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The new thinking on compensation.


A new cost consciousness is driving lenders to rethink their compensation practices. Profitability is replacing volume as the uppermost thought on the minds of managers.

In today's world, as some companies are finding out, fewer originations and narrowing spreads are causing lenders to question the strategy of incentive pay based purely on volume.

"Historically," says Tom Greeley, a partner at MCS/Grant Thornton in Irvine, California, "loan volume was equated with company profitability. But that relationship may not be accurate anymore."

Real estate lenders "finally are paying attention to the cost of doing business," notes John Thomas, president of ICM Consultants in Valley Forge, Pennsylvania. He estimates that each year, half of all mortgage banking firms evaluate their compensation plans. And each year, he says, more of them are "getting very serious" about making changes.

As a result, firms ranging in size from Houston's Cornerstone Mortgage Company, with two branches, to multi-branched, Riverwoods, Illinois-based Sears Mortgage Corporation, are developing pay scales that are contingent upon meeting goals other than increased volume.

Some observers see smaller firms leading the way. For instance, Cornerstone President Marc N. Laird says that having fewer levels of management makes communicating goals easier. He adds that employees in a larger company often "don't know where the goal line is and where the out-of-bounds marker is. My job is to define the playing field, and then be the coach and cheerleader."

Tracking results

Yet Sears, with roughly $3.7 billion in 1990 originations, uses its automation system to track--and compensate for--employee efforts that save the company money. For instance, collectors who prevent loans from going into foreclosure will receive about 10 percent of what Sears would have spent if the loans were foreclosed, says Richard Ridge, vice president of human resources.

Not everyone in the business believes increasing performance incentives will help profitability. One lender who tried giving processors incentives for speed notes that "sometimes they worked, sometimes they didn't."

On the other hand, making branch managers responsible for their office profits has helped remove a whole level of management at ARCS Mortgage Incorporated in Calabasas, California. Senior Vice President Ira Cohen oversees 52 branches on his own, without any regional managers. "Each office is a profit center," he explains, and branch managers are rewarded for their results. But, Cohen allows each branch manager some room to work. "I don't call up and say, `It's slow, look at your staffing,' or `Here's a good place to buy typewriters," he adds.

ICM's Thomas says today's compensation programs are variations on traditional policies, rather than unique plans. Still, some of them are quite unusual. For instance, First California Mortgage Company President Dennis M. Hart has loan officers on salaries. "We've paid too many people too much for too long," he asserts. Hart compares loan officers making 50 basis points per mortgage to "Wall Street MBA's a few years ago," whose incomes exceeded the economic value of their accomplishments in his view.

Hart has a pay structure that satisfies 72 loan officers while also letting the company make money. "Just about all of them have different goals and objectives," that their individual compensation is based on, he says. "Our [loan officer] turnover rate is extremely low. They won't go for a short-term gain with another firm."

Good originators are not as quick to change jobs as some in the business think, agrees Thomas. But, other firms still try to find ways of keeping employees loyal to their companies. For instance, MCS's Greeley recently helped set up a long-term pay plan for a mortgage company president.

The plan was structured such that a bonus of up to 25 percent of the executive's salary is offered annually. However, only 40 percent of the incentive is paid during the current year. Equal distributions of the remainder can be made in each of the following three years.

But, Greeley adds, corporate profitability and loan quality targets must be met to assure payout of the earlier bonus. The bonus's deferred portion can be reduced by the board of directors if company performance doesn't reach specified levels in years two through four. In that way, the executive has the incentive to stay at the firm and to keep doing high-quality work.

Putting the plan together required "balancing fairness with complexity," says Greeley. He adds that a program which would be "extremely fair" could be "so complex [that] it's difficult to administer."

Paying for goals

When putting together pay packages, Greeley's first question to a firm is: "What are you trying to accomplish?" Most companies that are changing their compensation plans do so not out of a desire to pay less or cut costs, but to encourage employees to be "more in tune with company objectives," says Thomas.

Recognizing that profits are more important than production--and paying on that basis--is a healthy trend for the industry. And firms that have implemented pay changes generally believe that the results are showing up on their bottom line, and that they are better able to hire workers who fit in with their business plan. "We've substantially upgraded the organization in the last year-and-a-half," says Sears' Ridge.

He adds that new workers often embrace the pay system more readily than more seasoned employees. "What's wrong with the way we've been doing it?" is a commonly heard response of long-time workers, Ridge says.

Some lenders have made sweeping staff changes while revamping their businesses. Jacksonville, Florida's BancBoston Mortgage Corporation has replaced about 80 percent of its loans officers since setting up a MELOP (Minimum Expected Level of Production) system in early 1989.

Senior Vice President Thomas C. Palmer says loan officers with more than five months experience at the firm are now expected to bring in certain minimum levels of fee income each quarter, or else their draw against their commission is halved. Originators falling below the requirement for two consecutive quarters are asked to leave BancBoston.

Better training can be a profit enhancement because workers tend to "do the job correctly the first time," Palmer adds. He enforces this concept both with processors and loan officers. For instance, originators are urged to "add value" by showing how different loans can alter a sale, rather than just being order-takers. Additionally, they are expected to bring in completed applications.


Only the receptionist doesn't have performance incentives at First Savings Mortgage Corporation, McLean, Virginia, says President Larry F. Pratt. He uses incentives to reduce fixed costs at the independent, two-year-old firm. Pratt's strategy is to find areas that show "extreme costs, and offer carrots to reduce them."

Because loans that fall out require processing and pipeline expenses, First Savings rewards originators and correspondents when fall-out rates are 12 percent or less. But high fallout reduces loan officer compensation, although Pratt gives originators a window of two weeks after application to take loans out of the pipeline without a penalty.

He adds that fall-out rates have been 7 percent since starting this program four months ago, even though it's "hard to get a loan officer to say a loan won't make it."

Pratt cuts originating expenses by using in-house staff at an "extremely reduced commission rate" to take applications from refinancing customers. Two months before their loans adjust, a refinancing offer is mailed to these borrowers.

Underwriters at First Savings are paid extra for fast turnaround time and for having loans without conditions. Incentives are also given to delivery, closing, post-closing and shipping employees, Pratt says. As a result, loans are spending an average of just 12 calendar days in the warehouse.

"We pay out money [that] a lot of companies don't," he admits. But, salaries at First Savings are lower than at other firms, so when volume is down, expenses also fall. FICA taxes and insurance expenses have dropped as well, since incentives now are playing more of a role in compensation.

But firms with different goals use other compensation tools. For instance, First Franklin Financial Corporation in San Jose, California is completely a wholesale lender. CEO and co-founder William D. Dallas wants managers who will help the company grow over time, and yet not have to compete for them by offering high salaries. And since First Franklin is independent, potential employees must be reassured that the firm won't be sold out from under them.

"We tried a few things that didn't work," Dallas says. Then, two years ago, First Franklin began a "Managing Directors Performance Bonus Plan" for nine of their top employees. Now, as the servicing portfolio grows above $1 billion, a percentage of its value is set aside for these managers. Currently the portfolio is at $1.5 billion, and the bonus is 10 percent of the amount above $1 billion.

When the portfolio exceeds $6 billion, these managers will receive the full value, Dallas says. Each one vests differently, however. Payout of half the account will occur on January 1, 1995, and the rest will be disbursed December 31, 1997.

Dallas is pleased that "we've been able to keep our salaries at a reasonable level," while managers also believe "they operate the firm. We haven't lost one [of them]," he adds.

ARCS Mortgage also fosters a sense of ownership among its branch managers, Cohen says. "Each office is a profit center," and they are held accountable by monthly profit-and-loss statements. Branch managers are motivated by a system that offers a profitability bonus of up to half of their salary.

Finding entrepreneurs

Additionally, managers are given a fair amount of leeway in running their offices. "People that we hire are entrepreneurial," Cohen explains. Consequently, they "know what it will take to be successful" in their local markets. Focusing on the managers means that branches are opened "where there are good people," says Cohen, rather than just looking for places where originations are strong.

ARCS has given its managers responsibility for their own bottom lines, and has "made money every year we've been in business," notes Cohen. In fact, the 20-year-old firm has never had to sell its servicing, and now holds a servicing portfolio of $6 billion. Some managers have been with the firm practically since it was founded.

All ARCS employees take company-sponsored classes in mortgage banking and providing customer service. In addition, management trainees go through a two-year program that begins with a stint in the home office. Afterward these potential managers work on new housing tract business, before moving on to become loan officers.

Quality workers are important at Tampa's Market Street Mortgage Corporation. Executive Vice President T. Donnell Smith believes mortgage bankers can only survive with "real `A' players. If you've got `B' and `C' players, it's tough."

Smith "focuses on the cost of originations," figuring if he can bring in loans at a 40 basis point net loss, he can make money. If that loss gets up to 65 basis points, Smith says the business isn't worth having.

Loan officers are paid 30 basis points for originating $350,000 to $400,000 in a month. Volume up to $500,000 earns 40 basis points, while monthly originations between $500,000 and $1 million are paid 50 basis points. Production reaching $1.5 million earns 55 basis points. Finally, loan officers bringing in more than $1.5 million in a month receive 60 basis points for the full amount, Smith says.

Market Street's branch managers also can receive an override of 10 basis points if their costs are within a certain range. All 10 of Market Street's branch managers also tow the line by bringing in loans, and there are no regional executives. "I can't afford that level of management," Smith says.

Looking at all aspects of the business from the viewpoint of origination costs has brought a "phenomenal" impact to the firm's earnings in the five years it's been used, says Smith.

Hiring lures

What entices good workers to switch companies today? Recruiter Darlene Secord of Bellevue, Washington, says regional managers might be offered hiring bonuses, outstanding relocation packages, and, at times, the opportunity of partial ownership, once performance goals are met. She explains that hiring bonuses--rather than higher salaries--are used so that new employees won't throw off the corporate pay scale. Pay isn't the only lure, though. Secord notes that mortgage employees are aware of the industry's trend towards mergers and downsizing. For that reason, a company with a strong reputation or innovative products appears attractive. Providing an opportunity to take on more responsibility also can persuade workers to change firms, even if their salary doesn't go up, she adds.

"Smart loan officers are looking at the quality of the company," agrees ICM's Thomas. Many of them previously have worked for firms promising 75 basis-point commissions, only to watch the company go out of business within two months. Thomas says originators are smart enough to recognize that firms offering "the craziest plans" are "the tents that [have] folded up first" when originations have slowed.

More stable firms make sure workers understand the financial underpinnings of the business. For instance, new First California Mortgage employees sign contracts that begin by describing the firm's focus on customer service and loan quality.

First California's Hart says his company "couldn't make money" if the company paid originators 50 basis points for loans. But each loan officer does have individual specific objectives affecting compensation. Hart makes these goals measurable and gives deadlines. For instance, he says a bonus might depend on a loan officer "developing business with two new real estate offices that the manager identifies within a 90-day period."

In addition to rewards for meeting objectives and small production incentives, First California offers "a fair salary, and a supportive and stable work environment," adds Hart. He notes that loan officers "like the stability of a salary." About 70 to 75 percent of total originator compensation comes from salaries.

"I don't see how companies can justify keeping compensation levels where they have been in the past," Hart contends. He notes "the value of conventional servicing has dropped by 50 percent," and is surprised firms haven't lowered commissions to reflect that change in what production is worth.

Branch profitability at First California is figured from "direct operating expenses"--without adding on the value of servicing, or subtracting a portion of head office expenses. Managers "know that they're in control," Hart says, and make decisions on matters such as how much space to rent.

Sixteen of the company's 23 branches are profitable, according to Hart. "It's amazing how much these branch managers can save you" when they're in charge of their own destiny, he adds. Hart says at least 30 percent of branch manager pay is tied to their profits.

Non-monetary rewards

Although processors and closers receive cash incentives of $8 to $15 for loans closed "within company standards," Hart believes other forms of incentive are just as powerful. Recognizing individual efforts at monthly meetings and awarding plaques to members of the "President's Circle" can provide rewards as meaningful as a bigger paycheck, he suggests.

Additionally, the firm encourages all workers to take classes or otherwise advance themselves professionally. First California pays 50 to 100 percent of the costs, says Hart.

It's part of his campaign to use means other than just paying more to get good response from employees. In Hart's view, the industry has tried to offer more lucrative incentives when "hard work and leadership" are what's needed.

Hart eschews numerous traditional practices, including the payment of overages. "We describe overage as `gouging,'" he explains. When overage splits are offered, "there's a tremendous incentive to get overage on every loan."

Tradition lives

First California's approach isn't traditional, and many companies don't agree with its premises. For instance, Cornerstone's Laird pays loan officers purely on a commission basis. Up to $1.2 million of production in a month earns 50 basis points, which rises to 55 basis points on larger volume, before capping at 60 basis points with originations of $1.7 million.

Laird offers incentives to processors who bring files to underwriting within 21 days. Set-up workers also receive a cash payment when verifications are sent, and when an appraisal and credit report are ordered within 24 hours of application. Paying incentives of $5 to $15 per file when standards are met allows workers to earn an extra $350 to $400 a month, he adds.

Closers are rewarded for being on the ball and having the file ready the day before closing, and shippers get paid extra if the loan is out of the warehouse within 10 days. Laird now reports that his average time to shipping is eight days after funding.

Incentives are described in a document that defines Cornerstone's standards and "tells people what the company is about," he says. New employees read and comment on the document before agreeing to work by its provisions. Cornerstone doesn't offer incentives for loan quality, because that is an "ingrained requirement" in the firm. "Our biggest risk is fraud and buyback," Laird adds. Not following quality guidelines is simply "cause for termination."

Team bonuses

American Residential Mortgage Corporation in La Jolla, California, also rewards underwriters, closers and clerical staff on a team basis. Loan officers and the company each contribute half of the $15 per loan bonus into a pool.

In addition to providing loan officers with volume bonuses, at times the firm pays increased commissions on certain loans to encourage production of those mortgages, says Mark Conger, vice president of human resources and finance.

About 15 percent of the company's 800 employees have incentive stock options encouraging them to stay with the firm, he adds. Stock options held by middle managers vest over five or more years, while vesting of options held by senior managers is determined by company performance, notes Conger.

Upper management bonuses at Directors Mortgage Loan Corporation in Riverside, California help to keep people working as a team, says President Ray Crebs. Additionally, the plan requires that corporate pre-tax income reaches a specific point before upper management gets a bonus.

A percentage of the salaries of the 35 managers in the program then is awarded, says Crebs. Up to 80 percent of an executive's bonus comes from this plan, with the rest based on meeting individual performance objectives.

"We've always had it," although it was formalized this year, Crebs says of the incentive program. He says providing the bonus helps managers "work together more as a team." All other employees who have been with the firm at least one year also receive a bonus, he notes.

What's it worth?

A more recent innovation that Directors began in 1989 is compensating loan officers "based on the value of loans they produce," says Crebs. But on some loans, not all of the origination fee is eligible for commission. For example, refinancings aren't preferred loans, because Directors wants originators developing a client base. A sliding scale of 45 to 65 basis points is offered, depending on production volume.

Crebs says this way of viewing production isn't common, because all mortgage firms know loans have different values, but they're afraid field reps will move to the competition if they start pricing mortgages differently.

Sears also pays loans officers based on the types of loans produced, Ridge adds. Fixed-rate mortgage originations receive 55 basis points and adjustables are worth 5 basis points less.

While commissions are a loan officer's total compensation, production managers earn a bonus that is dependent on more than just volume, explains Ridge. "An incentive on each loan that closes" funds a pool, he says. Payout of the bonus pool then depends on several factors.

Customer satisfaction is one variable that can modify production manager bonuses, Ridge notes. Every Sears Mortgage borrower is surveyed. He adds that missing documentation also affects the bonus fund.

Another measurement is taken of the "first-time-through" rate. Loan files that aren't thorough enough to allow an underwriting decision when first submitted fail this test.

Also, branch profitability is calculated by subtracting the total cost of originations from servicing value produced. Loan officer productivity also is factored into the bonus. Such variables are weighted to reflect their importance before determining distributions. Ridge says portions of the pool are paid out every quarter, while the rest is rewarded annually.

Planning for the long term

Before adopting this program in 1989, Sears production managers received a salary plus a specific dollar amount for each closed loan. Managers became only "concerned with getting loans in the door," says Ridge.

In coming up with new incentives, Sears Mortgage tried to balance "what we had to do to be profitable, compete with other companies and deliver quality service" both to their customers and the secondary market, Ridge notes. He says the firm remains "very much concerned" with these issues. And Sears seeks workers that share its interest in "being here for the long term."

Such planning is welcome now. Mortgage lending is "beginning slowly to change," agrees MCS's Greeley. "We're seeing incentives that closely mirror realities of the business today."

Howard Schneider is a freelance writer based in Ojai, California, specializing in real estate issues.
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Title Annotation:mortgage bank managers
Author:Schneider, Howard
Publication:Mortgage Banking
Article Type:Cover Story
Date:Dec 1, 1990
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