Fed Rules Beget a (Mostly) Volume-Based Mortgage Commission Model

Regulations scheduled to take effect this month have prompted the top two home lenders to overhaul loan officer compensation by tying it to sheer volume to a greater degree than before.

Confidential documents prepared by Bank of America Corp. and Wells Fargo & Co. for their respective sales forces and obtained by American Banker offer a window onto the new model. Various bonuses and incentives will be eliminated, though new ones have been added; in at least Wells' case, they are designed to encourage good customer service and sound lending practices.

The Federal Reserve's compensation rules come on top of a regulations that the U.S. Department of Labor issued last year that are forcing many banks to put loan officers on payroll instead of paying them solely by commission.

"This is like Y2K for us — it is a massive change to all systems," declares Brian Koss, executive vice-president of Mortgage Network, a correspondent lender in Danvers, Mass. "You are adding a tremendous amount of cost — which comes from complying with this — including the programming, retrofitting your business to meet the Federal Reserve rules, and you have to factor in the assumption that people are going to make mistakes."

The Fed rules are designed to protect consumers from the deceptive lending practices that were blamed for inflating the housing bubble. The rules take aim at form of bank loan officer compensation known as a service release premium, under which banks made payments to loan officers upon the sale of a loan into the secondary market. Service release premiums were roughly equivalent to to the much-criticized yield spread premiums paid to brokers (which are also prohibited under the new rules).

The amount of revenue generated through an SRP was often related to loan terms that were disadvantageous to the borrower. One of the most controversial practices that often led to a higher SRP was putting a borrower into a mortgage with a higher interest rate than they qualified for. So the new Fed rules prohibit payments to a loan originator based upon the loan's interest rate or other terms.

"It is hard to argue that we" — the industry — "didn't incentivize our sales staff to sell products that disadvantaged the consumer," said David Lykken, managing partner of KLS Consulting, which does business as Mortgage Banking Solutions. "In the big scheme of things," he said, the Fed rule "could be good for our industry although it is bringing about a lot of pain, a lot of challenges."

B of A's plan says the bonuses loan officers once received for originating loans to low-income borrowers will no longer be awarded. The additional 15 basis points that loan officers once received on government-insured loans also are being nixed.

Under Wells Fargo's plan, loan officers will now be receiving 43 basis points, not per loan, but rather for a monthly volume of up to $899,000. The rate rises with an increase in volume. At $1.9 million in monthly loan volume a loan officer will receive 63 basis points.

Bank of America's loan officer compensation is on a similar scale. On a monthly volume of up to $899,000, loan officers receive 50 basis points. And at $2 million a month, loan officers will receive 65 basis points.

Both banks also have new bonus features to replace the many rate-based incentives that they can no longer offer. Under B of A's plan, a loan officer who sells a minimum $20 million of loans annually is eligible for admission to a "President's Club," which comes with a bonus of 4 basis points. B of A loan officers who sell a minimum of $32 million annually are eligible for the Chairman's Club, an honor that comes with a bonus of 7 basis points.

B of A spokeswoman Jumana Bauwens said it is complying with the Fed's new requirements but refused to discuss the company's new loan officer compensation plan.

Wells Fargo's compensation plan provides loan officers with the opportunity to earn bonuses according to customer loyalty and loan file quality measures. The new bonuses offset the reduction to the base compensation rate and should let top performers earn the same money they were making before the rule changes, said Wells Fargo Home Mortgage spokesman Tom Goyda.

The customer loyalty bonus is awarded semiannually to loan officers who receive a high score on a customer satisfaction survey and it is worth 3 basis points. Loan file quality, which is not defined in the plan and which Goyda would not describe, is worth another 3 basis points annually.

To address the new labor rules, Wells Fargo also is in the midst of transitioning all of its loan officers to an hourly wage salary, which will include overtime. Goyda said loan officers will still have an incentive to sell more loans from the new volume-based commission. "We are going to continue to be able to pay for performance," he said.

However, Lykken, the consultant, who reviewed the Wells Fargo and B of A compensation packages for American Banker, said the new plans will greatly reduce compensation for loan officers and he predicts that many will decamp to independent mortgage banks where he says they can make more.

"There are mortgage companies out there offering twice the compensation that B of A and Wells Fargo are offering," he said. "They will pay minimum wage" on the base salary, "and then they will pay a much higher rate for volume."

Arthur Axelson, of counsel to the Washington law firm Dykema, said incentives tied to loan terms sometimes allowed salespeople to cut a better deal for their customers by giving up a percentage of their YSP or SRP. However, he agreed that many abused the compensation model.

"To the extent that loan originators are not able to give up their share of a yield spread premium, the customer may lose out," he said, "but it does take the incentive out of the unscrupulous loan officers steering customers into high cost loans — so it is a double-edged sword."

Koss from Mortgage Network said the new Fed rules, in combination witht the new Labor Department rules, are changing the composition of the loan officer workforce.

"There is a whole new world of part-time loan officers who are being forced out," he said. "Most companies are just saying, 'We cannot afford to have you, this is now a demanding full-time job.'"

Koss said that under the new rules, some moderate-income customers will suffer. "By basing it on loan size, you are telling the loan officer, 'I will pay you more to go qualify people for the biggest loan,'" he said, "which normally you would expect to be wealthy people."

Under the old model, "where there was more work, you had more pay," he said. "You had more work to do to clean up [applicants'] credit but [loan officers] cannot do it anymore — even though there is a salary involved, you are telling them, 'don't spend time with people who need help.'"

Axelson agreed that there may now be a dangerous temptation for loan officers. "Loan officers will have to be careful that they are not discriminating on a prohibitive basis on the basis of the Equal Credit Opportunity Act," he said. "If a loan officer refuses to take applications for smaller loan amounts, it may have the effect of discriminating against lower income consumers who fall into minority or a protected class."

Still, as a result of the new rules, loan officers who took advantage of low-income borrowers might also find that there is no longer any room for them in the business.

"I think that you are going to see a huge turnover," said Lykken. "The guys who made an inordinate high amount of money in this industry, the low fruit pickers, the migrant opportunists, they are going to exit the industry and that is a good thing."