A few weeks ago, S&P said Canadian bank risk was rising, and it blamed mortgage brokers in the process.
The rating agency wrote:
“…The growing share of residential mortgages originated via brokers, compound the risks of high household debt and house prices…As brokers do not bear credit risk for the residential mortgages they initiate, and are generally compensated primarily on the quantity (not quality) of residential mortgages applications they process, we believe brokers have less incentive than a lender’s own staff to prevent fraud.”
It appears S&P analyst Nikola Swann felt there were enough broker bad guys out there to take a public shot at the whole industry.
But in crafting this report, Swann failed his clients, our industry and the Canadian public in four important ways.
He failed to quantify the risk of broker fraud at major banks.
It’s all-too-typical for analysts without hard data to opine on mortgage risk without estimating the actual risk and putting that risk into perspective (e.g., contrasting the industry’s dollar loss potential versus revenues).
He failed to support his assertion with data comparing fraud rates on broker and retail-originated mortgages.
Indeed, S&P’s implication contradicts reality. Scotiabank CEO Brian Porter recently reinforced what every dual-channel lender has ever told us, “…For as long as I’ve been in this chair, there has been no distinguishable [fraud] trends amongst or across [our three mortgage distribution] channels…”
He failed to acknowledge how obsessed lenders and regulators have become with fraud prevention.
Does any mainstream lender want another Home Capital fiasco, or denied claims from a mortgage insurer, or lost investor and depositor confidence? Lenders, regulators, Equifax and even CRA are cooperating and investing tens of millions to improve fraud detection and prevention.
He failed to acknowledge that the overwhelming majority of brokers wouldn’t dream of committing fraud, for dread of being cut off by their lender, REDX’d (blacklisted across the industry), publicly censured, fined and/or barred by the regulator, having commissions clawed back, having their consumer reputation indelibly stained and getting canned by their brokerage.
It was a big fat fail all around.
Instead, Swann largely based his broker commentary on old news: Home Trust’s and Laurentian Bank’s past (now-corrected) fraud experiences.
From there, he extrapolated recent events into an industry-wide warning that unfairly hurt bank valuations and public perception of brokers. Any regular Joe reading S&P soundbites in the news would have no inkling that broker-related fraud barely impacts bank arrears.
We have no beef with S&P but Swann’s opinions are more of a blog post than a balanced, well-researched institutional report.
And, incidentally, S&P noted that its “Economic Risk” trend for Canadian banks has been negative since December 2012. If you would have let that scare you from buying bank stocks, you would have missed a 62% gain.
But What About Specialists?
Maybe Swann should have waited for Tuesday’s report from the Financial Consumer Agency of Canada.
FCAC outlined a laundry list of bank rep wrongdoing in a 9-month-long study. Here are sample quotes from its findings:
“[Banks’] system of incentives and rewards is more developed than the controls to mitigate sales practices risk for mobile mortgage specialists (MMS)…”
“Controls to mitigate the risks associated with sales practices are underdeveloped.”
“Banks generally impose fewer controls and exercise less-intensive oversight on the sales practices of MMS compared with other bank sales roles.”
“Performance management programs—including financial and non-financial incentives, sales targets and scorecards—may increase the risk of mis-selling and breaching market conduct obligations.”
“[Mortgage specialist] mobility, coupled with 100 per cent variable pay, presents a higher risk to consumers, particularly given that controls are underdeveloped and levels of bank supervision are less intense. The proportion of mortgages sold through the MMS channel varies significantly across the six large banks. In some instances, banks sell upwards of 90 per cent of their mortgages through this channel.”
“Variable pay compensation models may discourage MMS from making reasonable efforts to assess and take into account a consumer’s needs and financial goals. The main risk to consumers in this compensation model is mis-selling. For example, the compensation model may encourage specialists to recommend mortgage products that earn higher commissions even if they are not the best option for the consumer.”
“The opportunity to earn higher commissions for reaching mortgage volume targets may also lead specialists to recommend larger mortgages to consumers. Furthermore, MMS may encourage consumers to acquire a mortgage sooner than they were intending, rather than encouraging them to save for a larger down payment.”
“Employees can mistakenly or deliberately imply that creditor insurance is sold as part of the credit product or that credit approval is contingent on the purchase of creditor insurance.”
“Direct oversight of MMS sales practices is underdeveloped. As mentioned, given the mobile nature of this role, MMS often operate outside the branch channel. They are expected to spend their time in the community developing business relationships with real estate agents, developers and others from whom they can earn mortgage referrals. This limits opportunities for direct supervision, observation of sales practices and coaching by managers.”
“In addition, the managers responsible for overseeing MMS often have a vested interest in promoting mortgage sales volume growth. A significant portion of a manager’s compensation may be directly tied to the volume of mortgages sold by the specialists they supervise. The scorecards of MMS managers are heavily weighted toward sales.”
“The competitive market for the services of high-performing MMS can make it more difficult for banks to enforce codes of conduct and take disciplinary action. During the review, FCAC learned there have been cases of MMS leaving their employer before the bank could complete its investigation or take disciplinary action.”
If this kind of activity exists at banks, as FCAC suggests, do you think it’s possible that some mortgage specialist might be bending (breaking) the rules and committing fraud?
Now, don’t get me wrong, this is not meant to imply that banks are the Wild West or that mortgage specialists are any worse or better than mortgage brokers when it comes to honesty. There are bad brokers and there are bad specialists, but most are upstanding professionals.
The point is simply that bad occurs everywhere in our business. But it’s not big enough to be a significant system-wide risk. And it’s not broker-specific, S&P.
Sidebar: Here are more findings from FCAC about mortgage specialists at the big banks:
“Each of the six large banks uses a 100 per cent variable pay model to compensate their MMS. This means MMS are paid straight commission and do not earn a base salary.”
“In addition to mortgage volume, compensation rates for MMS may be influenced by several factors, including: • mortgage types • term lengths • interest rates • cross-selling of other products as part of the mortgage sale.”
“Most banks also set individual volume and cross-selling targets for their MMS and pay higher commission rates for sales that exceed targets. For example, banks may raise the commission rate by 10 basis points when MMS reach 105 per cent of their quarterly volume target of $10 million.”
“Most banks use, albeit to a limited extent, compensation penalties to retroactively claw back commissions earned by MMS if certain events occur. For example, commissions are clawed back if the mortgage paperwork is incomplete or if the number of defaulting mortgages is too high. Presently, clawbacks are primarily used as a control to mitigate credit risk.”
“Specialists can also earn higher commissions by meeting cross-selling targets. In most cases, banks expect MMS to sell creditor insurance products such as life, critical illness or disability insurance to as many as one in three mortgage borrowers. (Oh, by the way, big bank creditor life insurance can’t be ported, which—if we’re talking about the consumer risks of this product—is one of the biggest consumer detriments of all.)”
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