Setting out their stall

Grant Bather

June 10, 2006

Mortgage networks have certainly been the subject of strong views ever since they came into being on ‘Mortgage-Day’.

Kevin Duffy, managing director of Hamptons International Mortgages, recently summed up current sentiment when he was quoted as saying: “As for networks, I sense that their day of reckoning has arrived. This is a chronically over-populated sector that I believe has been wrong-footed by the fact that, post-regulation, many mortgage practitioners either remained or became directly authorised (DA).” He went on to say: “Many networks add real value for their members via product procurement, fee collection, and compliance support services, but operating margins within smaller firms are skinny at best, not least because commission shares are weighted so heavily in favour of the appointed representative (AR).”

So, there you have it. There are too many networks, they don’t make enough money, but they do provide a useful service to members. So is Duffy right or is this an unfair analysis of where networks are currently at?

Let’s start with the facts. On ‘Mortgage-Day’, 31 October 2004, out of a total market of 13,500 mortgage intermediaries registered with the MCCB, 52 per cent chose to become DAs, while 39.7 per cent opted for AR status, 6 per cent left the market altogether and 1.6 per cent withdrew from authorisation.

At the time, 69 networks registered to do business, but today there are only 26, representing a total of 2,383 firms (as at 31 March 2006). The largest, Network Data Ltd, has 568 firms and, in terms of the number of member firms, is in a league of its own. The second largest is Pink Home Loans with 192 firms and the smallest is Connect Mortgage Network with just two member firms.

Quality of business

To put a bit more flesh on the bones, 10 networks have more than 100 member firms; six have between 50 and 100 firms; and 10 have less than 50 member firms.

The viability of networks, of course, is not simply dictated by the number of member firms it has. The volume and quality of business generated by the members is equally, if not more, important in determining the profitability of an organisation. However, all networks have to provide their members with a minimum standard of regulatory support and this means a significant investment in infrastructure, even if one member firm generates only one mortgage case each year.

In my opinion, I believe the economics of running a network of approximately 90 member firms or less has to be questionable (and this is a number I put forward knowing it will probably be shot down in flames). The fixed costs involved in providing a robust compliance infrastructure and adequate levels of support and supervision are considerable and small networks simply cannot generate sufficient income to offset that substantial cost base.

So, the statistics and economics of the mortgage network market appear to support Duffy’s claims. The majority of mortgage brokers did opt for DA status at ‘Mortgage-Day’, there were too many networks and considerable consolidation has already taken place and margins are thin, especially for smaller organisations.

Day of reckoning?

However, all of this doesn’t mean the day of reckoning has arrived for networks. As Duffy acknowledged, networks do provide their members with an essential support service, and this is the reason I am totally confident that networks are going to be an important part of the UK mortgage market for a long time to come.

The need for networks has not been entirely driven by regulation. The concept of organisations providing mortgage brokers with support services and leveraging the benefits of collective bargaining power has been about since the late 1980’s and early 1990’s, when organisations such as Private Label and TMO first came into being. Mortgage Next was launched in the mid 90’s and our raison d’etre at that time was to provide brokers with access to more competitive mortgage products and procuration fees than they could negotiate for themselves.

Inevitably, some of the ‘clubs’ transformed themselves into networks come ‘Mortgage-Day’ and Pink, Mortgage Intelligence, Network Data and Mortgage Next are just a few examples of businesses which made this transformation. Some of these companies also continue to offer a mortgage club service to DA brokers.

Has that transformation worked? To a large degree, yes. Research clearly indicates that the vast majority of brokers are happy with the regulatory choice they made at ‘Mortgage-Day’. A Datamonitor report, published at the end of 2005, confirmed 87.4 per cent of mortgage intermediaries have not changed regulatory status since ‘Mortgage-Day’ and have no intention of doing so in the near future.

There is always talk about disgruntled ARs, but research indicates less than 10 per cent of AR intermediaries have any intention of changing status (3 per cent have not yet made up their minds). The anecdotal feedback we get at Mortgage Next supports these statistics. The vast majority of ARs recognise that providing a comprehensive compliance support service themselves would probably not be a practical proposition for their business. This is especially true for smaller firms of up to 10 financial advisers.

Burden of regulation

The burden of dealing with regulation is an issue about which ARs are probably far more aware than most DA brokers. The truth is that the majority of brokers who opted for DA status have not yet been touched by regulation. Very few have had a Financial Services Authority (FSA) visit and their systems and procedures have not been fully tested. I suspect when the FSA does turn its attention to the DA sector – which it must eventually do to retain its credibility as an effective regulator – a number of DA brokers are in for a nasty shock and may run for the regulatory cover provided by a network.

Networks provide their members with all encompassing regulatory support, which includes the monitoring of all business, annual visits, completion of RMAR returns, the provision of personal indemnity insurance cover and help with everything from complaints handling to advice and checking of advertising and promotional materials.

Networks also provide essential point-of-sale systems (and associated training support), not to mention maintaining lender panels, negotiating exclusive deals and enhanced procuration fees as well as providing life and protection products and a wide range of other products and services. In short, networks are true ‘parental’ organisations, providing everything an AR needs to sustain their business. In reality, most small firms would find it more expensive to provide the equivalent level of support themselves, than by belonging to a mortgage network.

Too much ‘parental’ control?

But does the parent exert too much control which restricts the activities of its siblings? No. The ‘parent’ analogy should not be taken too far because, unlike children, ARs have the ultimate say in their future destiny. They can, if they so wish, move to another principal or change status altogether. The truth is that networks have to provide comprehensive panels, competitive proc fees and competitive services, or members will vote with their feet.

The level of switching between networks has been low. There has been some disenchantment, particularly with networks that are not specialists in the mortgage market. There has also been concern about the way in which some networks have attempted to lock-in their ARs to prevent them moving. I am aware of network contracts, which include clauses enabling the network to hold on to procuration fees in the event of a member leaving and which also insist on six years PI run-off cover being provided. I suspect such clauses are so onerous they are probably unenforceable, but it does pay for intermediaries to read contracts carefully before committing to them.

So what of the future? Will there be only five big networks, as some people have projected? There is no doubt that further consolidation will take place but I doubt numbers will reduce to as low as five. Although it makes sense for networks to acquire other networks to increase their critical mass, very few are willing to commit substantial sums of capital to this type of shopping spree. Mergers are a more likely outcome, but they are fraught with problems of ownership and control. Deals will be done, but don’t expect a rush. A continuous tickle is more likely.

As networks look to the future, so they will have to listen more carefully to their members. Inevitably, prior to ‘Mortgage-Day’, networks set out their stalls and hoped sufficient numbers of intermediaries would find their proposition compelling. Today, networks can ask their members what they like and dislike about the service being provided and then fine-tune it for the future. Listening to members is a key skill for principals in the future.

Of course, mortgage brokers also have an option which was not open to them prior to ‘Mortgage-Day’. Before committing to a network, they can ask its members what they think about the service on offer. There’s no substitute to hearing it from the horses mouth.

Running a network is a long-term challenge and one that is far easier and less nerve-wracking if you have substantial corporate backing. However, for all the pitfalls and problems, there’s no doubt networks are going to be an essential part of the market for many years to come.

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