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Morningstar | Royal Commission Recommendation’s Damage Mortgage Choice Business Model. Stock Under Review. See Updated Analyst Note from 04 Feb 2019

In our view, the Royal Commission’s recommendations on mortgage broker remuneration, tougher licensing requirements and that mortgage brokers act in the best interest of clients, damage Mortgage Choice’s business model to such an extent we put the stock under review, with a cut to our fair value estimate likely. The firm’s stock price is down more than 25% today following release of the recommendations, with the firm’s official response understandably broad and general. We intend to update our valuation and business case by mid-February with the firm due to release first-half fiscal 2019 results on Feb. 21. The proposed changes are a serious blow to the firm with a significant amount of earnings at risk. Existing contracts will run-off during the next four years with net trail commission forecast for fiscal 2019 of AUD 26 million reducing materially by end fiscal 2022. Net trail commission income represents 63% of our fiscal 2019 forecast broker commission revenue for the firm.

The Royal Commission made 76 recommendations, and we see the most significant applying to the mortgage broking industry with the proposed banning of lender paid commissions, replacing these with borrower paid fees. Mortgage broker commissions are to be banned over a period of two to three years, first by banning trail commissions on all new loans and then on upfront commissions. There is some uncertainty on the banning of upfront commissions with the Coalition indicating a period of review to assess the likely impact on competition in the mortgage market.

Another widely expected recommendation is for mortgage brokers to act in the best interests of borrowers, not surprising with the Royal Commission recommending mortgage brokers should operate under the same laws and regulations as financial advisors. We think it likely the major banks will move ahead of the three-year phase out period and remove broker commissions sooner, further damaging the viability of mortgage brokers.

The Treasurer stated from July 1, 2020, the government would ban trail commissions for new loans and limit upfront commissions to the amount drawn down not the loan approval amount. Trail commission on existing loans is unaffected by the proposed changes.
The coalition government would not initially implement the borrower pay regime, but it would review the situation in three years to determine whether the borrower should pay. Based on political polls, the opposition Labor party is the favourite to win government in May and the shadow Treasurer has confirmed a Labor government would implement all recommendations including the banning of lender-paid commissions.

Another recommendation covers misconduct by mortgage brokers, with Australian Credit Licence holding brokers should be subject to the same sharing and reporting procedures as financial advisors and be subject to the same processes of informing and remediating clients if misconduct is discovered.