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Large banks could end up pocketing higher profit margins on residential mortgages this year because of a rule from the Federal Reserve that restricts the pay of brokers and loan officers.
December 30 -
New regulations will soon restrict a common way of compensating residential mortgage brokers and loan officers. But those sales representatives still have to be paid somehow, and far more may change than simply commission structures.
August 26
The countdown clock on the Federal Reserve's rule to limit mortgage brokers' pay still has two months to go, but the shake-up is under way.
Large banks including Wells Fargo & Co. and Bank of America Corp. are still fine-tuning their pay plans for mortgage brokers and loan officers. Some loan officers and brokers are already shopping for new jobs because their pay could be slashed in half after April 1, when the Fed rule take effect.
The rule bars tying compensation to terms of the loan, such as paying more for loans with higher interest rates. It is expected to radically upend the mortgage industry's current pay model and will require far more oversight by banks of brokers and loan officers.
The Fed intended to curtail the practice of steering borrowers to high-cost loans by eliminating yield-spread premiums, the rebate paid to mortgage brokers for giving a borrower a higher interest rate in exchange for lowering the up-front costs.
"What we know is YSP is dead," said Kathleen Vaughan, executive vice president and national manager at Wells Fargo Wholesale Lending. "The broker can be compensated entirely by the lender or can be paid entirely by the borrower — not both. So when the broker is paid by the lender, the broker is going to work with its lender and it will be agreed-to compensation and it will be paid on all transactions."
Wells and B of A are expected to announce specifics of their plans in the next few weeks.
Most banks are expected to switch to a flat compensation model for loan officers and will have to put more management controls in place if they pay incentives based on the volume of loans produced, experts say. The controls would be necessary to ensure that such awards don't create a perverse incentive to make risky loans.
"You can't just give your loan officer a completely free hand," said Mitch Kider, a managing member at the law firm Weiner Brodsky Sidman Kider. "The incentives now are to keep on making loans, because they aren't paid on the profitability of the loan."
Banks also are expected to revise branch managers' compensation, because they can no longer share in the branch profits generated by mortgages.
"You can't pay a manager who also originates based on profits anymore, and that is going to be the most difficult thing to do," said Richard Andreano, a partner at the law firm Patton Boggs LLP.
Meanwhile, mortgage banks see an opportunity to poach high-producing loan officers or add brokers as affiliates with promises to find ways to preserve their income. But loan officers that work for banks are in a bind, since they are exempt from state licensing requirements in working for a traditional bank and would have to become licensed in individual states to join a mortgage bank.
"It's like a feeding frenzy," said Matthew Pineda, president of Castle & Cooke Mortgage LLC in Salt Lake City. "All these loan officers are shopping around and everybody is strategizing on how to roll out a compensation plan. They're crazy afraid and crazy excited and there's something to criticize in every proposal."
The mortgage banks likely will tie compensation to the volume of loans produced, a flat fee per loan or even a combination of both.
Andreano said banks are in a bigger quandary with broker compensation. Having brokers negotiate their pay from the borrower would require less managerial oversight but also could put brokers at a disadvantage.
"The consumer-pay option, where the consumer pays the broker, is just easier for banks," Andreano said. "It keeps the creditor out of the decision-making and tracking. With the implementation, monitoring and review, operationally (paying the broker directly) is too cumbersome."
Andrew Soss, founder and branch director of Stewart & Soss Mortgage, a San Jose, Calif., mortgage banker, said the new rule is widely viewed as a further "chipping away of the advantage of the broker."
"Market share will move significantly towards banking," he said.
Joe Lynyak, a partner at the law firm Venable LLP, said there will be "a great deal of confusion" until the Consumer Financial Protection Bureau exercises its authority to reconcile any differences between the Fed rule and the Dodd-Frank Act. The act limits compensation on high-cost loans to 3% of the total loan amount. Anything it does could take a while, since the CFPB isn't slated to begin operation until July.
"There's going to be real pressure on pricing and compensation, because if you're making 4 points on a loan, you can't sell that loan," Lynyak said. "All of these various components of Dodd-Frank will come together, and pricing is going to limit a lot of these practices that have been heavily criticized."
Kider said traditional banks more likely will slice and dice different pay structures for brokers perhaps based on regional differences, such as costs or competition in individual markets. It may not be viable for brokers to negotiate directly with borrowers for their pay because many borrowers cannot afford to bring more out-of-pocket money to the closing table since "in order to even get a loan they have to bring more for their down payment," he said.
As Lynyak put it, "Unless the broker can come up with a model based on a salary or per-loan perspective, they're in a lot of trouble."
