German Mortgages
January 2006


Transparency and cost efficiency become watchwords as the German mortgage market enters a phase of upheaval - its greatest, post-war. Prof Dr Thomas Kretschmar explains


The German residential mortgage market is in the throes of the greatest upheaval of the last 60 years. Direct providers and companies such as Hypoport are taking market share from traditional home loan lenders and bringing transparency and disintermediation that would have been unthinkable even three or four years ago.

Traditional savings and mortgage bank lenders, while grappling with huge jurisdictional changes, have seen their market share shrink dramatically. A multitude of banks has withdrawn completely from the market, unable to compete in a brave new world of cost-efficiency and transparency. Others have turned mortgage operations into credit factories, where the process of advancing home loans has been standardised and made much more efficient.

Internet intermediaries have entered the market, bringing the consumer closer to the lender. Hypoport’s europace B2B platform, which links brokers, lenders, risk managers, issuers and investors, has seen transaction volumes soar from around €300 million in January to more than €900 million per month today, approaching 10 per cent of the €100-billion yearly German residential mortgage market. The beneficiary in all this has been the customer. In the future, it is likely also to be the country’s depressed housing prices.

The main changes since the start of the new millennium are:


Mortgage banks have withdrawn from retail client business because the low margins meant they could no longer achieve return on equity (ROE) targets.
Private commercial banks have cut services to standard customers and closed large swathes of their branch networks.
The importance of independent financial advisors and brokers has soared, acquiring via on-line services as well as through franchise networks.
Independent consumer media have boosted awareness and transparency of home loan terms and conditions, so that
Independent brokers were obliged to begin to work with a larger selection of banks offering a greater range of mortgage products.
The first foreign lenders started operations in Germany.
Where is the pressure for change coming from?
To succeed in the German home loan market, all participants have had to overcome three main challenges in recent years. First, they have had to move to highly automated processes since margins, dictated by low interest rate levels, are very tight and personnel costs are high. Second, they have had to provide the transparency and improvement in documentation that borrowers and investors are increasingly demanding. Third, because of the break-up of the value chain, they have been obliged to simultaneously handle multiple business relationships with a large number of market players.

The changes in the German mortgage market really began around 1998. Savings banks, funded by cheap retail deposits, were the traditional mortgage providers, alongside mortgage banks. With nationwide networks of local branches, particularly in rural areas where large commercial banks are not present, savings and cooperative banks had a strong competitive advantage in distribution alone. The mortgage banks in the past had the competitive advantage of exclusive access to the cheapest capital market mortgage refinancing available, Pfandbrief-covered bonds. This exclusivity disappeared when the Pfandbrief law came into effect on July 19 2005, enabling any qualifying banks to issue covered bonds.

The monopoly had anyway begun to break down. Transparency started to come into the market at the end of the 1990s when newspapers and magazines began to publish lists of the top mortgage deals. The widely-read quality-testing organisation Stiftungwarentest began to publish reports on different mortgage offerings. Large financial advisory companies strengthened their brokerage services, working through a branch or a franchise network, the internet, or a combination of all three. These included MLP, the financial advisory group AWD, Bonnfinanz - now part of the Zurich Group - and DVAG. And the first internet broker emerged.

New mortgage financiers began to offer directly to consumers, using various paths to market. These included Dr. Klein, now a part of the Hypoport group, Interhyp - floated in November in a highly successful IPO - Creditweb (bought in 2002 by GMAC RFC), Westdeutsche Immobilienbank, Deutsche Bau und Boden, Nuremberg Hypo, and foreign institutions such as ABN-Amro and, in particular, ING which bought Direct Bank from the HVB Group and started to distribute mortgages exclusively through a highly successful ING-DiBa web portal. The giant Postbank, the partially privatised subsidiary of the German post office system, also began to think about tailoring mortgage products for its massive 14-million-strong customer base.

Establishing a new standard

One of the first milestones in this process was set by the largest mortgage broker in Germany, Dr. Klein & Co. After merging into the Hypoport group in 2002, it quickly stipulated that it would only work with finance institutions that used the group’s europace internet platform for processing. After initial misgivings, lenders rapidly began to recognise the immense turnover and cost-efficiency advantages of the unified standard and processing platform and, in turn, began to oblige their other brokers to process transactions via europace.

Hypoport has taken this further: one central database for the entire home loan industry - one continuous-process procedure from the broker to the investor. Even if its implementation was not straightforward, it saw that a common B2B platform could solve many of the industry problems - a paradise of transparency for mortgage customers and investors, and a utopia of efficiency for intermediaries and service-providers along the entire value chain. Home loan lending can be almost completely automated by the platform availability of scoring and valuation processes, automated cost calculation, document processing and commission payments. Lenders in the process only have to take the ultimate credit decision – and then solely in cases where the adviser has selected their product as conforming most closely to borrower requirements. The benefits in P&L terms are the sharp reductions in costs for loan applications that are never pursued.

In general, the German residential mortgage sector is not expecially renowned for innovative and rapid change, and the introduction of complex IT infrastructure is a particularly lengthy process. However, use of state-of- the-art technology has allowed europace to work around some of these obstacles. Instead of needing large computer terminals and local IT solutions, advisors and lenders on the system need only internet-linked PCs and, through these, can manage the entire range of work processes in a common marketplace environment.

Transparency in the process can be taken to an even greater level on the funding side too. Financing procedures can be accomplished via the platform. The services offered on europace stretch from portfolio management to investor reporting. Straight-through processing in one system allows investors in mortgage-backed securitisations, for example, to call up data pertaining to the entire origination process of the credit portfolio to which they have exposure.

Integration via one common platform drastically reduces the requirements to manage several different business relationships. Every market participant working with europace is working with one data standard and one system, and can reach all other market participants connected into it. Returns are realised through an ongoing transaction fee of one basis point, divided between advisor and lender in the case of a successful credit-approval transaction. Other fixed costs do not arise.

Always win-win situations?

What is of course clear is that a processing platform such as europace itself contributes to margin pressures in residential mortgages in Germany. In a situation where every single home loan is the subject of intense competition, the transparency of a platform offering a menu of different mortgages has immense advantages for the consumer. Last September, when lenders were offering a five-year fixed rate home mortgage at 2.8 per cent APR, German borrowers were able to tie in fantastic interest rates and use a higher proportion of income for amortisation to pay down the loan more rapidly.

As for the lenders themselves, they not only to steer new business into their own balance sheet but also support internal work processes and can compensate for the reduced margins via greatly diminished internal administration costs. Even in the stagnating markets of 2004 and 2005, lending institutions using europace were able to increase their entire business volume by no less than 60 per cent.

Foreign lenders gain particular benefits through using such a platform, and europace is certainly one highly-efficient response to the current debate over how to establish a European mortgage market. With a platform solution, the foreign lender circumvents most of the resource costs associated with the local jurisdictional and structural challenges. Even when margins are low and few market niches are left to occupy, such a developed marketplace can offer solid yields in a business with low and well-spread risk - as well as rapid access to a customer base that can also be used for cross-selling other financial products.

Following the Hypoport success in attracting onto the europace platform many of the most important market players, the biggest challenge for the future is to integrate the cooperative and the public sector savings and landesbanks. So far, three users have joined from these two banking sectors. 2006 will be a busy year.

Prof. Dr. Thomas Kretschmar is chairman of Hypoport AG, in Berlin


Europace

Nearly 40 Indpendent financial advisers now use the europace platform. These include:
Alte Leipziger
AWD
baufi.net
Baugeldbörse Rheinland
Bonnfinanz
Concordia Versicherungs-Gesellschaft
Creditweb
Deutscher Ring
Dr. Klein & Co.
FinanceScout24
FinanzDock
Freie Hypo
Gothaer Allgemeine Versicherung
Haus& Wohnen
Hypothekenbörse
Qualitypool
SIGNAL IDUNA Bauspar
Weberbank Privatbankiers

Among this group are banks and insurance companies that have taken the decision to concentrate on client advisory and offer loan products from other lenders into the market.

The lending group using europace is also rapidly expanding, and now encompasses:
ABN AMRO
BHW Bausparkasse AG
BW-Bank
DBV Winterthur
Deutsche Postbank
DKB – Deutsche Kreditbank
GMAC RFC
Hamburg-Mannheimer Versicherung
ING-DiBa
Quelle Bauspar
VOLKSWOHL BUND
Westdeutsche ImmobilienBank

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