OTS Opines That Federally-Chartered Thrifts and Their Operating Subsidiaries are Exempt From Georgia and New York High-Cost Loan LawsSteven M. KaplanOTS, HOLA, GFLA, New York's A.11856, Alternative Mortgage Transaction Parity Act, Last month, the Office of Thrift Supervision (OTS) issued opinion letters asserting that the Home Owners Loan Act (HOLA) and the related OTS regulations preempt the Georgia Fair Lending Act (GFLA) and New York's A.11856 (to be codified in Section 6-L of the Banking Act) (together the High-Cost Laws). According to the opinions, the High-Cost Laws do not apply to federally-chartered thrifts or their operating subsidiaries. The opinions, although surprisingly concisearticulating the agency's preemption arguments in five pages or lessspeak volumes about the agency's internal struggle to curb predatory lending activities while maintaining control over thrift lending activities. By issuing such sweeping opinions within a span of 10 days, the OTS has sent a clear message that it will not concede its regulatory power to the states, no matter how laudable the state or local public policy of eliminating predatory lending practices may be. Yet, ironically, late last year, purportedly trying to empower states to eliminate perceived predatory lending practices and sensitive to the claim that its position on preemption made it an "enabler" of predatory lending practices, the very same agency took action designed to curtail the preemption of certain state laws under the Alternative Mortgage Transaction Parity Act (the Parity Act) relating to prepayment fees and late fees on alternative mortgage transactions (AMTs). While the two new preemption opinions of the OTS appear to be correct as a matter of law, this position nevertheless creates the very disparity between federally-chartered and independent housing creditors that Congress sought to eliminate under the Parity Act for AMTs. Thrifts and their operating subsidiaries, for example, may rely on federal preemption under HOLA to charge prepayment fees notwithstanding contrary limitations under the High-Cost Laws, while independent housing creditors may not rely on the explicit provisions of the Parity Act to achieve comparable federal preemption on AMTs. Go figure! Although the opinions leave no room for doubt that the agency interprets HOLA and its implementing regulations as occupying the field of loan origination, certain ambiguities remain. For example, how do the opinions affect assignees and servicers of mortgage loans originated by federal thrifts and their operating subsidiaries? While the opinions certainly are good news for federally-chartered thrifts, many questions must still be answered before their effect on these and other state high cost laws can be fully understood. This article is divided into four main parts: (i) a discussion of the High-Cost Laws; (ii) the OTS's opinions regarding preemption of such laws; (iii) the areas of ambiguity not addressed in the opinions; and (iv) the preemption of real property-related provisions. Background of the High-Cost Laws A. Georgia Fair Lending Act The GFLA contains some of the most draconian provisions of any anti-predatory lending law in the country.1 Not only does it contain onerous origination restrictions, it imposes severe penalties for even innocuous and unintentional violations of its requirements. Perhaps the most disconcerting aspect of the law for parties in the mortgage industry is the fact that innocent purchasers and servicers of certain loans subject to the GFLA may be liable for origination violations of brokers and lenders. Because of its expansive scope and harsh penalties, the GFLA has been the subject of intense scrutiny by the mortgage lending industry since Georgia enacted the law last year. The threat of liability under the GFLA has caused many loan originators to stop making certain loans in Georgia, and made secondary market purchasers wary of acquiring loans subject to the law. Further, Standard & Poor's (S&P) recently announced that conforming-balance loans and manufactured home loans covered by the GFLA can no longer be included in S&P-rated structured finance transactions.2 S&P concluded that the potential liability risk to transaction parties in securitizations, including depositors, issuers, and servicers, was too uncertain, given the fact that "it is not feasible to ensure that all GFLA-governed loans have been originated in compliance with the Actand given that the liability associated with non-compliance may subject depositors and trusts to liability exceeding a loan's principal balance."3 An announcement from Moody's Investor Services followed close on the heels of S&P's announcement. Moody's announced that the risks of including loans subject to the GFLA in rated residential mortgage-backed securitizations are "prohibitively high."4 Moody's premised its decision on "(i) the potential for mischaracterizing loans in the various tiers established under the Act, (ii) the difficulty in complying with the Act's restrictions in each tier and, most importantly, (iii) the unlimited liability that securitization trusts would take on if a loan is found to be out of compliance."5 Moody's characterized an assignee's liability as "theoretically immeasurable because there is no cap on punitive damage awards."6 B. New York A.11856 New York's A.11856 is the state's second attempt to curb what the state deems to be "predatory lending" practices. It goes into effect for loan applications taken on or after April 1, 2003. Note that the law does not replace anti-predatory lending regulations adopted earlier as Part 41 of the General Regulations of the Banking Board. Nor does it preempt New York City's own anti-predatory lending ordinance scheduled to go into effect as of Feb. 18, 2003. Thus, lenders making loans in New York City must comply with a law, a regulation and an ordinance when originating loans.7 According to its terms, A.11856 applies to "lenders." The term "lenders" means a Mortgage Banker or an exempt entity as defined under Sections 590(e) and 590(f) of the Banking Law. Section 590(f) of the Banking Law defines a "Mortgage Banker" as a person or entity who or which is licensed pursuant to Section 591 of the Licensed Mortgage Banker Act to engage in the business of making mortgage loans in New York. An "exempt entity" includes national banks, federal savings banks, federal savings and loan associations, federal credit unions, and may also include any subsidiary of such entities. The penalties under A.11856 are harsh, including voiding of the loan upon a finding of an intentional violation of the law, a right of rescission that is available without a time limitation, and other statutory damages. Notably, A.11856 is the only one of the three New York anti-predatory lending initiatives to include express penalties. Unfortunately, the drafters of the New York law borrowed a page from the Georgia legislature and the right to rescind can be expressed either affirmatively or defensively. Another notable point about A.11856's penalty provisions is that defenses can be raised by borrowers when in foreclosure. The OTS Opinions Under HOLA, the OTS is responsible for organizing, incorporating, examining, and regulating federal savings associations and their operating subsidiaries, "giving primary consideration of the best practices of thrift institutions in the United States."8 The OTS has interpreted this grant of authority as authorizing it to promulgate regulations that preempt state laws affecting the operations of federal savings associations when the OTS deems such preemption to be appropriate "to facilitate the safe and sound operation of federal savings associations, to enable federal savings associations to conduct their operations in accordance with the best practices of thrift institutions in the United States, or to further other purposes of HOLA."9 Concluding that these purposes would be best served by giving federal savings associations "maximum flexibility to exercise their lending powers in accordance with a uniform federal scheme of regulation," the OTS has, subject to certain exceptions, occupied the entire field of lending regulation for federal savings associations.10 Section 560.2 of the OTS's regulations contains a non-exclusive list of the types of state laws that are preempted in regard to federal savings associations. This list, too extensive to be included here completely, includes state laws relating to the licensing of lenders, insurance on loans, loan-to-value ratios, terms of credit, and loan-related fees.11 It was against this federal preemption framework that the OTS examined the provisions of the High-Cost Laws. The inquiring party or parties (such information has been redacted from public copies for privacy reasons) asked the OTS to confirm that federal law preempts the application of the High-Cost Laws to federal savings associations (in Georgia the request also specifically included operating subsidiaries and loans arranged by mortgage brokers). The opinions confirm that federal law preempts the application of the High-Cost Laws to federal savings associations and their operating subsidiaries (and, in Georgia, those loans arranged by Mortgage Brokers, provided the thrift of the operating subsidiary is the entity named on the note). Despite the complexity of the High-Cost Laws at issue, the opinions do not present a provision-by-provision analysis to describe the extent of the federal preemption. Rather, the OTS's approach is to do the following. First, provide a summary of the relevant high-cost law in general terms. Second, after summarizing the law in general terms, the OTS summarizes HOLA and its implementing regulations, which provide for federal preemption of state laws. The OTS's intent appears to be to reaffirm that its regulations completely occupy the field of lending regulation of federal thrifts. Thus, states simply may not impose additional restrictions on the lending practices of those entities. Finally, the OTS concludes that because the High-Cost Laws impose "a number of specific restrictions and requirements on home loans," most of the requirements under the High-Cost Laws do not apply to federal thrifts. The OTS also expressly stated that the High-Cost Laws do not apply to operating subsidiaries, since state laws purporting to regulate operating subsidiaries of federal savings associations are preempted to the same extent that such laws are preempted for their parent institutions. Further, in the Georgia opinion, the OTS stated that federal thrifts and their operating subsidiaries would not have to comply with the GFLA provisions when funding loans in their own names through independent Mortgage Brokers, provided that the loan documents evidence that the thrift or operating subsidiary is the lender. Limitations of the OTS Opinions While the OTS opinions are likely to be welcomed by federal savings associations and their operating subsidiaries, certain questions remain. For example, to what extent will the High-Cost Laws continue to apply to servicers and assignees of loans originated by federal savings associations and their operating subsidiaries? Additionally, to what extent will the High-Cost Laws apply to loans originated by state housing creditors that are subject to the OTS's regulatory authority under the Parity Act? Below, we have identified a number of issues that the OTS notably did not address in either of the opinions: Assignee Liability The OTS did not address the question of whether assignees of loans originated by federal savings associations or their operating subsidiaries could be held liable if the loan was not originated in conformity with legal requirements that are not preempted by HOLA and OTS regulations. Servicers The opinions also did not discuss preemption of the High-Cost Laws provisions restricting the fees that servicers of mortgage loans (that are not federal savings and loans or their operating subsidiaries) are allowed to charge. This omission is unfortunate for servicers because it leaves open substantial questions about the extent to which these servicers must comply with the High-Cost Laws when servicing loans originated by federal thrifts. Servicers might be able to rely on these opinions to argue that they can charge fees otherwise prohibited by the High-Cost Laws so long as they are charging those fees as the contractor or agent for and on behalf of their federal thrift clients. Is the result the same if the fees collected by the servicers are retained for their own account, recognizing that the right to receive ancillary income is an important ingredient in the determination of servicing fees? Arbitration/Forum Choosing Another set of provisions that the OTS did not address is arbitration-related provisions. The OTS expressly did not opine on whether federal law would preempt Section 7-6A-5(6) of the GFLA, which renders ineffective any provisions in a high-cost home loan agreement that would require the borrower to assert any claims or defenses "in a forum that is less convenient, more costly, or more dilatory for that resolution of a dispute than the judicial forum established in this state where the borrower may otherwise properly bring the claim or defense or limits in any way any claim or defense the borrower may have." Similarly, the OTS refrained from opining on Section 6-L(2)(g) of the New York Banking Law, which prohibits arbitration clauses that are oppressive, unfair, unconscionable, or substantially in derogation of consumers' rights. "Other Entities" The Georgia opinion explicitly stated that it does not address whether the GFLA's provisions would apply to entities other than federal savings associations and their operating subsidiaries (the New York opinion generally is silent on this point, but notes that the opinion does not apply to home contractors). The "other entities" to which the letter referred are most likely state housing creditors subject to the OTS's authority under the Parity Act.12 As noted above, it is ironic that the OTS so readily concludes that most of the GFLA's provisions do not apply to federal thrifts, even as it is acting to restrict the preemption available to state housing creditors under the Parity Act because of a concern over predatory lending practices.13 Real Property-Related Provision Preemption Even though the two opinions are remarkably similar with respect to both content and approach, there is one noticeable difference. In the New York opinion, the OTS displayed a willingness to address a real property-related foreclosure issue, even though the agency was silent with respect to the Georgia counterpart. The New York law provides that a borrower who is in default more than 60 days or who is in foreclosure may assert any claims in recoupment and defenses to payment against an assignee attempting to enforce the loan that the borrower could enforce against the original lender. The party requesting the New York opinion asked whether this provision is preempted for federal savings associations. The OTS found that such provision has "more than an incidental effect" on the lending operations of federal savings associations and would run contrary to HOLA's purpose of allowing federal savings associations to exercise their lending powers in accordance with a uniform federal scheme. The OTS notes, however, that, in general, real property laws are not preempted for federal savings associations and their operating subsidiaries. Rather, such laws are preempted to the extent they more than incidentally affect the lending operations of federal savings associations or are inconsistent with HOLA's purposes. Since the purpose of A.11856's foreclosure provision appears designed to compel compliance with the law, such provision does not qualify as the type of real property law that generally is not preempted. Section 7-6A-6(c) of the GFLA indicates that the borrowers of covered loans, upon receiving a notice of acceleration or foreclosure or if the loan is in default for more than 60 days, may assert a violation of the law as a defense. This provision bears a striking resemblance to the New York provision that the OTS deemed preempted; however, the Georgia opinion did not expressly state that the Georgia provision is preempted. Conclusion The opinions are noteworthy for two reasons, one substantive, one political. As to the substantive reason, the opinions are a clear assertion that federal law controls with respect to federal savings associations and their operating subsidiaries. Politically, the letters are groundbreaking, paving the way for the Office of the Comptroller of the Currency and the National Credit Union Administration to follow the OTS's lead for their respective regulated entities and also for thrifts and their operating subsidiaries to request guidance on the many other state laws and local ordinances currently in effect. Footnotes 1: A detailed discussion of the GFLA, including a discussion of the law's implications for various mortgage industry participants, may be found in a recent Kirkpatrick & Lockhart Alert, "Buyer Beware: New Georgia Fair Lending Act Holds Innocent Purchasers Responsible," K&L Alert: Mortgage Banking Commentary, Sept. 26, 2002. For more information, visit www.kl.com. 2: See "Standard & Poor's to Disallow Georgia Fair Lending Act Loans," S&P Press Release, Jan. 16, 2003. For more information, visit www.standarsandpoors.com. 3: See id. 4: See "Moody's Expands Consideration of Assignee Liability for Residential Mortgages in Securitizations." For more information, visit www.moodys.com. 5: Id. 6: Id. 7: For a comparison of these three initiatives, see "New York, New York, New York: The Three Faces of Anti-Predatory Lending Laws in New York," K&L Alert, Jan. 23, 2003. For more information, visit www.kl.com. 8: 12 U.S.C. § 1464(a). 9: 12 C.F.R. § 560.2. 10: Id. 11: There are, however, certain state laws that are not preempted by OTS regulations. As a general rule, federal savings associations are subject to state laws relating to contract and commercial law, real property law, homestead laws specified in 12 U.S.C. § 1462a(f), tort law, and criminal law. See 12 C.F.R. § 560.2(c). Further, Section 560.2(c) gives the OTS the authority to determine that federal savings associations are subject to a specific state law that would otherwise be preempted if, upon review, the OTS concludes that the law (1) furthers a vital state interest, and (2) either has only an incidental effect on lending operations or is not otherwise contrary to the purposes expressed in Section 560.2(a). See id. 12: State housing creditors other than commercial banks and credit unions must comply with OTS regulations when engaging in "alternative mortgage transactions" pursuant to their authority under the Parity Act. 12 U.S.C. § 3803(a)(3). The opinion letter also does not apply to entities such as national banks, state commercial banks, or credit unions, but this limitation is implicit in the fact that OTS does not have regulatory authority over these entities. 13: The OTS recently promulgated amendments to its Parity Act regulations that the OTS believes would require state housing creditors under its jurisdiction to comply with state restrictions on prepayment fees and late fees, even if the state housing creditor is operating pursuant to its authority under the Parity Act. See 67 Fed. Reg. 60,542-60,555. This article was reprinted with permission of Kirkpatrick & Lockhart.
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