Ed. #73: LO Comp, Bozo Buckets and "P&L Branches"

Compliance convo over cocktails?

Most people-even mortgage folks-can’t fathom how I find intellectual curiosity, humor and creativity when discussing mortgage regulatory compliance issues. To be honest, I don’t blame you. I mean, most people think, ‘what’s so interesting about looking up a law or regulation to see if you can or can’t do something’. Moreover, unlike someone like Rob Chrisman who can hold audiences raptured with jokes about clowns tasting funny and speculative discussions about the direction of interest rates or home prices, I can say with absolute certainty that discussing the nuances of RESPA at a cocktail party or local bar will do nothing to impress your neighbors, former classmates, or persons you fancy.[1]

Contrary to that popular misconception, however, answers to the regulatory questions I generally get are not just a matter of looking up the answer.[2] True, many mortgage compliance questions can be answered clearly by merely[3] looking at a regulation and making a binary decision. Highly prescriptive regulations like TRID, HMDA, and the servicing regulations fall into this category, so when dealing with these kinds of regulations it is fine to ask “show me where it says I can’t do that” or “show me where it says I can.”

Compliance nuance

Framing compliance questions on the assumption you can always just look up the answer, however, is why most people assume mortgage compliance is boring. Compliance with many of my favorite regulatory acronyms like RESPA, LO Comp and UDAAP, however, offer a totally different analysis and opportunities for shaping interpretations through narrative and, frankly, mischief.[4] It is this nuance and room for ambiguity and creativity that holds my fascination with these regulations and inspires my passion, prose and even nostalgia (Chicagoans of a certain age might want to skip to the Bozo Buckets link and fn #17). More importantly, navigating regulatory nuance, narrative, ambiguity, and creativity also helps pay the bills.[5]

LO Comp is still the worst!

Which brings me (back) to today’s topic: TILA’s Loan Originator Compensation Rule (a/k/a “LO Comp”)[6]. I can complain about the uselessness of LO Comp all I want, but notwithstanding my rants[7], the 10 year review process mandated by Congress announced a year ago, and the mortgage banking trade association letter from 2018, I don’t hold out any hope that, absent dramatic political changes in Washington, CFPB will do anything to eliminate or even ameliorate[8], this Dodd-Frank era anti-consumer and anti-competitive rule which hasn’t resulted in a public CFPB enforcement action since 2015.[9]

With that as background on my priors, there has been recent buzz in the industry around a couple of LO Comp related issues. I’ll come back the issue of regional manager compensation later but, first, a December 2023 Housing Wire headline oddly warned, “Loan officers are dramatically cutting their pay to win clients. It’s often illegal.”[10]

I know the idea that it is illegal to cut your own pay sounds silly to anyone who hasn’t ever worked in the retail residential mortgage lending business (at least since 2011), but LO Comp actually does make it illegal for loan originators (LOs) to cut their own pay to reduce costs to consumers[11]. Again, this is an anti-consumer/anti-competitive rule that if most consumers really understood how it tends to raise costs unnecessarily[12] they would wonder what the heck CFPB and/or Messrs. Frank and Dodd were thinking[13] when they came up with it.

(Bozo’s?) Bucket List

Anyway, in its article, Housing Wire described what it called “the growing issue of pricing bucket manipulation” in reference to how some mortgage companies allegedly enable their LOs to make pricing exceptions by selecting different commission rates that are supposed to be applicable to different lead sources of consumers.[14] Housing Wire’s bottom-line allegation is that these LOs and their companies are violating LO Comp by enabling “the practice of falsifying lead sources to lower loan officer pay.”

Meanwhile, in a separate article, Housing Wire also noted allegations regarding LOs funding pricing concessions through lead bucket selection that were asserted in an employee poaching lawsuit among mortgage company competitors.[15] I have all kinds of thoughts about this whole lead bucket manipulation issue, most of which are much better heard in the confines of an attorney-client relationship (which this blog does not create).[16]

My "Bucket" list

Still, I do want to make a few points of general interest about the lead bucket idea-my “bucket list”, if you will.

· Evidence of Lead Source. It is a separate violation of LO Comp if you do not have documentary evidence of why you paid an LO a certain commission. So, if you allow different commissions for different lead sources, you also should be prepared to provide evidence that the lead source was truly outside the LO’s control.

· Lead source can’t change. Once the lead source of a consumer is established, that is it. There are no do-overs in life, Bozo Buckets[17] or with lead source.

· Narrative matters in LO Comp compliance just like RESPA. Narrative is only good if you can back it up with facts. You aren’t trying to sell margarine that tastes like butter, but it's not nice to fool Mother Nature.

· Don’t assume CFPB Enforcement is sleeping on LO Comp. Speaking of not fooling Mother Nature, if you bump into a senior CFPB official and ask about LO Comp enforcement they will inevitably say, “[o]f course, we can’t comment on ongoing enforcement or supervision matters.” You can read what you want into that kind of comment, but just because they haven’t had a public LO Comp enforcement action in nearly a decade doesn’t mean they are not actively investigating violations. CFPB officials can read Housing Wire too[18], and are hiring another 75 or so enforcement attorneys increasing enforcement staff by 50%. So, FWIW, although I have zero knowledge of anything specific, I would not be at all surprised to hear about a CFPB LO Comp enforcement action involving improper use of lead buckets (among other possible issues) arising in the coming weeks or months.

Regional managers

As for the other LO Comp issue, in his special mid-day edition on February 13, 2024, Rob Chrisman mentioned a shift in regional manager’s pay to more profit-based rather than strictly volume based. Said Chrisman,

“Obviously the “regional manager model” is withering, especially if that person’s compensation is not based on profits and only production, and that production is what they brought on board a year or three ago and has dropped dramatically…. Which has raised the question, “Should loan officers be paid on profits rather than volume?”

I don’t know exactly what was meant by “regional manager model”, but when I saw that last question, I reminded Chrisman that,

“As much as that makes sense from a business perspective, it’s illegal to pay LOs on profits under TILA’s LO Comp Rule. There are other things a lender can do that are permissible, but the whole gist of the LO Comp Rule was to prevent LOs from being paid on individual loan profitability.”

Without digging deep into LO Comp[19], however, it is fairly non-controversial that a mortgage company can pay a non-producing manager (regional, local or national) based on loan profitability. The heavy lifting there is figuring out if someone is producing or not (i.e., are they an LO) under LO Comp’s definitions.

P&L Branch Model?

But the question about the regional managers and their compensation may relate to the complicated LO Comp questions relative to the common industry practice of paying producing managers based on the misnomer “P&L Branch Model”.[20]While agnostic on the benefits of such a model[21], in his excellent June 2021 analysis of this compensation structure, Jim Cameron of STRATMOR Group illustrated the distinction between a true profit and loss (P&L) compensation scheme and one which is only designed to incorporate certain non-loan level expenses into the compensation calculation for a producing manager. Cameron asked,

“Is the branch manager paid a percentage of the bottom line in addition to salary, overrides and commissions on personal production? Or, is the structure more of an Expense Management Branch (EMB) where the branch manager is paid the residual bottom line after the receipt of a fixed revenue credit, payment of all expenses, fees to the parent and after holding back reserves?”

Mr. Cameron’s terminology can help prevent the confusion (and, frankly, LO Comp compliance narrative challenges) caused by use of the term “P&L Branch” (I also eschew use of that term)[22]. It would violate LO Comp to pay a producing manager based on the actual profits and losses of a branch. Actual profits and losses not only takes into account branch expenses such as marketing, rent, utilities and employee salaries, but also individual loan revenues (e.g., fee income and secondary market sale results) as well as individual loan expenses (such as uncollected lock or credit report fees, or TRID tolerance cures).

That said, subject to state employment law, you generally can incorporate certain expenses into a producing manager’s compensation, but the gross revenue side of that compensation calculation must be a fixed percentage (not actual loan by loan revenues). You also need to carefully avoid including loan level expenses in that commission calculation (which still are expenses on an actual P&L).

In fact, in addition to the details of what is and isnt a loan level cost or revenue, there are lots of other issues to navigate in terms of state and federal wage/hour and other employment laws in determining any compliant compensation structure. Looking at LO Comp alone when establishing compensation plans is insufficient. This is definitely an area you will want to get qualified legal counsel to help navigate. Keep in mind too that an EMB model is just a compensation calculation. It is not a true accounting of branch profitability, so the model does not allow a mortgage company to fully ignore branch cost control management nor does it substitute for actual GAAP accounting.

[1] Discussing those nuances over cocktails at mortgage conferences such as i) MBA’s Legal Issues, ii) RESPRO, and iii) Lenders One (all of which I will be speaking at this spring), however, is often my plan to create riveting conversation.

[2] That is as simplistic as the guidance from my 6th Grade social studies teacher, Ms. Costas. She used to repeatedly say, if you want to find the answer, “lookie-lookie in the bookie.” This was, of course, before the internet and search engines where I now get most of my answers. I wonder what 6th Grade teachers say now.

[3] “clearly by merely” is known as an “internal rhyme”.

[4]Fair lending falls in this category too despite the desire of many to make that an objective analysis. See e.g., https://mortgagemusings.com/f/ed-62-duties-defining-discouragement

[5] I have written previously in these Musings how regulatory complexity is actually a subsidy to larger/wealthier businesses. Smaller businesses often cannot afford to pay for complex, nuanced guidance.

[6]Generally speaking, LO Comp prohibits LO compensation based on loan profitability.

[7]See also, https://mortgagemusings.com/f/ed-52-outrage-empathy-and-policymaking

[8] Since I don’t get paid by the word, I’d like to have one word that means, collectively, eliminate or ameliorate. One word that encompases improve or get rid of. How about “elimeliorate” or “ameliminate”? Those are easier to write than to say, however.

[9]More on LO Comp enforcement later.

[10] I was quoted in the Housing Wire article saying, "the[LO Comp] rule creates “a tremendous amount of anxiety for the mortgage lending industry that doesn’t benefit consumers in any meaningful way. The industry is frustrated. They’re unable to easily reduce prices. For example, in the past, before the rule was around, LOs were able to take less as a commission, just like any other salesperson – a car salesperson – to make the deal work. That’s illegal now for loan officers. The mortgage company can make that decision [of lowering their margins and reducing rate], but the loan officer cannot.”

[11] The LO Comp Rule permits mortgage lending companies to offer discounts to consumers, but those companies are not allowed to reduce the LO’s compensation to account for lower profitability of any discounted loan, even if the LO wants to do that. See however, https://mortgagemusings.com/f/ed-56-compliance-for-thee relative to a innovative, if not contrary, position taken by industry giant wholesaler UWM relative to mortgage broker compensation last year.

[12]One might be able to say the same about RESPA. In fact, has anyone done any empirical research since the 1970s on whether referral fees actually increase costs to consumer (RESPA’s stated premise)? I mean, with the impact of the internet on consumer shopping behavior and changes to the way in which homes are bought and sold today (and coming tomorrow) if only there was a Federal agency with the staff and resources to study that question....,“Beuhler,…”

[13] I’ll admit I wanted to say, “what were they smoking?” there, but most folks don’t remember that LO Comp’s original drafters worked for Federal Reserve Board and it is hard to imagine those egg-heads with anything other than tobacco in their pipes. Still, there was this one guy at the Fed who looked a lot like a tall John Lennon…

[14]Lead source (or channel) is typically viewed as outside of the control of the LO (i.e., the LO does not control how the loan came in the door). Any factor outside of the control of the LO is generally not considered a “proxy” for profitability under LO Comp’s proxy rule so compensation variation based on lead source is permissible. [citations omitted and this is alot more complicated than just that.]

[15] This comment is not directed at any mortgage company litigant, but I have heard about a few “glass houses” in the industry when it comes to LO Comp.

[16]This is a good time to remind readers that, (i) this blog is not to be taken as legal advice, and (ii) no attorney-client relationship is hereby created.

[17]As someone who grew up in Chicago in the 1970s (when RESPA was enacted!), I can’t hear the word “buckets” without thinking about Bozo the Clown and the Grand Prize Game (GPG) from the Bozo’s Circus children’s show. Every 7-year-old in the Midwest practiced at home daily for when they might have a chance to sink a ping pong ball in all six Bozo buckets to win a new bike (after getting a coveted ticket to a live show at WGN Studios in Chicago). Seriously, between Bozo, the Cubs, Garfield Goose, and the Ray Rayner Show, back then, WGN was the best TV channel ever as far as I was concerned. N.B., 6 buckets is extremely hard to successfully achieve both for lead sources and Bozo Buckets.

[18] I am aware that many CFPB’ers have subscribed to and read this blog as well.

[19] The LO Comp Rule is not only useless and anti-consumer, it is also 541 pages long with Preamble and Official Commentary. See https://files.consumerfinance.gov/f/201301_cfpb_final-rule_loan-originator-compensation.pdf. Contact an attorney for legal advice if you have questions about LO Comp. I know some very good ones if you need a referral.

[20] The model is also known as Expense Control/Management or Assigned Revenue.

[21]Cameron concluded, “EMB model companies have a 'higher cost, higher revenue' model focused more on value and service, and less on price. Therefore, there are fewer transactions per branch and LO, but higher revenue per transaction. But, in the end, EMB profitability and gross margin is almost identical to corporate branch model companies.”

[22]Referring to a branch as a P&L branch also suggests that compensation is based on the profits and losses of the branch harkening back to the old “net branch” concept. That was really just a “rent a license” type scheme where an originator could set up their own shop using another company’s name and secondary market relationships. FHA has specific guidance prohibiting “net-branches”.