Ari Karen, a partner at the Maple Lawn, Md.-based Offit Kurman who represents financial institutions in labor and employment matters, has written an opinion piece on loan officer compensation issues.
Many who have been following the financial reform bills have been confused and concerned about the future of loan officer compensation. A common misconception is that loan officers will need to be paid on an hourly or flat fee basis, or alternatively, paid only on the size of the loan. This misconception will cause companies to:
• deprive themselves of valuable tools to safeguard their companies and clients from imprudent risk-taking
• place themselves in greater risk of negative compliance findings
• render themselves less competitive in terms of attracting top originators.
Banks and brokers who have struggled with the desire to place more risk on the loan officers (a practice limited by labor laws and RESPA), while balancing that desire with the competitive pressures associated with maintaining top producers will now be able to take advantage of these game-changing regulations and legislation; they will be able to adopt policies and practices they have wished to implement for years. Companies can and should look at these reforms, at least in regard to loan officer compensation, as an opportunity.
Along with the Frank-Dodd Financial Reform Bill, the United States Treasury recently published compliance guidelines concerning incentive compensation. Together, the new legislation and regulations explicitly prohibit the manner in which loan officers have been traditionally compensated. The problem with most current compensation plans is that they valued profit generation without regard to the risk created for the institution and consumer associated with that profit. There was nothing to counterbalance the desire to maximize the immediate profit on each deal. This resulted in loans with excessive fees and inflated interest rates. It was, obviously, great for the loan officer who was paid on the short term-and bad for the longer term interests of consumers and institutions.
Employers must now develop compensation plans balancing the need to attract top originators, without overemphasizing revenue generation to the detriment of responsible lending. A company cannot guarantee salaries for loan officers because it puts the institution at risk in the event of underperformance; it may also diminish the originator's motivation to make profitable loans. Compensation plans must provide sufficient motivation to generate revenue, while making the employee accountable for risk on all sides of the transaction. Moreover, the evaluation period for profit, revenue, and risk should be long enough to allow the employee to experience the impact of downstream underperformance, without being so remote that it affects present behavior. While overall company performance can be considered in compensation packages, over-reliance on it can undermine individual effort.
Fortunately, there are many creative compensation plans companies can implement which meet all of the criteria set forth above. In addition, such compensation policies can be contractually implemented in a manner more readily compliant with labor and employment laws.
Employers can use the legislation and principles set forth in the guidelines (even if not directly applicable to their organizations) to restructure compensation so that flat-fee payouts are adjusted up or down quarterly based upon the profitability and performance of the loan officer's loans. Quarterly and monthly bonus payments could supplement salary based upon overall profitability and loan performance. A twelve-month "claw-back" can be instituted to recover monies paid on nonperforming loans. Companies could implement compensation plans that adjust quarterly the flat fee per loan depending upon overall loan profitability per originator. For instance, by providing for a 90-day evaluation period on flat fee per loan payments (as well as a 12 month aggregate re-evaluation) loan officers could effectively be paid on a per loan basis consistent with the average per loan profitability historically earned by the loan officer.
Such a compensation plan would also introduce risk evaluation, consistent with the guidelines. Indeed, loan officers would suffer the repercussions of failed loans, reducing their future per loan fees. Loan officers would thus do only as well as the profitability and performance of the loans they sold. Because of the potential for a single nonperforming loan to devastate future income (whereas marginal additional income of a riskier transaction would have relatively little overall effect), loan officers would have an incentive to carefully consider risk along with profitability.
This self-evaluation at the loan officer level would produce healthy profits and compensation, while protecting lenders, brokers, and consumers from improper lending. Responsible top producers would continue to succeed. Loan officers who produce through risky and irresponsible lending to consumers would see reductions in income.
Such compensation systems sound difficult to implement, but in fact can be structured and maintained with relative simplicity. If developed and implemented correctly, a loan officer can make approximately the same amount s/he was making pre-reform, and the bank can be secured against irresponsible risk taking that disregards the interests of consumer and institution alike. Many policies and practices that were difficult to justify and/or enforce under various state and federal labor laws prior to the reforms, can use the principles underlying the reforms as a basis for legitimate implementation. The keys to many of these possible benefits underlying the financial reform bill are creative and well conceived compensation plans carefully articulated in employment contracts drafted by legal counsel familiar with banking and labor laws, as well as relevant business practices.
Proper incentive compensation for employees is no longer a behind the scenes issue. It will be in the forefront when evaluating the propriety of a financial institution's practices, policies and procedures. Companies will be forced to carefully craft and draft employment agreements and compensation plans. These will be critical areas examined by auditors, regulators and investors. The creativity and propriety of such plans will have a large impact on an institution's profitability, stability and comparative success. Those companies who invest the time, thought, and patience to develop and implement innovative compensation plans and contracts can truly have their cake and eat it too, attracting top producers and compensating them in a manner that makes them accountable for, and responsive to, the risk undertaken by the lending institution.
This is an opportunity that companies should seize. While recent government regulations rarely benefit mortgage companies, this is one aspect of reform that has a silver-or perhaps platinum-lining for those prepared to take advantage.
