Banking and Finance Law Daily Agencies propose path around precedent that blocks exporting interest rates
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Tuesday, November 19, 2019

Agencies propose path around precedent that blocks exporting interest rates

By Richard A. Roth, J.D.

The OCC is proposing two regulation amendments that would "clarify" that banks may sell loans that allow the buyers to collect interest at rates that otherwise would violate state usury laws. The FDIC is expected to do the same.

Buyers of loans extended by national banks and federal savings associations would explicitly be given the authority to collect interest at the same rate the financial institution could charge, even if that rate violated state usury laws, under regulation amendments being proposed by the Office of the Comptroller of the Currency and Federal Deposit Insurance Corporation. The OCC’s proposal would amend two regulations, one for banks and the other for thrifts, to say that the interest rate that is permissible under federal law would not become usurious if the loan were sold to another creditor. The FDIC’s longer proposal would add a new 12 CFR Part 331, titled Federal Interest Rate Authority.

Federal law allows a national bank or federal savings association to charge whatever interest rate is permitted by the law of its home state, regardless of where the borrower is located. This often is described as the ability to export that interest rate. The "valid when made" principle says that an interest rate that was legal when the loan was made remains legal, even if the loan subsequently is sold to a nonbank. This allows a bank to extend credit and then sell the loan to a nonbank that will retain the benefit of the exported interest rate.

Second Circuit. The U.S. Court of Appeals for the Second Circuit upended the valid when made principle in its 2015 decision, Madden v. Midland Funding, LLC. In that opinion, the Second Circuit rejected the valid when made principle and said that a debt collector collecting a consumer debt in New York was limited to the interest rate permitted by New York law. The interest rate export privilege the National Bank Act (NBA) gave to the national bank that originated the credit did not preempt the state usury law, the court said (see Banking and Finance Law Daily, May 26, 2015).

The Madden decision is the target of the proposed regulation amendments. According to the OCC’s notice, the decision has created uncertainty about the NBA’s effect on banks’ ability to make a loan that keeps the same interest rate through the life of the loan. The proposed rule "seeks to end this uncertainty by clarifying that when a bank assigns a loan, interest permissible prior to the assignment will continue to be permissible following the assignment."

Potential problems. The proposals seem to present two immediate problems. First, they could interfere with state efforts to control the interest rates charged by short-term lenders. Allowing banks to export interest rates with no state control would facilitate so-called "rent-a-bank" schemes in which banks make loans that actually were originated by payday lenders, then sell those loans—accompanied by the arguably predatory interest rates—to the payday lenders.

The FDIC’s proposal notes that the agency will "view unfavorably" companies that partner with state banks to evade lower interest rate limits imposed by the companies’ licensing state. However, the new CFR Part is silent on such activity.

Second, it should be noted that in the Madden decision, the Second Circuit was not considering OCC or FDIC regulations. The court explicitly addressed whether the NBA preempted state interest rates laws when loans were sold and concluded it did not. The OCC’s proposed regulation says explicitly that it "would clarify that when a bank sells, assigns, or otherwise transfers a loan, interest permissible prior to the transfer continues to be permissible following the transfer," which would appear to contravene the Second Circuit directly.

The Second Circuit said that applying the New York usury law to collection efforts by a debt collector "would not significantly interfere with any national bank’s ability to exercise its powers under the NBA" and, as a result, it reversed a trial court decision that the NBA preempted the New York usury law. The OCC’s proposal says unequivocally that the NBA, and other federal laws, do preempt state interest rate laws. However, the ability of a regulatory agency to overturn a decision by a U.S. Court of Appeals in that manner is questionable.

As a result, unless a future appeal convinces the Second Circuit to change the Madden precedent, creditors operating in Connecticut, New York, or Vermont could find themselves subject to state usury laws while operations in other states would not. Such companies would need to decide whether to risk usury suits if they rely on the amended regulations.

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