowers, but will only lower the cost of capital for subprime lenders.

Some commenters wrote that the GSEs should not receive credit under the housing goals for high cost mortgages that are subject to HOEPA. Many other commenters felt that such a standard would not go far enough, and that the GSEs should not receive goals credit for purchasing loans with certain features. Such features would include fees greater than 3 percent of the loan amount, prepayment penalties on high cost loans, and prepaid single premium credit life insurance that is to be financed in the loan. Commenters also provided additional features for which the GSEs should not receive goals credit, including negative amortization and accelerating indebtedness, fees to renew or modify, balloon payments, yield spread premiums, mandatory arbitration, or high cost loans for which the borrower did not receive homeownership counseling.

One commenter suggested that the Department should treat loans purchased from an institution that engages in predatory lending the same as loans that actually have predatory features in order to send a message that such lenders are not responsible business partners and to restrict further the availability of mortgage credit for such loans. Other commenters suggested that the GSEs should not be allowed to purchase subprime loans at all, so that they will have an incentive to develop conventional mortgage products to reach out to those borrowers. Another suggestion was that the GSEs should be affirmatively penalized for purchasing certain abusive mortgages (

i.e.,

by subtracting points from the numerator but fully counting such loans in the denominator).

A number of commenters suggested that GSEs should be required to conduct fair lending reviews of subprime loans before they purchase them in order to receive credit. Such reviews would include determining whether the lending institution is reporting borrowers' full payment histories to credit bureaus.

Many of the commenters that supported the disallowance of goals credit for high cost loans and loans with certain harmful features asserted that the GSEs' support of such lending poses great risks. These commenters argued that the types of mortgage products that strip equity out of homes and lead to higher foreclosures are not consistent with the GSEs' public mission. Further, to the extent that defaults on these loans lead to losses, these commenters asserted that the GSEs' financial condition will likely be affected.

With regard to data collection and reporting, several commenters suggested that the GSEs should be required to provide full information on their subprime loans, including the APR, total closing costs, points, and fees (including financed credit insurance premiums), delinquency and foreclosure rates, and the length of time between purchase and refinance on an aggregate basis.

Both GSEs and a large group of commenters objected to the Department's proposal regarding the disallowance of goals credit for purchases of high cost mortgages. Many of those commenting in this regard provided substantially similar responses to those submitted by Fannie Mae. These commenters emphasized the difference between legitimate subprime lending and lending through the use of abusive and predatory practices such as those outlined in the HUD/Treasury report. Several of these commenters expressed concern that the Department should not take any action that would discourage the GSEs from serving the subprime market. The GSEs both remarked that they are using enhanced technology (

e.g.,

their respective automated underwriting systems) to allow them to offer products targeted toward borrowers with impaired credit, and that they are, therefore, able to move into the legitimate subprime market in a responsible and prudent manner, bringing liquidity, standardization, and efficiency to that market. The GSEs argue that disallowing goals credit for high cost mortgages will provide a disincentive for them to reach out to those borrowers and will do nothing to combat the predatory lending practices about which the Department is concerned. Indeed, Fannie Mae argued that disallowing goals credit for high cost mortgages would simply drive predatory lending “into the government market or to secondary market sources who are less responsible than Fannie Mae on this issue.”

Fannie Mae argued that disallowing goals credit for high cost mortgages is inconsistent with the Department's inclusion of A-minus mortgages in the market estimates to which the Department compares the GSEs' performance. Fannie Mae further argued that the Department would need to “recalibrate the goals” in order to implement a system of disallowing goals credit for high cost mortgages, which would be “extremely difficult, if not impossible” due to “the lack of reliable market data on loan costs.”

Nonetheless, Fannie Mae urged the Department to work with other regulatory agencies to collect more data on the problem. Freddie Mac urged the Department to await the outcome of any Federal legislative or regulatory initiatives that may arise as a result of the widespread concern and focus on these issues among members of Congress and regulatory agencies.

The GSEs also both objected to any additional reporting requirements related to monitoring their purchases of high cost mortgages. Fannie Mae argued that the relevant information is not now captured in the primary market, and that collecting and reporting this information would force a “tremendous change to the way the market operates.” Freddie Mac similarly argued that the required data elements are not stored uniformly across lenders, and collecting and reporting such data elements would require “substantial investments,” the economic impacts of wh

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