Part Four-Understanding Loan Originator Pricing
This is part 4 of our 5-part series about “The Compliance Person’s Guide to Pricing Gibberish”. If you missed parts 1-3, you can read them at our blog on www.fairlendingdiversity.com. I strongly recommend that you read those first as they provide the foundation for each posting.
In previous postings, we covered basic terminology used in pricing, margins, and risk adjustments. This posting is all about loan originator pricing. Without a doubt, this is the biggest area of risk for fair lending compliance because this is your frontline offering to the consumers that you serve. Consistency or lack of consistency in this area can cause chaos in your fair lending reviews. This is also the area that will require one of your strongest compliance management systems and monitoring.
How your company loan originator pricing is structured and how it impacts the individual consumer and consumers as a whole, determine the degree of risk. Understanding how your pricing works and affects the consumer is the first step to your action plan for how to fix it or defend it in an exam.
For most of you, your company uses a pricing engine to “configure” the pricing output from the investor, by adding the appropriate margins, risk adjustments and finally with the loan originator pricing.
There are two areas to hyper-focus on.
- Loan originator pricing variations
- Loan originator or sales management discretion/exceptions/concessions
Loan Originator Pricing
Loan originator pricing can be your fair lending and profit minefield! Done well, your fair lending statistics, ability to recruit and profitability are well-balanced. Done poorly and you throw off your balance and increase risk in one of those three areas. Lack of balance and increased risk will always require adjustment, whether it is from your finance officer, head of sales or the regulator. Each of them has a distinct way to make your life miserable!
From a compliance perspective, you are of course checking for loan originator compensation rules. However, what some compliance folks do not realize is that even though it may be legal to compensate a certain way, this does not mean your company is compliant from a fair lending perspective! The wrong compensation plan can cause many issues including, pricing disparity, redlining, reverse redlining and disparate impact.
The most common issues I see in loan originator pricing is pricing disparity within the same branch or MSA and use of exceptions. One practice that was common before all of the regulatory requirements was negotiating a compensation plan with an originator, and then based on how much you had to pay them, adjusting the pricing to the consumer by either increasing it or decreasing it. In Fair Lending world, this causes pricing disparity. Trust me when I say that this is still a popular practice with some mortgage lenders.
For instance, let’s assume your company has one branch with 6 loan originators. 2 are top producers, 2 are medium producers and 2 are just getting started. Your company pays the top producers 150bps per loan, the medium producers 100bps per loan and the ones just getting started 50bps per loan. This is what you are told:
In order to get top producers, your company believes they have to pay the going rate. The same is true for the medium producers. The ones just getting started must have better pricing because they do not have as much of a base of business so they need lower rates to compete. Your top producers are well established and do not worry about having the lowest rates because they are not “shopped” as much. They generally worry only about being competitive. After all, their objective is to earn more on the file. This “pricing to objective” strategy is the number one contributor to pricing disparity. The examiners will look at this from the consumer’s perspective. Why would it be okay for a consumer to contact that branch, and based only on the compensation to the originator be charged more or less? I’m sure you would not like walking into Wal-Mart, picking up a TV for the big game this week, and then paying a price based on cashier compensation, right? Now, I know some of you are going to say things like, “I’ve been doing this longer and give better advice and service”, and it is conceivable that this is true. Yet the cashier could make the same statement, and I will bet you still would not like to pay more just because they are faster, more experienced and nicer. Nor, would it be fair to the consumer purchasing a product from a company to have varying pricing schemes in the same area as well, unless there is a real reason. You may have a bit more latitude in the MSA, but keep in mind that latitude = business justification backed by empirical data, not just your opinion.
The next issue is exceptions. Exceptions are defined as any deviation from the pricing presented to the originator, regardless of pricing policy discretion or exceptions allowances. If it differs, it is an exception and should be on your exception log with a reason.
Exceptions Become an Issue When:
- The exception becomes the rule and not the exception.
- The pricing policy allows for loan originator discretion, branch discretion and other management levels of exceptions to a high degree.
- They are not logged, monitored and watched to ensure that both well-served and under-served clients are receiving exceptions.
Take a good look at your secondary pricing policy. If the fair lending team had no input into that policy, that is the first problem!
Loan originators are given discretion so that they can compete in their individual markets.
Compliance folks, there is nothing wrong with discretion/exceptions being allowed within reason.
Yes, it will elevate your fair lending risk, but that is why it must be monitored. Every exception should be logged and this data monitored at the local, regional, state and national level. You want to see how discretion is being used and how it is applied to both well-served markets, under-served markets, majority minority areas and majority non-minority areas. Too much in any area should be examined further.
The New HMDA Data
Now I realize that there are just a few geeky people like myself that have dissected the new HMDA data requirements and what they may reveal in pricing disparity. This topic is another article, but suffice to say that the majority of your secrets in pricing will be revealed through this new data! Dr. David Skanderson, of Charles River and Associates, and I wrote a white paper on this subject which can be found on my site. Most of you know David, but for those of you that do not, he is a Doctor of Economics and one of the most respected fair lending analysts in the country.
The CFPB added fields outside of Dodd-Frank and most of the fields they added are related to pricing. Why? Pricing disparity is rampant and those who generally get the worst deals are minority clients. In the old HMDA data sets, it was geographically tough to pinpoint disparity. It was also cumbersome to detect this because the data sets were not robust to either highlight a problem or dispel one. To a large degree, the new HMDA data sets will correct this and they will be able to identify pricing disparity down to the neighborhood/subdivision level. Yikes!
Now some of you say, well true, but HMDA Plus data sets have been used in evaluation before. I don’t disagree with this, but one of the biggest uses of HMDA data is to prioritize lenders for fair lending exams. The new data will highlight some of you, that may have flown under the radar screen previously.
On the bright side, it will also help some of you justify why one client received a higher rate/cost over another. After all, if the cost differential is related to verifiable risk adjustments, then this newer and more robust data set will prove that.
What to Do!
If you have been reading my work, then you know I don’t like to leave you with a problem without giving you some practical tips on resolving the issue. So here they are:
- Have secondary run a report on all margins added to the raw price by branch. Your company pricing engine has the ability to run this report.
- Review the disconnects by MSA, close-proximity MSA, and Branch. You are looking for pricing variations within a branch or within an MSA where a consumer could conceivably receive disparate pricing.
- Find out your exception percentage. If it is over 20% there is an issue that needs to be addressed. If 80% of your loans are exceptions, then your pricing is out of whack and you are likely seizing higher pricing opportunity for the other 20% who do not receive an exception. Are those 20% majority minority? That is just one example of a problem.
- Review how exceptions are being applied. Is it just in the well-served areas or all areas of your market?
- Review your HMDA data using all of the new HMDA required fields for years 2015 & 2016. Is there a pricing disparity concern? Has it gotten better or worse?
- Review the pricing of your peers in each of your markets. In some pricing engines, this data is available so ask if the pricing engine has a data and analytics feature to save yourself time and resources.
- Discuss your findings with your Executive team to come up with a plan of action to minimize risk.
The final posting in our series will tie all of the concepts together and give you some practical tips to assist you in better monitoring your pricing for compliance concerns.