Originator Compensation Reform: Putting the Cart Before the Horse

Originator compensation is a hot topic among MND readers.

The broker situation has been outlined fairly well by the wholesalers. Not much change vs. the current process is anticipated. Brokers will get paid either by the lender or the consumer. One or the other. Not both. That's it. That sector of the industry looks to be on track for April 1 implementation.

The same cannot be said about the mortgage bankers though.  In fact, no one has a clue what to expect in the direct lending world. Last I checked, most folks were waiting for guidance from the five major lenders: Wells, BoA, JP Morgan Chase, GMAC and Citi.  I haven't heard much from that crowd either. Have you? If so please share with the community!

Barring any surprise leaks in the comments section, this leaves us to wonder how the situation might go.

Let's start by clearing up some terminology confusion. YIELD SPREAD, REBATE, OVERAGE...they all mean the same thing.  They all come from the same source. There is a premium paid for above market note rates (discount cost for below market). Attached to that premium is another premium paid for the value of the servicing.

BASE PRICE + SERVICING VALUE = FINAL PRICE (plus delivery incentives if applicable). Wholesalers call that final price "yield spread", retailers call it "overage", direct bankers call it "rebate". 

For the sake of simplicity, I will refer to final pricing as REBATE. There is nothing wrong with using yield spread or overage, that works too as long as you understand that they all come from the same sources and mean the same thing. SRP is another story. Classifying rebate as "SRP" leaves out half of the loan pricing equation, the base price, whether it be a discount or a premium. (disco)

MISINTERPRETING THE DISCLOSURE OF REBATE

One thing that makes bankers and brokers different is...only one of them has to disclose "rebate" on the HUD. Brokers do. Bankers do not.  This is a topic of contention within the industry.  Why must brokers show rebate while bankers do not? The answer is fairly simple. It's the reporting method used to monitor different types of loan originators and what they're charging consumers. Its about regulatory accountability. Yes. In the big picture it really is about protecting the consumer, but the disclosure of rebate on the HUD is more about the reporting method in which the Federal Reserve uses to regulate the loan brokering business. Bankers face the same standard of reporting accountability but their paper trail follows a more direct  path than brokers,  one that removes the consumer from the process and automates compliance.

Here's how it worked when I had to do it as a banker. After I locked a loan (me = secondary, )I was under strict orders to promptly enter loan pricing and points (O+D) data into the back shop loan operating system.  This ensured the closer was able to run their Section 32 "High Cost Test" in advance of closing. This HMDA data was expected to be accurate because it was reported to the Feds on a monthly basis. This is how the Feds forced accountability upon us and maintained oversight.

Just to ensure we avoid a broker vs. banker battle here, it's important to recognize that much confusion (anger) arises around the implementation of new compensation regs because brokers must demonstrate compliance at the closing table on the HUD, in front of the consumer,  while bankers are able to report directly the Federal Reserve. While this may seem unfair, it's a necessary evil because no other means of monitoring the broker business has been offered by the industry.  This is often cited as a competitive disadvantage for brokers, but we have to remember it's intended to be a source of regulatory accountabilility. 

IMPLEMENTING NEW COMPENSATION REGS

Excerpts from the Federal Reserve's Final Rules on Originator Compensation...

The final rules, which apply to closed-end loans secured by a consumer’s dwelling, will:

• Prohibit payments to the loan originator that are based on the loan’s interest rate or other terms. Compensation that is based on a fixed percentage of the loan amount is permitted.
• Prohibit a mortgage broker or loan officer from receiving payments directly from a consumer while also receiving compensation from the creditor or another person.
• Prohibit a mortgage broker or loan officer from “steering” a consumer to a lender offering less favorable terms in order to increase the broker’s or loan officer’s compensation.
• Provide a safe harbor to facilitate compliance with the anti-steering rule.

The final rule applies to loan originators, which are defined to include mortgage brokers, including mortgage broker companies that close loans in their own names in table-funded transactions, and employees of creditors that originate loans (e.g., loan officers). Thus, creditors are excluded from the definition of a loan originator when they do not use table funding, whether they are a depository institution or a non-depository mortgage company, but employees of such entities are loan originators.

The rule requires creditors and other persons who compensate loan originators to retain records for at least two years after a mortgage transaction is consummated.

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Under these rules the broker is essentially treated as a third party service provider in the transaction. This makes the implementation of new compensation regs somewhat "black and white" for the broker. Their income will be out there for everybody to see at the closing table. It's obvious whether or not rebate and origination points are being collected because it's right on the HUD!  Sounds like business as usual for brokers since the implementation on new RESPA regs. (except any rebate will only be applicable to third party fees).

When dealing with a banker originator however, the consumer pays the bank directly to borrow mortgage funding and the bank pays the originator once they sell the loan in the secondary market or securitize it on their own. The mortgage banking originator is paid a commission by the bank/lender based on the "all-in" rebate + points paid income earned by the bank. These new regs will put a stop to that. The rule strictly prohibits an originator from "receiving payments directly from a consumer while also receiving compensation from the creditor or another person".

So this rule change level the playing field a bit. Just like brokers, mortgage bankers will soon have to choose between an origination point or rebate. One or the other. Not both. This means both mortgage bankers and brokers will need to engage the consumer to decide on an appropriate note rate. One that is based on the best buydown structure for the borrower.  Above all else, these compensation reforms seem like they will usher in a new era of transparency and competitiveness in the home loan business. Perhaps lenders will be more willing to share their rate sheet with borrowers?

I guess it all boils down to HOW MUCH originators will be paid though. That seems dependent on the competitiveness of the primary mortgage market and there is definitely the potential for a backfire here. By limiting the consumer's choice of originator compensation methods to either rebate through a premium note rate or paying points to buydown the note rate, we are also limiting their "best execution" financing options. This would imply, based on the segmented nature of the mortgage market, that some consumers might end up paying more than they would have for the same note rate before these regs were implemented (no lender prices the same as another). Then again, the final rules clearly prohibit a mortgage broker or loan officer from “steering” a consumer to a lender offering less favorable terms in order to increase the broker’s or loan officer’s compensation. Yikes. I'm not sure how that rule will be monitored or enforced from the perspective of the consumer's most efficient buydown structure. If there is no rebate standard/originator commission standard, then how do we regulate the industry? I believe we need a better definition of what constitutes steering a consumer away from an expensive buydown (good) vs. steering a consumer toward a higher rate just to increase commission (bad). The obvious fix is rebate caps.

The final rules are effective April 1, 2011. I don't think the industry is anywhere near ready for them yet. I don't think the government isready either!Congress pitched this reform under the pretext of consumer protection, so why are we pushing the implementation of the rule before the Consumer Finance Protection Board is even up and running?

The CFPB has a July 2011 deadline for having the organization up and running including several mandated offices for research, community affairs, consumer complaints, fair lending, and several other divisions of responsibility; the number of reports it must make to Congress, and the competing interests the Bureau will have to consider.

 We need a little more time to ensure this is the right move. If not based on that argument,  GSE reform is the most important issue on the mortgage industry's "to do" list and Congress hasn't made much progress on that lately, at least not publicly (too distracted by roboclosuregate or whatever we're calling it now). How we can we implement new originator compensation regs without a stable housing finance system?

Perhaps we should tackle the 800lb gorilla in the room before we attack anymore internal policies and procedures? We're putting the cart before the horse. Again.

MND SEARCH RESULTS FOR "ORIGINATOR COMPENSATION" <<<<------lots of good stuff in there