Some time ago I was talking to the marketing director of a sub-prime lender that I now know promotes and uses deferred marketing allowances as a tool to build volume via packagers. At the time I didn't have the faintest idea DMAs existed. Call me naïve but due to Optoma's almost exclusively prime positioning we had never been offered additional income of any sort from a lender.
As the conversation went on I was informed that sizable sums were available if we agreed to distribute this lender's products. Hitting certain targets would see DMAs triggered allowing us to pass metaphorical brown envelopes to introducers who contributed to the volume. I was surprised, not at the presence of these allowances but at their size and availability – and at the routine nature of the conversation. It answered one question though – why our business had never managed to build sub-prime volume. Perhaps procuration fees and good service alone are not enough.
I always thought it paradoxical that many introducers who consistently moaned about service from packagers, carried on using the ones they had vowed never to use again. It suddenly became apparent how a marketing allowance could help overcome service issues. Optoma has never received DMAs and has never passed on income to brokers over and above what is received as a proc fee. After all, many in the industry – including the FSA it would appear – consider a 1.25% proc fee sufficient for arranging a sub-prime mortgage.
I am not condemning the use of DMAs. My point is, how will this additional income be able to find its way to the introducer after the FSA's rules on financial inducements come into effect? With such sums abounding I guess lenders have a few options. Firstly, they could put the saving back into better products – which would be refreshingly ethical. Secondly, they could spend it on improved service. Or it could be returned to shareholders as profit. I hope it will end up in higher procuration fees for packagers and brokers and nullify any argument about volume-based enhancements.
FSA regulations state that disclosure must take place, i.e. that the consumer is fully informed of the fees that will be received by the broker. The FSA hates volume-based financial inducements and rightly so as they are nothing more than kickbacks.
However, marketing, promoting, selling and administering mortgages is not cheap, especially in sub-prime where clients are not always forthcoming with information. In such a situation why shouldn't an introducer who is doing a good job and selling more via referrals, receive a higher proc fee than someone who isn't servicing their clients as well? Many consumers need brokers who are adept at placing complex sub-prime cases. If the money isn't there, neither will the brokers be. After all, the mortgage doesn't cost any more if the broker gets a higher proc fee.
So how would this work in practice? Brokers use sourcing systems if not to find a product then to access proc fees and criteria and to bring information into compliance documentation. Sourcing systems such as Trigold have their limitations, one of these being the inability to express different proc fees for different brokers at the point-of-sale.
Inducements aside, I wonder how the development of sourcing systems will accommodate the challenge of regulation – the illustration of packaging fee and any other payments for processing a case.
The FSA has stated that where packagers and ARs are operating within connected companies the fee received by the packager needs to be communicated to the applicant. Again we come across the difficulties of producing compliance documentation – when the introducer creates an illustration they will have to include all the fees received by the packager. This will add complexity to client communication as a packaging fee will have no influence at all on the advice given by a network's appointed representative.
An example is the MGM club run by Optoma. The FSA has identified that there is no likelihood of the advice given being influenced by packagers' lender receipts and such advice can remain undisclosed.
And there is a let-out from the FSA relating to unconnected companies: where packaging is done at 'cost' the full fees do not need to be revealed. But how many packagers with networks want to run at break even on all the business generated by their ARs?
The sourcing systems will require significant development.
But there is another move afoot which may make life easier: lender KFIs. These will hopefully provide a solution to the problem of accurate illustrations. Lenders are investing heavily in creating online key features documents that will enable precise illustrations to be produced. With inside knowledge of proc fee arrangements and packaging fees the lender should be able to provide a solution for all circumstances. With KFIs originating from the lender the FSA can be assured there are no local arrangements between packager and broker as these cannot be incorporated into KFIs. I am aware that solicitors such as TLT in Bristol have brought these issues to the attention of the FSA.
For me there are a number of things that could prevent the nightmare of mis-quoting at point-of-sale by ARs or advisers. For a start, no more deferred marketing allowances. Let us have fat increases in proc fees that are disclosed easily via a search engine and if someone receives a higher fee, let it be as a reward for the quality of their advice, not for volume.
Secondly, the FSA could realise that packaging fees in non-broker/packager companies are not inducements but receipts for outsourced activities and as such do not influence advice. If packaging fees have to appear in the illustration it will be extremely complex to implement.
Above all I hope regulation eradicates volume-based incentives rather than drives them underground, thus exacerbating the problem that the FSA sought to cure.