Operating a mortgage network used to be a numbers game – with some networks guilty of putting quantity before quality.
This way of doing business came to an abrupt end in 2008 when a number of high-profile networks collapsed, taking many of their entourage of broker firms with them.
There is still healthy rivalry among today’s networks but they are no longer in competition with each other to attract the most brokers but instead to attract the best ones. This has resulted in some networks cherrypicking advisers and turning down up to 40 per cent of broker applicants, while other networks have had to adapt their business model.
Just recently, Sesame Bankhall Group announced that it plans to close its investment adviser network and focus solely on its mortgage and directly authorised business.
Under the new structure, the network for investment advisers will cease to exist but SBG will retain its mortgage arm, which will include the PMS mortgage club and a network for mortgage firms.
So are today’s networks sustainable or will the next 12 months see consolidation in the sector as regulatory pressures increase and networks battle it out to recruit the best ARs?
The network model came to fruition in the run-up to M-Day in 2004 when the market became regulated by the erstwhile regulator, the Financial Services Authority. Networks promised to take care of brokers’ compliance needs and to secure some of the best mortgage deals for their members.
Mortgage Intelligence managing director Sally Laker says that, 10 years ago, there were just over 100 networks with everyone fighting to announce that they had the most ARs.
“Some of the networks that had the largest numbers are no longer in business and, actually, most networks had similar numbers on M-Day,” she says. “Over the past 10 years, our numbers have increased substantially and a lot of the brokers that joined in 2004 are still with us.”
Networks were at their most vulnerable during the credit crunch when those that had relied heavily on getting the highest number of brokers through the door found themselves in financial trouble when the mortgage market suddenly dried up.
Which Network director and network consultant Gary Watts says networks, just like their brokers, were not immune to the financial pressures of the recession.
“There was a period of several years when it was almost impossible to get a mortgage in anything but the most straightforward of circumstances,” he says. “This played a big factor in the collapse of certain networks that were not financially solid or were running with weak compliance systems.”
One of the most high-profile network failures was that of Network Data, which was among the largest networks at the time.
In 2006 the network announced its flotation on the Alternative Investment Market, with the company valued at £11.24m. At the time it seemed implausible that the network would be appointing administrators just two years later.
Such failures changed the landscape of the market forever and not only made brokers question their own network’s financial resources but vice versa. As a result, many networks introduced more stringent tests for their would-be recruits.
Pink revealed in March its new policy of asking potential AR firms whether they have income protection in place should the principal be too ill to work. If they do not, they will be asked what other provisions they have made. Previously, the network simply conducted a business review before deciding whether to take on a new firm.
Personal Touch Financial Services sales and marketing director David Carrington says the firm has moved from the traditional numbers game to a much smaller and higher-quality network that is more productive and profitable.
“Five years ago, the network allowed advisers in with limited checks,” he says. “We now conduct a range of checks to understand the financial and propriety situation of all new firms. We do turn some firms away that do not meet our standards although, as we have a reputation for high quality, we tend to attract better-quality applications.”
Some of these checks include carrying out financial due diligence on firms, seeking references from previous employers or networks, checking for a criminal record and performing knowledge checks through the induction process.
Carrington says the traditional network model of playing the numbers game with advisers is broken. “The only way to be profitable is to focus on advisers who are aligned with your cultural values and who put the consumer ahead of their own commercial interests,” he says.
In the years following the credit crunch, the market also saw a number of networks snapped up by larger firms.
LSL Property Services bought First Complete in May 2010 for £1.5m. At the time, the network had just 400 ARs.
As well as wanting to recruit the best ARs, networks need to maintain a healthy membership in order to grow and remain profitable. First Complete sales operations director Toni Smith says her network’s membership has increased dramatically since 2010.
“We have grown from 400 sellers to more than 1,000,” she says. “We are approached almost daily by other AR firms looking to join our network and currently have a pipeline of 150 individuals asking to join us.”
Watts says his firm’s research suggests that the network market has become more targeted over the past decade, and particularly so during the past five years.
“By this I mean the larger IFA networks, sometimes driven by being acquired by huge IFA companies, are tending to concentrate more on investment and pension products sold by financial advisers than on mortgage brokers,” he says.
“Because of this, we are seeing entry criteria for these two types of network morphing to their particular product ranges. Additionally, because of the increasing cost of professional indemnity insurance and compliance monitoring, we are also seeing most networks looking at taking on more professional, full-time ARs, which is no bad thing for the industry.”
Those networks that were not already carrying out the necessary checks on their members found their hand forced in 2012 when Abbey for Intermediaries became the first lender to pay networks higher proc fees based on the quality of their members’ business.
Stonebridge Group managing director Richard Adams says his firm “rigorously” checks all new partners to ensure they have the highest standards so that its brand and reputation are not put at risk.
“Lenders and providers often judge the quality of the network by the actions of its members, so it is incumbent on us to ensure that the actions of a few do not damage the livelihood of all our members,” he says.
Such checks can sometimes result in networks turning away potential members.
Laker says: “When we set up the network, there were, and still are, key areas that were important to us and were also essential to the longevity of a network. We wanted to be a network that was in business for the long term and therefore we needed a viable model financially and a recruitment policy that mitigated risk as much as possible.”
She adds: “That policy means that we take up all the usual references and do thorough checks, which also means we end up turning away a number of potential ARs. However, we see this as part of the service that we offer to our network members. If one of our firms wants to add an adviser who, to all intents and purposes, seem to be the perfect candidate, the checks that we do hopefully confirm that to be the case.
“If that is not the case and we are unable to authorise them, the firm will know that we have done all the checks on their behalf and, while we cannot disclose confidential data, we are acting in their best interests.”
TenetLime managing director Gemma Harle says the Financial Conduct Authority expects AR checks to be more robust than those for DA brokers and these include taking more time to gain an understanding of the broker’s business model to ensure that the network is the right fit for them.
“We aim to build a long-term relationship with all our firms,” she says. “There is no point in someone joining us and then leaving within the first year.”
She adds: “We do turn away ARs, chiefly due to directors failing financial checks.”
Harle believes it is important to guard against complacency. She says: “We are constantly reminding brokers of the need to look peripherally at the market and not just focus on pure mortgage business. There are many other related opportunities out there, such as protection, which could generate equally lucrative income streams.
“As regulatory costs continue to escalate, we have to keep adapting accordingly. The rising cost of IP is also a major issue for brokers but we are well placed to deal with that and keep costs down.”
Carrington says PTFS has deliberately reduced the size of the network to remove firms that it believed generated the greatest risk.
“These firms were typically the very large firms, where it was harder to maintain control, and also the dabblers that saw clients infrequently,” he says. “We also parted company with firms that didn’t share our consumer-centric strategy.”
Smith says First Complete has always conducted thorough due diligence on potential ARs and has not found it necessary to make its checks more stringent.
“We habitually seek information relating to financial background, fitness and propriety, identity and address verification, employment/self-employment history, regulatory history and qualifications,” she says.
“We don’t have to turn away many would-be ARs but there are occasions when applicants don’t meet our criteria and are declined.”
Since the financial crisis of 2007, networks have faced another hurdle with the implementation of the Mortgage Market Review.
Adams says: “It’s fair to say that the MMR created new challenges for the entire mortgage market and all those working within it.
“For us it acted as a catalyst to undertake a complete review of our compliance processes. It also resulted in significant changes to our point-of-sale technology in order to support the changes required to our sales processes and documentation.”
Smith believes that, with the advent of the MMR, the most important point is to maintain communication with brokers. She says: “Since last April, the market has become more competitive and buoyant, leading to even more updates. Therefore the lines of communication to our brokers have become even more important to ensure that they always have up-to-the-minute information on the latest products and exclusives.”
Harle says that, from a regulatory perspective, the MMR brought little change for networks because most were already operating on an advised basis.
But she adds: “The chief challenge has been the approach that lenders have adopted to assessing affordability and the amount of paperwork they require brokers to do on their behalf. This has been compounded by their handling of the transitional arrangements, making it very difficult for brokers to help their customers.
“And there is still the issue of lenders developing execution-only propositions to contend with. On the plus side however, their inability to advise in branches has been a huge boost for the intermediary sector.”
She also believes that the new regulatory model has been advantageous to networks.
“The network model will continue to prosper as it is needed by both the broking community and the FCA,” Harle says. “The regulator cannot supervise an increased number of DAs, and ARs continue to benefit not only from the regulatory umbrella provided by a network but from numerous other benefits, such as marketing, recruitment support, better commission terms and training.
“Provider and lender support for networks also remains constant, with no sign of that changing over the next five years.”
Carrington agrees and says the MMR has created more opportunities than challenges for the sector.
“The MMR is all about knowing your client even better and this has encouraged advisers to meet additional client protection needs as well as finding the right mortgage,” he says.
“The adviser’s proposition post-MMR is advice, not product, and this is increasingly being recognised by consumers. Our firms have never been busier and the MMR is one of the key reasons why.”
The road ahead
The next 10 years will be a challenging time for networks as lenders continue to place demands on them and their brokers for high-quality business, while regulatory fees and pressures continue to increase.
Which Network’s most recent Network Review for Mortgage Strategy shows there are currently 5,729 ARs in the market, compared to 7,796 at the start of 2011. Although the number of AR dropouts shows signs of abating, a lack of new blood in the industry could create problems for networks.
Watts, however, believes the industry is starting to see a steady stream of new mortgage brokers and financial advisers joining the market, along with the return of many who had left during the recession to do other things.
He says: “We have been left with a smaller number of networks but, with a couple of notable exceptions, networks that are stronger, more focused on their ARs and better able to help them take advantage of the ongoing upturn in the nation’s economy.”
But Adams believes there is further consolidation to come in the network market.
“We’ve already seen a fair amount of this and, given the fact we’re unlikely to see any new network entrants, I believe there will be a smaller pool for AR firms to choose from,” he says.
“I’m also convinced that the big, catch-all network model has had its day.
“At Stonebridge, we don’t try to do things that we have no expertise in; we stick to those areas such as mortgages, general insurance, protection, etcetera, where we are incredibly strong and can offer great opportunities for firms, with the necessary level of compliance.”
He adds: “There are some who see the entire network sector under threat but I don’t believe this is the case. I think there will be a continuing move towards AR status from those smaller firms that are currently directly authorised.
“They will be looking for a great proposition and strong compliance support because one thing is certain: the regulatory pressure and responsibilities they will need to meet are only likely to grow.”
Networks have not escaped the FCA’s attention over the past few years and several have faced fines.
Carrington says: “The toxic behaviour of some networks in the past is coming home to roost as the regulator intervenes. We believe this will lead to a contraction in the number of networks.
“Networks that have placed commercial interests ahead of the interests of the clients are doomed.”
He adds: “We have let go of the numbers that dominate most businesses and have put the interests of the consumer first. By operating a smaller, quality-based model, we receive fewer complaints, have become more profitable and, critically, are generating safe profit – in other words, profit that will still be in the company in five or 10 years’ time, rather than having been used on complaints redress.”
Laker says if networks do not adapt to the changing market conditions, they will no longer have a successful model.
She says: “Brokers have also had to adapt their models and those that are now enjoying increasing business levels have done exactly that.
“I passionately believe in the network model – not as the only model but one to complement the DA club model. As a business with both types, we have seen the benefits, and having both has been a key part of our financial stability over the years.”
Laker believes the regulatory focus has increased substantially under the FCA and will continue.
“It will put pressure on any network that does not have a strong financial model,” she says.
“However, I see the network model as a business partnership. Where changes occur, we need to work with our AR members to ensure that they know and understand what the changes are, alongside helping them to grow their business.”
She adds: “In 2003, we all thought there would be approximately six mortgage networks when there were over 100. But we will be approaching that number in the next few years.”
Smith also believes consolidation is on the horizon for networks.
“It will be survival of the fittest – both regulatory-wise and profit-wise,” she says. “Ever-increasing regulatory fees may finish off the smaller, less well-funded networks.
“There will be increasing differentiation between mortgage and protection networks and the wealth management networks because they are regulated and run so differently. Support services in networks that try to combine the two may struggle to offer such different propositions with such different regulation and ways of working.”
Smith continues: “In the round, however, things look positive. Our market is driven by the housing market, which has a healthy outlook.
“Increasingly in this space, we have brokers who have come through the MMR, have weathered the credit crunch, have seen banks and building societies close and have altered their business models so that they now offer protection as a matter of course. These brokers will have very robust business models, offering very good support, and will be the ones setting the standards of what we expect.”
Without a large influx of mortgage brokers into the sector, further consolidation among networks seems a possibility. Existing networks will want to ensure that their business models are robust enough to withstand another market downturn.
Under the FCA, many networks appear already to be fully stretched in their checks of potential members. But given the rate at which some networks are rejecting applicants, the entire sector needs to stay alert to avoid admitting anyone that may pose a threat to them and their existing members.
Better quality of membership has raised the bar all around
Mark Graves, director at Pink
During the four years since Pink was acquired by LSL, our membership numbers have remained fairly constant. However, the quality of members has improved significantly.
This has been achieved by increasing standards across the board, which has resulted in replacing 50 per cent of our advisers. This raising of the bar has had a positive effect all around: clients get a better quality of advice and advisers have significantly increased their sales performance.
The tests we carry out on ARs are now more stringent, which we started long before the MMR. Advisers are at the sharp end of the business so it is logical that we make sure they are fit for purpose.
We ensure that any adviser who joins us passes our fit-and-proper test. We carry out in-depth checks on their financial history and they must have a robust business plan. This should include a contingency plan in case they are unable to work through ill health.
Industry standards have increased, which has left a number of advisers on the outside looking in. Our standards and systems are very robust: we reject around 40 per cent of advisers applying to join our network on a monthly basis.
Four years ago, Pink was not profitable, so we clearly had to make a number of changes. We started by offering more hands-on advice to our sales people. We focused on training and offering clients the full range of products available through the network.
Inevitably this resulted in a large increase in protection advice, which translated into more sales. We have helped advisers to become better at their jobs and this in turn has helped them to become more successful and Pink more successful as a network.
If we assume that the size of the broker market will stay the same over the next five years, networks will be competing with each other and with the DA market. Therefore it will come down to cost versus benefits.
So far, most networks have built business models around taking advisers from other networks by enticing them with financial incentives and highly competitive terms. This is not an arena Pink wishes to play in as it has no long-term value because it unsettles existing advisers who are now worse off than the new advisers. We greatly believe in growth through investing time and effort in our existing firms and helping them to grow by developing new people.
With FCA fees continuing to rise over the next five years and the cost of running networks getting more expensive, network heads will have to think long and hard about how they will become, or remain, profitable and continue to adapt.