What is a broker worth?

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What is a broker worth?Fed up with the negative messages bombarding the broker sector Ian Lane, Senior Business Development Manager Nationalcorp Home Loans set about researching and assessing a broker’s true value.

The result, the first Australian study of its kind, is eye opening.

Late last year Nationalcorp Home Loans carried out a survey and discovered that brokers are buying into fear, which is leading them to choose to deal with banks over non-banks in order to satisfy their customers’ false notion of security.

The purpose of Lane’s work is to attempt to change the mindset of brokers and arrest them away from damaging industry talk.

His concern is “they’ll get to a point where they accept only upfront commissions and no trails”.

“It’s a bit like the boiling frog analogy,” he told Lending Central.

“It starts out in cold water and before it knows what’s happening it’s boiled. That’s what’s happening with brokers.”

Lane used three methods to determine a broker’s value; a business model, a professional time costing model and a value to customer model. His comparisons between financial costings follow.

Method 1 the Business Model

A single broker with no support, working from a serviced office compared to a salaried mobile lender.

The broker’s cost structure would look something like this:

Per Month:

1. Office Rent: $1,150
2. Professional Indemnity Insurance: $125
3. Broker Organisation Membership: $50
4. Car Cost: $700
5. Fuel: $200
6. Insurance: $100
7. Internet: $100
8. Advertising/Referral fees: $500
9. Ombudsman Membership: $25
10. Continuing Education: $100
11. Stationary/Postage etc: $100
12. Phone: $300
Total: $3,450

If the broker grosses the same as a mobile lender, whose package is about $120,000 (base $60,000 + car + expenses + commission), then gross turnover needs to be $10,000 per month. Less expenses of $3,450, leaves $6,550 or $78,600 per annum including super etc.

To turnover $10,000 per month the broker needs to settle $24,000,000 in loans per annum at .50% upfront commission, or, at an average loan size of $254,000 (APRA/ABS figures), 8.59 loans per month for 11 months allowing for one months holiday.

Not every appointment goes to an application, not every application settles, the figures used to determine how much time is taken up in the month are based on industry evidence and will vary from broker to broker.

Starting from the number of loans that need to be settled we can work out the following:

Applications that settle: 65% (industry figures)
Applications needed to achieve target of 8.59 settlements: 13.22
Appointments to application at 75% conversion: 17.63
Calls/Contacts conversion to interview: 60% or 29.38 calls

This gives us a framework to find a time value:


Method 2 the Professional Time cost model

Professional firms use a rule of thumb of 1/3 salaries, 1/3 costs and 1/3 profit to determine their charge out rates. Using a formula accepted by accounting and legal professions and the $78,600 broker’s income, as the professional’s salary, calculating an hourly charge out rate gives the following outcome:

Alternatively, in the case of a bank using a mobile lender instead of a broker the cost structure would be roughly:

To recap, broker hourly rate $64.39, accountant $99.13 and mobile lender $87.27!
So in relative terms the broker is cheaper all the way through.

To achieve the total return to the bank at the same rate of profitability as a broker, a mobile lender needs to generate $28,800,000 in settlements.

These models are great for a business case but what about from a customer perspective? We know that rates have been driven down by competition in the past, so the customer is better off. The problem is there is little information available to put a dollar value on the broker from a client’s perspective. Contacting broker organisations and conducting internet and academic database searches show that we know how to put a value on the time component, the problem area is the intangible knowledge and value component.

In an article on “Fourteen ways to charge for knowledge”, Karl-Erik Sveiby discusses how to approach this using commissions, percentages of the outcome (loan amount), taking equity for effort, success fees and so on, you get the idea. Still intangible as he puts no dollar figure on any outcome, Sveiby says putting a traditional value on intangible items such as knowledge does not work, and there are a body of authors who agree with him.

Method 3 the Customer value model

There are some activities we can quantify with the broker acting on behalf of the customer:

On the average loans size of $254,000 this equates to an upfront cost of .45%.

On the knowledge or value side, the following is put forward as a suggested framework.

Today’s brokers and their customers are benefitting from the work of non-bank lenders and brokers in the 90’s and early 2000’s. The RBA only started to show figures on discounted loan interest rates from major banks in 2004 and these discounts only came about from competition in the industry. The difference between the standard variable rate and the discounted rate in December of 2008, according to the RBA was .65%. It is not the case that a customer who qualifies for this discount will be offered it if they go direct to the bank. It is also possible, depending on the loan offered by the bank, to have a whole raft of fees associated with the total package, increasing the real cost.

This is where ‘knowledge value’ enters the equation. The benefit of a reduced rate to the customer in the first year using the average loan size of $254,000 at .65% is $1,651. The broker has used technology, industry knowledge, independence, buying power and competitive pressure to bring this benefit to the customer, and it is for the life of the loan.

Add the first year benefit (success fee) to the previous total and the value proposition to the customer is $2,792.35, or 1.10% of the loan amount.

Conclusion

Lane maintains that whether you agree with his numbers or logic it is hard to deny the case that brokers are worth more than current commission rates reflect.

“According to the customer value model the broker is worth $141.60 an hour and provides a lifetime benefit of $50,671. To the banks the broker represents a saving, on current commission rates, over a mobile lender of a minimum of $24,000. The brokers’ net income is not exorbitant, as claimed by some industry figures, nor is their time spent neglectfully,” he says.

“To arrest the downward trend in commission rates, brokers need to reignite competition using the non-bank lenders, address total cost of loans not just rate and listen less to the fear mongering of the “big” banks. The alternative is to watch incomes decline and work for less than the average wage.”

Declaring that brokers are being seriously undervalued Lane concludes by saying “if brokers don’t create competition there’ll be nowhere for them to go”.

“Don’t allow banks to dictate your terms. If you do it’s going to be at your own expense,” he says.

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7 COMMENTS

  1. Finally, we have someone who has done the analysis and posted it for all to see – well done. Whilst the numbers will vary from state to state and broker to broker, it is pretty spot on. Another thing I do is track my dollar earn per loan and I have done this for 15 years. Mine has increased year on year and it is because the average loan amount has increased.

    I feel that brokers need to focus on dollar earn per loan and work on increasing this. In order to increase the dollar earn brokers need to focus on either increasing their average loan (ie find clients with higher loans)or place their business with lenders that pay higher commission levels (or combination thereof). Total loan volume is not so relevant – the trick is to write more volume with less loans at a higher average commission level because by and large, the amount of work is the same regardless of the size of the loan. This is the key to managing work flow and your hourly rate.

    Brokers need to look at their business as if it is a processing business and focus on efficiencies. So many brokers will write whatever business they can and then wonder why they are working long hours for less return.

  2. Finally. Great research. We look at our business as a cost per transaction which incorporates all overheads etc. If we won’t make our money back, we either agree to accept the business and charge a fee to the client or pass on the business respectfully.

    Not enough brokers are running a business whcih is why any article revolving around comissions tends to get so much attention. If you write more and more, year on year, and constantly look to control overheads then the cuts aren’t as savage. A cut in volumes has the same effect on the bottom line and this could occur for a thousand reasons other than what the lenders are doing with comms.

    I would like to have things return to the previous comm levels but we are just pushing through to August when our trails start to come back again and try to spread the business around.

    Great article.

  3. Hi there, Ian you have way to much time on your hands…but very nicely presented. Brokers are not only looking at the major banks for the reasons you stated but also due to product changes and interest rates. The current financial debacle has also made the government take their eye off the ball in regards to market control; this issue is of more concern then anything else. Currently there are two lenders who are getting over 80% of the business written today. This issue will have a greater impact on long term market influences/control, as we all know; no competition equals expensive products and less pay. The two banks mentioned have a track record of beating up brokers and wanting to control the market, your thoughts…

  4. This is hardly an objective or even realistic study, as the introduction states his agenda: “The purpose of Lane’s work is to attempt to change the mindset of brokers”.
    The budgeting model might apply to a broker just starting out, but it doesn’t take into account changes in focus as determined by market conditions over time. It doesn’t factor in a fall off of loans, early repayment, property sell off rate or attach any value to the ability to keep a customer due to obtaining the best loan etc., and simply determines worth by an hourly rate. If you follow the logic, a broker who earns more then the above “per hour”, isn’t as cost effective to a lender. I admire the maths but not the reality.

  5. Brilliant research and thought proces even though there are some minor flaws in drop off rates, clawbacks and perhaps the life of a loan. However what it does highlight is that brokers need to seriously analyse their business and decide if they are writing enough loans to justify their business. 8 or 9 Loans a month doesn’t sound much to make an average income as I read the analysis but it appears to be about right even if there are minor flaws in the analysis and there are an awfull lot of brokers not writing that many. To make a really ‘good’ living you need a lot more than 8 or 9 a month.

  6. GReat info and I am 100 % sure this just confirms what every full time broker knows.
    I find this very usefull info for looking at how best to package a Salary for a new loan writer.
    Interest rate discounting has already come under fire and I firmly believe it is the big four bank’s agenda to reduce discounted lending via the broker channel. We have all been sucked into the easy sell of cheapeast rate…NOW we have to remind ourselves to sell ourselves based on service.
    IN the future customers will be able to get cheaper rates at the branch and quicker answers…..so what must we do?
    Look at spreading your business now to other lenders outside the big four, IF you do not then no matter how much you justify your salary and value you will lose!
    Get back to basics; reduce costs, do more yourself, sell based on service, be prepared to walk away from a deal sometimes, contact customers 6 times per year and do more then home loans for your customers…..IF YOU DONT’t then you can forget about what dollar value we add….there will be no business to value.
    The home loan broker of 2007 is now dead, as it was a model that was working only during a boom.

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