The Federal Reserve Board is showing no signs of backing down on its loan officer compensation rule despite congressional requests and industry lawsuits to delay the April 1 effective date.
The Fed believes it has the law on its side, arguing that Congress basically codified the compensation rule in 2010 as part of the Dodd-Frank Act.
The Fed has struggled since 2007 to come up with a way to address abuses associated with yield-spread premiums and other payments that incentivized loan officers and brokers to steer borrowers into higher-cost and risky subprime loans during the housing boom.
Finally, in August 2009 the Fed came out with a proposed rule that prohibited lenders from basing compensation on the terms or conditions of the loan, except for the loan amount. This means compensation cannot be based on the interest rate of the loan, whether it is an adjustable- or fixed-rate mortgage, or whether it has a prepayment penalty. (Previously, loan terms could be manipulated to increase an LO's compensation at the consumer's expense.)
Just before the Fed finalized the compensation rule last summer, Congress passed the Dodd-Frank bill, which included similar LO compensation restrictions. Passage of the bill gave the Fed a strong signal to move ahead with the final rule, according to Fed senior attorney Paul Mondor.
"We looked at each other and said, 'Congress has stamped an imprimatur on our rulemaking.' It effectively codifies the board's final rule," Mondor said. He made this comment during a March 17 Fed webinar on the compensation rule.
Krista Kully, an attorney with K&L Gates in Washington, said Fed officials fully expect the rule will go into effect April 1. "They feel they were emboldened to finalize the rule by Congress," she said.
With such conviction, the Fed has taken a hard line on compliance issues and repeatedly rejected industry proposals that would allow more flexibility.
In particular, the central bank has taken a hard line when it comes to compensating branch managers who originate loans, ruling that they must be paid like other LOs and cannot participate in profit sharing plans.
The Fed's standard is so tight that even "nonproducing" managers can run afoul of the rule if they pitch in during crush times and originate a loan. At many companies branch managers also are top producers, earning a high level of compensation. Going forward, banks and mortgage companies are likely to pay these managers a salary and bonuses based on their individual loan volume or other allowable criteria.
But there are concerns that lenders will make adjustments so branch managers don't see a reduction in pay. Companies will have to be careful that those adjustments aren't a proxy for profit sharing and violate the Truth in Lending Act rule.
Fed staffers also made it clear during the webinar that a company can offer different pay scales. For example, one LO can earn 100 basis points, with another earning 85. "In sum, creditors don't need to pay all loan originators the same," said one Fed attorney.
During the webinar the agency discussed an industry proposal to create "point banks" but shot down the idea. "We have yet to hear a variation on the theme of point banks that we think really can succeed under this rule," Mondor said.
Lenders proposed taking 10 basis points from every loan transaction (or overages) to fund the point bank. After reviewing the proposals, Fed staff concluded that overages are tied to the terms and conditions of a loan, which would violate the new compensation rule.
The idea behind point banks is to give loan officers the flexibility to grant pricing concessions to borrowers. Currently, an LO can reduce compensation to persuade a borrower to take out a mortgage.
However, it is a violation of the Fed's rule to raise or lower the LO's compensation from one loan transaction to the next.
Fed staffers said taking 10 bps from every loan transaction amounts to spending an LO's previously earned compensation—and this, too, violates the rule because the LO is bearing the cost of the price concession. "The only one that can bear the cost of a pricing concession is the creditor," Mondor said.
This interpretation also makes it difficult for managers to penalize LOs for mistakes and errors. The Fed has ruled that mortgage companies cannot dock a loan officer's compensation if they incorrectly calculate closing costs and exceed the tolerances of the RESPA good-faith estimate disclosure.
If RESPA "forces you" to lower the closing costs to the consumer—that's a pricing concession to the consumer," Mondor said. "A loan officer or originator cannot be made to bear that cost," he added.
The American Bankers Association disagrees with that interpretation, according to senior vice president Rod Alba. The penalty is "not based on terms or conditions," he said. It is based on "someone violating the regulation."
The lack of flexibility also makes it difficult for lenders participating in state affordable housing programs. State housing finance agencies finance mortgages for first-time homebuyers through tax-exempt bonds. On these loans the origination fees are very thin.
Lenders generally reduce an LO's compensation on such transactions—but now it appears that such maneuver would violate the Fed's rule starting April 1. "It is causing a lot of lenders to reconsider whether they can participate in these state programs any more," one industry source said.
