Capital Thoughts
analysis and commentary on critical business and legal issues
Compensation
What's in a Wage?
By Anne E. Sutherland, Nationstar Mortgage LLC
New laws are shifting the rules of compensation for the mortgage industry. Are other industries next?
McKnight SUtherland
Having dependable compensation agreements between workers and employers is crucial to the smooth functioning of business. So it was jarring to our industry, and others, when the federal government intervened in ways that affected large swaths of employees in one fell swoop.
In August 2004, the Department of Labor implemented sweeping and controversial changes to the Fair Labor Standards Act of 1938. In addition to setting a national minimum wage and regulating child labor, the law also guarantees overtime pay for certain jobs. The overhaul of the labor laws reclassified thousands of jobs and redefined which workers were considered "exempt" from the overtime rules. Exemptions are narrowly defined, and employers must show that employees clearly fit within the terms of the exemption.
The law has had a profound effect on the residential mortgage industry. In 2006, in response to a request by the industry to interpret how the 2004 changes affected loan officers, the Department of Labor issued an opinion that "traditional" loan officers (i.e., those who spend the bulk of their time working from their employer's place of business taking applications and communicating with borrowers) could qualify for the administrative exemption and, therefore, were not entitled to overtime pay. The industry generally followed that interpretation.
But in March 2010, the Department issued a new interpretation, finding that "traditional" loan officers do not automatically qualify for the administrative exemption. They were now to be considered hourly workers, eligible for overtime, and commissions had to be included in calculating overtime pay.
In addition, in the wake of the mortgage meltdown and foreclosure crisis, new truth-in-lending rules (which became effective in April 2011) prohibit compensating loan officers based on the terms or conditions of the loan. The lack of formal guidance from the Feds has contributed to the confusion and further complicated efforts to develop and implement compliant loan-officer compensation policies.
These changes have meant a dramatic adjustment for the residential mortgage industry in workplace practices, technology and culture. Within the industry, the hiring of new loan officers has taken on new complexities given the changes in laws and/or the interpretations of these new laws as they relate to compensation. More broadly, the changes could add costs to the residential loan process as the industry adjusts to the new rules.
The impact of new FLSA interpretations has gone beyond the residential mortgage industry. Employers in other industries should be concerned about whether the classifications of specific job categories will be challenged and what sort of potential liability they might face in the form of class action lawsuits.
Employers should revisit each of their job positions and classifications at least annually, making sure they have very specific job descriptions and reviewing whether the jobs are still properly classified. Technology can also alter job descriptions, as time spent on certain tasks may change, which could affect whether a job is considered exempt.
Implementing the new interpretation is proving quite challenging for our industry. Loan officers often work odd hours. The reclassification means loan officers are potentially eligible for overtime compensation. But employees may react negatively when they are required to track their hours to ensure that they are being compensated for any hours beyond 40 in a week. There is a cultural issue to overcome, and it's necessary to explain that changes in the law make tracking (with employee cooperation) necessary.
Technology provides some solutions. Loan officers in an office can log onto a computer and a timekeeping system to track their hours, but policies and procedures are still needed to deal with timekeeping that falls outside the normal workday, work from home and other issues. One tool: company-issued cellphones and a requirement that loan officers conduct business on those phones, which serve as another tracking mechanism.
Staying competitive in compensating loan officers is also more challenging under the Department's latest interpretation and the government's position on the truth-in-lending compensation rule. Ensuring that your company is in compliance with FLSA and truth-in-lending loan-officer compensation rules is more than just a human resources or compliance department issue. It could come back to haunt you in the boardroom as well. There's a flurry of activity in mergers and acquisitions in the residential mortgage industry, with companies buying and selling mortgage servicing rights and platforms, divisions and entire companies. One element in due diligence—and a potential liability—is compliance with FLSA and loan-officer compensation regulations. Adhering to the rules and being aware of and responding to changes could be key not only to running a good business but also to making a good deal.
Commercial Financing
Ready, Set, Lend
By Steven A. Museles & David M. Martin, CapitalSource Inc. & Patton Boggs LLP
Middle-market lenders are back on their feet
During the financial crisis of two years ago, many traditional lenders that served middle-market companies sharply curtailed their lending as they focused on mounting asset quality challenges and, in the case of many non-bank finance companies, struggled to maintain their own sources of funding to survive. Lenders with stable funding sources also found the market difficult, as even healthy middle-market companies grappled with long-term financing decisions in the face of historic economic uncertainty.
Museles
Today there remains a widespread misconception that many American businesses are unable to expand and create jobs because no one will lend them money. While it's true that many U.S. lenders are still recovering from the financial crisis, after a two-year span of battening down the hatches and streamlining their businesses, yesterday's survivors are eager to tackle the new market for deal making. Deals of all sizes are getting done with greater frequency, and, though the deal flow is more limited and lenders are only thirsty for certain quality assets, lenders are actively competing for business. Commercial banks, operating under the watchful eye of state and federal regulators, are looking for clean deals with healthy borrowers. All lenders prefer borrowers with strong management teams, proven track records and lasting business models. And borrowers with relatively simple capital structures, few layers of debt and the backing of a strong private equity sponsor provide an added level of comfort.
Industry specialization is increasingly important to both borrowers and lenders. Borrowers want to know their partners, and their lenders understand the unique post-recession challenges in their field. In any case, borrowers will often have more success in obtaining financing from lenders with expertise in their industry and a greater understanding of the inherent risks and rewards.
But what about the lenders and their own financial stability?
Though the lengthy list of failed banks on the FDIC's website might cause one to think otherwise, the funding sources for banks tend to be stable and actually increase during times of economic uncertainty as consumers seek the safety of FDIC-insured accounts. Banks obtain their funding primarily through consumer deposits such as checking accounts, CDs and money market accounts, and deposits in commercial checking accounts. Finance companies, by contrast, fund their loans by borrowing money from large commercial banks, selling debt instruments and recycling the proceeds of asset securitization sales. These funding sources tend to be more volatile, and when the global capital markets froze up, many non-bank financial companies had to close their doors. Even large finance companies that were considered highly stable resorted to federal programs for survival or went out of business.
When CapitalSource started out 11 years ago, it was a commercial finance company that relied on the debt and asset securitization markets for funding. CapitalSource provides financing for small and mid-sized businesses for growth, acquisitions, recapitalizations or working capital. More than three years ago, and prior to the financial upheaval, company executives sought to diversify CapitalSource's funding base by adding retail deposits. The company applied for an industrial bank charter in California and acquired the deposits and branches of a troubled industrial bank there. CapitalSource Bank launched as a fresh-start bank with 21 retail branches throughout Southern and Central California. CapitalSource essentially transformed its business model, pairing an independent regional bank and a national lending platform in niche industries.
Like other companies, CapitalSource took its share of medicine during the financial crisis, but it never relied on TARP or any other government assistance program. The company returned to its roots and focused heavily on specialized lending, namely health care finance, equipment finance, security and technology. CapitalSource is currently seeking a commercial bank charter, which will allow it to further diversify its funding base by adding consumer and business checking accounts to the mix.
For lenders and borrowers alike, the financial crisis provided a vivid reminder of the importance of having uninterrupted access to stable sources of funding. For borrowers, finding the right financial partner in the post-recession era will increasingly become more important than just finding a willing lender. Borrowers learned that the best lenders evolve with their clients through both good times and lean times. They partner throughout the cycle of the relationship to find alternatives or utilize various loan structures that fit the financing needs of the borrower. For their part, lenders have learned that a diversified funding base is the key to surviving tomorrow's downturns.
Technology Funding
Bridging the Valley of Death
By George "Chip" Cannon, Jr., Patton Boggs LLP
Loan guarantees pave the way for clean energy innovators
As technology progresses at an astonishing rate, the relation between humans and nature changes at a similar pace, but laws, regulations and perceptions tend to lag behind. I had the privilege of helping to close that gap when I found myself at the heart of a legal case that led to a landmark decision by the U.S. Supreme Court. At issue was the right to obtain patents to protect the successful results of millions of dollars and thousands of hours of laboratory research.
In the early 1970s I was working for General Electric on ways to clean up oil spills—a question that remains quite relevant today. Oil is a mixture of many different chemicals, and, while there are many bacteria known to devour it, no bacterium is capable of doing the job by itself. Logic might suggest that we let different bacteria occurring in nature work together to take care of the problem. The reality is that they compete with one another.
My job was to study the DNA and the genes responsible for hydrocarbon degradation in bacteria. Then, I removed those genes from a variety of bacteria and put them into a single bacterium, rendering it capable of doing the oil-eating by itself.
Here's where the controversy arose. To be a commodity, a scholarly academic or industrial invention must be shielded by the Intellectual Property Rights system. In the case of scientific and technological innovations, that usually means patenting. I believed that my work met all of the statutory criteria for a patent. There was no dispute about its utility or its novelty, and it was clearly not something that would be "obvious" to anyone working in the field. The restriction against being able to obtain a patent for a "living" thing was another matter entirely.
Cannon
The threat of global climate change has turned clean energy innovation into an imperative, and the funding needs for technologies that reduce greenhouse gas emissions while meeting future energy demands in the U.S. are higher than ever. Yet pioneering clean energy companies still must find ways to cross the commercialization "Valley of Death," the gap between transforming promising innovative ideas into viable commercial operations.
Generally speaking, the funding construct required to turn innovative clean energy technologies into factories and power plants—concrete and steel in the ground—is too capital-intense for venture capitalists and too risky for commercial banks. Many promising companies are unable to scale up to commercial operations, becoming stranded (and often perishing) in the Valley of Death. While the U.S. government recognizes this problem and has taken steps to catalyze clean energy investment, the results have been decidedly mixed.
Six years ago, Congress enacted a loan guarantee program for precommercial enterprises that were developing innovative technologies that avoid, reduce or sequester greenhouse gases. In Section 1703 of Title XVII of the Energy Policy Act of 2005, Congress sought to help renewable, nuclear power and other clean energy projects obtain affordable commercialization financing in the form of loan guarantees issued through the Department of Energy.
But the program lacked support from the Bush administration, and the industry complained that the DOE never developed a coherent implementation plan. While the industry expressed interest in the program as a viable path to achieving commercialization for new technologies, the DOE, by early 2009, had not yet issued a single guarantee. With frustration and pessimism mounting, the program was invigorated through the American Recovery and Reinvestment Act of 2009 (ARRA) and the support of the Obama administration.
The ARRA amended Title XVII with a temporary program known as Section 1705, which, unlike the 1703 program that was designed for precommercial technologies, provides guarantees for commercial, "shovel-ready" clean energy projects. The 1705 program was initially presented as one of the crown jewels of the Obama administration's clean energy policy—and hyped as something of a panacea for an energy sector hobbled by a constricted credit market. While the program was slow to get off the ground and its overall impact on the industry is still being debated, the DOE has put in place an implementation program that has been successful at processing applicants and issuing guarantees with greater regularity.
Nevertheless, uncertainly remains. In particular, the DOE has faced criticism for being too risk averse in its selection criteria to the detriment of otherwise worthy prerevenue companies. The Office of Management and Budget appears to bear much of this responsibility, especially for its lack of transparency in articulating the program's most controversial element, the calculation of Credit Subsidy Cost. The CSC is the risk to the government of paying back the loan upon default. To make the program cost-neutral to the government, and to manage risk, Congress structured 1703 as a self-pay program, whereby the borrower pays the CSC. While Section 1705 sought to address this issue by appropriating $6 billion to cover the costs of guarantees for shovel-ready projects, more than half of these funds were siphoned off to fund an extension of the popular Cash for Clunkers program and aid cash-strapped state governments.
Casting further doubt on 1705 was a leaked October 2010 White House memo arguing that another ARRA program, the Section 1603 program providing a grant in lieu of renewable tax credits, was generating superior investment results. The memo noted that the tax credit program involved a four-to-six-week review period, closed 3,851 projects and only required a staff of 20, while the 1705 program required more than a six-month process, closed only four loans, and required a staff of up to 200. The administration subsequently clarified that the 1705 program needs to be streamlined, not abandoned.
Because Section 1705 was structured as a temporary program to place concrete and steel in the ground and create jobs as quickly as possible (the primary driver for ARRA programs generally), its future is uncertain. But the need for a mechanism to assist developers of innovative clean energy technologies in obtaining commercialization financing will not be eliminated once the current economic conditions have improved. Paradoxically, the DOE is telling applicants that because of the program's uncertain future, their business plans should not depend on obtaining a guarantee; guarantees may go to companies that may not necessarily need them. Confusion aside, the program's fundamental basis remains legitimate and clear: Clean energy innovators need safe passage through the Valley of Death.
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