The commissions were also costing CBA a lot of money. It estimated it could save almost $200 million over five years if the rest of the market followed its plan to shift the industry to a smaller, flat fee – which would slice the average revenue a broker earned on a loan from around $6000 to closer to $2000.
The testimony sent the mortgage broking industry into a tailspin. Many brokers were so angry they raised their concerns directly with Comyn.
Some in the industry smelt a rat. The largest aggregator of mortgage brokers, AFG, thought CBA’s position was “clearly self-serving and designed to win market share from the smaller banks”, CEO David Bailey said this week.
But Hayne went with Comyn. Trail commissions were “money for nothing”, the final report declared. The observation had a devastating impact: the government immediately moved to ban about $1 billion in annual trailing commissions received by brokers with effect from next year. The party is over.
And it could get even worse for the embattled industry. It wasn’t only the trail in the Commissioner’s sight: Hayne wants all conflicted remuneration gone. That also means brokers’ upfront commissions which, like the trail, are calculated as a proportion of the amount borrowed.
Fee paid by the customer
To Hayne, commissions are fundamentally wrong. They create an incentive for brokers to push customers towards large loans, regardless of whether it is wise for them to borrow the amount.
A broker arranging finance receives an average upfront commission of about 0.6 per cent of the loan value, and a trailing commission of just under 0.2 per cent of the loan outstanding, over the life of the loan. That amounts to a fee of about $6000 for an average loan of $357,000.
And so, in his most dramatic recommendation, Hayne called for broker commissions to be replaced by a fee paid by the customer.
The future of about $1.5 billion in upfront commissions paid each year to brokers by banks has now become a political flashpoint.
Labor said it will adopt the new customer-paid model. Mortgage brokers will also need to comply with a new legal duty to act in the customers’ best interest, effectively regulating them like financial advisers.
After moving to abolish the trail and supporting the best interest duty, thegovernment said it will review the call for a ban on upfront commissions in three years, after getting advice from the Council of Financial Regulators and Australian Competition and Consumer Commission on the impact on smaller lenders.
Because any customer-paid fee is likely to settle at a level closer to payments for financial advice – perhaps one-third of the level of the average bank-paid commission – broker income is set to plummet. Not surprisingly, thelarge mortgage aggregator groups were the biggest losers from the royal commissionon the sharemarket: AFG stock lost 30 per cent on Tuesday; Mortgage Choice slumped 25 per cent.
It’s been a savage turnaround in fortune for the mortgage broking industry, which in the early 1980s cracked open the cosy monopoly big banks had on home lending and inflicted serious damage on major bank profits.
It’s in the DNA of the industry to aggravate the biggest lenders – often by serving borrowers who fall outside stricter requirements from stuffy banks.
Applying to a bank for a residential property mortgage in the early 1980s was like a painful job interview before a deeply sceptical boss. Applicants rolled up to a local branch dressed in their best clothes in the hope they could persuade the manager they were worth risking savers’ deposits.
Branch managers needed to be confident a borrower could pass the three ‘C’ test: credit, cost and character. That roughly translated into making sure the borrower had a sizeable deposit – at least 20 per cent – a job to cover repayments, and wasn’t a ratbag.
Back then, the median price of a house in Sydney was about $70,000, and about $44,000 in Melbourne. Olivia Newton John’sPhysicalwas aCountdownchartbuster, Malcolm Fraser was prime minister and John Howard was his treasurer.
Gathering dust in the treasurer’s bookcase was the Campbell Review into Financial Services, an epic 45-chapter, 832-page review of the Australian financial system, the first since 1936.
Its opening lines were a call to arms for the nascent free-market revolutionaries being championed by prime minister Margaret Thatcher in Britain and Hollywood-hack turned president Ronald Reagan.
Campbell started from the view that “the most efficient way to organise economic activity is through a competitive market system, subject to a minimum of regulation and government interventions”.
This shook the “protectionist” pillars of economic orthodoxy that had closed the Australian economy, particularly financial services, since Alfred Deakin’s premiership and the beginning of the federation at the turn of the 20th century.
Ironically, it was Howard’s successor, Labor treasurer Paul Keating, who, to use his words, “spent the political capital” that opened the door to competition in the financial services sector.
The next generation of property buyers quickly embraced customer-focused mortgage brokers who chased their business, by visiting homes, offering options and never asking for payment – because lenders were paying their commissions.
From the mid-1980s, the mortgage broker industry grew rapidly. It now comprises more than 7000 businesses, 17,720 employees with revenues of about $2.2 billion and total wages of more about $1.5 billion, according to IBISWorld.
Brokers account for about 59 per cent of deals – much more among smaller lenders with small, or no, branch networks.
Business boomed as houses evolved from the great Australian dream of a suburban block, to a tradeable commodity, then a national obsession. As interest rates fell, prices boomed and lenders competed aggressively for new business with discounts, cash incentives and fee waivers.
The first big property boom in deregulated markets happened within years of the reforms, pushing property prices in places like Melbourne to heights not seen since the gold rushes in the 1860s, when Marvellous Melbourne was the fastest growing city in the British Empire.
Mortgage rates of 19 per cent in the early ’90s tamed demand for a time but broker numbers continued to grow, encouraging more competition as smaller banks without branch networks realised they had a new, mobile distribution network.
Mortgage mavens like John “Aussie Home Loans” Symonds, who lives in a $100 million Sydney Harbour mansion wherepaintings by Sidney Nolan, Charles Blackman, Arthur Boyd and John Brack compete for wall space, typified the gold-rush spirit.
The real estate and mortgage good times only got better after a modest speed bump following the global financial crisis.
Average house prices in Sydney had blown out to more than $1 million, or 15 times what they had been in the 1980s, blowing out the incomes of the brokers who were paid based on the size of the loan.
Comyn told Hayne the top 200 Sydney-based brokers weretaking home about $2.5 million a year.
Big banks joined the party, offering incentives to their broker networks and establishing aggregators, which acted as intermediaries between brokers and the banks. Generous commission payments were boosted by top-ups, volume bonuses and special incentives ranging from administrative support to champagne-soaked entertainments.
The Australian Securities and Investments Commission started investigating these “soft dollar benefits”. It found one aggregator had splurged more than $1 million on taking high-performing brokers on an international “conference”, including an all-expenses paid Caribbean cruise costing $13,000 per broker.
Chasing the money
Case studies examined by the royal commission showed many brokers were chasing the money. Ironically, themost egregious case studyinvolved Aussie Home Loans, now a CBA subsidiary (although the bank is trying to sell it), which involved the falsification of documents to lenders and brokers going to big lengths to protect the flow of their precious trail commissions.
It was time to grab the punchbowl.
The royal commission follows ASIC, the Productivity Commission, the prudential regulator APRA and AMP chairman David Murray’s 2014 inquiry into the financial system – which raised the alarm about concerning practices, such as leveraging superannuation funds to buy apartments – in pulling on the reins.
The timing could not have been worse.The seven-year-long residential property boom is beginning to buston account of caps on investor borrowing and credit becoming harder to access. Auction clearance rates have plunged and property prices are tumbling.
Brokers had been confident that they could adjust to the regulatory changes and ride out an economic downturn.
Then along came Hayne’s recommendations to replace commissions with fees, that hit the sector like a giant wrecking ball, shattering assumptions and splintering old relationships.
The industry is still putting up a fight. On behalf of 15 aggregators, brokers and smaller lenders, the Mortgage & Finance Association of Australia, a lobby group, launched a national advertising campaign this week, arguing “the last thing Australia needs is policy change that further entrenches power amongst the few lenders with large branch networks.”
Comyn declined to respond to the assertion this week, but in an attempt to calm the horses, called on the government to consider the model suggested by Hayne – which would require banks to charge customers an equivalent fee to maintain “channel neutrality”.
This model was introduced in the Netherlands in 2013. In his report, Hayne said the mortgage broking industry there has continued “without significant adverse consequences to its own operations, the market generally or individual participants”. He also applauded emerging fee models, including those based around an hourly rate.
WithReserve Bank governor Phil Lowe this week backing the government’s cautionon shifting to a customer-paid model, to properly understand the competition impacts, the industry is stepping up its political lobbying in expectation the issue will flare up at the election.
Labor is sensitive to accusations it could be strengthening the Commonwealth Bank’s power. But its desire to end conflicted remuneration appears even stronger, and party sources said it understands the sensitivity of smaller lenders and will ensure the future model preserves competition.
Hayne wanted policy makers to question the pro-competitive effects of brokers in the market. He pointed to the Productivity Commission’s review of banking competition last year, which found ownership of major broking groups by the major banks had tapered the competitive impact brokers are having.
“The revolution has become part of the establishment,” the PC wrote.
Hayne understood his report would trigger plenty of criticism from rent-seekers and sought to debunk a lot of the post-report drama in advance.
He encouraged mortgage brokers – rarely short of confidence – to convince customers of the value of the services they provide.
“Changes of the kind I propose will give brokers the incentive to give borrowers value for money. In particular, the changes will induce brokers to search out the best deals available. To do that, they will have to look beyond the entities with which they may have become accustomed to dealing.”
Hayne also provided a solution for brokers worried customers won’t be willing to pay a new fee: the cost could simply be capitalised into the cost of the loan and paid down over its life. The amount of any fee would be tiny compared to the overall amount borrowed.
But for many brokers, such asNicole Cannon, who has been a mortgage broker for 17 years, the proposals are an existential threat – not just to her business, but the entire industry.
“I am floored by this,” she said this week.
Smaller lenders are also alarmed at the prospect of finding it tougher to distribute their products. The major banks – who stand to be the big winners from any diminution of broker power – are keeping their counsel.