Credit Union Incentive Plans Can Be a Useful Tool to Drive Performance, if Done Properly + Compliance Trivia!
Written by Shereefat Balogun, Regulatory Compliance Counsel
Credit unions generally use incentive plans to drive results, whether that be more loans or more deposits. The overall goal is to reward employees for achieving certain results. In May 2016, NCUA and other financial regulators issued a proposed Incentive Compensation Rule; while the rule is not yet finalized, credit unions are subject to other regulations that place restrictions on employee compensation or incentive plans. NAFCU gets a number of question regarding employee incentives, and given NCUA's growing concern and examination of these plans, credit unions are advised to develop an Incentive Compensation policy that is approved by the Board, and complies with the regulatory framework governing compensation and incentive structures.
NCUA Regulations
There are generally 3 NCUA rules that limit incentive compensation practices: Section 701.21 (c)(8) which restricts practices in connection with lending activities; Section 701.23(g) which places limits on compensation relating to the sale or purchase of eligible obligations; and Section 721.7 which addresses compensation related to incidental powers.
NCUA's lending rules prohibit senior management employees from participating in a loan incentive plan. Section 701.21(c)(8)(i) prohibits paying compensation in connection with any loan made by the credit union. This rule regulates incentives given to employees in connection with the extension of a loan to a non-employee member. There are some exceptions in (c)(8)(iii), which include salaries and incentives based on overall financial performance. There is also an exception for employee loan incentive programs established and monitored by a credit union's board of directors; however, senior management is specifically excluded from this exception. From the rule:
(8)(i) Except as otherwise provided herein, no official or employee of a Federal credit union, or immediate family member of an official or employee of a Federal credit union, may receive, directly or indirectly, any commission, fee, or other compensation in connection with any loan made by the credit union.
(iii) This section does not prohibit:
(A) Payment, by a Federal credit union, of salary to employees;
(B) Payment, by a Federal credit union, of an incentive or bonus to an employee based on the credit union's overall financial performance;
(C) Payment, by a Federal credit union, of an incentive or bonus to an employee, other than a senior management employee, in connection with a loan or loans made by the credit union, provided that the board of directors of the credit union establishes written policies and internal controls in connection with such incentive or bonus and monitors compliance with such policies and controls at least annually.
(D) Receipt of compensation from a person outside a Federal credit union by a volunteer official or non-senior-management employee of the credit union, or an immediate family member of a volunteer official or employee of the credit union, for a service or activity performed outside the credit union, provided that no referral has been made by the credit union or the official, employee, or family member.
12 C.F.R. 701.21(c)(8)(emphasis added).
Note that under this rule an employee, including senior management employees, may receive an incentive in connection with a loan based on the credit union's overall financial performance. However, only non-senior management employees may receive incentives in connection with a loan pursuant to the credit union's written procedures that are established and approved by the Board of Directors.
Section 701.23(g) is very similar and tracks the language of 701.21(c)(8), except that the restrictions pertain to the purchase, sale, or pledge of an eligible obligation (i.e., a loan or group of loans). The rule generally has the same restriction and exceptions, as well as limitation as applied to senior management employees.
Similarly, Section 721.7 places the same restriction but is not specific to any particular activity, and is more broadly applied to any authorized activity the credit union engages in. See, 12 C.F.R. 721.7.
Regulation Z Prohibition on Mortgage Loan Originators Compensation Practices
Incentive compensation is also regulated in Regulation Z, as applied to mortgage loan originators and is indeed a much scrutinized area. Regulation Z, 1026.36(d) prohibits mortgage loan originators from receiving compensation based on certain terms of a mortgage loan transaction, such as interest rate, APR, collateral type, and origination fees. See, 12 C.F.R. 1026.36(d).
It's worth flagging, the CFPB's definition of loan originator, as this could include non-lending employees. The rules definition of loan originator is broader than the definition of loan originator used in the SAFE Act, and includes the following activities if done for or in the expectation of compensation:
- takes an application;
- offers, arranges, assists a member in obtaining or applying to obtain credit;
- negotiates, or otherwise obtains or makes an extension of credit for another person; or
- advertises, communicates, or represents to the public that they can or will perform any loan origination activities.
See, 12 C.F.R. 1026.36(a).
NCUA in 2014 issued a Regulatory Alert discussing the CFPB's Mortgage Loan Originator Compensation Requirements.
Preferential Loans to Employees
On a related matter, we also receive questions relating to preferential loans to employees. Generally, credit unions may give preferential loans, or lower loan rates, to its employees, so long as those employees do not include officials. The relevant section to rely on is 12 CFR 701.21(d).
Section 701.21 sets forth the standards to which a federal credit union must adhere when making loans. Under this provision, a federal credit union is prohibited from granting preferential loans to its officials or an immediate family member of an official. See, 12 C.F.R. 701.21(d)(5). This includes any member of the Board of Directors, credit committee or supervisory committee. However, there is no prohibition against a federal credit union offering preferential loans to its employees.
For reference, here are two NCUA legal opinion letters on the topic:
In light of the current rules regulating compensation and incentive structures and the impending finalization of the Incentive Based Compensation Rule, credit unions are strongly advised to develop comprehensive Board policies regarding compensation. The policy should comply with the regulatory framework, including the presence of strong internal controls, and should be reviewed by the Board annually.
As always, if you have any questions relating to this article or any other compliance issue, please contact NAFCU's regulatory compliance team. We're here for you!
Trivia: Under the proposed Incentive Based Compensation Rule, what would be the record retention for documenting the credit union's incentive-based compensation arrangement?