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Another Commission Squeeze

DowntrendIf you weren’t sure whether mortgage broker commissions are trending down, you can be sure now.

Scotiabank, the biggest participant in the broker channel, is the latest major lender – after First National and MCAP – to cut broker finder’s fees.* The bank lowered its compensation today by five basis points on 5-year terms.

“The economics of the business are changing. We’re looking at what appears to be a sustained low-rate environment,” said David Stafford, Managing Director, Real Estate Secured Lending at Scotia. “All the banks are looking at compressed margins. As long as we’re in this sustained low-rate period, there has to be a bit of give and take.”

In addition to record low mortgage rates, there’s also “steep competition for deposits,” notes Stafford. With deposits still the top source of mortgage funding, that’s put lending margins in a vise.

Here’s a chart we ran on the spread between the estimated “typical” 5-year fixed mortgage rate and the 5-year GIC rate. When Bay Street analysts talk about lending margin pressure, they’re not making it up.

(Click chart to enlarge)

In reality, there are many other sources of mortgage funding besides 5-year GICs, but this gives you a sense of how deposit-based lending spreads are changing.

Stafford says that funding costs have also risen because of the liquidity credit premium that’s been baked into mortgage pricing since the credit crisis. On top of that, lenders face higher securitization costs thanks to both CMHC insurance changes and new accounting rules.

Meanwhile, overall broker compensation on 5-year fixed mortgages hasn’t changed much for years.

“We’re fully committed to this channel but we’ve all got to be realistic about sustaining it,” Stafford added. “Other lenders have looked at the economics of the market and simply walked away. We have no intention of doing that but we also have to be realistic about it at the same time.”

On a gross basis, Scotia’s compensation cut will save it roughly $5 million a year for every $10 billion of volume in related mortgages. But the move will also cost the bank business from less loyal brokers who shift to higher-paying lenders. Fortunately for Scotia, its range of mortgages (which arguably leads the broker market) and end-to-end service model make demand for its products somewhat inelastic.

Another force working against brokers is Internet-driven competition. “Brokers have proven that they’re willing to advertise a lower ‘bought-down’ rate in an effort to compete,” says broker Peter Kinch, of Dominion Lending Centres Peter Kinch Mortgage Team. “In other words, they’ve said ‘I’ll work for less money as long as you give me a more competitive rate.”

“We’ve always said that selling rate instead of creating a true value-add proposition is simply a race to the bottom. Scotia’s decision is not only a trend – it’s predictable and inevitable.”

With FirstLine dropping out of the broker market this year, Scotia and First National (ranked #1 and #2 respectively) hold some powerful cards. “You’ve got two lenders that are now pulling down 40% of the
market,” says Geoff Willis of Origin Mortgages. “They are the market makers.”

Willis suspects that today’s changes are partly related to the costly effects of pooling (which helps smaller brokers benefit from the lender “status” enjoyed by larger brokers). Pooling has caused Scotia to pay out more compensation than it anticipated when it designed its broker incentive programs. “Until it figures out how to crack down on that, the only other place (management) feels they can gain savings is with the finder’s fees,” Willis reasons. “I think First National’s management had that same discussion.”

Looking forward, it’s not a leap to expect that more lenders will cut commissions. Volume bonuses and pooling will come under particular scrutiny. As one example of this, more lenders may start checking to see who pulled the applicant’s credit bureau. The goal being to confirm if that broker is registered and qualifies for status incentives.

“Right now, lenders don’t know who they don’t know,” Willis says.

* Note: First National reduced commissions across the board in August. MCAP reduced commissions only on one- and two-year terms and it was partly offset by a lower rate. MCAP Spokesperson Jack Shapiro states, “We have worked hard not to
cut our 5-year compensation.”

Rob McLister, CMT