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.
