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   ARTICLE   |   From Scotsman Guide Residential Edition   |   February 2014

Take the Long View on Compensation Changes

Conforming to the intricate terms of the loan-originator compensation rule requires careful consideration

Take the Long View on Compensation Changes

It’s 2014, and if you’re still in the mortgage business, you've survived the initial Consumer Financial Protection Bureau (CFPB) Title XIV rulemaking implementation phase. You feverishly worked through the end of 2013 to implement compliance systems that addressed all of the new rules, and now it’s time to put those systems to the test.

There are certainly new business opportunities created by this regulatory environment, but make no mistake: There are also new pressures, and a host of new compliance traps for the unprepared. One area that warrants special attention is loan-originator compensation. As a variety of new regulations come into effect this year, it’s important to ask: Is your compensation compliant?

With so many new rules and regulations coming into effect this year, mortgage brokers and originators have a range of compliance issues to focus on. The topic of loan-originator compensation certainly isn’t a recent addition to mortgage professionals’ regulatory radar, but that doesn’t mean its guidelines are fully understood by the originators working in the industry today.

Boiled down, the CFPB’s current loan-originator compensation rule is actually a revision of the Federal Reserve’s version of the rule, but it also contains new features that have not been vetted in the marketplace. Certain loan-originator compensation also relates to the 3 percent cap on points and fees in the safe harbor of the ability-to-repay (ATR) qualified mortgage (QM) rule.

To complicate matters, the Dodd-Frank Wall Street Reform and Consumer Protection Act amended the Truth in Lending Act to add new liability for individual loan originators and provided consumers with a new defense to foreclosure when it comes to loan-originator compensation violations. This defense is similar to the ATR provisions, which borrowers can raise as many as 20 years down the road.

Of course, if a borrower raises the defense 20 years after the fact, the lender has a strong argument that the borrower had the ability to repay when the loan was consummated, assuming that the lender conducted the ATR analysis at or before consummation. For a loan-originator-compensation violation, however, the passage of time likely doesn't improve facts in the originator’s favor.

Given this new reality, mortgage professionals should take a closer look at a few select issues in the CFPB’s loan-originator compensation rule. Which key facts and figures should your company bear in mind going forward?

Terms and proxies

First and foremost, mortgage professionals should know that the compensation provisions in the CFPB’s rule prohibit compensation based on the “terms of the transaction” or a “proxy” for terms of the transaction. The Fed’s rule prohibited compensation based on “terms or conditions of the transaction” and “proxies” for terms or conditions.

The CFPB’s rule also defines the meaning of “terms.” In many respects this is helpful, but “terms” is defined somewhat broadly and includes the payment of any fee or charge imposed on the consumer for products or services required as a condition for the extension of credit. If a lender, for example, pays an originator extra compensation for referring a borrower to the lender’s title-insurance affiliate and purchasing a lender’s title policy, the originator is receiving, and the lender is paying, compensation based on the terms of the transaction. In short, this is a violation of the rule.

The rule also defines what constitutes a “proxy,” which basically includes factors that consistently vary with transaction terms over a significant number of transactions and that can be manipulated by a loan originator. In general, under the CFPB’s definitions of “terms” and “proxy,” compensation based on borrower characteristics such as a borrower’s income level or geography may be permissible assuming a loan originator can’t change the borrower’s income or the borrower’s decision where to live. There may be rare occasions when a loan originator could manipulate these factors, however, so mortgage professionals should take care. They also should be aware of potential fair-lending implications when compensation is based on the characteristics of a borrower or the location of the underlying security property.

Take note of this past December’s joint fair-lending action by the CFPB and the Department of Justice against a major auto lender. At a certain level, the CFPB views auto dealers and mortgage brokers the same to the extent loan pricing is determined based on each group’s respective compensation structures. 

Policies and procedures

Another part of the compensation rule clarifies that a determination under the rule with respect to whether compensation is based on transaction terms is made

according to the objective facts and circumstances of the situation. In other words, if a loan originator is compensated on some basis other than transaction terms, but the compensation appears to track closely with certain transaction terms, the compensation could be viewed the same as compensation based on transaction terms. This same provision also explains that if compensation is paid according to a company’s written policies and procedures (and those policies and procedures were being followed), then the determination would be based on whether the compensation as spelled out in the policies and procedures violates the rule. This is an important component that ties the rule together — a kind of mini safe harbor.

Although this part of the rule highlights the importance of policies and procedures, still another part of the rule expressly clarifies that different loan originators may be paid differently for the same loan. This provides leeway for lenders to reward higher-performing loan originators — used on higher volumes, quality of loan files, long-term performance of loans originated, etc. — with higher commissions, but this can create fair-lending issues, as well. Again, note the auto lender action referenced previously.

Commission bands establishing minimum and maximum limits for loan-originator-compensation plans should be considered to reduce this risk. For example, some lenders require that all loan-originator commissions be within a defined range of 100 basis points (e.g., minimum commission of 1 percent and a maximum of 2 percent).

Profit sharing

Under certain circumstances, the CFPB permits companies to reward individual loan originators with compensation based on profits without violating the prohibition on paying compensation based on transaction terms. Mortgage-business-related profits turn on a number of factors but are typically derived from revenues generated by interest rates, prepayment penalties, origination fees, etc.

The CFPB’s rule clarifies how payments based on mortgage-business profits are generally prohibited. It does provide safe harbors, however, for two different types of compensation:

  1. Compensation paid into defined contribution plans that are designated tax-advantaged plans (e.g., certain annuity and pension plans); and
  2. Nondeferred profits-based compensation when the compensation is 10 percent or less of the individual loan originator’s total compensation, or the individual loan originator originates 10 or fewer transactions in the previous 12 months

The rule also provides a safe harbor from liability for individual loan originators who rely on the company’s accounting to determine nondeferred profits-based compensation under the 10 percent test.

The rule further clarifies that certain bona fide dividends paid on bona fide ownership interests of equity are not considered “compensation” for the purposes of the rule. Stock or dividend distributions paid to a loan originator as an award or paid from a sham company, however, could be considered compensation subject to the rule. Thus, shell companies that receive payments from creditors and lenders but that provide few services other than perhaps holding assets and that in effect funnel mortgage profits via dividends back to loan originators are highly questionable. This includes dividends from these companies paid to producing managers based on the profits of transactions originated by other loan originators.

The rule also creates a dilemma for mortgage brokers. The CFPB’s rule redefines compensation to not include bona fide and reasonable fees charged by a mortgage broker company or an affiliate for performing services that are not loan-originator activities. Under the rule, a mortgage broker is permitted to employ individual loan originators who perform origination activities and also employ, for example, a title insurance producer who sells title insurance. The broker could charge separately for each service and pay each individual for the service performed (i.e., pay the individual loan originator’s compensation and pay the individual title producer an insurance fee or commission). Only the broker’s charge for the loan origination and payment to the individual loan originator are subject to the compensation rule. A mortgage broker originating QM loans, however, must consider the impacts of such a model on the 3 percent  points and fees test in the ability-to-repay rule.

Records

Finally, there are three key words of loan-originator-compensation-rule wisdom: record-keeping, recordkeeping, recordkeeping. Along with policies and procedures, records will help prove what really happened and should be viewed as an essential tool for compliance.

For those who attempt to evade the requirements of the rule by not maintaining records or for those who simply haven’t taken the appropriate steps to comply with the recordkeeping requirements, the CFPB has forensic accountants who are capable of determining how compensation was calculated. For example, a recent CFPB enforcement action announced this past November would, apart from requiring the mortgage company involved to pay $9 million in restitution to consumers and $4 million in civil money penalties for paying illegal bonuses to loan officers, require the mortgage company to retain evidence of compliance with the loan-originator-compensation rule, such as payroll records. In addition, in a fair-lending inquiry, records could be used to help show legitimate business reasons for why higher rates or points and fees were charged to some borrowers and not others.

•  •  •

With its final rules on loan-originator compensation, the CPFB intended to increase the protections of consumers and to create responsible pathways for lenders and loan originators to achieve legitimate business goals in compliance with the overall objectives of the rule. These pathways can lead to risks in other regulatory areas, however. The establishment of any compliance framework around existing or proposed business structures requires multiple regulatory considerations, in addition to considering the primary rule that triggered the assessment and compliance review in the first place.

Moreover, even if the compliance framework was established with the appropriate regulatory considerations, mortgage brokers, underwriters and lenders should conduct testing and monitoring of their policies and procedures and periodically review how they operate under changing business conditions and regulatory requirements.

In this regulatory environment, these overlapping compliance considerations and periodic testing checks must be considered the norm. The Dodd-Frank Act raised the compliance bar for everyone participating in the mortgage space, and it’s up to loan originators and their companies to make sure they can be compliant and successful at the same time. 


 
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