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Why I read last rites for networks

Anyone who heard my speech at the recent Building Societies Association annual conference in Harrogate or read about it in Money Marketing will be aware that I predicted that within 12 months there will be no mortgage networks.

To be more precise, I predicted that, if nothing changes and current market pressures remain, few mortgage networks will be robust enough to still be here in a year’s time. I say this as a director of Skipton Building Society group, which includes two networks, Pink and Enable. Why?

It is worth looking back to just before mortgage regulation. At that time, market commentators were predicting that, of all the brokers registered with the Mortgage Code Compliance Board, 70 per cent would choose to become appointed representatives and the remaining 30 per cent would seek direct authorisation. These predictions meant that the future looked rosy for mortgage networks.

However, six months into regulation and with the dust finally settling, the reality is vastly different. Much bigger numbers of brokers have chosen the DA route, leaving the number choosing to join networks significantly reduced.

At this point, I would like to set out my view for the longer term. In three to five years, the proportions of ARs and DAs will have balanced somewhat as the latter realise that the route they have chosen is just as expensive, offers no more control and leaves the broker carrying all the risk. Indeed, our networks have already seen an increase in enquiries from DAs wishing to change to AR status.

Staying with the current scenario, though, with not enough ARs to go around, it is inevitable that there will be consolidation of the mortgage networks, especially for those at the lower end with broker numbers in single digits.

It is my belief that the market could shrink to a third of its size, ending up with around 10 networks because that is all that market demand can accommodate. The problem for the surviving networks is how to merge new ARs into their business while ensuring that quality is maintained.

While investigating acquisition opportunities with other networks, Enable has come to the conclusion that many networks have signed up brokers without going through the same level of reference or induction processes that it carries out itself. This belief is based on the fact that over half of brokers who made enquiries with Enable were not acceptable. These brokers have since signed up with alternative networks or taken the DA route.

The need for quality leads me to the issue that sparked off this whole debate. The cost of regulation, of which professional indemnity insurance is a part, will add business pressures which could reduce the number of networks still further. Since regulation, PI insurance to cover for misselling issues and any claims is mandatory but the price and potential availability of this cover could present a major hurdle for networks.

While price has been softening recently and capacity improving, we all know how fickle this specialist market can be. You do not have to go back far to remember price increases of around 50 per cent in 2002 and 27 per cent in 2001, when turnover increased by only 3 per cent and 12.5 per cent respectively – an issue that the FSA alluded to in its original consultation papers on this subject.

As a current example, Pink, with 75 ARs in its network, pays costs running into six figures and that is with highly qualified brokers. For newer networks, this premium will be on top of high start-up costs, leading to an ever greater need to generate revenue.

The real threat, though, is future costs. At the start of any new market, there is no claims’ history on which to base premiums on and costs are inevitably at their lowest point. As flawed sales practices become identified and misselling chickens come home to roost, premiums will grow to reflect the increased risk, adding more pressure to the profit margin.

Less experienced brokers or those with a history of claims may suffer material changes to pricing, cover or, in extreme cases, removal of capa- city. Networks must be careful not to have their entire business tarred with the same brush if a broker is not up to scratch.

From the broker’s point of view, it is equally important that they should join a quality outfit, as they do not want to end up with a network which is subject to regulatory censure or one with reduced PI cover and increased premiums.

As I stipulated earlier, if nothing changes, networks will struggle to survive with a reduced pool of income generators, increased competition for business and crippling PI insurance costs. But all is not lost. Diversification is a key factor to survival, giving the ability to generate income from more than just the AR network.

For example, as well as being a network, Pink remains a mortgage distributor selling a range of services – compliance, packaging, administration and so on – so brokers can be involved with the company at a number of levels. As a result of this spread of services, 70 per cent of Pink’s business comes from DAs.

Technology is also paramount. No network achieves the scale to run an efficient business when the amount of management time spent on networks is disproportionate to the return. Therefore, only those with robust technology to run a network efficiently will overcome this hurdle.

The third key ingredient is qual- ity brokers which, as well as generating quality business, have the added benefit of keeping PI insurance premiums in check. Here, a well documented and rigorous compliance infrastructure is key to successful pri- cing and capacity negotiations.

The future for networks is not as rosy as we thought it would be before November 1, 2004 but with consolidation, diversification and an eye on the longer-term game plan, there could be some light at the end of the tunnel. Let us hope it is not an oncoming train.

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