Every mortgage broker is aware that the Productivity Commission (PC) has recently evaluated the banking and broking relationship in an attempt to assess the state of the current banking system and, more importantly to brokers, the existing remuneration structure. While not implicitly stated, there's a clear undertone suggesting that Mortgage Brokers are biased (not acting in the best interest of their client), and they're not providing a level of customer care that justifies a trail commission (which the PC has recommended be eliminated). I'd seriously argue the former point, but the latter may have merit: it's why we've built numerous systems to build upon relationships to generate billions in refinancing and referrals via our suite of relationship tools. As an industry we (and by "we" I mean "all of you") are the subject of a productivity commission designed to (in part) dismantle and totally undermine the existing remuneration structure. If recommendations are acted upon - and we suspect that the influence of the big banks will ultimately determine what legislation is passed (despite being the primary subject of the inquiry) - we believe it may be untenable for smaller brokers to operate profitably, and consumers will ultimately see less competition in the marketplace.
As a marketing company we engage with the finance sector regularly and we've returned results that are putting those that claim to compete with us to shame. I've owned a few broking agencies, and founded NSW's "best broking" business - and one of the best in Australia - as voted by MPA Magazine. Having worked with hundreds of brokers in Australia and thousands globally, we're in a fairly unique position to comment on the recommendations and how the report relate to the grass-roots mortgage businesses whose interests largely ignored by the report. Of the 34 recommendations that are aimed at providing competition, 11 directly relate to mortgage brokers and home loans. This article makes reference to just a few of those recommendations.
Keep in mind that the Productivity Commission report is just one report of many that the Government will consider before making any recommendations. They will also factor in the Royal Commission report, the ASIC Broker Remuneration Review, and analysis from Treasury.
The banks were well and truly waterboarded by the report with chairman Peter Harris concluding that competition is best described as "persistent marketing and brand activity designed to promote a blizzard of barely differentiated products" with an "illusion of choice" designed to create the perception of competition. The report further states that many mortgage aggregators are now owned by lenders, suggesting that the revolution caused by early popularisation of brokers has now become part of the establishment.
The PC, using data obtained from ASIC current as of December 2015, determined that aggregators owned by lenders originated approximately 70% of broker-originated loans, and 36% of all loans (broker-originated loans made up approximately 52% of all loans at that time). The NAB submitted that the aggregators it owns collectively represent about 30% of mortgage brokers in Australia. The very clear saturation of big banks into the broking market - and the primary causal factor for suggesting the industry was part of the banking establishment - might be the issue that requires assessment by the Productivity Commission above all else. Limiting bank ownership of aggregators is likely the most sensible option moving forward since dismantling the current broker system and integrating the profession back into the hands of our banking overlords effectively destroys the competitive environment that they claim to advocate. Brokers represent the last line of defence against the "illusion of choice" the PC claims it has uncovered.
Consumers may believe that brokers can get them a better interest rate, but the interest rates on loans obtained through brokers are most often similar to those obtained through proprietary channels. And although consumers say they value the services brokers provide, this does not appear to extend to paying for them (Key Points, p301).
While many brokers advertise "unpublished rates" and their own bargaining power - which is often the case - the commission rejected the assertion stating that there was rarely a distinction between those rates offered by the banks and those from broker channels (the Commission only evaluated interest rates - not structure - and they didn't differentiate between rates offered by 'bank-owned' broking businesses where downward pressure is most likely to apply, and those businesses operated by independents). Additionally, ANZ said that "... if one channel delivered better rates through better negotiating power or market insight, it would be reasonable to expect the other channel to drop its rates in response". Again, this claim is unequivocally false. Most brokers have the resources to negotiate product variances in a market where most consumers would be utterly overwhelmed. The comment seems to do little but belittle or devalue the role of the broking industry... and the claims needs to be further scrutinised since they're at the heart of many recommendations made. The idea that interest rate in isolation is a metric for determining broker value also demonstrates an utter disregard for the role of a broker in structuring a loan around individual circumstances.
The high degree of vertical integration between lenders, aggregators and mortgage brokers reduces competitive pressures and can mean that the interests of brokers are not necessarily aligned with those of their clients. The Commission has made recommendations to introduce a legally-backed best interest obligation for all providers in the home loan market and to develop an online calculator for greater home loan price transparency (page 284).
The high degree of vertical integration is of concern and, as stated earlier, perhaps this issue alone should have been the subject of the commission's scrutiny. There is a perception in the broking community that bank-owned businesses aren't offering the competition the consumer deserves, and this claim is validated by Aussie franchises overwhelmingly favouring parent products to the tune of 39.7 percent of the mortgages that brokers sold by volume and 37.5 per cent by value sold under the umbrella of Commonwealth Bank, BankWest and Aussie Select. An ASIC report in January found that on average 68 per cent of bank clients' funds originated from in-house financial products yet those products only made up 21 per cent of the advisers' list of choices. If it were this behaviour that prompted the commission then certainly it's this behaviour that needs to be addressed. The report states that most banks acknowledge that they'd prefer if loans originated through their proprietary channels... so their intrusion into the origination and retail market, and the acquisition of once-independent chains, is evidence of their efforts to undermine the independence of distribution networks. It's the more legitimate and unbiased "independent" broking industry that has become a punching bag for consumer-facing trust issues, and they're being used as a human shield against the banks' poor customer service.
The PC report states that "by owning an aggregator, a lender gains the opportunity to influence the products recommended to consumers by brokers working under that aggregator, which can enhance its competitive position". While banks dismissed the idea, it's clearly a problem (as described above). A broker should and almost always exercises their due diligence and duty of care to ensure they place their client into an appropriate product. It should be further noted that all banks make an attempt to influence brokers via most forms of communication, during Professional Development days, or anywhere else. This is called education; not influence. Much of the time, brokers aren't even aware of the banks that hold a stake in their upline aggregator. Further, the Commission notes the potential for banks to exert influence over an aggregator, and they do so with no evidence this has taken place.
One of the most telling comments in the report reads as follow: "... we ultimately consider it implausible that the industry as a whole is unaffected by the substantial incentives created by commission-based remuneration". So, the Commission has essentially ignored all testimony and contributions from industry, and has produced no tangible evidence to support their conclusions. While the practice of leaning towards bonuses and bigger commissions does exist, it's not nearly as widespread as the report would have us believe.
The vertical integration adds multiple layers of indirection to a system already prone to a bureaucratic and nonsensical regulatory oversight. Additionally, the MFAA and FBA have often failed to maintain relevance with a board that is populated with the who's who of nobody, and these industry associations are often incestuously connected to the banks in a manner that compromises their ability to properly represent the brokers it was established to protect. We feel that if these associations had adequately articulated the nature of the industry to the PC, the report might have excluded business-crippling recommendations.
The statement suggesting brokers are not necessarily aligned with those of their clients might only be described as unsubstantiated nonsense intended to assign justification to the report. The commercial viability of a broking business is based upon providing unbiased and professional advice in order to survive and grow. Suggesting that small commission gaps or the influence of an aggregator might influence the advice given by an independent broker is an insult to those that have spent the better part of 25-years building the only viable channel that delivers genuine competition and choice (and how to do this more efficiently should be our focus). Dismantling the current system serves only one purpose: increase bank profitability.
With access to digital data, actual home loan interest rates recently negotiated can and should be collected by APRA, and made accessible to consumers by ASIC via an online calculator (with a lag of no more than 6 weeks). An online calculator would provide a consumer with the median interest rate offered to home loan borrowers in similar circumstances to them (p347).
One of the independent comparison calculator recommendations states that the number of loan and borrower characteristics are "kept to a minimum to facilitate timely development of the calculator and to ensure that it is useful to consumers - not overwhelming with options and information requirements, like home loan products themselves" (p358). While a little off-topic, the report does recommend that data be published in a way that is accessible to application developers - a function that is virtually impossible today given the inaccessibility of data. This is one isolated area of the report we tend to support.
For very good reasons, various stakeholders did not support the PC's logically fallacious calculator conclusion of "increased transparency of home loan interest rates" since consumer choice would be decreased, the mortgage broking business model would become unviable, the regulatory burden would be high, and tools already exist with comparison websites (the report's didactic response is intended to support their half-baked conclusions without consideration of industry submissions). The idea that a machine-generated comparison tool might replace the human-analysis is absurd; it fails to acknowledge the role of a broker in terms of providing advice on structure, ongoing education, and support. If the NSW Green Slip Calculator has taught us anything it's that a consumer will gravitate towards price above all else without consideration to numerous aspects of a product that might provide value. To suggest that a calculator might replace a broker is simply wrong.
Allowing financial advisers to compete with mortgage brokers in offering personal advice on home loans would expand the sources of competition in home loan distribution as well as provide more holistic personal financial advice services to consumers (page 279).
The report goes on to state that "a recommendation to allow financial advisers to advise on home loan and credit products should, therefore, be seen as forward looking. And we envisage that the role of financial advisers in the credit space would most likely be focused on providing holistic advice to customers, rather than the often administrative services, such as completing the loan application process, currently associated with mortgage brokers". Again, a rather condescending remark intended to relegate the role of mortgage broker to that or a data-entry clerk.
The report recommends a licencing structure that would allow Financial Advisers to take on the role traditionally managed by mortgage brokers, citing increasing consumer competition, an innovation in service delivery, and a "holistic service innovation" that would ultimately benefit consumers. The addition of around 25,500 financial advisers into the home loan market would mean another 9,435 "brokers" (or 37 percent of the adviser market) acting under the umbrella of a parent bank. However, the move would devalue the role of broker, introduce unspecialised competition, dismantle existing referral partnerships, and reduce competition (by virtue of the ubiquity of adviser-banking relationships). If I were take a conspiratorial approach to the recommendation I'd have to suggest that the introduction of financial advisers into the market - while it does on the surface seem a very reasonable idea - might benefit the big banks above all else.
Financial advisers (and others, such as the real-estate agents and accountants also included in the recommendation) are currently in a position where they can make referrals directly to a bank with a payment "only slightly below the amount received by a mortgage broker" (the existing financial adviser arrangement already compromises on competition since the referral is normally based on a relationship with a parent brand and not a broad panel of lenders). If a licencing structure (for two distinct offerings) was introduced the existing referral practice would also be subject of consideration. If a dual licence was implemented, it would likely result in less competition since less business would be referred to an unbiased and specialised broker, as is usually the case.
The remuneration recommendations made in section 11.2 (p43) are as follows:
- Ban the payment of trail commissions in mortgage broking for all loans originated after end-2018.
- Require upfront commissions to aggregators and brokers to be paid based on the funds limit drawn down by customers, net of offset, instead of the limit of the loan facility.
- Ban the payment of volume-based commissions, campaign-based commissions and volume-based payments.
- Limit to two years the period over which commissions can be clawed back from aggregators and brokers (and extend the ban on early exit fees to explicitly prohibit commission clawbacks being passed on to borrowers).
It's the ban on trail that potentially has the most immediate effect on remuneration, and it's one issue that concerns us more than most others. The report states that "... the substantial geographic reach of the major banks - which account for 60% of all branches - along with their scale and longevity contributes to their brand recognition and the perception that they are safe, stable institutions compared to smaller rivals". They go on later (page 49) to state that "each smaller lender would have needed to open 118 new branches to generate the equivalent market share achieved through use of brokers". So, while brokers may not be a cheaper originating source for big bank loans, smaller banks do rely on brokers for product distribution - meaning we rely on brokers in order to preserve a competitive market. This network of brokers doesn't exist exclusively for just writing a loan; with any product comes the exception (both from the customer and the bank) that the broker will continue to support a product as a representative of that bank, and the current trail component is a small payment designed to remunerate the broker for providing that necessary service. To ban trail will often mean it won't be commercially viable to to support those smaller and often more competitive bank products, and it's often these products that provide the only real and significant competition to the big banks.
It's our experience that the post settlement care and product support during the life of a loan is the area where most brokers fail to fulfill their obligation... and it's one area where we work with brokers to introduce levels of customer care that the banks would never be able to provide. Sadly, the report provides an example of post-sales care by sharing an example from a broker that contacts a client one month after a loan is written, and then again after 12 months. Again, the report uses a bad example of customer care (rather than the extensive support program that we would endorse) in order to seemingly belittle the role of a post-settlement support. The Commission criticised the lack of documentation requiring brokers to provide product support after settlement (the PC asked for examples and none was provided). The blame for this massive oversight lands squarely in the lap of aggregators that have failed to adequately or formally document the justification for ongoing trail via a recommended support program. However, simply because the provision doesn't exist doesn't mean that brokers haven't put their own policy in place. The Commission wrongly believes that the "remuneration arrangements that have become entrenched in the mortgage broking industry as a matter of convention". The banning of trail (as recommended) is based purely on anecdotal fairy-tales and not on any concrete evidence. We suggest a further review in five years - giving the entire industry time to formalise their fiduciary duties.
The notion that upfront commissions to aggregators and brokers should be paid based on the funds limit drawn down by customers, net of offset, instead of the limit of the loan facility does have merit... but it's totally unworkable. Paying net of offset doesn't consider the lifetime value of the loan, or even the value of a sale a broker introduces to a bank. An upfront commission is paid on settlement - not on termination. A home loan is purchased in totality, and if additional funds aren't required then they simply shouldn't be purchased by a consumer.
The Commission has recommended a new obligation would clearly articulate what duties lenders and brokers owe to their clients, and provide an overarching legal framework for resolving conflicts of interest. The 'best interest obligation' "sets out a new standard for acceptable conduct on the part of financial service providers in the home loan market. This obligation is designed to build on the existing laws that apply in the home loan market, and represents a step up in terms of the duties that financial service providers owe to borrowers". The principle points of the 'best interest obligation' are summarised as follows (page 334):
- Act in the best interests of the client.
- Not offer or recommend a home loan unless it is appropriate to the client, having regard to the duty to act in the best interests of the client.
- Prioritise the interests of the borrower.
- Meet certain disclosure requirements.
The 'best interest obligation' - applied to financial practitioners and lenders - would formally align the interests of both parties with those of the borrower through legislation. Many contend that the National Consumer Credit Protection Act 2009 (Cth) were sufficient to protect consumers. Coupled with the commercial pressures to deliver leading customer care (as with any business), we see the 'best interest obligation' as a practice that was more than implied and/or expected by the industry. We believe additional legal framework will have no tangible benefit to consumers. The implication is clear: the Commission believes (without presenting supporting evidence) that a broker might be influenced to act against their client's interests if there's a financial advantage.
We can only hope the industry has enough influence to convince Treasurer Scott Morrison that the Productivity Commission's report is flawed. More effort needs to be applied in identifying how the core conflict of interests (such as bank ownership) can be best managed or legislated from the industry entirely in order to facilitate necessary competition. Further regulating the broking industry, or empowering the banks any further by way of a distribution network or increased profitability, will only have the opposite on competition to that which is intended.
The multiple recommendations made with relation broker remuneration are based upon anecdotal evidence at best. More oversight should be applied to gather data so statistical evidence might be obtained before any changes are made. Current recommendations undermine the value of brokers and will ultimately evolve into a non-competitive environment by handing power back to the banks.
Many brokers are their own worst enemy... and they don't know it. As mortgage professionals we need to revert back to a model where we have a laser-like focus on education and post-settlement service. It's only after we reclaim ownership of the industry that regulators won't be able to take it away from us.
If you haven't already, read the report here . We've barely covered the first few pages.