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Explicit Compensation Disclosure – Part II

It’s shaping up as one of the most pivotal and contentious regulatory issues ever faced by mortgage brokers in B.C.

As noted in yesterday’s story, the B.C. broker regulator (FICOM) is proposing a change that would require mortgage brokers to communicate (to the dollar) the exact amount of compensation and perks lenders give them. That includes finders’ fees, volume bonuses, efficiency bonuses, lender “points,” free travel and other rewards. FICOM believes that consumers need to know how much these items are worth in order to judge the value of, and motivations behind, a mortgage broker’s services.

We have no reason to believe that FICOM’s intentions are not good. But, the way this change is executed could nonetheless have far-reaching unintended consequences for the industry and consumers, and not just in B.C. Here’s a breakdown of the issue.



Explicit Compensation Disclosure – Part II



It’s shaping up as one of the most pivotal and contentious regulatory issues ever faced by mortgage brokers in B.C.

As noted in yesterday’s story, the B.C. broker regulator (FICOM) is proposing a change that would require mortgage brokers to communicate (to the dollar) the exact amount of compensation and perks lenders give them. That includes finders’ fees, volume bonuses, efficiency bonuses, lender “points,” free travel and other rewards. FICOM believes that consumers need to know how much these items are worth in order to judge the value of, and motivations behind, a mortgage broker’s services.

We have no reason to believe that FICOM’s intentions are not good. But, the way this change is executed could nonetheless have far-reaching unintended consequences for the industry and consumers, and not just in B.C. Here’s a breakdown of the issue.

*********

How compensation disclosure works today in B.C.:

  • Mortgage brokers in British Columbia must make known that they’re being paid by a lender.
  • The precise dollar amount of compensation does not need to be disclosed.
  • Brokers must also disclose other conflicts of interest that could impact their mortgage recommendations. This is done on Form 10.
  • Here’s a look at the current B.C. Form 10 and its monetary conflict disclosures:

Form-10

Here’s what we know about FICOM’s position:

  • The regulator believes that consumers of financial services are more vulnerable than other consumers due to the complexity and intangibility of investments, insurance and mortgages.
    • As a result, borrowers place a much higher reliance on advisers’ recommendations
  • Compensation differences, incentives and status programs create conflicts of interest that cause some brokers to provide mortgage advice that’s not in the consumer’s best interest. This point is virtually impossible to refute.
  • FICOM says it receives “many complaints” from consumers about the advice they receive.
    • There have reportedly been no complaints in B.C. related to a lack of compensation disclosure by mortgage brokers.
    • In fact, many consumers may be unaware that pecuniary conflicts exist at all.
  • FICOM believes this change is justified and important enough to implement quickly (within a few months).
  • Compensation disclosure is a hot topic among regulators internationally.
    • This is not just an issue in B.C. or Canada, and it’s not just about mortgages. New rules are being developed for investment and insurance advisers as well. The compensation disclosure rules for investment advisers in “CRM 2” is but one example.
  • This is the regulator’s decision, it says. It does not need new laws to be passed or permission from other levels of government in order to effect this change.
  • A new Form 10 will be introduced to facilitate these enhanced disclosures.

Here’s what we know about our industry’s response:

  • Mortgage industry groups hold that FICOM is making this change unilaterally and prematurely.
  • They feel they have not been invited to participate in the customary commenting process that precedes regulatory changes of this magnitude. That’s a mistake. Regulators are not practitioners so financial rule-making without industry consultation runs a high risk of side effects and/or impracticality.
  • Broker trade groups, including CAAMP and MBABC, have reportedly received hundreds of comments on this proposal, and both have submitted written concerns to FICOM. Their position is that the proposed changes will harm both the industry and consumers.
  • MBABC argues that B.C.’s Registrar may not have the legal authority to make such impactful changes.
  • CAAMP has escalated the issue by directly appealing to B.C.’s Minister of Finance, requesting a more detailed review of the potential implications.

Why this idea needs re-thinking:

  • Research does not support disclosing compensation to the dollar:
    • There is ample evidence to show that broker-originated mortgages cost consumers less compared to mortgages from most banks and credit unions. Findings from Bank of Canada studies show this clearly.
    • To the best of our knowledge, the regulator has not publicly cited data showing that lender compensation and benefits cause consumers in general to pay more, especially when compared to mortgages originated by banks and credit unions.
    • One landmark U.S. study showed that detailed compensation disclosure actually confuses consumers, leading people to choose mortgages that are “more expensive than the available alternatives.” Following these findings, American regulators adopted an alternative compensation disclosure method that was simpler and less onerous.
  • Anti-broker bias
    • Research confirms what brokers fear most, that a dollar-based broker compensation disclosure create a “substantial consumer bias against broker loans, even when the broker loans cost the same or less than direct lender loans.”
    • We have no doubt that certain less scrupulous mortgage salespeople outside the broker channel will point to these disclosures, and “all the money brokers are making,” as a reason to doubt brokers’ advice.
    • Bank reps do not currently need to disclose the additional dollars they get paid for selling mortgages at rates that are above their “floor rates” (i.e., the lowest rates they can offer without further approval). Therefore, assessing compensation would be a decision that only broker customers have to make.
  • There’s no benchmark
    • If a consumer learns that their broker will be paid $3,276.42 by the lender, how do they know if that’s reasonable? There is no easy way to compare this number. Certainly bankers aren’t going to disclose the dollar value of their compensation. Nor does the regulator publish a table of typical broker compensation (maybe they should?).
    • Nor is there any way to objectively compare a broker’s compensation to the value of his or her advice. For example, if a broker recommends a lower penalty mortgage and the client breaks that mortgage, how should the consumer compare the money that broker saved them to the lender’s compensation to the broker?
    • The one thing that’s certain is that many consumers will see a dollar amount on the broker’s disclosure and think (even if only subconsciously) that it’s somehow coming out of their pocket.
    • If the consumer was paying the broker directly, value would be easier to determine. But how do you judge the value of a broker’s advice by knowing the amount that another party (the lender) pays the broker? If the lender pays a $2,000 commission instead of $1,000, does that make the broker’s advice less useful or more suspect? Of course not.
  • Higher costs for borrowers
    • The research cited above concluded that “the bias against mortgage brokers will put brokers at a competitive disadvantage relative to direct lenders and possibly lead to less competition and higher costs for all mortgage customers.”
    • As CAAMP economist Will Dunning asserts, “The psychic cost of using a broker would be raised, distorting the decision process, certainly to the disadvantage of the brokers, and ultimately to the disadvantage of the consumers themselves.”
    • It is highly likely that some consumers will use this new-found knowledge of broker compensation as leverage to negotiate rate buydowns. Now, don’t get me wrong, buydowns are great for consumers in terms of upfront savings—other things equal. But other things are not equal when buydowns cause brokers to slash the effort and investment they put into advising and servicing clients—which is exactly what may happen over time with dollar-specific compensation disclosure. What’s the risk of that? Potentially less suitable mortgages with higher back-end costs that dwarf the bought-down rate savings—e.g., higher penalties, worse blending privileges, worse porting flexibility, fully closed mortgages and so on.
    • One might argue that consumers will see these disclosures late in the process, after they’re already approved—thus reducing the chances that customers will try to negotiate the rate lower. But the truth is, lender commitments don’t prevent people from shopping around.
    • If compensation disclosure leads to more cancellations, it could very well affect brokers’ access to the best rates (which typically come from lenders who demand high efficiency — i.e., low cancellation ratios).
  • Accuracy is impossible
    • Brokers cannot quantify in dollars the benefit of a volume bonus they may never receive.
    • Suppose a lender pays 5 extra basis points if the broker meets an annual volume level, and the broker is just halfway into the year. In that case there may be no way of knowing if the target will be reached.
    • The same goes for efficiency bonuses paid quarterly or annually, which depend on future unknown cancellation numbers.
    • Then there are the legal ramifications of not disclosing a volume bonus that you didn’t expect at the time.

Alternatives for enhancing disclosure:

  • It’s been written here many times and all brokers and lenders know it: extra compensation and rewards sway the recommendations of some in our business.
    • If brokers don’t meet volume minimums for key lenders, for example, they can lose critical access to lower rates, faster service and bigger bonuses.
    • Oftentimes, certain brokers may be inclined to recommend one mortgage over another in order to meet lender status requirements. That mortgage may be inferior to another mortgage at the broker’s disposal.
    • Note: This is far less of an issue for:
      • higher volume brokers with top status at all key lenders, and
      • brokers with access to deal hubs that pass along best pricing and lender volume bonuses
  • Base compensation is not the issue
    • If brokers all made the same amount per deal, conflicts would be minimized because we’d have no monetary incentive to choose one lender and product over another.
    • That’s a key point because, in practice, most brokers make somewhere around 1% of the mortgage amount on a standard 5-year fixed term, regardless of the lender. Therefore, base compensation is not the trouble-spot. It is additional compensation and perks that pose potential problems. That is where regulatory focus should be placed.
    • Regulators could easily establish the base remuneration that is considered typical for each term (e.g., 80 basis points on a 3-year fixed, 90 basis points on a 4-year fixed, 105 basis points on a 5-year fixed). The province could then mandate more detailed disclosure for any compensation above that amount. This would achieve the same end with more clarity—since consumers would now have a reference point—i.e., they’d know when a broker is getting paid above-normal compensation.
  • In many cases, the higher the interest rate, the more a broker earns (just like mortgage specialists at many banks)
    • Some lenders offer tiered rates where a broker is paid 10 to 40+ basis points above average for selling a higher rate.
    • This should be disclosed and FICOM is right to pursue that particular angle.
    • The challenge is that some borrowers have difficult applications. The time required to get them approved can be 2-3 times more than a regular client, justifying a premium for the added work.
  • Broker relationships should be disclosed
    • In 2011, Maritz found that 90% of the typical broker’s volume goes to just three lenders.
    • Consumers need to know when a broker is essentially a salesperson for a small number of lenders. (And if it’s fully disclosed and they’re the right lenders, that’s not necessarily problematic…as long as the broker doesn’t imply they work with several lenders.)
    • Some argue that close lender relationships result in better rates and service for the client, and that’s often true. But many times a better product exists at another lender, and it’s in the consumer’s best interest to know that.
    • Knowing the percentage of the broker’s volume going to a recommended lender can be far more valuable than knowing how much the lender paid them. That is useful disclosure.
  • Incentive details should be disclosed
    • You can’t blame lenders for providing benefits to their top brokers. That’s nothing more than Sales 101. But such benefits can unintentionally create conflicts of interest, and disclosing them is a way of influencing brokers to provide more suitable advice.
    • At the least, FICOM is justified to require more detailed disclosure of lender perks, as well as general information about how monetary bonuses are calculated.
    • That creates an unlevel playing field of course, because consumers never see how a bank’s in-house mortgage reps are compensated. But FICOM doesn’t regulate banks and they feel that their job is to minimize the conflicts they can control.
  • National standards should be the goal
    • Mortgages are no longer sold locally. The Internet has enabled countless firms to offer mortgages in multiple provinces. The time has come for national consistency in mortgage broker policies—consistency that
      • Reduces confusion among consumers
      • Makes regulation and compliance more efficient, and
      • Enhances interprovincial trade, and thus consumer choice and savings
    • A decision by one province to deviate from the norm in such a profound way makes national standards less achievable.
    • Provinces, including the largest province of Ontario, have already considered dollar-based compensation disclosure and judged that the cons outweigh the pros.
    • This is a matter of enormous consequence to brokers everywhere. It’s one that all provinces should tackle together, led perhaps by the multi-jurisdictional Mortgage Broker Regulators’ Council.

FICOM believes that brokers’ value proposition should stand on its own, and that consumers will figure it all out for themselves if they’re given detailed earnings breakdowns. If only it were that simple. Elaborate compensation disclosure will have wide-ranging ramifications for brokers and there is easily potential for a net negative outcome. MBABC CEO Samantha Gale, a former B.C. mortgage broker regulator herself, summed it up plainly on Thursday: “This isn’t the right way to do it.” There are multiple alternatives and policy-makers need to carefully study them.

The good news is that this doesn’t appear to be a done deal just yet. We believe that FICOM does not want to impose any rule that could ultimately cause consumers to pay more and make sub-optimal choices. Not only would that be contrary to the public interest, but it would contravene B.C.’s Mortgage Brokers Act. The folks over there are reasonable and want to do the right thing. We believe they’ll assess all alternatives before casting the final verdict.

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