CFPB Clarifies Rules on Loan Originator Compensation to Pension Plans

Thanks to new guidance issued by the Consumer Financial Protection Bureau (CFPB) in April 2012, financial institutions now have clarification on a particularly troublesome issue: whether pension plans are included in restrictions on how loan originators can be compensated. CFPB’s bulletin states that employers can contribute to a qualified retirement plan from a pool of profits derived from loans originated by employees – an exception to the general restriction on such compensation.

There has been a great deal of uncertainty in banks about whether their bonus plans for employees run afoul of the Truth in Lending Act (TILA) and the Dodd-Frank Act. Pension and retirement plans were not directly addressed in the proposed regulations issued in 2010, so this new pronouncement provides financial institutions with much clearer direction.

Whether the CFPB’s interpretation will stand remains to be seen. Final loan originator compensation requirements are set to be established by January 21, 2013.

Loan originators and Regulation Z

In order to understand the CFPB’s guidance on pension plans, it is important to go back and look at the loan originator compensation restrictions in Regulation Z of TILA.

Regulation Z defines a loan originator as “a person who, for compensation or other monetary gain, or in expectation of compensation or other monetary gain, arranges, negotiates, or otherwise obtains an extension of consumer credit for another person.” Generally speaking, these individuals may not receive, directly or indirectly, any compensation based on any terms or conditions of a closed-end mortgage transaction. Prohibited terms and conditions include:

• Interest rates
• Annual percentage rates
• Loan-to-value ratio
• Prepayment penalty

In other words, a loan originator cannot receive more compensation for a loan with a higher interest rate than would be received for the same loan at a lower interest rate.

It makes no difference what a fee or charge is called (origination fee, processing fee, application fee, etc.), or how it is disclosed or described. What counts is the amount of the fee that was retained by the loan originator. Compensation does not include amounts paid for legitimate business expenses, such as fixed overhead. It also does not include amounts collected by the originator for third party fees, such as appraisal fees. However, if the originator marks up the amount of the third party fee (known as “upcharging”), the difference must be included in the loan originator’s compensation.

In addition, compensation cannot be based on any factor of the loan that is a proxy for a term or condition of the loan. For example, a loan originator receives more compensation for a loan in which the borrower had a lower credit score, and less for a loan in which the borrower had a higher score. That arrangement would constitute a violation if the score difference increases the rate of the loan to the lower-scoring borrower.

As long as the amount of compensation paid to a loan originator is not based on the terms or conditions of the particular loan, it should be permissible under this rule. Forms of permissible compensation include:

• The salary or hourly rates paid to loan originators
• Flat fees paid for each loan
• Payments based on the quality of loan files (for example, accuracy and completeness of information) submitted by the loan originator to the creditor
• Bonuses based on the overall loan volume of the originator

A new look at pension plan funding

Since bonuses cannot be based on the terms or conditions of a particular loan, banks are restricted in how bonus programs can be structured for employees. This could impact a bank’s benefits and pension plans, and lead to questions about how a bank can fund a pension plan for mortgage loan originators using earnings derived in part from mortgage lending. Pension plan funding appeared to be prohibited based on original interpretation of the rule.

Now that the CFPB is responsible for Regulation Z, it is softening earlier interpretations and allowing financial institutions to contribute to qualified plans out of a profit pool derived from loan originations. The key to remember is that this exception applies only to qualified plans. So if a financial institution has a discretionary, nonqualified pension plan that is tied to profit goals, it cannot include income from closed-end mortgage loan originations in the plan.

The CFPB is not done tinkering with loan originator compensation requirements, although time is running out. The Dodd-Frank Act requires the CFPB to finalize loan originator compensation requirements by January 21, 2013, and for the rules to take effect by January 21, 2014. The new rules will almost certainly address issues related to bonuses and pension plans. The hope is that they will include less confusing requirements on the permissibility of bonus plans and loan originator compensation in general.