Mortgage broker salad days are numbered
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The salad days when top-performing mortgage brokers could enjoy holidays in exotic places paid out of the commission income earned from writing home loans would appear to be numbered.
But there is a much bigger threat to the mortgage broking industry from the Australian Securities and Investments Commission’s review of remuneration structures.
It could well lead to the end of commissions in an industry that has escaped the crackdown that has occurred in financial planning and life insurance.
Brokers live in fear that commissions will be outlawed and when you look at the numbers you can understand why.
Brokers originated about $50 billion in new home loans during the September quarter last year. The upfront commissions on that would have been about $300 million based on the range of upfront commissions between 0.6 per cent and 0.65 per cent.
The September quarter lending would have locked in another $50 million in annual trailing commissions. These will last for the life of each loan.
Total trailing commissions in the industry are probably running at about $300 million a year assuming mortgage brokers have probably written about a third of all owner-occupied mortgages.
Although commissions are disclosed to home loan borrowers at the time of sale it is not clear whether or not the final recommendations given to consumers are in their interests.
It is that uncertainty which prompted the Financial System Inquiry to recommend an inquiry into mortgage broker remuneration structures. That recommendation was accepted by the government, which ordered ASIC to conduct its review.
Assistant Treasurer Kelly O’Dwyer has given ASIC until the end of the year to review the industry’s remuneration structures and that suggests action some time next year.
A ban on commissions in mortgage broking would be in keeping with the actions taken by the government in financial planning and, to a lesser extent, in life insurance.
The obvious alternative would be a fee-for-service system but when that was applied in New Zealand it virtually wiped out the mortgage broking industry.
Mortgage brokers have worked hard in recent years to lift professional standards, particularly through the Mortgage and Finance Association of Australia. But its standards continue to lag those being imposed on other sectors including financial planners.
ASIC’s review of remuneration structures kicked off officially this week with the release of a document outlining the final scope of the regulator’s inquiries. Letters will go out to lending institutions, mortgage aggregators, mortgage brokers and other online businesses.
The review, which is being led by ASIC’s senior executive leader in credit, Michael Saadat, does not extend to the gathering of information about fraud in the mortgage broking industry.
Fraud has reared its ugly head over the last five years but ASIC has decided to gather information about that as part of a separate project, which is only happening because of the additional funding in the recent federal budget.
One area that will get attention as part of the review is in relation to the contentious issue of default rates on loans written by mortgage brokers. Data published by the Australian Prudential Regulation Authority has found that default rates are higher on loans written by mortgage brokers.
ASIC will gather its own data on loan performance over the past five years to inform its own decisions.
The review of mortgage broker remuneration structures looks like being one of the largest “big data” projects undertaken by the regulator because it involves dissecting commission income across a range of channels.
ASIC’s early market soundings have uncovered widespread anecdotal reports about the payment of “non-monetary benefits” which includes cruises and other holidays for brokers who meet certain sales targets.
ASIC is concerned that these sorts of benefits could influence the sales practices in the industry. There is unlikely to be a law banning the practice but it is hard to see them survive if the industry is serious about presenting itself as an ethical role model in financial services.
The review will “predominantly focus on the remuneration arrangements of lender, aggregator, broker and referrer and introducer staff associated with the sale of residential mortgage products”.
Vertical integration in the mortgage broking industry will also be under ASIC’s scrutiny. This will obviously focus on the mortgage broker businesses fully or partly owned by Commonwealth Bank of Australia, National Australia Bank and Westpac Banking Corp.
The fact that ASIC is examining the impact of vertical integration in mortgage broking should provide ammunition for those who think a royal commission into financial services is a waste of time.
Labor has said vertical integration will be a focus of the royal commission but it could well be doubling up on work already done.
Finally the last pieces of the puzzle called “the Target disaster” have been released by Wesfarmers and the full picture does not look good for Wesfarmers chief executive Richard Goyder, finance director Terry Bowen and revered retail consultant Archie Norman.
All three executives were on the Target management board along with former Target CEO Stuart Machin, who resigned in April. Goyder has previously said that the Target board should not have to take responsibility for what happened at Target.
“You rely on processes and systems and the integrity and behaviour of people in the business,” Goyder said last month.
But the scale of the disaster within Target was much greater than previously thought. The company’s culture was clearly broken.
That is ironic given Machin declared that Target’s culture was broken when he took over the business in 2013. He put forward a five-year plan to fix the business but it went off the rails in his last year in the job.
When Machin left in April he was praised by Goyder for his great effort in “working to rebuild Target”.
But Wednesday’s announcement that Target would lose $50 million this financial year and need up to $1.3 billion in goodwill impairments tell you that Machin was not as good as the market was led to believe.
All of the financial signals that Target was sending to the board were flashing red but it appears that no one noticed.
Sales were weak and costs were rising. The combination of these factors would tell an experienced retailer that something was not right in the business.
Guy Russo, who now heads the Wesfarmers department store division covering Kmart and Target, says too much stock was coming in the back door and not enough was going out the front door.
Three years after Machin took over the discount retailer was suffering the same fundamental problem which he identified as needing fixing when he arrived, including excess inventory.
The rising costs in the business were a clear sign of inventory not being shifted. It is not unreasonable to assume that Target’s summer range of fashion products were not marked down when they should have been.
That is happening now with an $80 million charge. But this problem should have been obvious to those with a handle on what was happening inside the stores.
When Russo took Goyder on a tour of a store in Perth recently, all the customers were bunched around the large area set aside for clearance sales and not in areas where higher margin fresh stock was available for sale.
Machin’s last big marketing push was around the Jean Paul Gaultier range. It did not sell well and why would it when a leather jacket is $299? That is not a Target price range.
The recovery strategy involves greater co-ordination of the property portfolio of Kmart and Target.