James Eyers & Joyce Moullakis| Australian Financial Review| 28 September 2018
Up-front and trailing commissions paid to mortgage brokers by lenders are making the home loan market more risky, the royal commission said in its interim report, keeping the prospect of a clampdown on broker pay alive.
The report said “assertions” by Aussie Home Loans and other broker groups that commission-based remuneration structures in the mortgage broking industry aren’t causing bad outcomes “are not to be accepted”.
Commission payments explain why mortgages written by brokers have higher leverage, more interest-only loans, higher debt-to-income and loan-to-value ratios, higher interest costs and an increased likelihood that borrowers will fall into arrears, the report said.
It cited analysis done by the Australian Securities and Investments Commission and also referenced Stephen Sedgwick’s banking pay review.
“Value- and volume-based remuneration for intermediaries in the home loan industry has been an important contributor to misconduct and conduct falling short of community standards and expectations and poor customer o
Commissioner Kenneth Hayne also took a dim view of industry efforts, through groups such as the Combined Industry Forum, to improve standards, describing proposed reforms as being “limited” and suggesting that, while “perverse incentives” created by volume-based commissions (which reward brokers for the number of customers placed with a lender) are already being removed, up-front and trailing commissions based on loan value remain.
“While basing those commissions on funds drawn down removes an incentive for brokers procuring a loan larger than the borrower will use, the change does not deal with the more basic problem of borrowers being encouraged to borrow more than they need,” the report said.
“As noted elsewhere in this report, value-based remuneration conflicts directly with customers’ interests.”
In response to the interim report, AFG chief executive David Bailey said the broking industry required time for reforms suggested by ASIC to be implemented and assessed ahead of any further changes.
“ASIC did its review and it is important that the recommendations from the main regulator be allowed to be implemented and then we’ll see how they flow through,” he added, noting measures including a code of conduct and a new “customer-first duty”.
AFG, a mortgage aggregator that supports brokers, is of the view the existing model represents a “good balance” between lenders, borrowers and brokers.
Separately, the Productivity Commission in August called for trailing commissions in the broking industry to be banned, but recognised the important role mortgage brokers play to encourage competition.
“We accept that up-front commissions may rise as a consequence of such action. Broking businesses would need to remain commercially viable,” it said.
Mortgage brokers – which account for about 55 per cent of new home loans written – typically earn an up-front commission when a home loan is settled of about 0.65 per cent of the amount, plus a smaller annual commission referred to as a trail.
Commissioner Hayne said “it will be important to consider” whether value- and volume-based remuneration of intermediaries “should be forbidden”.
“Remuneration arrangements for third-party intermediaries and for all staff, both frontline staff and senior executives, have rewarded sales and profitability,” the report said. “Doing the ‘right thing’ has not been rewarded.”
The report also highlighted the conflict between a broker’s interest in maximising their income against the borrower’s in minimising costs, and pointed to potential beaches of a section of the National Consumer Credit Protection Act.
“I go no further than noting that continuing to pay intermediaries a value-based up-front and trail commission after the deleterious consequences of the practice had been identified might have been a breach of Section 47(1)(b) of the NCCP Act,” Commissioner Hayne said.
Among other hotspots, the interim report flags changes to the law to make it clearer who mortgage brokers represent in the selling process.
It says there is “no simple legal answer to the question who they act for” and it seems a broker owes no general duty to the borrower to seek out the best loan for them. Rather, it appears the duty is only to not negotiate an unsuitable loan.
Commissioner Hayne wants to know in fresh industry submissions what duties an intermediary owes a borrower, and what duties they should owe.
The interim report also points out that major banks could be supportive of reforms to broker incentives. It refers to a letter written by former Commonwealth Bank chief Ian Narev to Mr Sedgwick, who reviewed remuneration for the Australian Banking Association, in which Mr Narev said: “We would support elevated controls and measures on incentives related to mortgages that are consistent with their importance and the nature of the guidance that is provided. For example, the de-linking of incentives from the value of the loan across the industry; and the potential extension of regulations such as Future of Financial Advice (FoFA) to mortgages in retail banking.”
Any changes to remuneration structures of brokers could have a dramatic impact on the sector, given brokers account for more than half of all new residential property loans.
According to Deloitte Access Economics the mortgage industry has grown since inception 25 years ago to directly and indirectly employ about 27,000 people and is worth $2.9 billion to the local economy.