It took just one sentence in the 2,300-page financial reform law to end federal preemption for mortgage lenders that operate as subsidiaries of national banks.
Now, those banks have a choice. They can keep their mortgage subsidiaries as such, which would subject them to a patchwork of state consumer-protection laws. Alternatively, they can roll up their subsidiaries, retaining the federal preemption shield but losing the practical benefits of keeping the mortgage business in a stand-alone unit.
Industry lawyers expect most institutions to go the roll-up route, partly out of fear that sooner or later the states would try to force operating subsidiaries — and, potentially, their individual loan officers — to get state licenses. The burden of satisfying 50 state regulators would outweigh the cost in legal fees of restructuring.
"There is a whole business model that surrounded the bank operating subsidiary and cutting the costs of the enterprise by avoiding state licensing and state regulation," said Clinton Rockwell, a partner in the BuckleySandler LLP law firm. "That was the big sales pitch for a lot of those entities, and basically that model is dead."
The mortgage market is volatile, and banks like to be able to get in and out of it with ease. This is the main reason financial institutions like to keep their mortgage businesses in separate operating subsidiaries — with separate management teams, human resources departments and health plans, such outfits can stand on their own and thus are easier to sell.
In the seminal 2007 case Watters v. Wachovia, the Supreme Court ruled that the operating subsidiaries of national banks enjoyed the same preemption from state consumer protection laws as their parent institutions. Operating subsidiaries now enjoyed the best of both worlds — like federally chartered banks, they did not have to comply with the laws of 50 jurisdictions but were still easily sellable if their parents chose to do so.
Deborah Robertson of the McGlinchey Stafford PLLC law firm said many banks restructured their mortgage businesses as operating subsidiaries after the Watters decision. Now they may simply do the reverse.
"When Watters was decided, they all surrendered their state licenses, so the banks will look at this" — the Dodd-Frank Act's removal of preemption for subsidiaries — "and change accordingly," she said.
The Secure and Fair Enforcement for Mortgage Licensing Act of 2008 required loan officers working at national banks and their operating subsidiaries to register with the Nationwide Mortgage Licensing System, a database run by the states.
Each loan officer gets a unique identifier (so all loans can be tracked) and undergoes a criminal background check under the SAFE Act.
The law has additional, more rigorous requirements for originators working at nonbanks: They must not only register but also be licensed in the states where they do business.
To do so, they must pass national and state exams and take at least 20 hours of continuing education a year.
Though most states probably would maintain the existing requirement that banks' operating subsidiaries only have to register with them, states have the authority to make operating subsidiaries meet the tougher licensing requirements, experts said.
That possibility could be the decisive factor in pushing national banks to restructure those entities.
"Right now, being a bank originator is a safe harbor," said Jeffrey Naimon, a partner at BuckleySandler. "Operating as a 50-state licensed entity has always been very difficult, but post-SAFE Act, it is becoming even harder."
Banks also are concerned that mortgage loan officers could ultimately face tougher standards when the job of umbrella enforcer for the SAFE Act is transferred from the Department of Housing and Urban Development to the planned Consumer Financial Protection Bureau in the Federal Reserve.
The CFPB may ultimately resolve the question of whether loan officers at bank subsidiaries need state licenses, said John Ryan, an executive vice president at the Conference of State Bank Supervisors.
"The line has already been drawn: Employees of federally regulated operating subsidiaries are registered; everybody else is licensed," said Ryan. "It might create a conflict with the SAFE Act to say that operating subsidiaries would have to be licensed when now they just have to be registered. So they might have to call in the CFPB."
Rockwell, the BuckleySandler partner, said that requiring licensing would completely change the way operating subsidiaries do business.
"The visitorial authority between the state regulators on the one hand and the banking regulators and the CFPB on the other is going to be difficult to coordinate and manage," he said.
Some of the largest banking companies have big mortgage operating subsidiaries that previously were preempted, including JPMorgan Chase & Co.'s Chase Home Finance LLC in Iselin, N.J., and Citigroup Inc.'s CitiMortgage Inc. in O'Fallon, Mo.
At Bank of America Corp. and at Wells Fargo & Co., mortgage origination is a division of the national bank. But B of A's home loan servicing business is an operating subsidiary, meaning it is now subject to state consumer protection laws (though SAFE Act licensing requirements do not apply to servicers).
And Wells Fargo Home Mortgage in Des Moines has more than 115 operating subsidiaries that are joint ventures with firms like home builders and real estate agents, according to the Office of the Comptroller of the Currency.
Tom Goyda, a spokesman for Wells, said it is still assessing the new law. "There will be a period … when regulations are promulgated by new and existing regulators, so it's difficult to predict the impact," he said.
B of A commented: "We are evaluating the impact the new preemption rules would have on Bank of America's lines of business." JPMorgan Chase declined to comment.
Mark Rodgers, a spokesman for Citi, said: "The matter is under consideration, but it is too early to tell."