Mortgage brokers were also reviewed briefly in Issue 116 of the Business Values Newsletter in July 2011. Whilst the primary focus of the FOFA legislation was aimed at financial planners (see our article on financial planners in this newsletter) as time goes on it is likely that mortgage brokers will see further impacts from this legislation. For example, in the next five years fee structures that currently include volume based/trail commissions for mortgage broking services may be the subject of increased scrutiny and reforms. Whether this happens to the extent that it has in the financial planning industry, is however dependent somewhat as to whether mortgage brokers are seen as financial advisors, or more simply as product sellers.
Mortgage brokers aid borrowers in sourcing and applying for mortgage finance. They normally do not charge any fees to their mortgagee clients but rather receive origination and trailing commissions from lenders. The sector now holds around 50% of the new home lending market.
The mortgage broking industry in Australia has annual revenue of approximately 2.2 billion dollars. It is made up of around 5,800 businesses. Major players include large mortgage broking groups such as Australian Finance Group Limited (AFG) and Mortgage Choice which hold 23.1% and 8.6% of the market respectively. The Commonwealth Bank of Australia, through its purchase of Aussie Home Loans in recent years, holds around 14.2%.
The broking groups provide support, marketing, compliance and ongoing education to the individually owned brokerages. The vast majority of products sold (around 90%) are residential loans for investors, owner occupiers and refinancing with only around 10% being for commercial, personal or other loans.
Total revenue in the industry has increased by an estimated 8.1% per annum over the past five years due to factors including the following:
- Favourable credit conditions with low interest rates.
- Continuing gain in market share from banks as mortgage brokers are seen as providing unbiased advice and offering a greater array of products.
- Increasing house prices (particularly in main states of NSW and Victoria).
- Strong growth in the number of new homes built.
Going forward over the next five years revenue growth is forecast to slow significantly to as little as 0.1% per annum, due to the following main reasons:
- Predicted sluggish growth in the residential property market.
- Higher competition amongst brokers to put downward pressure on profitability.
- Banks pushing to cut the commissions that they pay.
The market conditions going forward are likely to lead to consolidations and a reduction in the number of businesses in the sector.
Wages make up over 62% of expenses, other expenses 20% to 21 % and profit around 17%. Profit margins have been decreasing due to increased competition and pressure on margins.
For smaller mortgage broking businesses with around three or less brokers working in them, valuations are mainly done using “the market value method”. This method effectively applies a multiple against the trail commissions. It is only for larger businesses where additional goodwill for other commission income and revenue can apply.
The actual multiple paid for trailing commissions typically varies between 1.5 to 2.3 times the trail commissions dependent upon factors including the following:
- Franchise agreement/level of restrictions and royalties paid.
- Drop off rate of loans in recent years/average length of loan.
- % Growth in size of trail book growth in recent years.
- Size of loans and trailing commissions paid.
- Level of personal goodwill of owners.