Trailing off...?

At a recent roundtable discussion with mortgage managers from across Australia, the consensus on the future of trail commissions was unanimous.

"Trailers will be gone for sure," said Ken Sayer, managing director of Mortgage House.

His words were met with murmurs of agreement.

Mortgage managers have been warning brokers for months that continued support of the major banks will have disastrous consequences for the third party channel.

They are predicting that major banks - bolstered by market dominance and the continued scarcity of securitized funding for non-banks - will increase their margins by further cutting commissions - upfronts and trail.

But is this a real threat, or scaremongering by a mortgage sector hoping to claw back market share?

Australian Mortgage Brokers (AMB) CEO Paul Gollan says rumours that trail will disappear are "absolute rubbish".

"The organisations that are saying this are the ones that stand to benefit from brokers buying into this argument," he says.

While Gollan says it is dangerous for 90% of business to be going to the banks, but he can't imagine any lender cutting trails at this point.
 
"I don't think it makes commercial sense for the banks to try it. They would have to know that the other major banks would follow suit and the only way they'd know would be if they were colluding. So assuming that they're not breaking the law, I just don't believe it will disappear in the next five years," he says.

Stepping back

You can't determine where trail is heading without taking a look at how it came into being.

Trail commissions first materialized in Australia in 1996. At the time margins were good and broker groups started to ask lenders for a share in the ongoing profits. In an effort to woo brokers' business, some lenders broke ranks and started paying trail - and it wasn't long before all the major players followed.

By 1998, brokers were making trail commissions of 25bps - but upfronts were lower. Brokers selling HomeSide products, for example, were making a flat upfront fee of $400.

By 2000, the Australian mortgage industry went through a period of dramatic growth and the emphasis switched to upfront commissions.

"The veracity around which companies were looking for volume and product sales led the market to about 70bps upfront as an average," says Matt Lawler, regional general manager of NAB Broker.

Then by about 2005, lenders started to tweak trails. CBA, for instance, changed trail commissions to 20bps in year one from the date of funding and 25bps from year two.

NAB took a slightly different approach and introduced a trail commission that progressively increased from 25bps in the fourth, fifth and sixth years.

Lawler says the decision was made to try and get more of a balance between product selling and ongoing client management.

"If you've got a large bias toward product sale, what you create is a product selling culture...but clients don't get serviced on an ongoing basis," he says.

"We wanted to encourage brokers who were looking at servicing clients and making sure the clients' needs were met not only at the time the product sale was made, but on an ongoing basis."

This brings us to 2008, at which time brokers saw the most dramatic changes to date. Across the industry, lenders lowered upfronts and reduced trails in year one.

For example, CBA changed trail commission to zero bps in year one and 20bps from year two, while NAB continued with its stepped trail philosophy - offering no trail commission in year one, but progressively increasing trail from 15bps in year two up to 35bps in years six and up.

Rounding the bend

Fujitsu Consulting's managing director Martin North, ventures that the future of trail in Australia is dependent on what role lenders believe brokers should have with respect to their clients.

"There are two arguments," he says. "The first put by NAB and a few others is they want brokers to switch from just doing the transaction to essentially being a quasi relationship manager of that customer over the medium term, so they've actually increased trail commissions, particularly in later years.

"So if you believe that the future of mortgage broking is more aligned to financial planning and advice, and relationship managing, then there's probably an argument for saying that trail commissions will have a place."

North argues that lenders adopting this philosophy may not squeeze trail commissions; however, brokers could expect them to make further reductions in the upfront.

The other school of thought, North says, is that mortgage broking is fundamentally transactional in nature and the trail commission is really not something that's relevant to that transaction. Lenders that want to take over that relationship are less likely to pay trail, but might keep upfront commissions high.

"My view is commission pools are smaller, there are less active brokers, and the four banks have major market power, so they will continue to drive commissions down -but whether they do it by reducing upfronts or trails will be determined by their business strategy vis-…-vis a transaction like CBA thinks, or is it a broader financial services relationship like NAB thinks," he says.

"I personally think we will see quite a lot of pressure on trail."

Comments from NAB indicate there are no plans afoot at the moment to make immediate changes.

"We're very comfortable with the balance that we've got in terms of the numbers. We think that we've got a good balance between encouraging the sale, and the work that's required to do the sale, and the ongoing service to the client," Lawler says.

He adds, however: "I don't think that everybody is in the same boat there. I think that some people have too much economics at the front end."

As for the CBA, Kathy Cummings, executive general manager of third party banking, says there are no immediate plans to change their current level of broker remuneration.

"There are almost no countries in the world where trails are paid," says Martin North, managing director of Fujitsu Consulting.

"Macquarie was the first to do it in Canada, but I'm not sure it's that widely used there. And certainly in New Zealand it's disappearing faster than you can say sliced bread."

Australia's Commonwealth brothers - New Zealand and Canada - are the only two other countries in the world where trail has ever had any traction.

While almost all lenders in Australia had already started paying trail by 1998, only one lender in New Zealand had introduced the ongoing commission at that time.

Of its four key lenders, only two others followed suit.

AMB CEO Paul Gollan, who was sent to New Zealand in 1998 to set up Ray White Financial Services for his former employer, says trail commissions never really got any traction in New Zealand because the majority of loans sold there are fixed rate mortgages.

"Because so many Kiwis love low margin, fixed rate mortgages, it became unsustainable for the banks in New Zealand to continue to pay trail," he says. "The second part of this is that New Zealand never had anywhere near the level of competition that we've got in Australia."

In Canada, trail is a much more recent invention and offered as an "option" for brokers, rather than a guaranteed part of their income.

According to a recent article in Canadian Mortgage Professional (CMP), while few lenders in Canada currently offer the trailer fee compensation model, it is gaining popularity with brokers who are looking for some income stability.

Merix Financial's president Boris Bozic said an estimated 75% of all approved originators - a 15% increase from 2007 - chose the model over the traditional upfront model in 2008. While 83% of the lender's new approved originators signed up for trailer fees.

"More and more originators are seeing the value of this model, especially in these tough economic times," Bozic said.

Macquarie Financial has reported increased interest in the trailer fee model, which the company introduced close to five years ago.

Grant Mackenzie, the company's CEO, says he's seen a slight increase from last year in brokers who opt for the original trailer fee model (75bps with trail every year) as opposed to those who choose an upfront payment with a trail on renewals.

"We're paying in excess of $100,000 a month in trailer fees," said Mackenzie. "When business isn't coming in for brokers, it's a good insurance policy for them to have."

While the idea of trail may be popular with Canadian brokers, it remains to be seen if more lenders adopt the model.

Do you predict trails will disappear in Australia? MPA asked aggregators for their response...

Michael Osborne, head of sales and marketing of The Brokerage:

"Any moves to remove trail would be a poor outcome for the necessary competitive elements in a market and for consumers as far as advice and ongoing relationship management."

Joe Sirianni, executive director of Smartline:

"Trail will continue. It is designed to reduce or eliminate churn which it does - if done correctly. Lenders will make sure broker groups do what they should, to earn that trail. They'll want brokers to implement a customer care program, since trail is paid to make sure the client sticks with the lender. Lenders are stick of 'set and forget' broker transactions, and are looking for broker groups to stay in contact with their customers."

Steve Lambert, CEO of National Brokers Group:

"What I'm trying to do with all our guys is trying to get them to cross sell different products and services, so that the client relationship stays with the broker rather than the lender. Once you've got that relationship the lender is going to be far less inclined to drop the trail because you actually are actively servicing the client, you're looking after them. You can't just provide a one-off transaction and think you deserve some trail. Once that takes more traction, it will be okay."

Steve Kane, managing director of FAST:

"There are some banks that clearly want brokers to be more involved with the management of customers which is what trailing commission is all about.
And there are a number of major banks that are keen to ensure that brokers have available data so they can help manage their customer relationship, that will reinforce and strengthen the position around trailing income."

Mark Haron, principle of Connective:

"Some lenders have increasing trail components. Brokers can take a lot of comfort out of that. That's a signal to brokers that banks see us as an important part of the ongoing relationship with the client. As brokers we've got to embrace that and make sure the banks offering that are getting that business and that will clearly signal to some of the other lenders that are considering not having trails as part of their offering that that's a no go zone."