Mortgage brokers: overrated and overpaid

Mortgage broker commissions have blown out to $2.40 billion a year - a jump that will see the banks push for a better deal by switching to a fee-for-service model, according to UBS analyst Jon Mott.

"While mortgage brokers are unlikely to be happy with this outcome, we believe there is little they can do," he said, noting that broker commissions are never disclosed. Rather than being expensed, mortgage brokerage is a contra-revenue that is deducted from net interest income, according to the analyst.

“We believe many people may be surprised at the level of commissions paid to mortgage brokers,” he said. 

According to ASIC, total upfront and trail commissions paid to mortgage brokers totalled $2.40 billion per annum in 2015 - up a whopping 18 per cent compound growth rate since 2012 when total commissions paid were $1.46 billion. 

In recent weeks two major reports have been released which identified a number of material conflicts of interest in the industry and called for sweeping changes to the way brokers are paid.
 

ASIC, Sedgwick Review

The ASIC Review of Mortgage Broker Remuneration and the Retail Banking Remuneration Review (Sedgwick Review) found broker loans were larger, higher loan-to-value, more likely to be interest-only, and were paid off more slowly by borrowers than bank-originated mortgages. 

“Despite perceptions that brokers achieve the 'best rate' for customers, there was also no evidence brokers achieved a cheaper loan than proprietary channels,” commented Mott. “Broker-originated mortgages therefore cost customers more over the life of the loan.”

A key recommendations of the ASIC and Sedgwick Reviews was to "adopt approaches to remuneration of aggregators and mortgage brokers that do not directly link payments to loan size”. 

“We believe this is appropriate given the blow-out in commissions paid to brokers,” Mott told clients in a note released on Wednesday morning. “Although commissions are deducted from net interest margin (not expensed) this is equivalent to 23 per cent of the cost of running the big banks entire personal and consumer banking operations.

“We find it astounding that average commissions are now $4,600 per mortgage, which we believe is disproportionate for advice provided on a simple, commoditised, single product - particularly when compared to the fees charged by financial advisors for 'simple' financial advice ($200 to $700).”
 

Cost of funding

What's even more shocking to the UBS analyst is that, on his estimates, mortgage broker commissions add 16 basis points per annum to the cost of every mortgage in Australia, irrespective of whether the mortgage was broker or proprietary originated.

“Although mortgage broker commissions are paid by the bank not the customer, commissions are factored into the bank's cost of funding and have been a driving factor in mortgage repricing in recent years," said Mott.

“We believe these payments are an illustration of excesses built into the financial system following a 26 year economic boom. We expect the banks to negotiate materially lower fee-for-service mortgage commissions in coming months."

However, over time, Mott expects open data and analytics will result in the value-add from mortgage brokers to become marginalised, particularly as the prudential regulator’s "sound lending practices" prevent differentiation via underwriting. 

Certainly, advice for a commoditised, single product such as a mortgage can be easily provided by robo-advice. 

“We believe the current quantum of economic rent being extracted by the mortgage broking industry is unrealistic and is likely to fall dramatically in coming years. We expect these benefits to be passed on to the customer, which could help offset anticipated repricing for the Bank Levy," he added.

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