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:
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
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.
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.