Rollin' Up The Op Subs

One of the advantages of a national bank or federal thrift charter used to be that for those banks or thrifts that engaged in mortgage lending on a multi-state scale, the mortgage operations could be housed in an operating subsidiary that had all the benefits of federal preemption that were afforded the parent bank or thrift (as confirmed by the Watters v. Wachovia ruling). The operating subsidiary could be exempt from state licensing and examination  requirements, as well as many other pesky state law requirements. For regulatory reporting purposes, the assets and liabilities of the operating subsidiary are consolidated with those of its parent; however, for liability purposes (as long as the bank and operating subsidiary avoid pitfalls that might allow a plaintiff to "pierce the corporate veil"), the parent's balance sheet can be isolated from the legal risks imposed by the subsidiary's business activities, which in the consumer lending area can be substantial. In addition, as Kate Berry observes in today's American Banker (paid subscription required), the operating subsidiaries are also sometimes set up as stand-alone operations that can be sold quickly when times got tough, which in a cyclical business like residential mortgage lending, they do on a regular basis (although usually not as rough as we've been seeing for the past several years).

With the passage of Dodd-Frank, which eliminates federal preemption for operating subsidiaries, Ms. Berry discusses the brave new world of mortgage banking, which may necessitate the wholesale "roll-up" of a lot of operating subsidiary mortgage lenders.

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.

The SAFE Act also comes into play.

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 Naiman, 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."

As an added bonus, Dodd-Frank added to the house of horrors the dreaded Consumer Financial Protection Bureau.

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."

If Elizabeth Warren is heading up the CFPB at the time it's "called in," bankers can expect the ultimate decision to be one that is not kind to their operating subsidiaries.If state banks have fumed for decades over the desire for Lebensraum shown by the preemption Nazis at the OCC and the OTS, wait until national banks and federal thrifts get a load of Reichsführer Warren and her ankle-biting storm troopers. National banks and federal thrifts will be rolling up op subs into the mother ship faster than Taylor Lautner sheds his shirt.