A Direct Assault on Small Business!

In September 2009 CAMP had a series of discussions with the Federal Reserve regarding the new Loan Officer Compensation rule under Reg. Z scheduled to go into effect April 1st, 2011. Ken Jones posted the result of those discussions on our website. We indicated at that time there were two different views of how a mortgage broker may be able to compensate their loan originators when receiving compensation from a borrower directly (see the post at www.theCampSite.org). The 2 ways were; one under a normal basis point agreement and two hourly (or salary ) with a bonus plan. We were very concerned about the second option and posted it as a “Warning” in the analysis , however, at that time it did not seem to be the preferred interpretation by our industry or the Fed. Within the past four weeks it has become increasingly clear that when receiving borrower paid compensation, the broker themselves does not need a pre-arranged agreement with the creditor as with lender paid, however, they may have to pay their originators based on an hourly (or salary) structure with perhaps a bonus plan. This would treat the brokering channel significantly different as explained below and would be extremely harmful to small business in America! As such, NAMB has arranged a teleconference set for today with the SBA Office of Advocacy. Ken Jones will be representing CAMP and NAMB in these very important discussions. Stay tuned!

Below is a detailed written explanation by Ken Jones, Esq. CAMP Government Affairs co-chair.

The Federal Reserve Compensation Rule introduced in August 2010 contains specific language that will substantially harm the small business broker and greatly reduce their number as an alternative source to larger banks.The actual impact of the language in question is so counterintuitive that it has only recently become the subject of discussion.

The Language in Question

“Payments by persons other than consumer. If any loan originator receives compensation directly from a consumer in a consumer credit transaction secured by a dwelling:(i) No loan originator shall receive compensation, directly or indirectly, from any person other than the consumer in connection with the transaction; (Federal Register, Volume 75, No. 185, pg 58534, (d)(2).)

The result of this language is that it will force the small broker (state license with no warehouse line) to compensate their loan officers in a bizarre fashion whenever the consumer chooses to directly pay compensation.This situation arises whenever a consumer chooses to take a lower interest rate “market rate” loan, where yield spread premium (YSP) is not paid by the lender to the broker to cover the compensation.When the consumer pays their own fees, the language above dictates that the broker can only pay their employee through a salary or hourly wage.

We arrive at this conclusion (as does the Fed) in the following manner:the consumer can only legally pay compensation to the actual broker or broker company (not to their employee non-broker loan officer.) Because the broker company (also consider a loan originator) has received compensation directly from the consumer, “no other originator (their employee) shall receive compensation, directly or indirectly from any person other than the consumer.”

The Catch 22

Reading the preceding paragraph, one would assume that a sub-set of the compensation paid by the consumer could flow through the broker to their employee.This makes sense especially given the Fed’s stated approach to compensation payment:

“The Board notes that transaction amount is commonly used throughout the mortgage market to determine the amounts paid to other parties, such as real-estate brokers, mortgage insurers, and various third- party service providers. The Reform Act also specifically permits compensation to loan originators based on the amount of credit extended.For all of the reasons discussed, the Board believes prohibiting originator compensation based on the amount of credit extended would be unduly restrictive and is unnecessary to achieve the purposes of the final rule.” (Federal Register, Volume 75, no. 185, pg 58521.)

However, when a consumer pays the compensation to a broker, the above no longer applies.The Fed logic: under the rule, the fed indicates that the only time a consumer can pay compensation to a MLO is to pay it directly to the broker (who even if a company is considered an MLO.)Once the broker receives this money, the money changes character, and becomes “broker” money, ergo 100% non-consumer funds.The broker is prohibited from passing along this money to their producers because the rule does not allow any party other than the consumer from paying MLO compensation.The bottom line – the salesperson cannot be paid based on the loan at all.

The Fed’s Response to this Bizarre Outcome

When queried on this issue, the Fed directs people to Comment 36(d)(2)-1

1. Compensation in connection with a particular transaction. Under § 226.36(d)(2),if any loan originator receives compensation directly from a consumer in a transaction, no other person may provide any compensation to a loan originator, directly or indirectly, in connection with that particular credit transaction. See comment 36(d)(1)-7 discussing compensation received directly from the consumer. The restrictions imposed under § 226.36(d)(2) relate only to payments, such as commissions, that are specific to, and paid solely in connection with, the transaction in which the consumer has paid compensation directly to a loan originator. Thus, payments by a mortgage broker company to an employee in the form of a salary or hourly wage, which is not tied to a specific transaction, do not violate § 226.36(d)(2) even if the consumer directly pays a loan originator a fee in connection with a specific credit transaction. However, if any loan originator receives compensation directly from the consumer in connection with a specific credit transaction, neither the mortgage broker company nor an employee of the mortgage broker company can receive compensation from the creditor in connection with that particular credit transaction. (Federal Register, Volume 75, No. 185, page 58537, underline added)

Within the underlined section above, the Fed informs that when a consumer pays compensation to a broker, the broker may only “legally” pay their loan officer in the form of a salary or hourly wage.

Impact on Small Business

As the Fed properly notes “prohibiting originator compensation based on the amount of credit extended would be unduly restrictive and is unnecessary to achieve the purposes of the final rule.” (Federal Register, Volume 75, no. 185, pg 58521), yet, this is exactly what they do.The outcome demands some sort of hybrid pay plan where a broker company’s loan officer can be paid based on percentage of the loan amount when the consumer chooses a higher interest rate and compensation is paid by the lender, but must somehow flip back to hourly wage or salary when the consumer selects a lower rate and chooses to pay compensation directly.

This situation does not exist if the loan originator chooses to work for a lender (creditor -a larger company that can afford a warehouse line.)On every loan, a lender can pay compensation based on the loan amount regardless of the source of the compensation.Where will employees choose to work?As the Fed has indicated, transactional pay is common throughout this industry.Loan originators prefer it, and to small businesses it is critical.

Most small brokers don’t have access to the resources required to offer a salary which would be competitive to competing commission structures.Additionally, if such is offered, and that producer does not enjoy immediate and sustained success in our challenging market, the small business will be decimated by a substantial salary expense not accompanied by revenue.If salaries are lowered, the right employees will not be attracted.If this clause of the rule is implemented, small brokers that employee others may cease to exist.

Why was the Rule written this Way?

As this issue was only uncovered recently, it was apparently not vetted within the comment period. There has been no offer of explanation as to why broker employees, and by extension, broker companies, should be singled out for disparate treatment in this way.There has been no offer of explanation why a loan originator can work on one side of the road and get paid commission, but move to the other side of the road to work for a small business broker and have their commission further regulated.If this outcome is simply the outcome of a scrivener’s error, it is to big an error to sweep under the carpet.

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