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Analysis
Bracing for battle Channel conflict threatens commission cuts In a low credit growth environment, brokers have urged banks to increase commissions in order to encourage higher volumes. But is the deathknell for commissions being sounded?
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leading financial services consultant has claimed banks will increasingly try to shut out brokers as the mortgage market becomes more competitive, ramping up direct channels and eroding commissions. Amid an intensely competitive home loan environment, banks have made aggressive discounting moves in an attempt to woo customers. With very little margin left for discounting, some industry figures – such as Mortgage Choice CEO Michael Russell – have claimed banks could see higher volumes through an increase in broker commissions. However, leading financial services consultant Max Franchitto of MGF Consulting Group does not see this happening. Rather, he believes banks will employ the strategy of increasing their focus on direct channels at the expense of the broker network. In such an environment, brokers waiting for an upward move on commissions may find themselves sorely disappointed. “It’s an assumption filled with fallacies. Unless everyone agrees to raise commissions to exactly the same level, the moment I have a bit of disparity in commissions the seed of doubt is planted. If he’s getting more commission, how do I know that the advice is unbiased?” According to Franchitto, it is doubtful banks will consider the strategy of increasing commissions, because it still has questions of viability in the current market. “Will it encourage greater productivity? Probably not. It certainly won’t encourage loyalty,” he said. Instead, brokers have been warned that they will see increasing channel conflict, as banks pit their direct channels against brokers in a bid to control distribution. “Channel conflict is something we have to be aware of and manage on a day-to-day basis. Why am I going to pay top dollar to a distribution channel if I have the option of picking up clients in a direct fashion?” Franchitto said. There’s little doubt discounted mortgage rates are eating into bank margins. JPMorgan recently advised clients in a letter that bank discounting of standard variable rates ran the risk of eroding profitability. JPMorgan’s Scott Manning reportedly told investors that 0.9% discounts were “uneconomic” if sold through mortgage brokers. With this level of discounting, direct sales will become increasingly economically attractive to banks. And in this environment, the growth of channel conflict is undeniable, Franchitto claims. “I think industry players that are playing down channel conflict are doing it because they don’t want to give life to an enigma that’s already happening,” he said. If channel conflict grows, banks could begin to ‘cherry pick’ the best clients for themselves, seeking to ramp up distribution through branches and mobile lenders. “I think owning the channel is now becoming a much more viable proposition, and if you look at some of the credit unions they have already moved in that fashion,” Franchitto said. “Mathematics doesn’t lie. Mathematics is not a subjective science. Why exclusively pay somebody when you can go direct?”
An inevitable erosion?
Max Franchitto
In fact, the erosion of commissions may be a veritable inevitability as banks focus on owning their client relationships. Franchitto argues that the money banks pour into their third party networks will eventually be diverted to ramping up their direct offerings. “Within two years, banks will transition towards using whatever channel is more cost effective. Using the third party channel, you have to spend lots of dollars to keep people’s attention on your product. Think about the overheads a bank has to service brokers,” he said. If these pressures come to pass, trail commissions may also be slated for the scrap heap. Franchitto points to the financial planning industry, saying industry regulations meant financial planners could no longer collect trail commissions ad infinitum, but had to allow clients to opt back in every 24 months. Mortgage brokers would see trail commissions vanish if similar measures were implemented, as opting a client back into a broking contract is unviable.
A ray of hope
Not all is gloom and doom for the future of the third party channel. Franchitto contends that mortgage brokers could survive, and even thrive, as the model of the industry evolves. However, in order to survive, Franchitto argues brokers will have to ensure their businesses evolve into a ‘one-stop shop’ model offering holistic financial services – rather than just mortgages. He said small brokers focusing purely on mortgage sales would face difficulty remaining viable, and would have to consolidate with larger players, or exit the industry. “The single mortgage broker sitting in an office selling Mum and Dad mortgages – that model has a use-by date. The bigger groups trying to offer a menu of financial services will eventually survive,” he said. This evolution may be a necessity if the industry is to have a chance at competing with the major banks, and winning the battle that may ensue between direct and third party channels. Franchitto predicted brokers who embrace the model will be well-placed to thrive in a competitive environment, regardless of commissions. “The one-stop shop has been the holy grail of financial services,” he commented.