Loan Officer Compensation Reform

QUESTION 

We are a Mini-Correspondent located in the Northwest. We mostly originate QM loans. When we do non-QM loans, we broker them. We've been in business for almost twenty years, and there are eight of us. All our compensation comes from the originating. 

I am interested in all the talk about how Congress plans to change the LO compensation regulations. Frankly, what I've read is complicated. I want to know what issues are involved. And, I want to know how Congress is planning to deal with those issues. 

My mortgage broker organization has put out some information about their position. And the lenders' organization has taken a position. But I am not sure what all the complaining is about. I'm not saying that some change is not needed. I just can't figure out what the change is supposed to be.

 My question is, what reforms are they trying to make to the LO compensation rule? 

SOLUTION 

Loan Officer Compensation Policy 

RESPONSE 

The arguments and proposals for loan officer compensation reform are somewhat complicated. So, trying to navigate their implications can be daunting. The Community Home Lenders of America (CHLA) recently released a white paper advocating for reforms to the loan originator (LO) compensation rule, specifically calling for Congress to narrow the scope of the current regulations.[i] The CHLA argues that the current rules, designed to prevent predatory lending practices, have unintended consequences that harm consumers and stifle competition within the mortgage industry. 

I'll provide you with some of the positions outlined in the CHLA's white paper. We are tracking these suggested reforms, as we do virtually all other federal and state regulatory compliance matters that affect banks and non-banks involved in residential mortgage loan origination and servicing. When appropriate, we will issue updates and alerts through our newsletters. 

I will outline the reform issues by outlining some of the main concerns, the proposed reforms, and the actions suggested to effectuate change. My outline contains sections and subsections to reduce the complexity of the subject issues. In the last section, I will delve a bit deeper. Keep in mind, though, there is considerable complexity, and my explication is not meant to be comprehensive. 

The CHLA's Main Concerns 

The CHLA has expressed several concerns. The following four, in broad strokes, are perhaps the main concerns. 

Harm to Consumers 

The CHLA argues that the current LO compensation rules, which restrict how much lenders can pay their loan originators, can effectively prevent lenders from matching competitors' offers and potentially result in borrowers missing out on better deals. 

Stifled Competition 

The CHLA claims that these rules create an uneven playing field, where brokers can offer more flexible compensation structures than retail lenders, hindering competition and limiting borrower choices. 

Unintended Consequences 

The CHLA contends that the rigid regulations discourage loan officers from working with borrowers over extended periods and make it less attractive for lenders to offer loans through State Housing Finance Agency (HFA) bond programs, which are crucial for low-income and minority borrowers. 

Focus on Inter-Firm Compensation 

The CHLA suggests that the original intent of the Dodd-Frank Act's LO compensation rule was to address yield spread premiums between firms, not to restrict compensation within a lender's own organization. 

the CHLA's Proposed Reforms 

Allow Matching Competitor Offers 

The CHLA proposes allowing lenders to reduce compensation to their loan originator employees to match a competing offer for the same borrower.

Sham Employment

QUESTION
We are the CEO and General Counsel of a regional mortgage banker. We decided to write you about an administrative action that has been taken against us by our state banking department.

The issue involves employer-employee compensation. The banking department claims that we are engaged in “sham employment” in violation of RESPA. We do not want to describe the alleged violation here. 

However, we would like to know some history and context related to “sham employment.” We have already contacted your firm to conduct a risk assessment of our employment practices. 

What is “sham employment?”

ANSWER
To say this area of the Real Estate Settlement Procedures Act (RESPA) is complicated would be an understatement. Thank you for contacting us to assist you. If you or anyone else would like to discuss this subject, please feel free to contact me HERE.

Right from the start, issues involving employer-employee compensation have proved to be one of the more controversial areas covered by RESPA. 

You can go back to HUD’s decision in 1996 to withdraw the employer-employee exemption the Department had promulgated only four years earlier,[i] followed by HUD’s Congressionally mandated postponement of the effective date of the withdrawal.[ii] 

As a result, the 1992 exemption, which states that Section 8 of RESPA does not prohibit an employer’s payment to its own employees for any referral services, remains in effect. That section of the RESPA statute specifically lists several practices that do not violate the statute. 

The statute provides: 

Nothing in this section shall be construed as prohibiting (1) the payment of a fee … (C) by a lender to its duly appointed agent for services actually performed in the making of a loan, (2) the payment to any person of a bona fide salary or compensation or other payment for goods or facilities actually furnished or for services actually performed … 

The foregoing subsections support the payment of fees by employers to their employees.

In December 2011, when the CFPB republished Regulation X as its own regulation, it removed the unimplemented provisions of the 1996 rule that had remained part of HUD’s Regulation X. Accordingly, Regulation X, RESPA’s implementing regulation, currently allows an employer to pay its own employees for any referral activity. For the most part, this is all most mortgage professionals usually need to know about employer-employee compensation in the context of “sham employment.” 

In place of the 1992 exemption, HUD adopted but then postponed the effective date, and then the CFPB permanently eliminated it, providing two additional limited exemptions for payments: 

1. One for employer payments to managerial employees.[iii] 

2. Another for payments to employees who do not perform settlement services.[iv] 

The proposed 1996 revision also would have added a third exemption to clarify that payments made to an employer’s own bona fide employee for generating business for that employer are permissible.[v] 

HUD’s May 9, 1997, proposal,[vi] which the Department withdrew on February 13, 2001,[vii] would have added a new “like-provider” exemption to RESPA’s Section 8 prohibition against kickbacks and unearned fees. (I will not treat the 1996 amendments and the proposed “like-provider” exemption in this response.)

HUD proposed amending Regulation X[viii] to add an exemption that would allow payments by an employer to its own bona fide employees for the referral of settlement service business to an affiliated settlement service provider, provided that the referred settlement service business is the same category of settlement service as provided by the employer of the employee making the referral, the employee makes the affiliated business arrangement disclosure[ix], and the employee making the referral does not perform any other category of settlement service in the same transaction.

Thus, here is the current situation with respect to your question about “sham employment,” specifically, the variety of developments regarding payments by an employer to its employees. Under RESPA, an employer may pay its own employees for any settlement service, including referrals to affiliates. A company may pay the employees of another company only reasonable compensation for settlement services actually rendered.

HUD has made clear, both in its regulatory guidance and its enforcement actions,[x] that it regards “sham employment” or “bogus employee” arrangements as RESPA violations. There is no reason to believe the CFPB takes a different position on this issue.

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director
Lenders Compliance Group

________________________

[i] 12 CFR 1024.14(g)(1)(vii), originally adopted by 57 Fed. Reg. 49600 (November 2, 1996) and republished by the CFPB, 76 Fed. Reg. 78978 (December 20, 2011)
[ii] Section 2103(b) of the Economic Growth and Regulatory Paperwork Reduction Act of 1996 (Title II of the Omnibus Consolidated Appropriations Act, 1997, Pub. L. 104-208), signed by President Clinton on September 30, 1996; 61 Fed. Reg. 58,472 (11/15/96)
[iii] Withdrawn Regulation X Section 3500.14(g)(1)(viii)
[iv] Withdrawn Regulation X Section 3500.14(g)(1)(ix)
[v] Withdrawn Regulation X Section 3500.14(g)(1)(vii)
[vi] 62 Fed. Reg. 25,740 (May 9, 1997)
[vii] 66 Fed. Reg. 25,478, at 25,497 (5/14/01). HUD withdrew the proposal following the January 20, 2001, issuance of a “Regulatory Review Plan” by the new Bush administration’s White House Chief of Staff, Andrew H. Card, Jr. HUD pointed out in its semiannual regulatory agenda that “Withdrawal of a rule does not necessarily mean that HUD will not proceed with the rulemaking. Withdrawal allows the new HUD Administration to further assess the subject matter and determine whether rulemaking for this subject matter is appropriate.”
[viii] Section 3500.14(g)(1)
[ix] As provided in 12 CFR 1024.15
[x] For instance, see the Znet Financial settlement (September 17, 2003). HUD found that Znet paid ReMax of Atlanta real estate agents as "employees" even though the agents performed little or no work for the lender. These agents were, therefore, sham “employees" who did little or no work for referral fees. Investigators found the agents performed little or no origination work other than filling out loan application forms.

Transitioning Loan Officer as Employee

QUESTION

A while back Jonathan Foxx discussed the transitioning of loan officers. He wrote about how to handle the licensing issues so that new loan officers can get to work. The questioner asked about transferring loan officers from their bank registration to become licensed loan officers. My question also deals with transitioning. Is a transitioning loan officer an employee?

ANSWER

Click Transitioning Loan Officer Licensing to read the post we published on November 7, 2019. I continue to see employers struggling with the issue of how best to effectuate the transitioning of a loan officer.

Indeed, it was in November 2019 that the CFPB issued an interpretive rule to construe an ambiguity regarding certain non-licensed loan originators. The Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 (EGRRCP Act) made it easier for loan originators to move from one employer to another, by giving a registered or state-licensed loan originator temporary authority to act as a loan originator in a different state if he or she:

• Has not had an application for a loan originator license denied or a loan originator license revoked or suspended;
• Has not been subjected to or served with a cease and desist order;
• Has not been convicted of a misdemeanor or felony that would preclude licensing in the new state;
• Has submitted an application to be a state-licensed loan originator in the new state; and,
• If applicable, was registered in the NMLSR as a loan originator during the 1-year period preceding the filing of the new application.

The statute separately addresses registered loan originators and state-licensed loan originators.

Regulation Z imposes training requirements on loan originator organizations for “each of its individual loan originator employees who

• is not required to be licensed, and
• is not licensed as a loan originator….”

This language, which the CFPB adopted before the EGRRCP Act existed, is ambiguous regarding whether the individual loan originators it references include loan originators with temporary authority under the EGRRCP Act. Accordingly, on November 19, 2019, the CFPB adopted an interpretive rule to address the ambiguity.

In its interpretive rule, the CFPB took the position that, although the language is ambiguous, the Bureau believes the most appropriate interpretation of Regulation Z is that the regulation does not refer to a loan originator with temporary authority under the EGRRCP Act, because a loan originator with temporary authority does not satisfy the first condition in Regulation Z § 1026.36(f)(3)—“is not required to be licensed.”

That is, to point a fine point on it, a loan originator with temporary authority is not an “individual loan originator employee … who is not required to be licensed….” He or she is an employee who is required to be licensed, although the employee can act as a loan originator while seeking the required license.

The CFPB issued its interpretation as an interpretive rule to further ensure that TILA § 130(f) offers a safe harbor to loan originator organizations that act in conformity with the interpretive rule. [84 FR 63791 (Nov. 19, 2019)] The Bureau plans to incorporate the interpretive rule into Regulation Z.

Jonathan Foxx
Chairman & Managing Director
Lenders Compliance Group

Individual Loan Originator Compensation and Borrower Paid Transactions

QUESTION

As a mortgage broker, our company pays the loan originator the same, irrespective of whether it is a lender paid or borrower paid transaction. However, we are hearing that we may be able to pay the loan originator differently on borrower paid transactions, which would allow us to be more competitive. So, can we vary compensation based upon lender paid versus borrower paid?

ANSWER

A conservative approach is that you cannot vary individual loan originator compensation based upon whether it is borrower paid or lender paid. However, in reliance on commentary to Regulation Z, some brokers and lenders are assuming a more aggressive approach and permitting an individual loan originator’s compensation on borrower paid loans to be based on the amount of compensation paid directly by the consumer to the brokerage company. For example, the individual loan originator earns 200 bps on lender paid transactions and 70% of compensation received by broker on borrower paid. To date, we have not seen any commentary from a regulator saying this practice is not permissible.  However, you need to check with your lenders as some will not permit a variation in compensation based upon borrower paid or lender paid.  

Here are some citations to consider.

12 CFR 1026.36(d)(2)(i)(C)

If a loan originator organization receives compensation directly from a consumer in connection with a transaction, the loan originator organization may pay compensation to an individual loan originator, and the individual loan originator may receive compensation from the loan originator organization, subject to paragraph (d)(1) of this section.

Official Commentary 36(d)(1)-2 [emphasis added]

“2. Compensation that is or is not based on a term of a transaction or a proxy for a term of a transaction. Section 1026.36(d)(1) does not prohibit compensating a loan originator differently on different transactions, provided the difference is not based on a term of a transaction or a proxy for a term of a transaction. The rule prohibits compensation to a loan originator for a transaction based on, among other things, that transaction's interest rate, annual percentage rate, collateral type (e.g., condominium, cooperative, detached home, or manufactured housing), or the existence of a prepayment penalty. The rule also prohibits compensation to a loan originator that is based on any factor that is a proxy for a term of a transaction. Compensation paid to a loan originator organization directly by a consumer in a transaction is not prohibited by §1026.36(d)(1) simply because that compensation itself is a term of the transaction. Nonetheless, that compensation may not be based on any other term of the transaction or a proxy for any other term of the transaction. In addition, in a transaction where a loan originator organization is paid compensation directly by a consumer, compensation paid by the loan originator organization to individual loan originators is not prohibited by §1026.36(d)(1) simply because it is based on the amount of compensation paid directly by the consumer to the loan originator organization but the compensation to the individual loan originator may not be based on any other term of the transaction or proxy for any other term of the transaction.”

Joyce Wilkins Pollison, Esq.

Director/Legal and Regulatory Compliance

Executive Director / Lenders Compliance Group

Loan Officer Compensation and Internal Referral Fees

QUESTION

If one of loan officer needs to price a loan lower than what our company normally requires in order for the officer to be eligible for compensation, could an “internal referral” of the loan be made to a non-commissioned loan officer/manager who then pays the originating loan officer a referral fee?  For example, John Smith has a deal in which he is competing with a local credit union offering a 4.5% rate. But to be paid his 2% commission under the company’s compensation rules, Smith has to offer the client a rate of 4.75%. Could the loan be “referred internally” to a non-commissioned manager who then gives the borrower the 4.5% rate to be competitive, and pays the LO a flat referral fee?

ANSWER

Regulation X, the implementing regulation for the Real Estate Settlement Procedures Act (“RESPA”) does authorize payment of compensation for certain “internal referrals.” Thus, as an exception to the anti-kickback provisions of RESPA Section 8, Regulation X [12 CFR §1024.14(g)(iv) and (vii)] specifically authorizes:  

“(iv) A payment to any person of a bona fide salary or compensation or other payment for goods or facilities actually furnished or for services actually performed;” and 

“(vii) An employer's payment to its own employees for any referral activities.” (Emphasis added.)

However, Regulation X is not the only regulation to consider.  In that regard, for at least two (2) reasons, I believe this arrangement, as you describe it, would probably violate the Loan Officer Compensation Rules in Regulation Z, the implementing regulation of the Truth in Lending Act:

First, the loan officer’s compensation appears to be based on term of the loan, or a proxy for such a term.  In that regard, Regulation Z provides at 12 C.F.R. §1026.36(d)(1) that:

 (i) Except as provided in paragraph (d)(1)(iii) or (iv) of this section, in connection with a consumer credit transaction secured by a dwelling, no loan originator shall receive and no person shall pay to a loan originator, directly or indirectly, compensation in an amount that is based on a term of a transaction, the terms of multiple transactions by an individual loan originator, or the terms of multiple transactions by multiple individual loan originators. If a loan originator's compensation is based in whole or in part on a factor that is a proxy for a term of a transaction, the loan originator's compensation is based on a term of a transaction. A factor that is not itself a term of a transaction is a proxy for a term of the transaction if the factor consistently varies with that term over a significant number of transactions, and the loan originator has the ability, directly or indirectly, to add, drop, or change the factor in originating the transaction.” (Emphasis added.)

Under Section 1026.36(d)(ii) of Regulation Z, “[t]he amount of credit extended is not a term of a transaction or a proxy for a term of a transaction, provided that compensation received by or paid to a loan originator, directly or indirectly, is based on a fixed percentage of the amount of credit extended…” (Emphasis added.) However, the interest rate most assuredly is a term of the transaction. And the so-called “referral fee” is actually compensation to the loan officer, the amount of which is indeed based on a term of the transaction or a proxy for a term; i.e., the interest rate. As you have described it, the loan officer is paid the referral fee only when the interest rate to the borrower is adjusted below what is normally required by the company for the loan officer to earn a commission. 

Second, the arrangement at least appears to violate (or encourage violation of) the “anti-steering” provisions of the Loan Officer Compensation Rules in Regulation Z. In that regard, the loan officer operating under the proposed arrangement would be dis-incentivized to make an “internal referral” of loans at the lower interest rate since the flat referral fee would presumably be less than the amount of compensation the loan officer would ordinarily receive under his or her regular compensation formula if the loan were made at the higher interest rate. The applicable provisions of Regulation Z [12 C.F.R. §1026.36(e)] read as follows:   

 “(1) General. In connection with a consumer credit transaction secured by a dwelling, a loan originator shall not direct or “steer” a consumer to consummate a transaction based on the fact that the originator will receive greater compensation from the creditor in that transaction than in other transactions the originator offered or could have offered to the consumer, unless the consummated transaction is in the consumer's interest.” (Emphasis added.)

Here, it is difficult to see how the consummated transaction would be “in the consumer’s interest” since the loan interest rate would be higher than what the consumer would have to pay under the referral fee arrangement. In that regard, Section 1026.36(e) goes on to state:

“(2) Permissible transactions. A transaction does not violate paragraph (e)(1) of this section if the consumer is presented with loan options that meet the conditions in paragraph (e)(3) of this section for each type of transaction in which the consumer expressed an interest. For purposes of paragraph (e) of this section, the term “type of transaction” refers to whether:

(i) A loan has an annual percentage rate that cannot increase after consummation;

(ii) A loan has an annual percentage rate that may increase after consummation; or

(iii) A loan is a reverse mortgage.

(3) Loan options presented. A transaction satisfies paragraph (e)(2) of this section only if the loan originator presents the loan options required by that paragraph and all of the following conditions are met:

(i) The loan originator must obtain loan options from a significant number of the creditors with which the originator regularly does business and, for each type of transaction in which the consumer expressed an interest, must present the consumer with loan options that include:

(A) The loan with the lowest interest rate;

(B) The loan with the lowest interest rate without negative amortization, a prepayment penalty, interest-only payments, a balloon payment in the first 7 years of the life of the loan, a demand feature, shared equity, or shared appreciation; or, in the case of a reverse mortgage, a loan without a prepayment penalty, or shared equity or shared appreciation; and

(C) The loan with the lowest total dollar amount of discount points, origination points or origination fees (or, if two or more loans have the same total dollar amount of discount points, origination points or origination fees, the loan with the lowest interest rate that has the lowest total dollar amount of discount points, origination points or origination fees).

(ii) The loan originator must have a good faith belief that the options presented to the consumer pursuant to paragraph (e)(3)(i) of this section are loans for which the consumer likely qualifies.

(iii) For each type of transaction, if the originator presents to the consumer more than three loans, the originator must highlight the loans that satisfy the criteria specified in paragraph (e)(3)(i) of this section.” (Emphasis added.)

Here, there is no indication that the terms of the above “options” exception have been satisfied. Accordingly, I would not recommend this suggested method of loan officer compensation.

Michael Pfeifer

Director/Legal & Regulatory Compliance

Lenders Compliance Group &

Servicers Compliance Group

Bonus for Loan Officer’s Recruitment of New Loan Officer

QUESTION

If one of my loan officers recruits a new loan officer for us, is it legal to bonus the existing loan officer ten (10) basis points for each of the loans that the new loan officer brings in?

ANSWER

This is an interesting question because the bonus compensation is linked to new loans brought in by another loan officer. This raises questions regarding compliance with anti-kickback provisions of Section 8 of the Real Estate Settlement Procedures Act (RESPA), and the Loan Officer Compensation rules of the Truth in Lending Act (TILA).

The bonus plan probably does not violate RESPA §8, if both loan officers are W-2 employees, because Regulation X, the implementing regulation for RESPA, specifically permits the following:

“(iv) A payment to any person of a bona fide salary or compensation or other payment for goods or facilities actually furnished or for services actually performed;” and 

“(vii) An employer's payment to its own employees for any referral activities.” (Emphasis added.) ^[i]

Also, assuming the bonus compensation is not paid by the consumer, so that the loan officers are not paid “dual compensation” by both the loan originator organization and the consumer in violation of Regulation Z, the implementing regulation for TILA[ii], such a bonus may be permissible under the TILA Loan Officer Compensation rules under certain conditions:

1. The compensation plan does not result in any kind of “steering” of consumers into loans not in their interest in order to increase the loan officer’s compensation. Such “steering” is prohibited under Regulation Z.[iii]

             

2. The compensation is not based on the term of a transaction or the profitability of a transaction or pool of transactions under Section 36(d)(1) of Regulation Z.[iv] In general, this section prohibits compensation based on “profits,” unless profits are from business other than mortgage-related business. However, the Rule adds two exceptions to this general prohibition: (1) mortgage-related business profits can be used to make contributions to certain tax advantaged retirement plans (which does not appear to be the case here); and (2) mortgage-related business profits can be used to pay bonuses and contributions under certain other plans if either the amount paid does not exceed 10% of the individual loan originator’s total compensation or the loan originator acts as an originator on 10 or fewer transactions over the preceding 12 months.[v]  The operative language of Reg. Z is as follows:

“(iv) An individual loan originator may receive, and a person may pay to an individual loan originator, compensation under a non-deferred profits-based compensation plan (i.e., any arrangement for the payment of non-deferred compensation that is determined with reference to the profits of the person from mortgage-related business), provided that:

(A) The compensation paid to an individual loan originator pursuant to this paragraph (d)(1)(iv) is not directly or indirectly based on the terms of that individual loan originator's transactions that are subject to this paragraph (d); and

(B) At least one of the following conditions

 is satisfied:

(1) The compensation paid to an individual loan originator pursuant to this paragraph (d)(1)(iv) does not, in the aggregate, exceed 10 percent of the individual loan originator's total compensation corresponding to the time period for which the compensation under the non-deferred profits-based compensation plan is paid; or

(2) The individual loan originator was a loan originator for ten or fewer transactions subject to this paragraph (d) consummated during the 12-month period preceding the date of the compensation determination.”

Under the scenario you have described, it is also possible that the loan officer may not actually qualify as a “loan originator” on any of the transactions you refer to, if he or she does not engage in any of the activities on any of the subject transactions that are described in the definition of “loan originator” under Regulation Z Section 1026.36(a). In that event the limitations of the Rule would not apply. The applicable definition of “loan originator” is as follows:

“(a)(i) For purposes of this section, the term ‘loan originator’ means a person who, in expectation of direct or indirect compensation or other monetary gain or for direct or indirect compensation or other monetary gain, performs any of the following activities: takes an application, offers, arranges, assists a consumer in obtaining or applying to obtain, negotiates, or otherwise obtains or makes an extension of consumer credit for another person; or through advertising or other means of communication represents to the public that such person can or will perform any of these activities. The term “loan originator” includes an employee, agent, or contractor of the creditor or loan originator organization if the employee, agent, or contractor meets this definition. The term “loan originator” includes a creditor that engages in loan origination activities if the creditor does not finance the transaction at consummation out of the creditor's own resources, including by drawing on a bona fide warehouse line of credit or out of deposits held by the creditor. All creditors that engage in any of the foregoing loan origination activities are loan originators for purposes of paragraphs (f) and (g) of this section. The term does not include:

(A) A person who does not take a consumer credit application or offer or negotiate credit terms available from a creditor, but who performs purely administrative or clerical tasks on behalf of a person who does engage in such activities.” (Emphasis added.)

Since the terms “arranges,” “assists,” and “otherwise obtains” are broad, it is theoretically possible that someone could construe the loan officer’s recruiting activities of another loan officer as falling within those specified activities, but that is not likely. Nevertheless, it is probably safest to assume that the loan officer is an “originator” and to try to comply with the terms of the exception to the L.O. Compensation Rule outlined above.

Michael Pfeifer

Director/Legal & Regulatory Compliance

Lenders Compliance Group &

Servicers Compliance Group

---

[i] 12 CFR §1024.14(g)(iv) and (vii)

[ii] 12 CFR §1026.36(d)(2)

[iii] With certain specified exceptions, under 12 CFR 1026.36(e)(1) “[i]n connection with a consumer credit transaction secured by a dwelling, a loan originator shall not direct or “steer” a consumer to consummate a transaction based on the fact that the originator will receive greater compensation from the creditor in that transaction than in other transactions the originator offered or could have offered to the consumer, unless the consummated transaction is in the consumer's interest.

[iv] See 12 CFR §1026.36(d)(1)

[v] See Section 1026.36(d)(1)(iii)-(iv)

Examination Hot Topics

QUESTION

As a stateside, non-depository, mortgage licensee, I am interested in learning about areas of concern relating to regulatory examinations. What are some of the hot topics and regulator recommendations in these areas?

ANSWER

I recently attended the 29th Annual Regulatory Conference, held in Boston, for the American Association of Residential Mortgage Regulators (AARMR). One of the breakout sessions was entitled Examination Hot Topics.  The session was moderated by a state regulator from Georgia and included three state regulators from the states of Missouri, Connecticut and Michigan.

Topics and issues raised are detailed below.

Loan Brokerage Fee Agreement: The disclosure should be provided by the broker and not the lender.

Profit-based Bonuses: Broker, mortgage loan originator, profit-based bonuses are exceeding the 10 % threshold.

Marketing Services Agreements: The use of Marketing Services Agreements has increased resulting in RESPA issues. One area of contention is whether advertising should be paid by the mortgage company or the loan officer. 

Rental Agreements: There is no basis by which to establish market value of rental agreements. The example referenced two identical office spaces within the same office complex valued at $300 and $600, respectively.

Change in Circumstances: The calculations do not provide adequate supporting information in the file to facilitate the examination review.

Mortgage Fraud known as “Convenience Fraud:” MLOs are signing borrowers’ names on forms. They are also using electronic signatures. This activity has resulted in loss of licenses.

Cut and Paste Tactics: This activity is on the rise. The activity includes altering IRS Form 4506-T relating to designation of third parties to receive the tax return information. It also includes the forging of signatures on borrower loan documents, claiming as an excuse that the borrower was on vacation. One regulator stated that they found practice signature evidence and the actual cuts in the borrower loan file!

Unlicensed Loan Originations: Unlicensed individuals are taking applications over the phone (usually in call centers), due to lack of management oversight of their operations. This process results in more loan volume. Companies offer the excuse that they are only taking “partial” applications.

Mortgage Call Report (MCR): The MCR information is inaccurate. The requested loan list at the time of examination does not correlate with the loans listed on the Mortgage Call Report. Companies need to establish a process that includes work papers to back-up the information. It was also recommended that MCR reporting duties should not be assigned to untrained individuals and that a back-up person be assigned to the task.

Unlicensed Underwriting: Brokers are doing underwriting without the required lender licensing.

Third-Party Processing: Lenders are inquiring about the requirements for third-party processing and underwriting. Many are engaged in the activity without the proper license.

Hiring Practices: There is evidence of companies hiring convicted felons in direct violation of statutes and regulations. Some of these companies have been reported to the regulators by competitors.

Disclosure Text Errors: Incorrect language is being used in disclosures related to TRID and foreclosures. Be certain to reference state and federal requirements in this area.

Advertising: Issues have been identified relating to advertising. The main point is that marketing and compliance departments have two different goals. The compliance group must review all ads prior to being released to the public. There are issues with companies misleading the public by holding themselves out as government agencies.

Mortgage Servicing Compliance: Examinations of mortgage servicers identified issues involving the lack of compliance with the terms and conditions by the new servicer. Recommendation was for servicers to have robust policies and procedures. It was also noted that companies are not posting payments properly. Files need to have better documentation.

Commingling of Funds: Companies are commingling operating funds and escrow funds in direct violation of the law.

It is my hope that you have come away with some new insights into examination areas of concern raised by state regulators.

We can assist you in preparing for examinations and in providing you with the ability to outsource some of the compliance functions in your operation. Our compliance support includes all mortgage banking policies and procedures, mortgage and servicing compliance, quality control analytics, vendor management, licensing and Mortgage Call Reports. Please contact us for a free consultation.

Alan Cicchetti

Director/Agency Relations, Lenders Compliance Group

Executive Director, Brokers Compliance Group

Deductions from Loan Officer Compensation

QUESTION

Can we deduct from our loan officers’ compensation the cost of marketing materials, such as the per- account fees of an outside customer relationship manager (CRM) to stay in touch with past clients and referral partners?

ANSWER

While it is theoretically possible to deduct marketing expenses from loan officer compensation in certain limited circumstances, attempting to do that in practice is fraught with legal and compliance risk.  

As a starting point, because loan officer compensation rules consist primarily of various prohibitions, determination of whether any loan officer compensation plan is "compliant" is a fact-specific and “situationally dependent” exercise that requires evaluation of the plan as a whole.

Secondly, there are many federal and state labor law requirements that must be considered. For example, the federal Fair Labor Standards Act (FLSA), and most state labor laws, prohibit any deduction from the pay of non-exempt employees (most mortgage loan officers) that is not specifically authorized by statute or regulation and that reduces the employee’s compensation below the applicable statutory minimum wage[i] or reduces the non-exempt employee’s overtime compensation in any amount. An employee must always receive at least the minimum wage and must be paid any earned overtime. Whether and how the deduction arrangement is documented in the LO's compensation agreement is also critical. Under most state laws, if the employee’s consent to the deduction is not specifically documented in advance in a written agreement, the deduction normally cannot occur. And if not structured properly, even authorization for such deductions in a written employment agreement can be problematic because employee compensation, once paid, normally cannot be reduced.

Thirdly, any such deduction would have to "pass muster" under both the Loan Officer Compensation Rules of Regulation Z of the Truth in Lending Act (TILA), and the Fair Lending laws. In that regard, Regulation Z prohibits basing a loan originator's compensation on "any of the transaction's terms or conditions" or the “terms of multiple transactions,” or on a “proxy” for such terms. The Dodd-Frank Act codifies that prohibition. Under Reg. Z, a "term of a transaction" is defined as "any right or obligation of the parties to a credit transaction." This means, for example, that a mortgage loan originator employee (LO) cannot receive compensation based on the interest rate of the loan or on the fact that the LO "steered" the customer to use a particular vendor in the transaction. 

The key language is found in Section 1026.36(d) of Reg. Z, as follows:

              (d) Prohibited payments to loan originators.

(1) Payments based on a term of a transaction.

(i) Except as provided in paragraph (d)(1)(iii) or (iv) of this section, in connection with a consumer credit transaction secured by a dwelling, no loan originator shall receive and no person shall pay to a loan originator, directly or indirectly, compensation in an amount that is based on a term of a transaction, the terms of multiple transactions by an individual loan originator, or the terms of multiple transactions by multiple individual loan originators. If a loan originator's compensation is based in whole or in part on a factor that is a proxy for a term of a transaction, the loan originator's compensation is based on a term of a transaction. A factor that is not itself a term of a transaction is a proxy for a term of the transaction if the factor consistently varies with that term over a significant number of transactions, and the loan originator has the ability, directly or indirectly, to add, drop, or change the factor in originating the transaction. (Emphasis added.)

Based on the emboldened definition above, a “proxy analysis” is required to evaluate whether deductions for marketing expenses (or other expenses) amount to a “factor” that “consistently varies with [a] term of the transaction (or series of transactions) over a “significant number of transactions” where the originator “has the ability, directly or indirectly, to add, drop, or change the factor in originating the transaction.” This, in turn, could necessitate evaluation of whether the marketing expenses deducted are the same for every transaction and every loan type and interest rate, or vary statistically depending on the terms of the loan. If the deduction in any way incentivizes the loan officer (qualitatively or statistically) to “steer” consumers into or away from loans with certain terms, there is a potential TILA LO Comp issue.  And, in the same manner, there could also be a Fair Lending” issue if application of the deduction results in a pattern of loan origination that has a disparate impact on a protected class of borrowers.[ii]

Finally, if your company originates FHA loans, the proposed deduction might constitute a violation of HUD rules requiring that all operating expenses be paid by the mortgagee. 

HUD Handbook 4001.1(I)(A)(6)(g)(ii) provides that: “The Mortgagee must pay all of its own operating expenses, including the expenses of its home office and any branch offices where it conducts FHA business. The Mortgagee must maintain all accounts for operating expenses in its name.” (Emphasis added.)  Section 4001.1(I)(A)(4)(d)(i) of the HUD Handbook also provides: “The Mortgagee must not engage an existing, legally separate mortgage company or broker to function as the Mortgagee’s branch office or DBA name or to conduct FHA activities using the Mortgagee’s FHA approval.” 

While there appears to be no HUD prohibition on employees voluntarily reducing their basic rate of compensation across the board because management’s expenses have increased, that would need to be documented in the LO’s employment agreement and, again, could not result in the compensation dropping below applicable minimum wage and overtime pay requirements.

Michael Pfeifer 

Director/Legal & Regulatory Compliance 

Lenders Compliance Group

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[i] The federal minimum wage is currently $7.25 per hour. Some state minimum wage requirements are higher.

[ii] Under the 2018 revisions to the Official Staff Interpretations of Reg. Z §1026.36(d)(1), a loan originator is permitted to decrease its compensation under very limited circumstances involving unforeseen increases in settlement costs. But those circumstances do not apply here. The applicable commentary reads: “Permitted decreases in loan originator compensation. Notwithstanding comment 36(d)(1)-5, §1026.36(d)(1) does not prohibit a loan originator from decreasing its compensation to defray the cost, in whole or part, of an unforeseen increase in an actual settlement cost over an estimated settlement cost disclosed to the consumer pursuant to section 5(c) of RESPA or an unforeseen actual settlement cost not disclosed to the consumer pursuant to section 5(c) of RESPA. For purposes of comment 36(d)(1)-7, an increase in an actual settlement cost over an estimated settlement cost or a cost not disclosed is unforeseen if the increase occurs even though the estimate provided to the consumer is consistent with the best information reasonably available to the disclosing person at the time of the estimate.”

Loan Officer Compensation

QUESTION

I have a corporate loan officer that is going to be helping a branch loan officer to close loans, how can the corporate loan officer be compensated?  

ANSWER

The corporate loan officer will need to be compensated on the same structure as the branch loan officer (i.e., bps or flat fee but must be the same) and pay should be divided based on percentage of work actually performed. 

[12 CFR 1024.14(c)]

This division should be set out in the compensation agreements for each of the loan officers with notation of the actual tasks to be completed by each; and make clear that each loan officer will receive the same compensation for each of the loans jointly worked. In no event shall the referral of jointly worked loans be based on the terms of the loan or a proxy for the terms. [12 CFR §1026.36(d)] No incentive should exist for a loan officer for steering a borrower to a jointly worked loan. 

Here are relevant citations.

12 CFR 1024.14(c) provides:

“No split of charges except for actual services performed.

“No person shall give and no person shall accept any portion, split, or percentage of any charge made or received for the rendering of a settlement service in connection with a transaction involving a federally related mortgage loan other than for services actually performed. A charge by a person for which no or nominal services are performed or for which duplicative fees are charged is an unearned fee and violates this section. The source of the payment does not determine whether or not a service is compensable. Nor may the prohibitions of this part be avoided by creating an arrangement wherein the purchaser of services splits the fee.”

12 CFR §1026.36(d)(1) provides:

“PAYMENTS BASED ON A TERM OF A TRANSACTION.

1. “Except as provided in paragraph (d)(1)(iii) or (iv) of this section, in connection with a consumer credit transaction secured by a dwelling, no loan originator shall receive and no person shall pay to a loan originator, directly or indirectly, compensation in an amount that is based on a term of a transaction, the terms of multiple transactions by an individual loan originator, or the terms of multiple transactions by multiple individual loan originators. If a loan originator's compensation is based in whole or in part on a factor that is a proxy for a term of a transaction, the loan originator's compensation is based on a term of a transaction. A factor that is not itself a term of a transaction is a proxy for a term of the transaction if the factor consistently varies with that term over a significant number of transactions, and the loan originator has the ability, directly or indirectly, to add, drop, or change the factor in originating the transaction.”

Brennan Holland

Director/Legal & Regulatory Compliance

Lenders Compliance Group