October 2014 Newsletters
Does the size of your loan originator’s bonus vary depending on the profitability or income of the entire bank? If you answered “yes,” then you better take a closer look at your compensation structure – you may have some Truth in Lending issues to contend with.
The overwhelming number of rules and amendments bellowing in from the CFPB make it difficult for compliance to stay up to date. One of the new rules directly implicates loan originator compensation, and it may have slipped under your radar. A lack of understanding may lead to violations at both the bank and individual loan originator level (that isn’t a typo, loan originators can be held liable by regulators for violations of this rule).
At its core, the rule prohibits loan originators from being compensated on the term, or proxy of a term of one or more consumer mortgage loans. On the surface the rule seems fairly simple – you can’t pay a higher compensation for a higher interest rate or pay out a higher commission on an ARM loan vs. a fixed-rate loan. But the rule runs deeper. You can’t base compensation on a proxy of the term of multiple transactions either.
The CFPB states in the official commentary to Reg Z that profits derived from the mortgage lending department of a bank is considered a proxy for the terms of multiple transactions. That is, basing any part of loan originator compensation on the overall profits of the consumer mortgage department violates the compensation rules. But it gets worse. Because the profits of the mortgage unit are included in the company-wide profits, basing loan originator compensation on the profitability of the entire bank will also be considered a violation of Reg Z compensation rules.
There are exceptions to the rule. The rule does not prohibit compensation in the form of a contribution qualified retirement plan, such as a 401k. The rule also allows non-deferred profit-based compensation so long as either the employee originated 10 or fewer covered transactions in the last 12 months, or the bonus was limited to 10 percent of the employee’s total compensation.
The official commentary to Reg Z provides, in part:
Assume that the compensation during a given calendar year of an individual loan originator employed by a creditor consists of only salary and commissions… At the end of the calendar year, the creditor pays the individual loan originator two bonuses: A “performance” bonus based on the individual loan originator's aggregate loan volume for a calendar year that is paid out of a bonus pool determined with reference to the profits of the mortgage origination business unit, and a year-end “holiday” bonus in the same amount to all company employees that is paid out of a company-wide bonus pool… If the company-wide bonus pool from which the “holiday” bonus is paid is derived in part from profits of the creditor's mortgage origination business unit, then the combination of the “holiday” bonus and the performance bonus is subject to the 10-percent total compensation limit. The “holiday” bonus is not subject to the 10-percent total compensation limit if the bonus pool is determined with reference only to the profits of business units other than the mortgage origination business unit, as determined in accordance with reasonable accounting principles.
The other alternative, as the example above alludes to, is to establish different pools of profits: one for the mortgage unit and another for the rest of the bank. The bank may then base the loan originator’s bonus on the profitability of the non-mortgage pool. Doing so, however, may require some more legwork for your accountants.
If you’re still uncertain if your bonus program complies with the rule, try a simple litmus test; holding all other factors equal, does your employee’s bonus change if the bank’s profit was higher or lower for that year? If the answer is “yes,” then you should be taking a closer look at your compensation structure.
Supreme Court May Decide Disparate Impact Case
This month, the U.S. Supreme Court (“Court”) has agreed to decide in 2015 whether people suing for housing discrimination must prove that they were victims of intentional bias, or if merely proving a lender’s neutral practice had a “disparate impact” on protected classes like racial minorities is enough.
Texas officials are appealing this case, Texas Department of Housing and Community Affairs v. The Inclusive Communities, in which they were sued by a group that advocates for racially integrated housing under the Fair Housing Act over tax credits for low-income building projects. The organization accused Texas of allocating a disproportionate number of federal low-income housing tax credits to minority neighborhoods.
The case could give long-sought protection to the lending industry, as the highest court will consider eliminating the disparate impact theory completely from Fair Housing Act jurisprudence. The Court has only agreed to hear two other Fair Housing Act disparate impact cases, but they both settled before a ruling was made, making this case crucial for lenders.
Disparate impact liability in the Fair Housing Act context has been a vague standard for lenders to meet and leaves much room for interpretation. The theory does not require any evidence of discriminatory intent, and lenders may become liable for nondiscriminatory policies when ability to repay factors, such as income, happen to correlate with race. Some parties have been able to utilize the murky and far-reaching standard against banks to obtain hundreds of millions of dollars in settlements.
The case could also affect the Equal Credit Opportunity Act, which contains language similar to the Fair Housing Act and covers auto lending as well as mortgages.
If a settlement is not reached, the case will be heard in the first half of 2015.
Privacy Requirements Finalized
The CFPB finalized a rule Monday that allows banks that meet specific requirements to post the required annual privacy notices online instead of through the mail.
Under GLBA, banks are required to send annual privacy notices to customers, which informs consumers how the bank shares nonpublic personal information. “If the institution does share this information with an unaffiliated third party, it (the bank) typically must notify consumers of their right to opt out of the sharing and inform them of how to do so,” the CFPB said in a press release.
Privacy disclosures have typically been sent to consumers in a separate mailing on an annual basis, as well as when an account is established. The new rule, however, will allow banks to include a privacy notice along with another type of communication such as a statement. This notice will alert the consumers about the availability of the privacy disclosure online, on the bank’s website for example.
In a CFPB press release discussing the privacy notices, Director Richard Cordray stated, "Consumers need clear and accessible information about how their personal information is being used in the marketplace, but some of these requirements were redundant.” Cordray went on to say, “Posting privacy notices online will make it easier for consumers to access these important policies, while also making it cheaper for financial institutions to provide disclosures."
The rule will take effect after it is published in the Federal Register.
In typical fashion, the CFPB issued a revised proposal to the integrated mortgage disclosure rule. Thankfully, the changes actually favor banks over consumers (albeit, ever so slightly). Most of the changes are technical corrections. The primary changes are: providing an extra day to send revised disclosures after a rate lock, amending language regarding new construction loans and requiring the NMLSR ID number on the disclosures.
The first substantive change allows an extra day to send revised disclosures when locking an interest rate or when interest rate dependent fees change. The current rule requires disclosures to go out the same day as the interest rate lock. The CFPB received numerous comments from industry professionals regarding the operational challenges involved with requiring a same day disclosure. The CFPB listened. The CFPB is graciously allowing revised disclosures to be sent the business day following the lock.
Note that revised disclosures only apply “in situations where a rate lock agreement has been entered into between the creditor and borrower or where such agreement has expired.” Not all lenders operate with a formal rate lock. In situations where lenders set a rate without a lock agreement, the revised disclosure rule does not apply. The new rule, however, does apply in cases where interest rate dependent charges change.
The next substantive change primarily focuses on format and clarity. The new disclosures attempt to provide clarity on how to disclose construction loans (which will now require disclosures, even if “temporary”). Under the current disclosure form, there is no room to permit a lender to provide language related to new construction loans. In particular, the form under the new proposed changes allows a creditor to include language that reserves the right to revise a Loan Estimate any time before 60 days prior to closing. This language is only permitted in transactions involving new construction.
The last substantive change requires the bank and loan officer to include their NMLSR ID on the Loan Estimate and Closing disclosure. This was expected as the CFPB reserved a section in Regulation Z to incorporate the new integrated disclosures.
Other minor changes include requiring all properties securing the loan to be listed on both the Loan Estimate and Closing Disclosure and other changes in the rule and official interpretation to harmonize language between sections.
Stay tuned, there is still quite a bit of time before these disclosures become mandatory. Also, don’t forget, you can’t use the new disclosures any earlier than Aug. 1, 2015.