Loan originator compensation is a key source of fair lending risk. Through the years, we have seen both regulator guidance and DOJ settlements that encourage the proactive management of Regulation Z and fair lending compliance.
As a quick reminder, Regulation Z states that “no loan originator shall receive and no person shall pay to a loan originator, directly or indirectly, compensation in an amount that is based on a term of a transaction.” Reg. Z also says that “a loan originator shall not direct or steer a consumer to consummate a transaction based on the fact that the originator will receive greater compensation from the credit in the transaction than in other transactions the originator offered."
How to Build a Strong Fair Lending & Redlining Compliance Management System
Examiners are looking at compensation
The Interagency Fair Lending Examination Procedures state that “before evaluating the potential for discriminatory conduct, the examiner should review sufficient information about the institution and its market to understand the credit operations of the institution.”
Relevant background information includes your institution's loan officer and/or broker compensation programs. Loan originator compensation is one of the most basic and consistent areas explored by examiners. This compensation review applies to both direct lending inside the financial institution and indirect lending outside the financial institution. The fact that examiners are evaluating compensation plans should not come as a surprise.
Monitoring compensation policy
Here are several best practices institutions should consider when managing consumer compliance risk associated with Reg. Z and the fair lending regulations:
1. Maintain written policy governing compensation: According to Reg. Z, an "institution must establish and maintain written policies and procedures reasonably designed to ensure and monitor the compliance of the depository institution, its employees, its subsidiaries, and its subsidiaries’ employees." Written policies and procedures must be appropriate to the nature, size, complexity and scope of the mortgage lending activities of the financial institution. Your policies should allow simple evaluation of whether the general compensation structures include incentives that depend on the type of product sold, volume of certain types of products sold, and the pricing associated with said product. Policies will typically have clear provisions for compliance with Regulation Z regarding loan originator compensation and steering (favoring one product versus another other from a compensation standpoint).
2. Document compensation plans by role & individual: Do you have compensation incentives for loan officers or management to charge more than the pricing sheet? How do you know? The best way to know for sure is to maintain written plans for individuals involved in the loan origination process (salary, variable compensation, bonus, and contest guidelines)? Are there components of your compensation that are not defined, like bonuses, sales campaigns, etc.? Do you understand the compensation at both the loan originator and management level?
3. Monitor compliance: Reg. Z also requires institutions to monitor compliance. Here are some ways to monitor policies and procedures:
- Look for discretion (loan officer or management): Annually interview the loan originators, production management, underwriters and pricing personnel. Are the loan originators and/or their managers afforded any discretion in the underwriting or pricing process? Are there any compensation systems based on loan terms? Annually review your policies and compensation plans to determine if the exercise of loan term discretion impact lender, staff or management compensation.
- Compare payroll to policy/plan(s): Is there a process to review policies and plans in comparison to the payroll? Are calculations consistent? All compensation should be accounted for in your written compensation plans.
- Analyze pricing: Regularly analyze pricing between prohibited basis groups and control groups to determine if disparities exist. The frequency of your review should be dependent on the size, complexity and the changes within your operating model.
You will greatly enhance your compliance management system by adopting written policies on compensation, maintaining written compensation plans for your originators and their managers, and having an active monitoring program.
This disciplined approach will help to ensure that all team members within your financial institution can proactively play a role in your successful compliance, and empower loan officers, sales management, HR, audit, and compliance.
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