ABA's Letter to the OCC on the Proposed Rule to Codify ‘Valid-When-Made’ Principle

Chief Counsel’s Office
Attention: Comment Processing
Office of the Comptroller of the Currency
400 7th Street, SW
Washington, DC 20219

Ladies and Gentlemen:

The American Bankers Association (ABA) appreciates the opportunity to comment on the Office of the Comptroller of the Currency’s (OCC) Notice of Proposed Rulemaking (Proposed Rule). In the Proposed Rule, the OCC affirms the “valid-when-made” doctrine by clarifying that interest on a loan that is permissible under 12 U.S.C. § 85 (National Bank Act or NBA) continues to be permissible when the loan is sold, assigned, or otherwise transferred.

I. Summary of Comment

The “valid-when-made” doctrine reflects the longstanding and settled understanding that if a loan is valid when it is made, with respect to the interest rate and other terms of the loan, then the loan remains valid and enforceable when assigned to another party. The doctrine provides critical legal certainty necessary for the effective and efficient functioning of the credit markets. Efficient lending by banks requires not only a functioning primary market in which banks make loans to borrowers, but also a robust secondary market in which banks sell their loans to other parties. Without an efficient secondary market, banks are impaired from selling loans to diversify their holdings, injecting risk into the safety and soundness of our nation’s banking system. An inefficient secondary market also means banks have less capital to make additional loans to meet their customers’ needs.

Congress understood that banks depend upon a stable, predictable, and consistent national legal framework to operate efficiently and in a safe and sound manner. In passing the National Bank Act (NBA), Congress vested in national banks the power to charge interest on a loan at the maximum rate permitted in the state where the bank is located. As the OCC previously observed, Congress sought through the NBA to avoid the negative consequences that would result from requiring banks to comply with multiple (and ever-charging) state usury laws. In 2004, the OCC stated, “The application of multiple and often unpredictable state laws interferes with [banks’] ability to plan and manage their business, as well as their ability to serve the people, the communities and the economy of the United States.”

The courts and Federal banking agencies have long concluded that the NBA preempts the application of state usury laws to loans originated to national banks, regardless of whether the loan is held by the national bank or sold to another party. NBA preemption provides the legal certainty necessary for credit markets to function efficiently, allowing banks and loan purchasers to diversify their assets efficiently and facilitating borrowers’ access to credit. However, in 2015 the U.S. Court of Appeals for the Second Circuit’s decision in Madden v. Midland Funding, LLC undermined the “valid-when-made” doctrine. The court held that the National Bank Act does not preempt the application of state usury laws to a loan originated by a national bank when that loan is sold to a party that is not a national bank. By calling into question the “valid-when-made” doctrine, the decision has injected uncertainty into the primary and secondary markets for consumer and commercial credit. When loans cannot be resold by lenders, or the ability to do so is substantially curtailed, credit availability decreases and borrowers’ costs rise.

ABA supports the OCC’s decision to codify its longstanding position that when a bank sells, assigns, or otherwise transfers a loan, all contractual terms of the loan remain enforceable after the transfer. The Proposed Rule would strengthen the primary and secondary loan markets, protect the ability of banks and loan purchasers to diversify against risk, encourage the origination of new loans, and promote borrowers’ access to credit.

To ensure that the Proposed Rule has its intended effect, we ask the OCC to clarify that the Proposed Rule permits a national bank to export the interest rate on a loan it originated through the sale, assignment, or other transfer of the loan to any party, including an entity that is not a national bank. In addition, we urge the OCC to continue to coordinate its work on this rulemaking with the Federal Deposit Insurance Corporation, which also issued a proposed rule to confirm the “valid-when-made” doctrine as applied to State-chartered banks and insured branches of foreign banks. It is imperative that the two agencies’ regulations are aligned as much as possible, so that courts do not conclude that the meaning of the two regulations differ.

II. The Proposed Rule Affirms Congress’ Intent to Provide National Banks with a Stable, Predictable, and Consistent National Legal Framework

National banks depend upon a stable, predictable, and consistent national legal framework to operate efficiently and in a safe and sound manner. We agree with the OCC that, in passing the National Bank Act (NBA), Congress created a Federal banking system where national banks could “operate across state lines without being hindered by differing state laws.” As the Supreme Court stated over 100 years ago, Congress intended for national banks to be “independent . . . of state legislation which, if permitted to be applicable, might impose limitations and restrictions” on banks that are “as various and as numerous as the states.”

To advance these objectives, the NBA vests in national banks enumerated powers and “all such incidental powers as shall be necessary to carry on the business of banking.” The “powers” of national banks indisputably include the power to originate, sell, and purchase loans, as the OCC has recognized. It is well established that the NBA preempts any application of state law that would “curtail or hinder a national bank’s efficient exercise of [its] power, incidental or enumerated, under the NBA.” When state laws “significantly impair” the exercise of one of the bank’s powers, “the State’s regulations must give way.”

Section 85 of the NBA permits a national bank to “charge on any loan . . . interest at the rate allowed by the laws of the State . . . where the bank is located,” regardless of the presence of a usury cap in the state where the borrower resides or where any collateral is located.15 Indeed, for a bank to make loans efficiently, it must be permitted to sell its loans to other parties and for each loan to be enforceable according to its contractual terms, regardless of any conflicting state law where the purchaser is located. The Federal banking agencies have long concluded that if the terms of a loan made by a national bank may change when the loan is sold on the secondary market, the loan’s marketability would be impacted, and the bank’s power to make the loan in the first place would be constrained.

However, in Madden, the Second Circuit incorrectly held that the NBA’s preemption extends only to national banks and their agents and subsidiaries, and not to other parties that may purchase the loan. This narrow and flawed understanding of the NBA contravenes the purposes of the statute and the substantial body of case law interpreting it. If a non-usurious loan originated by a national bank may become usurious once transferred to a non-bank purchaser — as Madden holds — the bank’s loan origination and sale operations would be “significantly impaired.”

Madden has disrupted the secondary market for loans originated by national banks and for interests in loan securitizations, impaired the ability of banks to originate loans, and reduced credit access, particularly for lower-income borrowers, as described below in Part III of our comment letter. The Proposed Rule would reverse these negative outcomes and affirm the NBA’s objective to provide a stable, predictable, and consistent national legal framework for banks to operate.

III. Madden Has Detrimentally Impacted the Secondary and Primary Markets for Bank Loans

After the Madden decision, potential purchasers of loans and interests in loan securitizations face the risk that a loan that was valid at origination may be ruled invalid after the transfer if the purchaser is located in a state with a usury limit that is lower than the interest rate on the loan. As described below, available evidence indicates that this increased risk has detrimentally affected the secondary loan market in the states under the Second Circuit’s jurisdiction and has discouraged lending by national banks in those states.

Insurance companies, asset managers, private equity funds, and other nonbank entities purchase loans from national banks (and other banks) to balance their portfolios and manage risk. Under Madden, these purchasers face the risk that a loan they purchase could be ruled invalid, eliminating the value of the asset. To mitigate this risk, potential purchases may feel compelled to conduct a costly and inefficient loan-by-loan assessment to determine whether each loan’s interest rate exceeds the cap in the state where the purchaser is located. Even after conducting this assessment, a purchaser cannot eliminate entirely the risk of purchasing a voidable loan because the purchaser may not be able to foresee all venues where a plaintiff could bring an action to challenge the loan’s validity.

Madden’s disruption of the secondary market also impairs the ability of banks to operate in a safe and sound manner. It is critical that banks are able to maintain proper levels of liquidity. The ability to securitize or sell loans allows banks to increase their liquidity and provide credit to their communities. The Proposed Rule will make banks’ loans more marketable, enhancing their ability to diversify against risk and to comply with risk-based capital and liquidity requirements.

The Madden decision also reduces banks’ incentive to originate loans. If a bank believes that it cannot sell a loan on the secondary market, it will be less likely to make the loan. Madden particularly discourages banks from making loans to higher-risk borrowers, who have less access to credit. One study found that the Madden decision significantly reduced the price of notes backed by loans that were made to borrowers in the States of Connecticut and New York at interest rates that exceeded those states’ usury caps. In addition, the study found that lenders responded to Madden by extending relatively less credit to higher-risk borrowers in these two states — i.e., borrowers who traditionally have less access to credit. Similarly, another study found that Madden has led to a reduction in credit access for low-income households in Connecticut and New York. The study also found that the total number of personal bankruptcy filings was 8% higher in Connecticut and New York relative to the states in the study’s control group, during the two years after Madden was decided. In sum, low-income borrowers have less access to credit in these two states and, as a result, file for bankruptcy more frequently.

The response to Madden by one ABA member, a community bank headquartered in Delaware, underscores the decision’s impact on bank lending. The bank originated essentially no loans in New York State after July 2015 (two months after Madden was decided). Prior to Madden, loans made to New York residents and businesses constituted approximately 16% of the bank’s originations; one year after Madden, in May 2016, that percent had dropped to 5%. The bank estimates that it did not originate $52 million worth of loans because of Madden.

IV. The Proposed Rule Reverses Madden’s Harmful Consequences

The Proposed Rule would reverse Madden’s negative effects on the secondary and primary markets for loans, and prevent other courts from adopting a legal standard modeled after Madden. The Proposed Rule provides that “[i]nterest on a loan that is permissible under 12 U.S.C. 85 shall not be affected by the sale, assignment, or other transfer of the loan.” This language confirms the longstanding and settled understanding of the “valid-when-made” doctrine that when a loan is valid when it is made, the loan is enforceable according to its contractual terms upon the sale, assignment, or transfer of the loan to another party. The OCC should act without delay to finalize this rule.

V. The OCC Has Legal Authority to Issue a Rule to Implement the National Bank Act

The Supreme Court’s seminal decision in Chevron v. Natural Resources Defense Council is clear: if a statute is “silent or ambiguous” about the “precise question at issue,” then a reviewing court should give “considerable weight” to an agency’s construction of a statutory scheme it is entrusted to administer. Those circumstances are present here. As described above, Congress passed the National Bank Act to create a stable, predictable national legal framework for banks to operate efficiently. The NBA granted the OCC broad authority to carry out this purpose and, as importantly, to assure the safety and soundness of the national banks it supervises.

More specifically, the NBA preempts state laws that significantly interfere with a national bank’s ability to exercise its powers, and those powers indisputably include the power to make or sell loans. As described in greater detail above, the Madden decision allows state usury laws to interfere significantly with these powers of a national bank. The Proposed Rule will restore core banking powers by providing legal certainty to national banks that a loan that was valid at origination will remain valid after the sale, assignment, or transfer of the loan. As the OCC concluded, the ability of banks to assign their loans is “an important tool to manage liquidity and enhance safety and soundness.” As described above, if the terms of a loan made by a national bank may change when the loan is sold on the secondary market, the loan’s marketability would be impacted, and the bank’s power to make the loan in the first place would be impaired. This would constrain banks from obtaining needed capital and from diversifying against risks associated with concentrated lending in particular market segments.

These adverse effects impair a bank’s ability to conduct its business in a safe and sound manner. The OCC has ample authority under the NBA to prevent this result from occurring. A court reviewing the final rule would be compelled to uphold the rule as a valid exercise of the OCC’s powers.

VI. The OCC Should Clarify that a Loan that is Valid When Made Remains Valid Upon Its Assignment to an Entity that is not a National Bank

ABA recommends that the OCC clarify that the proposed regulatory text (12 C.F.R. §§ 7.4001(e) and 160.110(d)) permits a national bank to export the interest rate and other terms on a loan it originated through the sale, assignment, or other transfer of the loan to an entity that is not a national bank. We agree that the National Bank Act vests in national banks the power to assign some or all of the benefits of a loan to a third party, including to a third party that is not a national bank. However, in the Proposed Rule, the OCC ties the permissibility of a loan’s interest rate to the rate’s permissibility under 12 U.S.C. § 85. Section 85 grants “any association” — i.e., any national bank — the power to export the interest rate on a loan. Section 85 does not expressly grant other entities the power to export a loan’s interest rate. Consequently, a litigant may assert that the Proposed Rule permits a national bank to export the loan’s interest rate only through the sale, assignment, or other transfer of the loan to another national bank, despite the OCC’s intent that a national bank may export the loan’s interest rate in a sale, assignment, or transfer to any other party. The OCC should make clear that a national bank may export the interest rate on a loan it originated through the sale, assignment, or other transfer of the loan to any party.

VII. The OCC Should Continue to Coordinate Its Rulemaking with the Federal Deposit Insurance Corporation

As the OCC is aware, the Federal Deposit Insurance Corporation (FDIC) also has proposed a rule to affirm the “valid-when-made” doctrine for State-chartered banks and insured branches of foreign banks (collectively, State banks). We encourage the OCC to continue to coordinate with the FDIC as each agency finalizes its respective proposals. The Federal statutory provisions in the Federal Deposit Insurance Act (FDI Act) that preempt application of state usury laws to loans originated by State banks are “patterned after, and have been interpreted consistently with, section 85” of the National Bank Act. Coordination between the two agencies is critical to ensure that the courts do not impose standards for NBA preemption that differ from the standards established for FDI Act preemption.

Conclusion

ABA supports the Proposed Rule. The proposal would restore the efficiency and effectiveness of the primary and secondary markets for loans, particularly in the Second Circuit. This would protect the ability of banks and loan purchasers to diversify when their holdings become concentrated and facilitate the origination of new loans, expanding borrowers’ access to credit.

Sincerely,

Jonathan Thessin
Senior Counsel
Consumer & Regulatory Compliance
Regulatory Compliance and Policy