Major bank profits could rise by 1.8% if trail is cut

Morgan Stanley’s findings were based off an analysis of data collected from the major banks’ full-year 2017 (FY17) financial results, and data from Mortgage Choice, which reported that, on average, the rate of trail commission paid to mortgage brokers is 18 basis points.

The research found that Westpac would report the largest profit increase if trail was removed (2.2 per cent), followed by Commonwealth Bank and ANZ (1.9 per cent), and NAB (1.3 per cent).

Commission costs vs branch costs

The research also shed light on the impact that upfront (average of 66 basis points) and trail commission payments have on the overall costs incurred by the big four banks.

Morgan Stanley found that broker commission payments make up approximately 4.6 per cent of CBA’s overall costs, Westpac’s at 4 per cent, ANZ’s at 3.1 per cent and NAB’s at 2.5 per cent.

However, the research revealed that costs incurred from broker commission payments are less than a third of the costs associated with operating branch networks.

The Morgan Stanley data revealed that, on average, 12.5 per cent of cost incurred by the majors banks are associated with operating branches in Australia.

The research noted that 15 per cent ($1.36 billion) of Westpac’s overall costs are associated with the operation of its Australian branch network, followed by CBA (14 per cent/$1.43 billion), NAB (11 per cent/$868 million) and ANZ (10 per cent/$855 million).

Morgan Stanley Research’s report follows calls from the Productivity Commission (PC) for evidence concerning the comparative costs of distributing home loans through the broker channel, against the costs incurred through the propriety channel.

In its draft report, the PC noted that it was unable to gather sufficient evidence from lenders and the third-party channel when pulling the report together.

However, executive director of the Finance Brokers Association of Australia (FBAA) Peter White previously suggested that the cost of using brokers was around half of the cost of the proprietary channel.

Appearing before the PC during its public hearings, Mr White said: “The use of brokers evolved from a clear recognition that the value proposition of using a broker was more attractive than branches and staff.

“The proliferation of brokers has occurred because of the benefit derived by product issuers from an expanding broker network, and, implicitly, product issuers know that a broker distribution model is cheaper and more effective than staff and branches, which is why it continues to thrive.”

Further, in its The Value of Mortgage Broking report, released in July, Deloitte Access Economics (DAE) noted that while “transaction costs are higher in the broker channel due to commission payments”, and “processing costs are similar for both broking and banks’ direct channels”, lenders can make “significant savings” through the use of the third-party channel.

The report stated that the distribution of mortgages through branch networks incurs higher overhead and infrastructure costs, which it claimed make up 40 to 60 per cent of such lenders’ operating expenditure.

DAE observed that the third-party channel absorbs much of the financial burden associated with compliance costs, highlighting data provided by mortgage aggregator Connective.

“The costs associated with staff compliance and training costs can be significant on a per-loan basis. Aggregators train and mentor their mortgage brokers and enforce compliance,” the report read.

“Connective, for example, estimated it spent around $2.7 million on educational events for brokers in 2017, on top of providing mentoring and business structure planning.”

Broker share of major bank flows rising

Moreover, Morgan Stanley’s research revealed that the share of broker-originated home loans processed by the major banks has increased, now representing 47 per cent of home loan flows.

The group attributed the rise to increasing complexities in the mortgage market, citing research from Australian Finance Group (AFG).

“We think this growth has been in response to rising mortgage product complexity and consumer preferences. For example, AFG reported that the number of its mortgage products rose  [by approximately] 135 per cent from 1,450 in 2015 to over 3,400 in 2017,” the report noted.

“Differentiated pricing and tighter lending standards are additional drivers.”

Morgan Stanley also reported that, based on its analysis, ANZ was the most reliant on the broker channel, with 51 per cent of its volumes originated by brokers in 2H17, followed by CBA (46 per cent), Westpac (43 per cent) and NAB (34 per cent).

However, according to Morgan Stanley, CBA is the only big four bank that has reduced its broker flows, noting that its broker-originated home loans dropped from 45 per cent in FY17 to 40 per cent in FY18.