The Impact of Mortgage Loans Transferred on Bank Employee Compensation

This paper compares how employees are compensated when they originate loans that are held by the bank versus loans that are sold. Banks may be less concerned about the credit quality of a borrower when they sell the loan to an outsider. This study looks at mortgages transferred out of banks where partial recourse is transferred. First, it finds that loans transferred out of banks into Government Sponsored Enterprises (FNMA and FHLMC) and private entities increase employee compensation by 6 cents per dollar of loans transferred. Compared to the 3.5 cent increase in employee compensation per dollar of mortgage loans underwritten and held by the bank, this impact of mortgage loan transfers on compensation is about 71% higher. Thus, employees receive a stronger incentive to focus on loan volume and potentially focus less on credit quality, for those loans where liability for loss is being partially transferred away from the bank. This suggests that banks should review their compensation practices, and be prepared to communicate to regulators and investors who purchase loans about these practices. Regulators and investors may need to pay closer attention to the compensation policies of banks, and may even consider creating policies regarding the compensation of employees who originate not only mortgages, but any kind of loan that is being sold and securitized, or where recourse is being transferred.