Regulators scrutinize lender compensation

With the Consumer Financial Protection Bureau (CFPB) cracking down on improper lender compensation plans, banks should anticipate increased scrutiny in this area from their primary regulator.

The CFPB’s enforcement activity reflects heightening scrutiny of compensation plans that may inadvertently incentivize loan officers to steer consumers into loans with higher interest rates. A financial institution should be cautious with how it compensates lenders and avoid plans that may be found to be based on transaction terms or a proxy for transaction terms. In instances where civil money penalties were assessed, the CFPB found that plans impermissibly tied loan officers’ compensation to the interest rates on the loans they originated. The following companies were assessed large civil money penalties that were directly correlated with lender compensation:

Castle & Cooke Mortgage, LLC was required to refund more than $9 million to 9,400 consumers who were illegally steered into mortgages with higher interest rates. Castle & Cooke, which does business in 22 states, paid its loan officers illegal bonuses based on the interest rates charged to consumers. The company and two of its officers were ordered to pay a $4 million civil penalty.1

The CFPB has filed a consent order that would require RPM Mortgage, Inc. to pay $18 million in redress to consumers and a $1 million civil penalty for illegally paying bonuses and higher commissions to loan originators to incentivize them to steer consumers into costlier mortgages. The consent order would also require RPM’s CEO, Erwin Robert Hirt, to pay an additional $1 million civil penalty for his involvement in the unlawful practices. 2

Guarantee Mortgage Corporation was required to pay a civil penalty of $228,000 for paying its branch managers based, in part, on the interest rates of the loans they closed. 3

Documentation expectations

Financial institutions need to establish written compensation plans or agreements, carefully review them for compliance and ensure that compensation is actually paid in accordance with those plans. Lenders also must maintain records of the compensation actually paid for each transaction and the agreement that was in effect when the interest rate was set. Keeping records for bonuses paid to individual loan originators is also necessary to ensure compliance with the records retention requirements of Truth in Lending. The rule generally requires that sufficient records of all compensation paid to loan originators, along with loan originator compensation agreements, must be maintained for three years after the date of payment.

Ultimate responsibility

If you’re a board member of a bank and you’re not sure how lenders’ compensation is determined, you need to ask. The institution’s board of directors and management have responsibility for ensuring compliance with compensation rules.

One common error is paying loan originators bonuses that are based on the bank’s year-end net income. Year-end net income can contain fees that are based on consumer mortgage transaction terms. The CFPB has stated that net income is a proxy for loan terms when paying bonuses if the financial institution’s net income contains fees from mortgage transactions and interest earned on consumer mortgage transactions.

There are concessions for paying individual loan originators bonuses based on net income including a 10 percent of total compensation rule. However, the lender can still establish volume-based incentives or set aside bonus pools in advance that are not distributed based on loan terms or profits. Further information regarding other acceptable forms of compensation can be found in the CFPB’s Loan Originator Rule Small Entity Compliance Guide (page 40)4. The rules expressly recognize seven permissible compensation methods with respect to payment of salary, commissions and other compensation. They are effectively safe harbors.

The KraftCPAs financial institutions team is available to help if you have questions or concerns about the process. You may reach us at (615) 242-7351.

Source: OCC, FDIC, CFPB, FTC, and NCUA, reference 12 CFR Parts 1026, Section 36

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