Clubs come up trumps

5 October 2009

Product regulation is a big concern for many but of equal importance could be the FSA’s warning that it is looking at applying the Retail Distribution Review to mortgages. Among a range of things, this aims to remove commission bias from the way products are sold. In short, it could sound the death knell of proc fees as a way of remunerating brokers.

This would lead to a major shake-up of the market, in particular the clubs that are now a key part of the distribution of mortgages in the UK. Next year marks the 15th anniversary of the first one, the Legal & General Mortgage Club. When it was launched in 1995 it marked the beginning of the proc fee-driven distribution model that brokers have enjoyed since.

And the man responsible at a group level for L&G’s club and network proposition, L&G Partnership Services, was also key in developing the club model. John Pollock is group executive director of protection and annuities at L&G. He has sat on the L&G board since 2003 and is also about to celebrate his 30th year with the global insurance giant, having joined in 1980.

He joined the company as a trainee computer engineer, starting out as an assembler programmer - which he describes as an early form of mainstream computer language - before moving on to PCs in the mid-1980s. These were early IBM machines with two floppy drives. To demonstrate how basic they were he shows me an early 10MB controller card he has as a memento in his office. It looks like something from a nuclear reactor.

In 1989 Pollock became administration manager for L&G’s personal pensions product line, helping to deal with the massive tax-driven boom the firm was seeing at the time. He then moved through various positions in the services area, rising to become client services director in 1994. This is where the origins of the mortgage club lie.

In 1996 Pollock moved to Australia to become managing director of L&G Asia. Unfortunately, the Asian economic crisis of 1997 led to a number of L&G’s partners in the region going under. As a result the company sold its Australian business and withdrew from the region.

Pollock returned to the UK in 1998 to take control of L&G’s protection and housing product lines. The company then reorganised itself and he became responsible for all of L&G’s operations in the UK.

In 2003 he was appointed to the board and made responsible for the firm’s retail products and corporate businesses. In 2006 the company reorganised again into business units and Pollock once again picked up responsibility for housing distribution.

“It’s like a wheel that keeps on turning,” he says. “But the club story really starts in our estate agency distribution. I can’t remember the precise starting point but I think the sales force embedded in the estate agents we were running then were happy to sell a range of products to customers and become one-stop shops - particularly Whitegates in the north.”

By contrast, L&G’s main sales force in those days was considerably less comfortable cross-selling general insurance and similar products, let alone mortgages.

“It wasn’t ground-breaking stuff but it was different for the time,” says Pollock. “When I took over responsibility in 1994 I went to Blackpool with my operations director because I appeared to have inherited an administration unit up there and I was shown some data on life sales, GI sales and proc fees.”

The notion of the proc fee, which at the time was a fixed fee of about £200 rather than a percentage fee, was a novel concept to Pollock.

“I remember asking what a proc fee was,” he says. “This was the first reference I’d heard to such a thing. Originally, there was a preferred lender strategy, which was how it was described to me. I thought - wow, this is a one-stop shop and we’re getting remunerated by lenders. I could see that it would be possible to extend the model to my broader sales force.”

Peter Brodnicki, now chief executive of Mortgage Advice Bureau, was working for Pollock back then and the aim was to establish an estate agency network whereby L&G could leverage its buying power. It would help estate agents run their businesses more efficiently, at lower cost and using the latest technology.

So Pollock and his team put together a proposition whereby L&G could become a one-stop shop and by early 1994 this distribution model started taking off.

“I thought we would get to around £1bn of lending and introduced the idea to my then boss, Robin Phipps, who got excited at the prospect,” says Pollock. “He had other sales forces available to him and saw the opportunity to strengthen our relationships with lenders on a reciprocal basis. It opened doors and allowed for a degree of negotiation.”

Phipps, who retired in 2007 from his position as executive director of UK operations at L&G, is the person Pollock credits with giving the scheme the serious injection of oxygen it needed to get off the ground. So the club was formally launched in mid-1995, although Pollock says it had existed in an embryonic state as far back as 1991.

“We always thought the provision of high quality compliance back-up and well-advised mortgages would be welcomed by lenders and that’s a philosophy we’ve stuck to throughout,” he says.

With the regulation of the mortgage market in 2004 this approach became even more valuable. While Pollock says the club hasn’t changed much in essence the same can’t be said for the regulatory environment in which it operates.

“Mortgage Day brought about a big change, generating the network concept. But prior to that what we were trying to do, still do and will continue to do is offer lenders a tightly controlled sales force to distribute their products,” he says.

“Because we’d had a large tied sales force throughout that period we had a good handle on what it meant to provide quality compliance - after all, we were already doing it.”

Rivals, in the shape of sticker mortgage clubs, appeared pretty soon after the club was launched.

“But nobody replicated what we were doing in terms of tight corporate controls, integration of products and reciprocal deals with lenders,” adds Pollock.

If lenders want controlled distribution via tranche size or exclusives L&G can facilitate this. Pollock says that even as the recession hit last year L&G still handled £5bn worth of exclusive products. What it offers lenders is controlled distribution, as if they are using their own branches.

“At the moment our offering is attractive as we’ve seen a lot of mortgage distributors disappear,” he adds.

That’s an understatement. The networks that have crumbled in the past year - from Prestbury and Network Data to Premier Network Group - all suffered from a lack of income resulting from the drop in mortgage volumes. In contrast, Pollock says his firm’s network proposition has weathered the recession remarkably well.

“L&G Partnership Services is slightly ahead of target this year, which is an astonishing position in such difficult market circumstances,” he says.

“That’s because of its history, the quality of its distribution and the strength of the relationships it has with clients years,” he adds. “Over the past 15 we’ve learnt how to manage and milk that. The support and business acumen we offer our distribution partners is aimed at ensuring lenders receive high quality business.”

After Mortgage Day, in contrast to rest of the network market, L&G Partnership Services spurned the advances of many smaller adviser firms. And while the club and network had a combined distribution of around £18bn in 2008, L&G still had a relatively small number of appointed representatives.

But as Mortgage Strategy revealed in its September 21 issue, L&G Partnership Services has now done a U-turn on this position.

“Throughout the 1990s we had a strategy of helping our business partners bring sales people into their businesses and we acted as an encouraging consolidator,” he says. “Historically, we always said to smaller firms that the best thing for them was to fold their business into a larger organisation that would manage their compliance regime and technology. That has been a successful strategy for us as long as we have been running the network.

“But what we decided to do this year, because there has been so much activity, is say we’ll let companies come directly to us and we’ll take responsibility for the supervision and compliance of their business.

“This change was driven by the fact that so many firms were getting out of the market,” he adds. “We have training packages, compliance and technology back-up, the capital base, the reputation and the strength to attract companies to us.”

But with such a dramatic shake-up of mortgage distribution in the past year, has there been any change in the attitude of the lenders L&G deals with?

Stephen Smith, who works under Pollock as head of housing at the company, recently wrote an article for Mortgage Strategy in which he said lenders should act more like wine producers. He said they should be choosy about who they deal with and look at different distribution models and their various benefits.

So is L&G seeing this response from the lenders that remain in the market?

“You’d have to talk to lenders directly about their plans but there’s no question that the senior people I have spoken to have been talking about reducing the number of firms they deal with,” says Pollock.

“They want to make sure that the companies they deal with have quality business as well as volume and I guess this will persist for some time. After all, it makes sense to manage your appetite for intermediated mortgages through the channels you choose.

“Before all the bad stuff happened in the market we were talking to lenders about them treating us as a branch because we can behave in that way,” he adds. “The message we’ve been sending to lenders recently is that the intermediary market remains a critical component of mortgage distribution.”

Pollock’s argument - one he says he’s been making forcefully to lenders - is that they have to spend a lot of money on marketing to attract consumers for mortgages as if they don’t have a branch in every village it’s unlikely that individuals will take out mortgages with them.

“So an intermediary who can offer panel lending or whole-of-market lending still represents a cost-effective way to get mortgages to market,” he says.

“We’ve certainly seen some drift towards the direct mortgage market but we’re pushing hard in support of advice in the marketplace. We believe it adds value to lenders and of course it’s important to us.”

But obviously a big problem for brokers has been that lenders have ceased to look on them as an extension of their branch networks. Instead, dual pricing has worked against brokers, with better mortgage rates available direct.

Mortgages Strategy’s letters pages have been filled to bursting with irate letters from brokers outraged at the strategy now being adopted by lenders, but Pollock remains sanguine.

“It’s just business,” he says. “It’s a commercial world and it is logical for organisations to adapt their business models to the conditions they find themselves in.

“Sensible lenders still recognise the importance of the broker market and that to me is a reinforcement of the fact that when the mortgage market starts to come back it will rely heavily on customers being able to get access to the advice and choice that only comes through intermediaries.

“The drift towards direct business has been less pronounced than might have been expected,” he adds. “The majority of mortgages are still placed via brokers and long may that continue.”

Last year L&G distributed about £18bn of mortgage lending. In terms of how 2009 has shaped up, while Pollock says he won’t be brave enough to call the green shoots of recovery yet it would be fair to say that the bottom of the market has now been reached.

“There are tentative signs of improvement in the housing market,” he says. “The lead indicators of this are surveys, and our estate agents are reporting that a higher number of transactions are beginning to come through too. There’s also a great deal of anecdotal evidence in the press concerning the return of first-time buyers to the market.

“But we are still seeing tight constraints on mortgage lending and this will continue to act as a brake on the market for the foreseeable future. I’m hoping 2009 will be a reasonable year for the network and am pretty confident it will be. That’s a reflection of our competence and quality, but the mortgage market is going to remain challenging for a while.”

The other big concern is the future regulation of the mortgage market. And while it’s difficult to know what will ultimately come out of the FSA’s review Pollock says it’s important that the regulator doesn’t inadvertently throw the baby out with the bath water.

“This has been one of the most challenging recessions we have known, as I think everyone is aware,” he says. “But we must ensure that regulators don’t over-react to the situation. The regulators must make sure they get the fundamentals in place and get these right first time rather than coming up with poorly considered initiatives that bring the law of unintended consequences into play.

“We’ve seen that a number of times before when regulatory or legislative change has been on the cards. A measured approach is the way to go.”

So as we prepare to celebrate L&G Mortgage Club’s anniversary and the widespread use of proc fees to remunerate mortgage advice, it has to be borne in mind that the transfer of the RDR to the mortgage market would profoundly change the situation.

Unsurprisingly, Pollock says that for high volume transactions the club is a sound model for customers. But could getting rid of proc fees improve the advice consumers get?

“Given that advice costs money, would you want to walk into a shop and, before opening your mouth, have to write a cheque and hand it to a guy who proceeds to give you advice you decide not to take?” he asks. “Or would you rather take advice which is paid for during the period of your loan? For high volume transactions I think that’s a sound model for customers.”

But he says customers need to understand precisely what they are being charged.

“When I was young, this way of purchasing used to be called buying on the never-never,” he says. “Hire purchase agreements and contract purchase agreements were the norm, whereby consumers would pay over a period of time.”

“I don’t see that model as being broken. It’s about ensuring customers understand what they are paying for, that they are properly advised and that it’s an open process in which they understand they are not being pushed one way or the other for the benefit of the distributor. As long as we can overcome that, I reckon we have a pretty robust market.”