Pay Attention: Final Rules on Loan Originator Compensation


4-19-13_Dinsmore.pngJanuary, 2013, was a watershed month for mortgage standards after the Consumer Financial Protection Bureau released the long-awaited final rules on ability to repay, qualified mortgages, mortgage servicing, and appraisal requirements.  Each of these rules promises to keep compliance gurus busy throughout this year and into 2014.

January also heralded another Dodd-Frank final rule of great interest to senior management, boards of directors, and certainly to the frontline, revenue producing, mortgage loan personnel – the mortgage loan originator compensation requirements.

The new compensation rules are potential bottom line changers both for mortgage loan officers/originators and financial institutions themselves—making it imperative that financial institution management and boards of directors move this topic to the top of their to-do lists.

In the aftermath of the mortgage market meltdown, politicians and pundits, and the federal regulators who answer to them, became increasingly focused on the role that loan officers and originators play in the consumer mortgage loan process.  Prior to the meltdown, training and qualification standards for loan originators varied widely within the industry.  Furthermore, compensation programs evolved to incentivize loan officers and originators to lead consumers into more expensive loans.  With Title XIV of the Dodd-Frank Act and the compensation final rules, the consumer protectors set out to end these practices.

What’s Not OK
The rules on compensation prohibit a loan officer/originator from being compensated based on any “term of the transaction” or any proxy for a term of the transaction.  This is not new; this prohibition has been part of Regulation Z since 2011.  The final rule now defines “term of the transaction” but leaves some uncertainty.

A term of the transaction is “any right or obligation of the parties to the credit transaction.”  What does this mean?  The commentary to the final rule answers that question by including descriptions of items the CFPB believes are “terms of the transaction.”  Those items include (see final rule commentary for full list):

  • interest rate
  • prepayment penalty
  • whether a product or service is purchased (e.g., lender’s title policy)
  • fees or charges requiring a good faith estimate and/or HUD-1 disclosure statement (and future Truth-in-Lending Act/Real Estate Settlement Procedures Act combined disclosure)
  • points, discount points
  • document fees; origination fees

What’s OK
CFPB acknowledges the compensation restrictions could create uncertainty for regulated institutions.  To allay this uncertainty, the final rule commentary provides a list of examples of permissible compensation mechanisms, which includes (see final rule commentary for full list):

  • originator’s overall loan volume
  • loan performance over time
  • whether the customer is existing or new
  • quality/condition of loan files
  • percentage of applications resulting in closed loans

Under the final rules, financial institutions are permitted to continue paying mortgage loan officers/originators bonus compensation.  However, bonuses will be subject to some restrictions.  Bonuses may not be based on the terms of the individual loan officer/originator’s transactions, and bonus compensation cannot exceed 10 percent of the individual loan officer/originator’s total compensation for the relevant period.

Looking Forward: Best Practices
The new compensation rules and the other residential mortgage related rules go into effect in January, 2014. Examination teams, armed with new exam procedures, will be descending on banks to test for compliance.  Below are a few best practice steps bank managers and boards of directors may take to be prepared.

  1. Ensure consumer compliance teams are trained on the new rules.  Modify consumer compliance audit/review procedures to ensure new rules are appropriately tested.
  2. Ensure mortgage lending management teams and loan officers/originators are trained on the new rules.
  3. Review existing loan officer/originator compensation programs, policies and practices to determine level of compliance; adjust programs and practices accordingly.
  4. Review existing employment, service, and management agreements and other documents relating to residential mortgage lending to determine if problematic provisions exist; amend agreements as necessary.
  5. Assign appropriate personnel to monitor release of guidance from CFPB and other federal regulatory agencies; review new examination procedures when available.
  6. Have management report to board of directors, or appropriate committee, on progress toward compliance.

There is Still More
The compensation final rules address several other important topics, including dual compensation, payment of upfront points/fees, loan originator qualifications, and mandatory arbitration provisions.  These topics are important for all participants in the mortgage lending arena, and you are encouraged to review them.

Confusion Reigns on Mortgage Compensation


lost.jpgYou 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!