The future of Mr Average

The commission cuts implemented by lenders over the past three years have had little impact on the industry’s elite writers, and while the lending market has changed, those business writers have evolved and so remain profitable.

For some brokers, evolving has taken the form of diversifying their product offering and suite of services; for others, it has meant targeting new and emerging segments of the market.

The development and maturing of the industry has brought with it tasty pickings for commentators, but while its most successful top quartile might be forging ahead, the impact of changes in the economics of broking has not affected all brokers equally.

For that large body of brokers, who might not write the highest volumes but who, nevertheless, represent the core and the future of the profession, it isn’t all rosy.

Licensing also looks set to have an impact on this sector – how significant remains to be seen – as some brokers decide new compliance obligations are simply not worth the effort and choose to leave the profession.

Once, lenders were falling over one another to win business from every broker they could find.

In 2011, several of the banks have made it fairly clear they are primarily interested in doing business with high volume brokers.

Today’s margins in mortgage lending are smaller and some banks have set their sights on securing greater volume from a smaller number of brokers to ensure the broker channel remains for them a profitable one.

The heady days of the early 2000s, when competition among lenders for a share of the broker market ran hot, are now largely consigned to memory.

Less than a decade ago, up-front commissions of 100 basis points or more were commonplace for straightforward deals funded by the non-banks.

To keep pace with a burgeoning alternative funding sector, the banks paid around 70 basis points up front and up to 25 basis points trail.

Leaner commission, however, is only one of several factors that have made broking tougher for the industry’s core tier. Today’s brokers find themselves squeezed by increasing business and regulatory compliance costs as well as by diminishing returns from residential commissions.

The future of broking looks bright as new regulations usher in an era of greater professionalism and an industry comprising advisers rather than mere overseers of transactions and processes.

For many brokers, however, the new economics means more time and money spent on running a business and on compliance while, taken at face value, the returns from traditional mortgage broking appear to be getting leaner.

Brokers who typically write lower volumes mostly work part time, relying on income from other areas of practice, including accounting and financial planning, as well as from other industries aligned with the property market. In other cases, these part-time brokers are semi-retired or returning to work after raising a family.

Part-time brokers face increased compliance costs just as their full-time counterparts do.

However, through diversifying their income stream – or maybe because they feel less pressure, with broking not their principal household income – many within the sector continue to work relatively unscathed.

The real pressure in today’s market impacts what you could call the ‘average broker’ – the full-time practitioner who typically writes medium volumes.

This sector is the backbone of the broking industry and it will be integral to the growth of mortgage and finance broking in Australia.

The industry has already witnessed the departure of a number of brokers – precise figures are not easily determined at this early stage, but anecdotal evidence suggests that across the board, that number runs into the thousands.

It will, however, be the full-time broker writing medium volumes – not the elite or the part-time practitioner – who drives the growth of the broking profession in Australia.

PORTRAIT OF A BROKER

So, what exactly does this key member of the profession look like? What is their ‘profile’? With the help of PLAN, AFG, and FAST, The Adviser has put together a picture of the ‘average broker’.

Based on analysis of a pool of close to 5,000 brokers across the three aggregation groups, the average broker would be 43 years-old, more likely male than female and they would have five years’ experience.

They would write four loans per month for a total dollar value of $900,000.

While some brokers generate substantial revenue with a diversified product offering, estimating how much an average broker adds to their bottom line through cross-selling is difficult to do accurately.

So, for the sake of simplicity, we’ll assume that the vast bulk of the average broker’s income is generated through residential mortgages.

With this in mind, we can estimate the returns the average broker sees.

Based on a commission of 50 basis points up front and 15 basis points trail, and for simplicity, assuming an

80/20 per cent agreement with the aggregator, the broker would receive monthly up-front commission of $3,600.

Monthly trail is a little harder to estimate. Assuming, however, that the broker has a current loan book of

$30 million, the average broker would earn in the region of $3,000 after the aggregator’s 20 per cent.

So, the average broker would bring in around $6,600 gross per month from their mortgage business.

According to the aggregators to whom The Adviser spoke, brokers could expect to face overheads of at least $1,500 monthly. This would cover costs such as phone, stationery, car lease and running costs, technology and lead generation costs, as well as several other operating expenses.

So, after these business expenses are taken into account, the average broker would be looking at a before-tax income of around $5,100 per month – or $61,200 per year.

Ray Hair, chief executive of PLAN, concludes that while the economics of broking have changed following bank commission cuts, there is still good money to be made.

DIVERSIFICATION THE KEY TO SURVIVAL

1 January saw the introduction of the new regulated environment, with brokers likely to face increased compliance obligations in the years ahead.

At present there is little indication that commissions will rise in the short term, so the question of what lies ahead looms large over many brokers.

What is clear is that several full-timers will need to change aspects of their business if they are to avoid decreasing returns on their efforts.

The path they choose will be down to each individual, but there are a few options.

The key will be to diversify revenue stream and one of the best places for brokers to start will be ensuring they offer – and write – an insurance policy with every loan.

“There are a number of products now available to members to facilitate this,” says Mr Hair.

“The onus is on creating a mindset to offer insurance as a matter of course.

“Brokers that do this will see a return by way of increased revenue. Once brokers have mastered this, they can seek to expand their product offering to meet their clients’ wider financing needs, such as equipment and business finance.”

Bolstering residential mortgages revenue through cross selling complementary insurance products is not new.

It may, however, become more of a necessity in the not so distant future.

This is not just because of the new regulatory requirements of the National Consumer Credit Protection Act (NCCP), which require brokers to provider a broader, more advice-based service. It represents an essential boost to revenue for full-time brokers who are writing fewer than four loans per month.

Steve Kane, chief executive of FAST, believes residential-based brokers should increase their capacity to offer a full suite of risk products to their clients.

“Under new NCCP legislation the emphasis is on the broker to take a holistic approach to their client interactions rather than simply facilitate a transaction,” Mr Kane says.

“As a result, they’ll identify opportunities to drive deeper relationships with customers through clearly identifying their needs and the products that meet their risk profile.

“Our role is to ensure they have access to these products; however, we’re conscious that we don’t want all brokers to be accredited with all products – just the ones that suit their business and client base.”

While PLAN and FAST both encourage diversifying revenue streams, they acknowledge that brokers can move too far in the other direction.

“Brokers won’t build a sustainable operation by simply ‘chasing rainbows’, trying to engage all products in their customer proposition,” warns Mr Hair.

“Large commercial deals, for example, are written by brokers that have experience, a strong SME base and a sound understanding of how to market and prospect to this sector. They need to invest significant energies and resources for winning this business, while not neglecting their other core business areas.”

Brokers can be very successful by just writing residential business with the right work ethic, he reiterates: “If they’re looking to generate more revenue, in many cases it’s just a matter of becoming more productive.”

RETENTION AND FEE FOR SERVICE

Nevertheless, increased productivity by itself will be wasted if brokers cannot retain their clients long term. Few would admit it, but a great many could improve retention, saving themselves valuable trail commission dollars and generating opportunities to win more business.

Client acquisition also represents an important challenge. There may be reciprocal referral relationships out there, but brokers are becoming more dependent on buying leads in one form or another, biting deeper into the average broker’s bottom line.

Even with a basic but systemised approach to customer service following settlement, brokers could make their business considerably more efficient simply by cutting down the leakage of hard-earned trail commission.

Most aggregation groups provide basic tools, such as client e-newsletters, to help ensure their members maintain client contact. Only a minority of brokers take advantage of this simple but effective tool.

With a number of lenders now offering stepped trails, with some as high as 35 basis points after five years, it makes sound commercial sense to keep clients engaged for the long haul.

Working towards tighter client retention, increased productivity and diversification raises few complicated issues; other ways for the average broker to increase revenue are perhaps a little more complex. Fee for service is one such issue and it has split the broking industry down the middle.

In a recent poll of 450 brokers conducted by The Adviser, a narrow majority of 52 per cent said the future of broking does not lie in charging a fee for service; 40 per cent believe it does. Brokers are not the only ones divided on the merits of charging a fee.

AFG has nailed its colours firmly to the mast in the fee for service debate, stating that any move toward such a model would be a “disaster” for the mortgage industry.

The aggregator’s general manager for sales and operations, Mark Hewitt, believes a fee for service model would also negatively impact consumers.

According to Mr Hewitt, borrowers would be more inclined to use the free services of a bank than go to a broker who would charge them a fee.

By forcing buyers into the arms of lenders who have a vested interest in selling from a limited product range, consumer interests would inevitably be undermined, he says.

Any move towards charging a fee would have significant unintended consequences, Mr Hewitt says: “I believe should charging be introduced, broker numbers would dramatically decline. Given the importance of brokers to non-major lenders, their market share would also be significantly reduced, ramping back up the Big Four’s market share to levels above 90 per cent.”

Others support the idea of brokers charging their clients a fee for service, including FBAA president Peter White who believes all brokers should charge for their advice.

Fee for service already exists in the marketplace and is the way of the future, Mr White told The Adviser.

Brokers who do not incorporate a fee into their business model run the risk of not being properly remunerated for their services.

“I think it is time to embrace fee for service,” he says. “With licensing and regulation, we are able to show consumers how professional the mortgage broking industry has become.

‘If consumers see value in the services brokers provide, they will not be averse to paying a fee.”

Mr White said he understood the widely held broker concern that introducing a fee for service could encourage the banks to reduce commissions. “The reality is the banks are already reducing commissions,” he said.

“We have seen some of our majors cut trail and up-front in the last few months alone, and this is a trend that is set to continue in the future.

“What brokers need to understand is that a bank only offers one small suite of product options.

“Brokers, on the other hand, offer a range of products as well as sound and reliable mortgage advice – and that is invaluable.”

Implementing a fee for service, however, is not necessarily as easy as it might sound.

To be able to do so, brokers need to reevaluate their entire service proposition and communicate this in every client presentation.

Even more importantly, they need to ensure they deliver true client value following settlement to justify their fee.

That takes us back to the need to provide a tight, structured client servicing proposition – including elements that will ensure the client is looked after in the long term.

THE SHAPE OF THINGS TO COME

As changes to the economics of broking unfold, regardless of whether brokers choose to charge a fee or beef up revenues elsewhere it is clear that those who operate in the middle of the profession will need to change tack if they are to thrive rather than just survive.

Mortgage broking was more lucrative – on a per loan basis – three or four years ago.

However, future opportunities for the regulated industry look promising and there is the potential for successful practitioners to build highly profitable businesses.

Debt is becoming increasingly complex as it penetrates deeper into the lives of every Australian and the role of the broker becomes more valuable by the day.

The ‘average broker’ represents the face of the industry for a majority of borrowers and this will ultimately determine the industry’s growth potential in the longer term.

Aggregation groups must recognise and support their members at every level and continue to help them adapt to the changing economic landscape that makes up the market.

Greater emphasis on client retention and on the tools to deliver it will bolster the income both of the aggregator and the broker. At the end of the day, though, the onus is on every broker to evolve in line with a changing market.

Regardless of the strategy ultimately adopted – whether a fee for service model or a diversified product offering – the client must lie at the front and centre of the broker’s business.