You probably thought the Consumer Financial Protection Bureau (CFPB) was just focused on, well, consumer protection, but the new agency has an important voice on certain compensation matters as well. And the beleaguered home mortgage industry, which really doesn’t need any more challenges right now, is waiting on the bureau to clarify whether mortgage loan origination compensation rules—first adopted by the Federal Reserve Board in September 2010 under Regulation Z—prevents the payment of performance bonuses to mortgage loan originators (or, to lapse into industry jargon, MLOs) as part of a non-qualified incentive compensation plan.
Rulemaking authority for Regulation Z, otherwise known as the Truth in Lending Act, was transferred to the CFPB by the Dodd-Frank Act, and in December 2011 the bureau issued interim final rules that recodified the Fed’s earlier restrictions on mortgage loan origination compensation. On the face of it, those restrictions were fairly straightforward. “Subject to certain narrow restrictions, the Compensation Rules provide that no loan originator may receive (and no person may pay to a loan originator), directly or indirectly, compensation that is based on any terms or conditions of a mortgage transaction,” according to CFPB Bulletin 2012-02, released on April 2 of this year.
In an official staff commentary issued by the Fed shortly after the rule was adopted, compensation was defined to include salaries, commissions and annual or periodic bonuses. Terms and conditions were deemed to include a loan’s interest rate, loan-to-value ratio or prepayment penalty.
I suppose it makes sense in our hyper-regulated world that the CFPB’s consumer protection authority would extend to MLO compensation because one of the more pernicious industry practices is steering, where borrowers—often low income people with poor credit histories—are unknowingly directed toward a more expensive mortgage that provides higher compensation to the originator than a cheaper loan.
Rod Alba, vice president and senior regulatory counsel at the American Bankers Association in Washington, says that up to this point the Fed’s commentary—including its amplification of “compensation” and “terms and conditions”—was easy enough to understand. But the commentary also stated that MLO compensation may not be based on a “proxy” for a term and condition. The CFPB bulletin explained it thusly: “[C]ompensation may not be based on a factor that is a proxy for a term and condition, such as a credit score, when the factor is based on a term and condition such as the interest rate on a loan.”
For Alba and others, that statement leaves too much to the imagination. “What the hell is a proxy?” he asks. “Well, a proxy is anything that would stand in the place of a term and condition. The problem with that is no one knows what it means. It was brought up in the commentary to the rule, not in the rule itself.”
More specifically, it’s unclear how banks can structure an incentive compensation program for their MLOs that won’t end up violating the rule. Alba worries that that any plan based on a profitability metric—whether it’s the profitability of a mortgage operation or even the bank itself—could run afoul of the rule if profitability is later judged to be an impermissible proxy. The regulatory rationale, I suppose, is that MLOs might still be tempted to engage in abusive practices like steering if they stand to gain under a performance-driven bonus plan that benefits the entire bank.
“Performance-based bonuses do fall into [the] proxy [definition] because the bonuses are derived from the loans,” Alba says. “That means [performance-based] bonuses are gone.”
“When they inherited this [from the Fed], the bureau didn’t clarify it,” adds Alba. “This rule is a mess!”
The CFPB has tried to provide some clarity about the compensation rule. In Bulletin 2012-02, the bureau states that banks “may make contributions to qualified plans like for loan originators out of a pool of profits derived from loans originated by employees under the Compensation Rules.” This would include 401(k) plans, which are the primary retirement programs for most employees today.
However, the bulletin did not provide guidance about how the rules apply to non-qualified plans like the ones that Alba is worried about.
Another confusing issue is the definition of an MLO. Is it someone who underwrites home loans? Or would the MLO designation also apply to, say, a branch manager who referred the borrower to an underwriter and might have played some role in negotiating the loan? If the latter turns out to be the case, then they would also fall under the rules and might not be eligible for a bonus paid out by a non-qualified plan.
Susan O’Donnell, a managing director at New York-based Pearl Meyer & Associates, relates the case of a client bank whose CEO might not be eligible to receive a bonus based on the bank’s performance because he has a license to originate loans and thus could be considered an MLO.
“If you fall into that category, then you can’t participate in any program that is tied to the profitability of the bank,” O’Donnell says.
How soon this mess gets cleaned up is anyone’s guess. In Bulletin 2012-02, the bureau points out that Dodd-Frank contains a provision that also deals with mortgage origination compensation and it must adopt a final rule to satisfy that requirement by Jan. 21, 2013. The bureau anticipates providing “greater clarity on these arrangements” in connection with that effort. But does that mean banks will be operating in the dark in terms of their MLO incentive compensation plans until next January? We don’t know.
The CFPB did not respond to an interview request on the matter. Neither did the Office of the Comptroller of the Currency, which along with the Federal Deposit Insurance Corp. (FDIC), has enforcement authority for Regulation Z at banks under $10 billion in assets. A spokesman for the FDIC declined to make an agency official available for an interview, but he did send along a Financial Institution Letter—FIL-20-2012—that was sent out to FDIC-supervised banks on April 17, 2012.
The FDIC’s letter framed the issue in pretty much the same fashion as the CFPB bulletin, and acknowledged that the CFPB has yet to provide any guidance about non-qualified incentive compensation plans for MLOs.
The letter concluded with this vague statement, which was probably meant to clarify the FDIC’s own enforcement perspective on MLO bonus plans, but probably didn’t clarify anything: “FDIC Compliance Examiners will review institution compensation programs in light of the Compensation Rules, and consider the specific facts of the institution’s compensation program, the totality of the circumstances at each financial institution, and the institution’s efforts to comply with the Compensation Rules.”
Hmmm… Good luck bankers!