The recent announcement that Pink Home Loans has bought a majority stake in BDS is perhaps atypical of what the market would expect in the current climate. The deal was acclaimed as a positive move for both firms, as neither was in any financial distress as a spur to signing.
While the firms will continue to operate as separate entities, there will be shared economies of scale that will boost profit. BDS currently buys in services such as compliance, HR, legal and finance, which it will now be able to access through the larger firm’s own set-up. In addition, the increased buying power has already had an impact, with one lender reportedly increasing the fees paid to BDS in line with Pink’s.
Commenting on the move, Nigel Gardner, managing director of GHL Group, says: “From what I know of both companies, they are both well run, with Pink having a bigger network and more appointed representatives (ARs). From the BDS point of view, it is traditionally a very strong packager. The fit seems to be good.”
Coming from a competing firm, that view may possibly be seen as kind. However, the fact is the pool of available ARs is growing. Around 70% of broker business was through the directly authorised route in 2004. But some estimates say this is now more like 50%, with a growing number of brokers becoming ARs as a result of rising FSA fees, increased regulation, the implementation of TCF, the possible increase in professional indemnity insurance and the drop in procuration fees caused by lenders seeking to rebuild their own margins.
Neil Hoare, associate director of proposition development at Pink Home Loans, adds: “Treating customers fairly (TCF) is really driving the move from directly authorised to becoming an AR, as there are no set rules for its implementation.”
Gardner adds: “The pool of networks has diminished as well. On Mortgage-Day there were 72, now there are around 26. A larger pool of ARs and a reduced number of networks makes the sector more sustainable.”
However, the pool of ARs is not increasing as a flood. John Cupis, head of mortgages and general insurance at Sesame, points out the FSA register is a good indication of movement in ARs and, to date, he has not seen a great amount of AR movement in the market.
He says in addition, the cost of running a network is rising: “In an environment where the costs on networks and advisers are on the increase, I would not be surprised that to be viable in the long term, you would need to be one of the bigger networks. I think the smaller networks that do not diversify or grow will find it increasingly difficult to remain viable.”
Matter of scale
It is interesting to note that in the recent deal, Pink revealed it had 545 ARs, compared with around 100 for BDS. Hoare acknowledges this point. He says: “If you are to run an AR network with the infrastructure needed to keep on top of it, then you would be looking at a minimum of around 200 ARs in order to be financially viable.”
However, he adds that this is really only true for a pure network. In reality, many networks have packaging arms and multiple strings to their bow, but still some of the smaller networks rely heavily on the income from ARs.
A lot of networks have gained valuable revenue off the back of packaging, but with the sub-prime market essentially closed for business, there remains the distinct possibility that the market will see distressed sales this year from packager networks who either have not diversified their packaging or who do not have a critical mass of ARs.
Volume in the packager market has fallen and packagers have found themselves fighting for a bigger slice of a smaller cake. Hoare says: “Those with the economy of scale will be the ones with the edge as they will be able to offer free valuations or legals as a way of differentiating themselves. This pressure is likely to cause some packager networks to look for financial security elsewhere.”
Added to this, there is limited scope for the network side to diversify itself. As Gardner notes: “The whole point of a network is about providing services to members, and if ultimately there is a demand for services such as bridging or commercial loans, then it is reasonable to expect a competent network would be providing that already.”
The bigger networks all have a generally universal proposition. Hoare says: “If you ask them for a typical AR, they could not tell you, as they have a full cross-section of the market. This broad offering is what offers a certain degree of protection. If a network attracted mainly sub-prime brokers, it would be in a difficult position.”
As such, Pink is expecting to increase its proportion of commercial deals, while BDS is focusing on secured loans over the year. “Brokers in past years were busy with new mortgages. Nowadays, they have a higher concentration of remortgage work, which does not take up the same amount of time. This gives an opportunity to explore new markets,” adds Hoare.
Nevertheless, diversification is a strategy that will not solve the long-term problem, which is the need for networks to maintain a critical mass of advisers to reap economies of scale in an increasingly expensive regulatory environment. The market is certainly likely to see more consolidation, but how much of that will be opportunistic and how much of it will be distressed, would be anybody’s guess.
However, while logic says consolidation is a given, overall the sector is in good shape. As Gardner says: “Potentially, we could see a large increase in ARs. I think TCF is quite a difficult concept for some brokers and as regulation starts to bite as the FSA raises the bar, many smaller brokers will let a network take the pain in that respect.” n