Insights

I. Introduction: Facts and Procedural Posture

The New Mexico Supreme Court recently addressed whether federal law preempts New Mexico's Home Loan Protection Act ("HLPA"). The case, Bank of New York v. Romero, 320 P.3d 1 (February 13, 2014), started as a judicial foreclosure proceeding by Bank of New York on Joseph and Mary Romero's home after they defaulted on their refinanced home loan. The Romeros defended against the foreclosure by arguing, among other things, that the Bank violated the anti-flipping provisions of New Mexico's HLPA because the entity that originated the loan, a company named Equity One, Inc.,[1] made the loan without determining whether the Romeros had the ability to repay.[2] The trial court ruled on the merits of the Romeros' HLPA defense, holding that there was no violation of the HLPA because Equity One's loan included a cash payment to the Romeros, which the court found was a reasonable, net tangible benefit. The trial court also held that federal law preempted the HLPA's application to the Bank. Neither party appealed the trial court's preemption determination to the appellate court, so the appellate court did not address the issue when it affirmed the trial court. And, when the Romeros appealed the appellate court decision, neither party brought the preemption issue before the New Mexico Supreme Court.

The supreme court reversed the lower courts, and found that the loan violated the HLPA because Equity One did not take into account the Romeros' ability to repay when it made the loan. But, New Mexico's highest court did not stop there, explaining that its analysis of the HLPA would be incomplete if it did not revisit the preemption determination of the trial court, regardless of the fact that neither party appealed the trial court's preemption holding.

II. The Court's Analysis: The New Mexico Regulator's Preemption Determination

First, the court considered the Bank's argument[3] that the trial court should follow a 2004 regulation from the New Mexico's banking regulator that recognized that federal law preempts the HLPA. The court pointed to a U.S. Supreme Court Case, Cuomo v. Clearing House Association, L.L.C., 557 U.S. 519 (2009), the Dodd-Frank Act, and an update by the OCC to its own preemption guidance to conform to Cuomo and the Dodd-Frank Act, and observed that since 2004 there have been a number of federal efforts to limit or attempt to limit the scope of the National Bank Act's preemption of state law. Having made that observation, the court suggested that the New Mexico regulation was out of date.

The court was correct here in saying that federal law, regulations, and jurisprudence since the financial crisis have re-tooled the way national banks must consider whether and how the National Bank Act preempts state law. However, federally chartered banks do not rely on the National Bank Act for their real estate lending authority. The Federal Reserve Act is the federal law that gives federally chartered banks the authority to make real estate-secured loans subject to the OCC's regulation[4] and national bank real estate lending powers under the Federal Reserve Act were not affected by Dodd-Frank and the other post-2004 federal developments observed by the court. Further, the New Mexico regulation did not actually declare the HLPA preempted with respect to national banks. Instead, the regulation recited a finding that national banks engage in certain activities prohibited by the HLPA as a result of OCC regulations and the OCC's stated preemption position,[5] and then extended the same authority to state banks: "State chartered banks are provided the same powers and authority granted to... national banks as a result of the... OCC preemptions."[6] In fact, the entire purpose of the rule was not to make a preemption determination affecting national banks, but instead to acknowledge the OCC's preemption position and to "grant state chartered banks the same powers and authority to engage in banking activity that federally chartered and insured depository institutions subject to the jurisdiction of the federal government are authorized, empowered, permitted, or otherwise allowed to exercise."[7] Accordingly, while the Bank may have been incorrect to rely in its defense on the New Mexico regulation that only applies to state chartered banks (because the Bank is a national bank), the court was incorrect to look to the National Bank Act for real estate lending preemption.

III. The Court's Analysis: The Dodd-Frank Act Preemption Standard

After deciding that the New Mexico regulation was out of date (rather than just inapplicable to a national bank), and that there was a new preemption sheriff in town, the court turned to national bank preemption standards as revised by the Dodd-Frank Act. Perhaps the most concerning aspect of the case is the court's application of the Dodd-Frank Act's preemption standards to the HLPA. First, the court recites what it believes is the Dodd-Frank Act preemption standard:

The Dodd-Frank Act preempts state consumer financial law in only three circumstances: (1) if application of the state law "would have a discriminatory effect on national banks, in comparison with the effect of the law on a bank chartered by that State," (2) in accordance with the legal standard set forth in Barnett Bank when the state law "prevents or significantly interferes with the exercise by the national bank of its powers," or (3) by explicit federal preemption.[8]

The first two prongs are accurate. A state consumer financial law is preempted under the Dodd-Frank Act when the state law discriminates against national banks as compared with state banks, or when the Barnett Bank standard applies. With respect to the third prong, the Dodd-Frank Act actually says that a state consumer financial law is preempted if, "the State... law is preempted by a provision of federal law other than" the National Bank Act.[9] The court poorly paraphrases the language of the Dodd-Frank Act to suggest that only "explicit" preemption of state law, language not used in the statute, will satisfy the third prong of the test. The sloppy restatement by the court of this third prong paints a preemption standard that is inconsistent with the plain language of the Dodd-Frank Act. The New Mexico Supreme Court would have readers believe that "explicit" - in other words, "express" - federal preemption is necessary for federal law not found in the National Bank Act to preempt state law. However, the Dodd-Frank Act did not require express preemption. Instead, the Dodd-Frank Act says federal banking powers from a place other than the National Bank Act can preempt state laws without necessarily having to pass the "discriminatory effect" test or the "significant interference" test, but it does not require that the federal law expressly state that it preempts state law.

The court's misunderstanding of the New Mexico regulation concerning the HLPA's application to state chartered banks, combined with its misleading characterization of the new preemption standards derived from the Dodd-Frank Act and the lack of an appellate record on the issue of preemption all culminate in a flawed analysis of Dodd-Frank preemption as applied to the HLPA, discussed below.

A. The Dodd-Frank Act Preemption Standard: Does federal law (other than the National Bank Act) preempt state law?

The supreme court says, "our review of the [National Bank Act] reveals no express preemption of state consumer protection laws such as the HLPA."[10] This is accurate. The National Bank Act does not expressly grant real estate lending powers to a national bank. For real estate landing authority, the analysis under the National Bank Act after Dodd-Frank is whether a federal law, other than the National Bank Act, preempts the state law. And, a federal law other than the National Bank Act gives banks the authority to make real estate loans. Under the Federal Reserve Act:

Any national banking association may make, arrange, purchase or sell loans or extensions of credit secured by liens on interests in real estate, subject to section 1828(o) of this title and such restrictions and requirements as the Comptroller of the Currency may prescribe by regulation or order.[11]

While the Federal Reserve Act expressly gives banks the authority to make real estate loans, it does not expressly, by its language, preempt state law. However, the U.S. Supreme Court, in the case of Barnett Bank of Marion County v. Nelson, recognized that preemption may still occur absent an explicit statement to that effect in the federal statute:

Sometimes courts, when facing the preemption question, find language in the federal statute that reveals an explicit congressional intent to preempt state law... More often, explicit pre-emption language does not appear, or does not directly answer the question. In that event, courts must consider whether the federal statute's "structure and purpose," or nonspecific statutory language, nonetheless reveal a clear, but implicit pre-emptive intent.[12]

While the ultimate holding in Barnett Bank forms a different prong of the Dodd-Frank Act preemption test than the one that applies for authority other than the National Bank Act, the case is still useful for analyzing a federal law that authorizes a bank to engage in certain activity without expressly preempting state regulation of that activity. In Barnett Bank, the Court considered a federal statute, similar to 12 U.S.C. § 371(a), that gave national banks the express enumerated power to sell insurance under certain circumstances and a Florida statute that expressly forbid banks from selling insurance. The federal statute did not, by its terms, make the bank's authority subject to state regulation. The Court explained that where a federal statute gives a grant of power to a national bank and expressly makes that power subject to state regulation, the federal statute does not preempt state law. On the other hand, if Congress does not "expressly condition[] the grant of 'power' upon a grant of state permission... no such condition applies... [because] Congress did not intend to subject national banks' power to local restrictions."[13] In other words, if Congress wants to avoid preempting state law, it must do so with express language in the federal statute.

Turning back to the Federal Reserve Act, there is no express indication that Congress intended for state law to limit national banks' real estate lending authority. Accordingly, there are no state law conditions on the grant of power in the Federal Reserve Act. Instead, Congress explicitly gave only the OCC authority to limit national banks' real estate lending authority. And, in 2004, the OCC promulgated a rule expressly preempting state limitations on real estate lending concerning:

(1) Licensing, registration (except for purposes of service of process), filings, or reports by creditors;

(2) The ability of a creditor to require or obtain private mortgage insurance, insurance for other collateral, or other credit enhancements or risk mitigants, in furtherance of safe and sound banking practices;

(3) Loan-to-value ratios;

(4) The terms of credit, including schedule for repayment of principal and interest, amortization of loans, balance, payments due, minimum payments, or term to maturity of the loan, including the circumstances under which a loan may be called due and payable upon the passage of time or a specified event external to the loan;

(5) The aggregate amount of funds that may be loaned upon the security of real estate;

(6) Escrow accounts, impound accounts, and similar accounts;

(7) Security property, including leaseholds;

(8) Access to, and use of, credit reports;

(9) Disclosure and advertising, including laws requiring specific statements, information, or other content to be included in credit application forms, credit solicitations, billing statements, credit contracts, or other credit-related documents;

(10) Processing, origination, servicing, sale or purchase of, or investment or participation in, mortgages;

(11) Disbursements and repayments;

(12) Rates of interest on loans;

(13) Due-on-sale clauses except to the extent provided in 12 U.S.C. 1701j-3 and 12 CFR part 591; and

(14) Covenants and restrictions that must be contained in a lease to qualify the leasehold as acceptable security for a real estate loan.[14]

In 2011, the OCC updated its 2004 guidance to comply with the preemption standard in Dodd-Frank, but did not change the list of types of state real estate lending laws that are preempted by federal law.[15] The HLPA and its regulations include at least five types of state law restrictions that the OCC says are preempted, above. The HLPA, in its efforts to regulate home loan origination, imposes limits on loan-to-value ratios, regulates the terms of credit, including interest rates, imposes disclosure requirements, and has provisions that impact the processing, origination, and servicing of mortgages.[16] Accordingly, based upon the OCC's regulation, the Federal Reserve Act preempts the HLPA's attempt to regulate national banks exercising their power to make real estate loans.[17]

The New Mexico Supreme Court got it wrong on the first prong of the Dodd-Frank Act preemption standard. The court incorrectly only reviewed the National Bank Act in search of "express" preemption, such as a grant of power to make real estate loans, when the court should have looked outside the National Bank Act for preemption, express or otherwise. Federal law other than the National Bank Act-the Federal Reserve Act-does preempt state regulation of real estate lending. And, the Federal Reserve Act conditions its grant of authority to make real estate loans on the OCC's restrictions only, and not on state law. Finally, the OCC's regulations promulgated under the Federal Reserve Act expressly preempt state law limitations concerning the terms of mortgage loans and the processing, origination, and servicing of mortgages. However, even with the strong textual arguments for real estate lending preemption, there are still valid arguments in favor of preemption under both the Barnett Bank and discriminatory effect prongs of the Dodd-Frank Act's preemption standard.

B. The Dodd-Frank Act Preemption Standard: Does state law prevent or significantly interfere with the national bank's exercise of its powers?

The supreme court addresses the Barnett Bank prong by saying, "the Bank provides no evidence that conforming to the dictates of the HLPA prevents or significantly interferes with a national bank's operations."[18] Setting aside the fact that neither party appealed the preemption issue past the trial court, the supreme court had to look no further than the text of the HLPA and the Federal Reserve Act to determine that the HLPA does significantly interfere with a national bank's power to make real estate loans. While the Federal Reserve Act gives national banks the power to make real estate loans, the HLPA imposes significant limitations on the terms of home loans, including interest rates, repayment, amortization, and acceleration, and imposes origination requirements, such as requiring lenders to consider and document the borrower's ability to repay and limiting loan-to-value ratios. Although these limits on a lender's ability to make loans to certain borrowers and on certain terms do not directly prevent a national bank from making real estate loans, they do significantly interfere with Congress's statutory grant of power by regulating loan terms and imposing burdens at origination that are not part of the federal regulation of real estate loan origination. The Bank did not need to set forth evidence of the HLPA's "significant interference" with its real estate lending authority. The HLPA itself provides sufficient support for a finding that, under the Barnett Bank standard, the Federal Reserve Act preempts the HLPA.

C. The Dodd-Frank Act Preemption Standard: Does the state law have a discriminatory effect on national banks as compared with state banks?

The court handles the "discriminatory effect" argument by looking only at the language of the HLPA. The court says:

[T]he HLPA does not create a discriminatory effect; rather, the HLPA applies to any "creditor," which the 2004 statute defines as a "person who regularly [offers or] makes a home loan." Section 58-21A-3(G) (2003). Any entity that makes home loans in New Mexico must follow the HLPA, regardless of whether the lender is a state or nationally chartered bank. See § 58-21A-2 (providing legislative findings on abusive mortgage lending practices that the HLPA is meant to discourage).[19]

The court's assessment is incomplete and incorrect because it did not consider the HLPA regulations in the New Mexico Administrative Code.[20] The New Mexico Administrative Code specifically exempts state-chartered banks from the HLPA.[21] So, as New Mexico law stands today, the New Mexico Supreme Court thinks that the HLPA applies to national banks, but New Mexico's state banking regulator says that the HLPA does not apply to state banks. And, the HLPA imposes a number of burdens on lenders when they originate high-cost mortgage loans. Accordingly, the HLPA does in fact have a "discriminatory effect on national banks, in comparison with the effect of the law on a bank chartered by [New Mexico]."[22] In all fairness, the court (believing that the regulation affects national banks and therefore is contradictory to the court's preemption determination) recommended the New Mexico regulator update the Administrative Code to "reflect clarifications of preemption standards since 2004."[23] Setting aside the separation of powers issues this recommendation poses, and the fact that the court is most likely asking the New Mexico regulator to make a preemption determination affecting national banks rather than state banks, if the regulator updates the Administrative Code by declaring the HLPA applicable to state-chartered banks, then the HLPA will no longer have a discriminatory effect. But, as long as the Administrative Code exempts state chartered banks from the HLPA, the HLPA will have a discriminatory effect on national banks under the New Mexico Supreme Court's preemption determination.

IV. Conclusion

Ultimately, the New Mexico Supreme Court remanded the case back to the trial court with instructions for the trial court to vacate its judgment of foreclosure. At this time, neither party has appealed the supreme court's decision. Given that the court addressed preemption sua sponte, and potentially without the benefit of argument and briefing, it is difficult to say how the U.S. Supreme Court would handle the preemption question if the parties appealed. The case is certainly one to watch, but not necessarily one that should be given much weight because, for the reasons above, the Federal Reserve Act and its regulations clearly preempt New Mexico's HLPA.

Bank of New York v. Romero, 2014 N.M. LEXIS 41 (N.M. February 13, 2014).

Anastasia V. Caton is an associate in the Maryland office of Hudson Cook, LLP. Anastasia can be reached at 410-865-5418 or by email at acaton@hudco.com.

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[1] The opinion does not make clear what type of entity Equity One, Inc. is, but it appears to have been a non-bank licensed lender subject to the HLPA.

[2] New Mexico's HLPA allows a borrower to assert a violation of the HLPA's anti-flipping provisions against the maker of a loan or any subsequent holder or assignee of the loan so long as the borrower brings the claim within three years after the home loan closed. N.M. Stat. Ann. §§ 58-21A-11(B)(3), 58-21A-4(B). While the opinion does not address the assignee issue, it appears that this provision was the basis for the Romeros to raise the HLPA as a defense to payment against the Bank, even though the Bank did not make the loan. One of the many issues not clearly resolved in the opinion is why the Bank decided to raise the preemption argument at trial, given that the alleged violation of the HLPA happened well before the Bank became involved with the loan.

[3] Did the Bank or the Romeros have the opportunity to make oral arguments or brief the preemption issue to the supreme court, given that neither party appealed the issue beyond the trial court? The court suggests that the Bank made a preemption argument at some point. 320 P.3d 1 at 14 ("The Bank of New York's argument that federal law preempts the HLPA relies on regulatory provisions of the New Mexico Regulation and Licensing Department's Financial Institutions Division.").

[4] "Any national banking association may make, arrange, purchase or sell loans or extensions of credit secured by liens on interests in real estate, subject to section 1828(o) of this title and such restrictions and requirements as the Comptroller of the Currency may prescribe by regulation or order." 12 U.S.C. § 371(a) (2012). Banks have enjoyed this authority for the past century.

[5] N.M. Admin. Code §§ 12.16.76.8(G), (H).

[6] N.M. Admin. Code § 12.16.76.9.

[7] N.M. Admin. Code §§ 12.16.76.2, 12.16.76.6.

[8] 320 P.3d at 15.

[9] 12 U.S.C. § 25b(b)(1)(C) (2012) (note - the statute as revised refers to "Title 62 of the Revised Statutes," which is a reference to the National Bank Act).

[10] 320 P.3d at 59.

[11] 12 U.S.C. § 371(a) (2012). Please note that the OCC's real estate lending regulations at 12 C.F.R. Part 34 are based on this authority, and not the National Bank. See 69 FR 1904-01, 1907, FN 18 and surrounding text (January 13, 2004).

[12] 517 U.S. at 31.

[13] 517 U.S. 25 at 34. (citing Franklin National Bank of Franklin Square v. New York, 347 U.S. 373, 378 (1954)).

[14] 12 C.F.R. § 34.4(a) (2014) (emphasis added).

[15] See 12 C.F.R. § 34.4 (2011) (former version of the OCC regulation).

[16] See N.M. Stat. Ann. §§ 58-21A-1 et seq.

[17] Interestingly enough, the New Mexico Supreme Court cited to 12 C.F.R. § 34.4 without considering subsection (a), which lists the 14 types of state laws preempted by federal law, and went on to declare that there was nothing in the National Bank Act which preempted the HLPA. 320 P.3d at 15.

[18] 320 P.3d at 15.

[19] 320 P.3d at 15.

[20] See N.M. Stat. Ann. § 58-21A-13 (giving the Financial Institutions Division of the Regulation and Licensing Department the authority to make rules necessary to implement the HLPA).

[21] N.M. Admin. Code § 12.16.76.9.

[22] 12 U.S.C. § 25b(b)(1)(A) (2012).

[23] 320 P.3d at 15.