Large banks could end up pocketing higher profit margins on residential mortgages this year because of a rule from the Federal Reserve that restricts the pay of brokers and loan officers.
The rule also could cull the ranks of wholesale mortgage brokers — some lenders predict by up to 20% — particularly if brokers end up earning a flat fee or set amount per loan. Such a shift could drive small producers out of the industry and lower overall compensation, though many are still trying to understand the rule's final impact.
"Everyone is scratching their head, waiting to figure out how to apply this and what it will mean," said Brian Koss, the managing partner at Mortgage Network Inc., a privately held lender in Danvers, Mass.
Under the Fed rule, brokers and loan officers cannot be paid based on the interest rate or any term or condition of the loan. That eliminates the payment of yield-spread premiums, a form of hidden compensation that consumer groups have long tried to eradicate.
"The Fed's rules are in favor of the consumer and the result will be less compensation for mortgage brokers," said James Deitch, the chief operating officer of the $1.14 billion-asset First Chester County Corp. in West Chester, Pa., and managing director of its American Home Bank mortgage division.
The rule was created to eliminate the "steering" or "upselling" of loans, a widespread predatory practice in the boom years. The rule seeks to bar the practice of brokers or loan officers selling consumers high-cost loans to receive the fattest commissions.
Most lenders are waiting for further guidance from the Fed on how to structure compensation for the wholesale channel before the rule takes effect April 1.
Meanwhile, lender and broker trade groups are trying to delay the rule's implementation, threatening to file lawsuits and simultaneously lobbying for changes.
Some lenders concede the industry brought the new restrictions on itself through bad practices. Still, there is ample disagreement about the rule's actual effect.
Some wholesale lenders say that broker compensation will not change at all and that the rule will promote fairer competition between brokers and loan officers who work for big banks. Others claim consumers will end up paying higher costs through up-front origination fees. Still others claim borrowers could get lower rates.
Brokers still have the option of collecting all their compensation directly from the borrower, most likely by charging 2 points in origination fees, compared with the current 1 point, to cover what would have been paid as a commission. But they are barred from being paid both by the borrower and the lender.
There also could be some advantages over bank loan officers, since brokers will have multiple price sheets and alternative ways to be compensated.
"The retail loan officer working as an employee will only have one price and compensation option," said Dan Cutaia, the president of capital markets and risk management at Fairway Independent Mortgage Corp. in Sun Prairie, Wis. "It's possible the third-party origination channel could become more profitable due to the Fed's loan officer compensation rule, but my sense is competitive forces will make any added pricing margin measurable by only a few basis points."
Complicating the issue are provisions of the Dodd-Frank Act that limit compensation on high-cost loans to 3% of the total loan amount. Dodd-Frank also calls for an outright ban on yield-spread premiums but the Consumer Financial Protection Bureau can make exceptions and resolve discrepancies with the Fed's rule.
Marc Savitt, the president of the Mortgage Center in Martinsburg, W.Va., said he worries that lenders will change their policies to comply with the Fed rule that takes effect April 1, and then the CFPB, which is set to go into effect July 1, could decide on changes to Dodd-Frank that differ from the Fed rule. "What's the cost to everybody involved to retool and do this all over again?" Savitt said.
Meanwhile, the National Association of Mortgage Brokers and the National Association of Independent Housing Professionals are threatening to file lawsuits against the Fed claiming it has overstepped its authority, which is limited to regulating unfair and deceptive practices.
"Their authority is limited to disclosures, they have no right to restrict income," said Savitt, who is also the president of the National Association of Independent Housing Professionals.
The Mortgage Bankers Association has joined the fray, claiming the Fed is giving lenders mixed messages in verbal responses, even though the Fed has provided bullet points of nine examples of compensation that can be paid that is not based on a loan's terms.
John Courson, the MBA's president and chief executive, sent Fed Chairman Ben Bernanke a 19-page letter in December rebutting most of the central bank's reasons for implementing the rule. The letter included a laundry list of 42 questions and answers in which the MBA provided the Fed's responses to questions and then countered with its own responses.
For example, brokers and loan officers cannot be paid differently depending on the loan type, so conventional loans and Federal Housing Administration loans (as well as purchase and refinance transactions) must be priced the same. Otherwise there is a danger that consumers will be steered to loans that produce the highest compensation for the originator.
The MBA said lenders should be able to pay brokers and loan officers based on the average cost and time it takes to originate different types of loan, including loans held in their own portfolios, as opposed to those sold to government-sponsored enterprises.
"Just as origination costs for different channels may vary so, too, may origination costs for loan products," Courson wrote.
As a result, some lenders may specialize in certain loan programs or products such as reverse mortgages or superjumbo loans while others may "walk away from certain types of business," Koss said.
Brokers that originate primarily Fannie Mae and Freddie Mac loans "will really feel the pain," Koss said. "That's where you'll see the big change. You can't be everything to everybody anymore."
Large lenders may be tempted to subsidize their own branches by cutting the pay of brokers and loan officers, particularly as originations fall in response to rising rates. Since most lenders expect refinance activity to slow significantly this year, lenders can use the savings from not paying brokers and loans officers to capture more market share from those same channels, Deitch said. "The lenders won't necessarily reap a windfall, but will use reduced broker compensation to build their retail channels to capture market share from the brokers," he said.
Chris Thomas, the owner of America's Mortgage, a correspondent lender in Westminster, Colo., said he is convinced borrowers will pay more for a loan and some bank lenders will reap a windfall. "The par rate for a loan almost always pays the originator something," he said.
"If that goes away then the front-end compensation will naturally rise," Thomas added. "If the originator is only making money on the back end, then they will have to raise the rate more than they do now to make the same amount, because the front-end compensation goes away."
