Hayne hits Mortgage Choice

Susan Mitchell is the CEO of Mortgage Choice. The company's shares fell 25% when the Royal Commission's report came out last week because of Hayne's recommendation that borrowers should pay the mortgage brokers, not the lenders. He had a few other recommendations about mortgage brokers, but that was the main thing.

The other listed mortgage broker, Australian Finance Group, fell about the same and they've kind of stayed there. Mortgage Choice went up a bit in the days following, and they've fallen back down again. It's been a big clunk for shareholders.

Mortgage Choice runs a big franchise network of mortgage brokers, and it has a particular model, which Susan Mitchell explains in the interview. I wrote a piece for The Australian the other day, explaining why I thought we'd be better off without mortgage brokers, but I didn't want to turn this interview into an argument with Susan Mitchell. I just wanted to learn what her views are, how Mortgage Choice operates, and just to try to help investors understand whether or not it might be a good idea to invest in Mortgage Choice, or any mortgage broker for that matter, and the answer is, well, it depends now. I mean, it's kind of a binary choice because if the borrower pays principle, outlined and recommended by Hayne is implemented, then mortgage brokers are in trouble, no doubt about it, because people won't pay anything like what they have been paying.  It's a question about that, really. That's the question, and we don't know, so it's a highly risky investment at the moment, and we don't know what is likely to be done.

Susan Mitchell explains in the interview that both sides are saying this is something they need to look at because they understand it's such a big change, so it still could go either way. Very interesting situation for investors in these companies, but I thought it'd be worthwhile to talk to Susan Mitchell given what took place last week. 

Here's Susan Mitchell, the CEO of Mortgage Choice.

Listen to the podcast or read the full transcript below:

Susan, perhaps we could just start with the quote from the Hayne Royal Commission final report, where he said that the remuneration that mortgage brokers receive is conflicted, and that the trailing commission is money for nothing.  What's your response to that?

My response to that is really more about the trail.  If you go back with a little bit of history, you'll find that actually he's suggesting that we go back to kind of where we started, which was a larger upfront fee, and then there came a point in time in the history of broker remuneration where the banks said let's take part of that upfront fee, and let's split it.  Let's give you half upfront, and let's spread the rest of it over time to make sure that the loans don't go into arrears, and I'm not paying you completely upfront for a loan that sticks with me for just a period of time.

It was actually structured right upfront to be deferred upfront remuneration received over a period of time, and then it kind of morphed into a longer period of time, and then it kind of morphed in the bank's eyes to fee for service, and personally, I think that has to do a little bit with some of their accounting, so they could move it to an operating expense.

Once you put it in the historical context of how it actually got here and what it is, I would say that trail revenue is deferred upfront remuneration that ensures that the bank doesn't pay entirely for a product that's been introduced to them until they understand that it's not going to go into arrears in two months, that there is no fraud, that if it's a loan that someone actually doesn't quite fit a person's needs, they won't refinance.

How would it affect your business and your franchisee's business if the trailing commission was abolished?

It's really not about the structure.  I personally think that the structure that we have right now actually works very well and ensures good consumer outcomes, as well as good broker outcomes.  Just to state my case right now, I understand that that is not the proposition.

The most important thing is actually the quantum.  If the structure changes, we're a business.  We will adapt to that.  We're resilient, we've adapted to other changes in the past.  I think the main thing, the main question, is the quantum, and the reason why I bring that up is because the proposal that Matt Comyn actually made in the Royal Commission wasn't about changing structure, it was actually about changing the quantum.  If you look and see, his proposal was about 35% of what's paid now, so that, I think, is just not commercially viable.

Oh, I see, he just wants to cut commissions, cut what's paid to mortgage brokers.

Exactly.

Of course, he does.

If you read some of the papers that some of the exhibits to the Royal Commission, I mean, I'm not creating any new information.  It's right there.  They had a distinct plan to actually disrupt the broker industry, so that they could bring more consumers back into their branch network, and they could get more value out of the branches that they were paying for.  It was a distinct line.  You can read it in the papers, yeah.

Sure, but that's not what Hayne went with.  Hayne's gone with an abolition of the trailing commission.

Yeah, and then moving onto consumer pay.  Consumer paid being the thing that actually puts the nail in the coffin.  I don't think that taking away trail, as long as it's replaced in a larger upfront that allows the overall quantum to remain fairly similar.  I think that's the important point, is getting rid of trail, but replacing it with what...  One of the things that's so difficult for the broking community right now is they've been very specific, and said, "You will take away trail, but we're going to let people figure out later what to replace it with."

You have 17,000 small businesses, where you're just telling them you're going to completely earn a different level of revenue in a year from now, but actually, I'm not going to tell you what it is.  I'm just going to tell you that some bits are leaving.  I'm not telling you what's going to replace it, and you don't actually get to consult on that either, by the way.  I'm going to announce it at 4:30 on Monday, and we're all done by 4:45 on Monday, and there it is.  Whereas the financial planning industry consulted for two or three years, and actually had input into what the structure was that they were going to be participating in, whereas I feel that Commissioner Hayne wants to simplify things, that was one of his overall messages, and isn't it just simpler if we just say brokers are planners, and we just plug them in over here, and now we're done.  Isn't that simple?  Isn't that nice?  It's all neat and tidy.

But you're right.  Hayne's point is that the remuneration, the fact that the banks pay the brokers makes their remuneration conflicted, so he wants the clients, the borrowers, to pay the brokers.  Do you think that borrowers will pay brokers?

I think borrowers will brokers.  I think the point is that borrowers will not pay brokers a fee that makes the channel commercially viable because I think there's already been several people who have done research on that, and the fees that the broker would pay are not enough to keep the channel going, especially with the added compliance that keeps being added.

Doesn't that tell us that the service that brokers provide to borrowers is not valuable enough for the brokers to make a living from it, fundamentally?

No, I don't think that that's what it means at all.  I think you need to look at who's using a broker.  You've got 60% of the people using a broker, and they've got a 95% satisfaction rating, a 70% Net Promoter Score.  Who has a 70% Net Promoter Score?  You look at the complaints in the first month of AFCA, in November, and 27 or 29 of them were broker complaints, and the other 65...  150 complaints were about somebody else.  I don't think that there's a fundamental problem here, and you've got great competition. 

When I go and look at our results, the Mortgage Choice result packages, we track what we place with the big four, and then what we place with other banks, and it's been going up.  Competition is at the forefront of what brokers do.  Those are a huge amount of advantages, and the consumer gets the same rate going through the broker than they do going through the branch channel.  Actually, the whole system works.

All that data you mentioned...

You can't tell me the consumer doesn't value the broker just because they don't...

No, I'm sure they do.  I'm sure all that data you said about the Net Promoter Scorer, and everything, is true, but it's all based on the fact that the consumer doesn't pay for it.  I'm sure if the consumer paid for it, it'd be a different story entirely.

The research shows that.  The research shows that they wouldn't pay more than 1000 or 1500 for it, and there's some similar research that's come through with financial planning that's having difficult being successful under FOFA, and totally going to a fee for service. 

You're right.  There's a cultural thing here in Australia, and they don't want to pay full freight for this, but I guess what I'm trying to say is the customer, when they go to the bank and they're getting a loan, they're effectively paying for the branch network, and they're effectively paying for the brokers.  They're paying for all of that support.  If we took away the brokers, they're going to have to pay for all the other people that the banks are now going to have to hire to get the 50% of their loans that are coming through a broker, who does it a lot cheaper than a bank employee's going to do it. 

The consumer's kind of already paying for it, so I'm not going to translate into brokers aren't worth it because the consumer's not willing to pay $5000 for them.  I think that they serve their purpose.  They do a great job, they do a lot for competition.  They serve as price discovery in an opaque pricing world, which Australia is.  There's an ACCC report on that.  They provide financial education, they deal with people before and after the loans.  There's a lot of people they do work for that they never get paid for because the loan never gets across, so I can't get excited...  I guess, that's not a great way to put it.

It's just not broken.  That's my point.  The point I'm trying to make in a very long-winded answer is it's just not broken now.

Perhaps we should focus on the point you're making about competition.  I think you've got a panel of lenders that all of your franchisees use.  How many lenders are on the panel?

It's growing.  We're trying to grow our panel right now.  Probably about 25 to 27, depending on what state you're in.  Some lenders are just restricted to a particular state because that's all they're interested in.  Some lenders don't have a personal preference.

Obviously the big four are on the panel, so that means there's another 20 or so, 22 or something, lenders are not the big four banks on the panel.  How much difference is there between the commissions that each of those lenders pay?

Almost nothing.  If you look at the ASIC report, you'll see that the commissions are actually not that different.  At Mortgage Choice, actually, we do something different.  We do something called Pay the Same, which would be a great solution for everybody if we'd have the opportunity to present it, is in a consultation period, is we take all the commissions and we average them together.  We pay our brokers based on the average, the pool average.  Actually, our brokers don't even know if CBA pays 65, and CUA pays 66, or someone pays 55, and someone pays 65. 

The reality is is they are not that far apart, and I think, I'll be honest with you, if you're actually down on the ground, there are so many things that make a broker pick a particular lender.  There's price, but a huge amount of it's going to be credit policy.  In other words, will I even lend against that piece of property that you have?  Some banks won't lend against small apartments.  Some banks won't lend against regional properties.  Some people won't lend against that flat in that building because they already have 25 in that building.  A lot of it's going to be credit policy.

And then the rest, the third one would be service.  I think you’re going to find, if you can find a couple of banks, if you're fortunate enough to find a couple of banks that you consumer fits into, believe me, you're not basing that where you're putting it on commission.  My guys certainly aren't because they're paid the same.

You said that you're tracking the banks or the lenders, that are getting your business.  Over the past 12 months or so, what proportion of loans have been written outside the big four?

I'm going to tell you in two seconds.  We publish this information as part of our information pack when we give our results each half-year.  If I go back to the results from August, which would have been our most recent pack that's public, and of course, we'll be coming out next week, and we'll have that information in that pack again.  I'm sorry, I'm getting to the right page.  I apologise.  We wrote 34, 47, let's say 50% of our...  Well, 48% of our loans did not go to a big four.

Right.

In the last time that we report...

Roughly half and half between the big four and the rest.

Yes.  Now, please understand...

I mean, that's still...

That's pretty good.

Sure, but it's still four banks getting 50% of your business.

Yes, I know, but if you go and you look at the market share of CBA, it's already at, say, 20, 22, something like that.  Let's say Westpac's very similar, and then ANZ and NAB, when you add them all up, they're going to be more than 50, so actually, we're moving that dial.

Are you saying that, in general, mortgage brokers write loans to the big four that are less than their market share?  That the flow of loans to the big four is less than the existing market share?

I'm saying you're making a pretty big statement on a fact that I gave you.  A fact that I gave you was that for the year ending FY18, I'm just going to stick to the facts.  The year ending FY18 June.  We wrote 42% of our loans to the big four banks.  Now, I want to be clear on that data.  That does not include St George or Bankwest because they actually have completely different credit policies.

Right, and about Bank of Melbourne?

So, it's just the big four banks.  Bank of Melbourne is St George.  There is no separate rule for St George, so is the BankSA.  That's all in that St George pot.

Is that changing over time?

Yes.  That chart is in our presentation.  Over time, we show it for the last one, two, three, four, five, six, seven, eight, nine, 10 years.  We show it for the last 10 years, and it's come from FY09.  It's come from like 69% just big four down to 42 in FY18.

Right.  I guess, that's your argument that the brokers are a force for competition.

Yes, it was.  I also think that if you look historically, there's been a reduction in the NIM over time, and I know it hasn't come down much further in the last couple of years, but I think one of the reasons it hasn't expanded is also because the brokers are here because the reality is is it's hard for a consumer to go out and truly research prices because a lot of the discounts, they're not on the websites.  Hayne's comment that mortgages are just like hotel rooms shows a naivety about how the market actually works.  You don't actually find out what your...  No one gets a standard variable rate.  You know that, and you don't actually know what your discount is until you're probably pretty far into the process.  A lot of those aren't advertised.  They're negotiated on a one-on-one basis.

The idea that you can get true price discovery from looking at websites, I think, is a fallacy, and one of the huge advantages that happens with competition with the way it's structured now is that the brokers provide that price discovery for the consumer that they can't do.  A broker can do it, and they can do it quickly because they're in and they're in tap with the market, and because they know that, the different banks have to meet the market.  The broker forces them to do that.  It's hard for a consumer to do that because they'd have to go around and go through an application process with five different banks.

One of the things people have said to me about Mortgage Choice is that although it's not owned by one of the banks, it's actually owned by a few of the banks.  I see that Commonwealth Bank owns 20%.  I can't see any other banks on your share register.  The suggestion has been made that Mortgage Choice is actually not quite controlled by the banks, but certainly part-owned by them.  Is that right?

Yes, it's a fact, but not exactly the way you've set it out.  I'll give you the exact facts.  So, Count Financial, which was an accounting firm, owned 17% of Mortgage Choice.  CBA bought Count, and therefore, acquired its stake in Mortgage Choice.  They have never sold that stake.  It is 17%.  The other 3% relates to holdings in Colonial Funds.  In other words, there would be a curtain between the two of those.  They're unrelated to each other.  They're not held for the beneficial account of the bank, but the bank does own 17%, and they do not have a board seat.  That's been since like 2010, I think, and then that 17% stakeholding in Mortgage Choice has been put into the group of assets that CBA is selling off.  You know, there's a group of assets that they are selling off during this year, probably about next September, and it includes Aussie, their stake in Mortgage Choice, and their ownership in several financial planning businesses.

Right, and none of the other banks have got a significant shareholding?

No to that.  I actually don't think that banks have any shareholdings.  I don't think that there's another bank that has a shareholding.

Okay.

Now, if it says a bank's name, you need to be careful that it's not a fund, as opposed to the bank holding it for their own account.  Our holding with CBA is actually held for their own account.

Yes.

But there is no board seat.

Right.  Mortgage Choice's future, has that become kind of binary now, where either Hayne's recommendations are implemented in full, or they're not?  If they are, then Mortgage Choice has a very difficult future, and if they're not, you're okay?

It's hard to know.  If I take Hayne's suggestions as a group, it will be difficult for the entire mortgage broking industry because we will need to adapt to a user pays if that does go all the way through.  If we put that one aside, and we just stick with the other four, which would be trail, best interests, goes into the financial services structure, and the last one's kind of participating in a program to monitor brokers throughout the industry, so you can make sure you get bad apples out of the industry.  That's kind of the group of things that go to Mortgage Choice.

Back to the conversation where we started, which is if you take away trail, remember, we started without trail.  If you take away trail, it's the quantum.  If there's enough quantum to make up for the loss of trail, absolutely.  The reality is 60% of the market uses a broker, so that proposition from the Royal Commission doesn't change.  People actually are voting with their feet.  They want to leave the banks and going straight to the bank branch.  They want to go to the broker.  They get service, they get choice, they get financial education.  It's a great product, and it's a great way to introduce competition into the system, so I absolutely think that Mortgage Choice can be a resilient and adapt.

As long as it doesn't go to user pays, or at least borrower pays.

I'm not going to say that.  I'm going to say that one's more difficult, and there's so much uncertainty around that, that I'm actually not sure I...  That's a very difficult one to answer because I actually don't know what that looks like because the more I look into the Dutch model, understanding that that's what Hayne has referred to, I just find so many hairs on that.  I just have an incredibly difficult time believing that that's going to be implemented.  It's fraught with hazard. 

You've got the concept that the fee is anywhere from 2000 to 3000 euros, so that's actually 5000 bucks.  You've got Hayne saying, "Oh, it's no big deal.  It's just a small amount of money.  Capitalise it in the loan," but ASIC has been after us for years not to capitalise extra things in the loan.  You've got over the last 10 years, you've lost about half the banks in the Netherlands.  It's become one of the most concentrated financial services industries in Europe.  I'm not sure that that helps competition.  If you look further into the system, you're going to see that actually they have one of the highest loans.  The consumers have some of the very largest loans. 

I just can't see that if you actually look at some of the results of that, when they research it, they're going to find that that's the direction that they want to go in.  It's actually the only model I could find that has that difference between the customer paying at the branch and at the broker, so it implies to me that CBA has thought that one out to their advantage.

The English may have looked at that, and they stuck with the lender pays.  The Irish looked at it, they stuck with the lender pays.  I'm confused as to why it is that this is the model to follow, so there's just uncertainty.  It's very difficult to answer that question.

The Labor Party, I think before the final report was released, said that they would implement all of the recommendations, whatever they were.  Do you think you understand where the ALP now sits on these things?  Because it's possible that it's their opinion that matters.

Well, some of the polls might indicate that that's the case.  I don't know that I know exactly where the ALP stands on it.  I think that their language has shifted slightly a little bit from they will do everything to...  I've forgotten the exact language.  You're probably more familiar than I am.  That they would do it in essence or...  I'd have to find the language, but it doesn't imply that it looks exactly like everything.  I would say that we won't really know, really, I would say, the ALP's plans frankly, until after, if they are successfully elected.  I think that's probably more likely that that's when we'll hear more about their plans.

And the Coalition's plan, they haven't made up their mind, is that right?

Well, it looks like, from what I've heard so far, that they kind of went with everything except for the consumer pays.

Right.

They seem to have taken up every recommendation except for that one, and if I read theirs correctly, they wanted to have a look at it in about three years, and just see what was going on with the competition.  I think the main message I got from the Coalition, and I'm actually getting a fairly similar one from the Labor Party, which is they're cognisant that this would be a huge change, and that there needs to be some discussion, and some involvement, and some analysis as time goes by to see, actually, what happens.  But you're right, ALP has said upfront that they will implement everything, and the Coalition to date has said they'll implement everything...

Except that.

...but this one item, and they're saying we need to look at it again in a couple of years, and see what's happened with letting go of trail.

Yes.  Well, it's really good to talk to you, Susan.  I appreciate your time.  Thank you.

Thank you.  I appreciate the opportunity.

That was Susan Mitchell, the CEO of Mortgage Choice.