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CIBC’s Mortgage Gamble

Bank-Strategy-GamblingCIBC felt it had to do something with its mortgage broker business.

It’s facing:

  • Shrinking mortgage margins
  • Slow balance sheet growth
  • Regulatory changes (IFRS and Basel II and III), which increase its mortgage funding costs
  • Policy changes (related to CMHC insurance, covered bonds, and securitization), which increase its mortgage funding costs
  • High broker compensation versus its proprietary sales force (50-100% more in some cases)
  • Lower retention rates on broker business
  • Far less cross-selling with broker-originated mortgages (compared to its retail sales force).

It had to make changes and it’s hard to blame CIBC management for evaluating all options, including curtailing its broker business.

That said, selling FirstLine (the broker-lending division that CIBC has spent 17 years building) and retreating from the broker channel would be a monumental gamble.

The potential price of failure—for shareholders, consumers, and the executives calling these plays—is significant.


Survival of the fittest applies in the mortgage market just like it applies in nature.

The “fit” lenders are generally the ones with growth and reasonable, sustainable margins.

The “fit” originators are the ones who provide value to consumers and sufficiently profitable mortgages to lenders.

Four out of five banks, trust companies, and wholesale mortgage lenders distribute through brokers because they feel most brokers are fit for their purposes.

BMO-MortgageThat said, with mortgage margins tight and getting tighter, some lenders feel they can squeeze more profit juice by originating mortgages exclusively in-house. This is why a small number of lenders, like BMO and HSBC, have exited the broker channel altogether.

But has leaving the broker market improved their lots?

Consider this: The following is BMO’s and HSBC’s market share performance since relying exclusively on their proprietary mortgage sales forces:

  • BMO’s market share upon exiting the broker market in Q1 2007:
  • BMO’s market share as of today:
    6.49% (Down 29% on a relative basis and 274 basis points in an absolute sense)
  • HSBC’s market share upon exiting the broker market in Q2 2010:
  • HSBC’s market share as of today:
    1.81% (Down 10% on a relative basis and 20 basis points in an absolute sense)

(This data is provided by McVay and Associates Ltd., for which we are much appreciative.)

Both of these banks expected share losses when they left the broker channel. But, to date, they still haven’t made up those losses and they continue to lose market share.

That’s even more surprising if you consider that BMO and HSBC have generally been advertising the lowest rates of any banks in Canada! What’s wrong with that picture?

Now, it must be noted that we don’t have data on BMO’s and HSBC’s mortgage margins since leaving the channel. Their margins have reportedly improved (at least somewhat) on a per-mortgage basis. But it’s still highly doubtful that said banks are now further ahead.

That bCIBC-Bankrings us back to CIBC, a bank with a mortgage book twice as big as BMO, and far more to lose.

If, as some expect, CIBC exits the broker channel (partially or completely), it will have its own potential market share waterfall to look forward to. The hundreds of new Mortgage Advisors it may hire this year will not make up the slack caused by divorcing thousands of brokers.

In a comprehensive report issued Friday, Darko Mihelic, Director, Institutional Equity Research at Cormark Securities, said this:

  • CIBC’s broker channel once accounted for up to 40% of its mortgage production
  • CIBC’s exit from the broker channel could “hurt” earnings
  • CIBC’s exit from the broker channel could “hurt the Company’s valuation multiple”
  • CIBC risks a “growing perception that (it) cannot help itself and needs to constantly tinker with its business plan every few years creating a one step forward two step backward kind of feeling”
  • CIBC could see significant “run-off” of its broker-originated mortgage portfolio
  • “The backlash and mortgage predation on (CIBC) could be formidable and not just the mortgages
    originally placed through FirstLine.”

Long story short, exiting the broker market could lead to an “unwelcome change in the eyes of investors,” says Mihelic.

But, it doesn’t have to be that way.

Profitability-analysisInstead of shutting the tap on broker deal-flow, CIBC could choose to re-tool their broker channel. (This option still cannot be ruled out in CIBC’s case, depending on what happens in relation to FirstLine’s reported potential sale.)

Among other things, CIBC could choose to:

  • Cross-sell more, by:
    1. Welcoming broker clients to the bank and assigning them a branch relationship manager (Granted, this would be easier if FirstLine and CIBC were not different brands), and
    2. Including optional product promotions in their approval documents(e.g.  Check a box if you’d like a line of credit at prime rate for six months, a pre-approved Aerogold Visa with no fee for a year, etc…)We’ve never understood why banks don’t do this more. Technology and cost accounting between divisions are sometimes cited as roadblocks, but those are not insurmountable.
  • Equalize compensation between brokers and CIBC’s proprietary sales forces (We’re seeing this slowly happen at other lenders, as a result of tiered pricing/compensation)
  • Pay brokers a token commission when their clients renew with CIBC, to reduce switching and lessen the appeal of competitors who pay trailer fees. (Trailer incentives do not have to be huge to be effective.)
  • Cut back on broker incentives (“Points” programs and the like)
  • Institute more policies and incentives to drive broker efficiencies.

Brokers wouldn’t be thrilled by the above, but we’d argue that it’s better than the alternative—losing a former #1 lender from the channel.

Banks have the power to make all of these adjustments and materially improve the profitability of broker originations. And now is the time to do it. The FirstLine news, and the concerning events that have preceded it, are making brokers increasingly receptive to more symbiotic lender relationships.

Sidebar:  Cross-sales are the nectar banks crave. Getting clients to bite on two or more optional products (high-interest savings accounts, GICs, lines of credit, credit cards, etc.) can boost mortgage profitability over 20%, says Deloitte. And bank employees have been more successful at it than brokers.

Banks cross-sell 3.4 additional products to mortgage clients who come through a branch, versus less than two products to broker originated clients (Source).

From a consumer’s perspective, not having to endure as many sales pitches is one of the many appeals of using a broker. Banks obviously have a different perspective.

Rob McLister, CMT

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Last modified: April 26, 2017

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