Heading for extinction

The last thing brokers want to worry about right now is the future of commissions, but the debate around fee-for-advice has reached fever pitch.

Only a few years ago the prospect of commissions being phased out was virtually unimaginable.

Commissions were firmly on their way up during the first part of the last decade. Lenders were falling over themselves to court brokers as securitisation pumped cheap money through the third party distribution channel and incentives to win broker business got bigger by the day.

But a correction was always on the cards and it hit hard in 2008 when the global financial crisis cleaned out much of the competition to the banks.

GMAC RFC and GE Money packed their bags and left Australian shores. Macquarie Puma shut up shop along with a host of boutique wholesale funders that were no longer able to raise funds.

Only a handful of lenders, such as RESIMAC, FirstMac and Challenger (now Advantedge), stood firm – but they no longer posed a real threat to big bank domination.

The first swathe of commission cuts came to bear as the GFC bit in 2008. Funding costs had increased by as much as 150 basis points – even for the biggest lenders – and something had to give.

THE FIRST CUT IS THE DEEPEST?

Commissions were cut by around 30 per cent in 2008 and the banks have since tweaked here and tightened there, sparking growing concerns that commissions may eventually become a thing of the past.

Broker fears are not without grounds when you look to other segments of financial services for clues as to what the future may hold.

In 2009, the Financial Planning Association formalised its decision to move away from commissions-based remuneration.

Since then, companies both large and small have actively sought to change their policy and implement a fee-for-advice – and to great success.

In 2006 Godfrey Pembroke, owned by MLC, made the move to fee-for-advice. The company said commissions were ‘a bad look’ for a professional advice firm and, as such, had no hesitation in charging directly for their advice – although remuneration methods vary and can range from flat fees to hourly rates to asset-based fees – or a combination of these, depending on the client.

But not all financial advisers were happy to make the switch. Some have argued that their clients prefer commissions and cannot afford to pay directly for financial advice regardless of the quality.

The broking industry is now in the midst of its own fee-for-advice debate.

Advocates of the model argue that charging a fee will not only improve their remuneration but also improve the way they are seen by consumers.

AN INDUSTRY DIVIDED

According to a recent The Adviser straw poll, the industry is split on the benefits of fee-for-advice.

Of the 450 respondents, 52.2 per cent said the future of broking does not lie in fee-for-advice, while 40.7 per cent see merit in the model.

Parallels are often drawn between the world of financial planning and the world of mortgage broking – increasingly since the implementation of NCCP.

Planners and brokers are generally self-employed, operating under a dealership group, aggregator or brokerage, and generate their own income rather than draw a salary.

Both professions provide advice and make product recommendations, though there are fundamental differences in the type of advice they are qualified to offer.

While there are indeed some striking similarities between the two models there are also stark differences that should be considered when determining the best way to remunerate brokers.

Planners provide a broad range of services, but a core offering is investment advice and there is a clear conflict of interest in earning a commission when it comes to advice on financial plans and issues.

Bad financial advice can – and does – result in Australians losing their life savings and so it is quite reasonable that commissions should not be paid by financial institutions for introducing business.

Mortgage advice is a very different proposition. While poor advice from a broker can be costly, these situations are rare and can usually be resolved.

Even in the very worst scenarios the borrower may face a hefty exit fee, but new legislation has now put paid to that.

THE CASE FOR CLIENT FEES

But even if the broking industry does not automatically follow the financial planning industry, there is still considerable noise from within the industry around charging a client a fee.

So as more groups announce that they too will look at a fee for their services, will this actually prompt the banks to cut commissions?

Whether you fundamentally agree or disagree with client fees, the important issue to consider is why this debate arose in the first place?

Fee-for-advice only came to the fore as brokers searched for an alternative to make up for the shortfall in commissions they have already suffered.

According to Advantedge’s general manager of broker platforms Steve Weston, under the current commission-based model, the average broker earns just $40,000 in their first year.

“Once they have paid their aggregator fees and any other overheads, they are practically broke,” he says. “They would be better off financially making sandwiches at the local cafe.”

“Commissions have been cut by 30 per cent and they could drop further. Instead of trying to write more business to make the same amount of money that they did before the GFC, brokers should take action and look at fee-for-advice as a way to bridge the gap in pay.”

And Mr Weston believes customers will be willing to pay for the professional service of a broker.

“Today, most borrowers want more than a home loan. They know that they can go to a bank branch for a loan, but they don’t because they want advice and they would be happy and willing to pay for this advice,” he says.

But many brokers will still view any prospect of fee-for-service as the beginning of the end for commissions. And the banks are surely poised to seize any opportunity to pare back or remove commissions completely.

While this prospect will remain a fear for the industry, history implies that this is an unlikely outcome.

THAT SHIP HAS SAILED

If commissions were going to be axed, it would have happened in the depths of the GFC.

While Westpac’s decision to move first to cut commissions raised the ire of brokers, the bank – along with CBA – continued to lend and pay brokers a commission while every institution in Australia faced a stark shortage of funds.

Rather than cutting commissions – or pulling out of third party distribution – the banks instead sought to control volumes by tightening policy and product pricing to ensure sustainability during the darkest days.So what does the future hold for brokers and how safe are commissions moving forward?

Australia’s lenders continue to see merit in retaining broker commissions, Smartline’s executive director Joe Sirianni says.

“The banks would be incredibly foolish to ever abolish broker commissions and they recognise this,” he says.

“Australia’s lenders would have to spend a lot more money on marketing than they do on broker commissions to attract not only the same level of mortgages, but the same quality of applications from borrowers.

“Look at it this way: the banks could spend money marketing their products on radio, TV or in print, but they choose not to. Why? Because a lot of the money they spend would be redundant. They only have to pay a broker when the loan settles. Advertising is hit and miss.”

OUR WORD IS OUR BOND

NAB, CBA, ANZ, Westpac and St George have all been quick to reassure The Adviser that they have no plans to change or abolish commissions in the immediate future.

St George’s general manager of intermediary distribution, Steven Heavey, says there will always be a place for broker commissions.

“It has been and continues to be the most effective way of remunerating brokers,” he says. “And while I can’t speak for all the banks, I can say that we have no plans to abolish commissions. In fact, the opposite is true.

“We are constantly revising our current structure to not only please our broker partners but encourage quality applications.”

But while it seems broker commissions are here to stay, are there likely to be any changes to the current upfront and trail structures?

According to Mr Heavey, both upfront and trail commission are imperative for different reasons.

“We pay the broker an upfront fee for introducing a customer to us and this will never change. They need to be rewarded for their service and upfront commission helps us do just that,” he says.

“Similarly, trail commission is also imperative. It is important that we reward the broker for their loyalty. If we didn’t pay trail, brokers may churn their book to earn a quick buck.”

NAB has also been firm in its stance when it comes to commissions.

The lender recognised the importance of rewarding broker loyalty back in 2007 when it introduced its stepped trail commission structure.

At its core, the lender’s commission structure works so that the longer a client stays with NAB, the higher the broker’s trailing commission.

“The Homeside stepped trail commission structure, launched four years ago, now offers eligible brokers the opportunity to earn a trail commission of 35 basis points a year,” NAB Broker’s general manager of distribution John Flavell says.

“Most importantly, our ramp trail applies to the ‘life of the customer’ not the ‘life of the loan’. Furthermore, we will continue to share margin where we make margin with our valued broker partners and maximise the long term value of their business.”

THE BACKUP PLAN

Although the majors have said they have no plans to restructure or abolish commissions, can brokers trust what they say?

The final and perhaps most compelling case for the sustainability of broker commissions is down to the strength of the broker channel.

Brokers now account for 40 per cent of all new business and this is a significant share of the billions in loans written every year.

In a lending industry where there is renewed competition across the major lenders, second-tier banks and the non-banks, brokers could easily and legitimately find alternative lenders should one group cut commissions.

“We would not want to jeopardise the relationship we have with their biggest business channel,” ING DIRECT’s executive director of mortgages Lisa Claes says.

“Given our branchless banking model, we have a strong relationship with brokers – with intermediaries accounting for more than 90 per cent of our mortgage production,” she says.

“Commissions reward brokers when they create value for the customer. This very much aligns to our model’s heavy reliance on third parties to distribute our products.

“At the end of the day, we are comfortable with our broker commission model and have no plans to vary it.”

And ING DIRECT is not alone.

All of Australia’s second tier and non-bank lenders have made it clear they have no plans to abolish broker commissions.

In fact, late last month Bankwest announced it would lift commissions for a limited time.

From now until 27 May 2011, Bankwest will pay brokers an additional 10 basis points upfront for any loan with an LVR less than 75 per cent.

The lender’s head of specialist banking Ian Rakhit says the changes were made to help Bankwest differentiate itself from the competition and show its broker partners just how important they are.

“While our policy changes are only in place for a limited time, we hope they will be enough to show our broker partners that we are committed to the channel and committed to providing quality products at competitive prices,” Mr Rakhit says.

“Increasing broker commissions allows us to reward quality and low risk applications. Commissions will always play an integral role in the mortgage broking industry.”

And, according to Mr Rakhit, Australia’s major lenders appreciate this just as much as the smaller players.

The majors understand if they abolished commissions, while the smaller players retained them, broker business will invariably swing to those that offer remuneration benefits – provided the suite of products satisfies NCCP.