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Is it time to take profits on Mortgage Choice and Australian Finance Group?

The strong run in our listed mortgage brokers could come to an abrupt and jarring end as the government comes under pressure from consumer groups to bar up-front and trailing commissions and replace them with fixed fees instead.

If the government looks swayed to the argument, the share prices of Australian Finance Group Ltd (ASX: AFG) and Mortgage Choice Limited (ASX: MOC) could return some of the stellar gains they have racked-up over the past year.

Australian Finance has surged 42% while Mortgage Choice jumped a respectable 20% over the past 12 months while the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) is up 9.5%.

But if there is one risk that is the most difficult to forecast and predict, it is regulatory risk. History is littered with examples of how changes in laws have brought ASX-listed entities to their knees.

Leading consumer groups have made a submission to the federal Treasury stating that mortgage holders are better served if the fee structure was changed, according to a report in the Sydney Morning Herald.

These groups believe that trailing commissions paid over many years by banks to mortgage brokers will hurt competition and only promote the interests of banks and brokers. This is because brokers will be reluctant to recommend that mortgage holders switch to a better product as it will put the brokers’ trailing commissions at risk.

Regardless of whether the government will make such dramatic changes, some change is likely that will negatively impact on the industry. Mortgage Choice and Australian Finance have told Treasury they are willing to sacrifice some of their bonuses, although they are urging the government to keep up-front and trailing commissions as these form a large part of the pay packets for their mortgage brokers.

Mortgage brokers have long recognised the conflict of interests and have undertaken some steps to mitigate these risks. For instance, some pay their brokers a flat up-front commission for each new mortgage they write regardless of how much each bank pays in up-front commissions. This has essentially allowed mortgage broking companies to pocket the difference.

While I do think that companies like Mortgage Choice are well-run (not to mention Mortgage Choice’s handsome dividend yield), I think the regulatory risks are not fully priced into either Australian Financial or Mortgage Choice. Given the strong rally in both stocks, it may not be a bad idea to think about taking some profit off the table.

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Motley Fool contributor Brendon Lau has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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