“The chief value of trail commissions to the recipient, to put it bluntly, is that they are money for nothing.”

Commissioner Kenneth Hayne,
Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry,
Final Report, February 2019

A clear message from the final report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry is that it believes conflicts of interest in financial services can’t be managed and must be eliminated. 

As a result, mortgage brokers are facing the abolition of commissions, on the basis that they are conflicted remuneration, and must learn to live in a borrower-pays or fee-for-service environment. The inquiry has recommended that the borrower, not the lender, should pay the mortgage broker a fee for “acting in connection with home lending”. It recommends changes in brokers’ remuneration should be made over a period of up to three years and that as a first step trailing commissions should be stopped on new loans, then “other commissions to mortgage brokers” should also be stopped.

The inquiry has also recommended introducing a best interest’s duty (BID) for mortgage brokers, similar to the duty already imposed on financial advisers. A BID would be underpinned by the threat of civil penalties for brokers who breach the duty and is likely to give consumers more confidence that brokers are acting in consumers’ interests when sourcing and arranging finance

But there’s a good reason why both the Productivity Commission and Treasury previously baulked at similar fee-for-service proposals for mortgage brokers, and it’s because they have the potential to decimate competition in the home lending market, undermine the benefits that brokers have created for consumers, and play into the hands of the larger lenders with the most branches.

Three scenarios emerge from the royal commission’s recommendations: the abolition of trailing commission and no increase in upfront commission; the abolition of trailing commission and an increase in upfront commission; and the replacement of all commission by fee-for-service. Each of the scenarios has particular implications for borrowers, brokers and lenders.

Scenario 1
Abolition of trail and no increase in upfront
Broker
• 45 per cent reduction in revenue – many brokers to exit industry
• Remaining brokers increase productivity and increased focus on efficiency
• Some brokers may start offering tiered service levels – for example, transaction-only (no fee) and ongoing service for monthly/annual fee
• Increase in rate of brokers changing head groups as ongoing trail handcuff removed
Lender
• Increase in volume mix to large lenders’ proprietary channels, and reduction in volumes to smaller lenders with more reliance on brokers
• Reduced level of discounting to maintain margins
• Major banks increase home loan profitability with commission saving outweighing increased fixed costs from employing more lenders
• Economics of broker loans now cheaper than proprietary loans
Customer
• More consumers, who may have wanted to go to a broker, forced to do their own legwork by going direct to lenders
• New customers paying higher rates due to reduction in level of discounting
• Increased wait-times and frustrations with having to deal with lenders direct on maintenance issue that brokers used to take care of

Scenario 2
Abolition of trail and increase in upfront
Broker
• 20% drop in broker revenue if upfront rate increased from 0.65% to 1.1%; lower-volume brokers exit industry.
• Remaining brokers look to increase focus on efficiency and further diversification to offset revenue loss
• Increase in rate of brokers changing broker groups as ongoing trail handcuff removed.
Lender
• Reduction in average loan life (currently 4.9 years*) as clawback restricted to two years and no trail to broker.
• Increased refinance rate, unless lenders alter the increased upfront amount to be payable monthly over five years.
• Lenders respond by offering more attractive fixed rates for three-to-five years to protect loan life leading to further margin decline.
Customer
• “Best interests’ duty” could lead to increased trust from customers who haven’t used a broker before, which together with continued complexity in lenders’ credit policy could see broker market share rising further.
• Increased competition and choice from a larger broker market could lead to further discounting, resulting in cheaper loans for the consumer.
 
* Source: Mortgage Choice 2018 results presentation

Scenario 3
Abolition of all commissions and introduction of fee for services to customer
Broker
• Decimation of broker channel as over 2/3rds of brokers leave the industry and large fall in new entrants to the industry.
Lender
• Large Increase in volume mix to large lenders’ proprietary channels and reduction in volumes to smaller lenders with more reliance on brokers.
• Reduced level of discounting to maintain margins
• Increase in loan life as customers won’t move unless the interest savings exceeded the fee for service they would pay on refinancing.
• Major banks increase home-loan profitability with commission saving and extra fee income outweighing anything passed back to consumers and the increased fixed costs from employing more lenders.
Customer
• Customers forced to pay a fee for service for going to branch or broker.
• New customers paying higher rates due to reduction in level of discounting from less competition.
• Existing consumers less likely to refinance for a cheaper rate as any interest savings would need to offset payment of new fee.
• Increased wait-times and frustrations with having to deal with lenders direct on maintenance requests that brokers used to take care of.
 

Of these three scenarios, Scenario 2 appears to offer the best outcomes for consumers.

Increasing numbers of consumers use brokers to help them arrange financing.  Brokers enjoy a high level of client satisfaction, and the number of complaints against them is low. The royal commission is suggesting there’s a problem just because of the way brokers are paid, and that has not necessarily been proven. There will always be the odd rotten apple, regardless of how brokers are paid. Removing so-called conflicted remuneration will not necessarily remove the odd rotten apple.

Commissions paid to brokers by lenders have converged over time, and the differences today aren’t significant enough to convince a broker to favour one lender over another. And while previously a situation may have arisen where a consumer was encouraged by a broker to borrow more than they needed, with the broker paid commission on the full loan amount and the excess of the loan placed into a mortgage offset account, work by the Combined Industry Forum now being implemented will ensure that commissions are paid only on the amount drawn down to fund a property purchase.

This change, along with the soft-dollar payments already abolished and the royal commission’s own recommendation of a broker’s best interests’ duty, should have been more than enough to make sure brokers act in the best interests of borrowers. Eliminating commissions altogether looks like overkill, and a solution to a problem that doesn’t exist.