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Mortgage brokers are in the spotlight on day three of the financial services royal commission, with the Commonwealth Bank the first to front, followed by its subsidiary Aussie Home Loans.
The first witness to appear today is CBA's executive general manager of home buying, Daniel Huggins.
Under questioning from the commission's senior counsel, Rowena Orr QC, Mr Huggins acknowledged there was a conflict of interest created by the commission payments banks make to mortgage brokers.
"The larger the loan, the larger the upfront commission," he said.
"The longer the loan takes to pay off and the larger it is, then the larger the trailing commission and that can lead to a conflict — that is a conflict — between the customer and the broker."
Ms Orr followed up to clarify that a broker's pay is generally directly related to how much their clients borrow.
"Because it's in the mortgage broker's interests to get the largest loan approved possible to extend over the longest period of time for the customer to repay it?" she asked.
"That's how they would maximise their income, yes," Mr Huggins replied.
CBA keeps commissions even though they hurt customers
Ms Orr then quoted from a report CBA provided to Stephen Sedgwick in February 2017, who led an Australian Bankers' Association review into retail banking remuneration.
The CBA analysis found broker-originated loans were reliably associated with higher leverage, a higher prevalence of interest-only repayments (causing the loans to be paid off more slowly), higher debt-to-income levels, higher loan-to-value ratios and higher incurred interest costs.
Ms Orr continued quoting from the report.
"Over time, higher leverage means broker customers have an increased likelihood of falling into arrears, pay down their loans more slowly and, on average, pay more in interest than proprietary customers," she noted.
"These findings are consistent with the hypothesis that differences in remuneration between the channels are driving different customer outcomes, and lends some support to the case for discontinuing the practice of volume-based commissions for third parties."
However, the report also argued that "any changes will need to be made uniformly across the industry", otherwise those organisations that removed commissions would be disadvantaged.
"I'm not sure I would suggest that the difficulties are surmountable if CBA would act alone," Mr Huggins said.
Because of this, Mr Huggins admitted that CBA has not taken any steps to move away from the practice of paying commissions to mortgage brokers based on loan size, and including trailing commissions.
CBA's report, submitted with a letter by chief executive Ian Narev to Mr Sedgwick, appears to contradict public statements made by Mr Narev later last year when the bank bought out the remainder of mortgage broker Aussie Home Loans.
"A large number of Australians want to go through a broker," he said in August.
"That's why we deal with brokers and have a relationship with Aussie, because it's good for customers, and we're very committed to the channel."
Commonwealth Bank failed to monitor brokers
An August 2017 internal audit report at the Commonwealth Bank found that the control of mortgage brokers to prevent and detect fraud and misconduct was only "marginal".
Ms Orr questioned Mr Huggins on this area.
"They identify significant problems in relation to the monitoring of aggregators and brokers by CBA, this is in August 2017."
"Yes, they identify some areas that need to be improved."
"And, as a result of that, the control environment is rated marginal only?"
"That is correct, yes."
Senior counsel assisting then moved on to some specific examples audit had detected where CBA failed to follow up on red flags of potential broker misconduct.
The audit identified 1,361 instances where the borrower, broker and the security property were in different states at the time of the application, 2,758 instances where the borrower and broker were from different states and another 332 where the borrower and the broker were in different countries.
Given that the broker is supposed to have a personal conversation with the borrower and has a role in verifying identity and documentation, commissioner Hayne expressed concern that CBA was placing too much reliance on its brokers.
"In many respects, in respect of house loan applications the bank depends on what the broker tells it," observed commissioner Hayne.
"That's right."
CBA accused of shutting some brokers out
Mr Huggins was also quizzed about CBA's treatment of mortgage brokers, after Brisbane-based broker Mark Harris yesterday testified that the bank had removed his accreditation because he had not written enough loans for them.
"The biggest concern, I guess, is that if there are minimum performance standards that a lender, the Commonwealth Bank, are putting in place, that seems to override any liability we've got in respect of putting a client in the best loan for them," Mr Harris told the commission.
"The concern is that that will push brokers into using Commonwealth Bank where they should not have done."
Counsel for the Commonwealth Bank questioned Mr Harris on how many loans he had written for CBA in 2015 and 2016, and he said he had not written any.
Today we learnt from Mr Huggins that 710 mortgage brokers were sent de-accreditation letters in early 2017 because they had been "inactive" or "less active".
Mr Huggins said the rationale for de-accrediting the brokers was that it was difficult to be confident that they understood the banks products and processes and could be good representatives of CBA to customers.
However, a document produced by CBA's communications team revealed that the bank had come under pressure from equity analysts and shareholders to rebalance loan flows towards its internal channels, and used the example of de-accrediting less active mortgage brokers as an example of the bank's efforts to achieve this.
Topics: banking, housing-industry, consumer-finance, consumer-protection, australia, melbourne-3000
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