Consolidation in the sector has seen mortgage banks pursue individual strategies. Lydia Westrup reports
Until recently, the German mortgage banks were a fairly homogenous group specialising in two areas of business: property finance and lending to the public sector. However, the sector is now not only faced with consolidation, the mortgage banks have also started to define individual strategic profiles.
“We are currently experiencing the first few waves of a storm that is likely to change the whole banking sector and the mortgage banks with it over the next two to three years,” says Karl-Heinz Glauner, speaker of the board of management of DePfa Deutsche Pfandbriefbank, Wiesbaden. “I do not think that there will be a sizeable number of pure mortgage banks in a few years time.”
After Deutsche Bank merged its three mortgage banks into Eurohypo a couple of years ago, Dresdner Bank also put its mortgage bank subsidiaries under the umbrella of Deutsche Hyp. The merger of the two BHW subsidiaries, Allgemeine Hypothekenbank (AHB) and Rheinboden Hypothekenbank, is planned for this July.
In March, HypoVereinsbank (HVB) announced plans to beef up its property business. Under its strategic initiative, Lead Competence Real Estate, the property elements of the group will be consolidated into a new property bank. First, the activities of its Nürnberger Hypothekenbank and Süddeutsche Bodencreditbank will be merged into Bayerische Handelsbank. The next step will see the property business of HVB brought into the mortgage bank. The property bank, which will be trading under a new name yet to be disclosed, is likely to start operations in September. Also in March, HVB announced the sale of its 75% stake in Westhyp (Westfälische Hypothekenbank) to WGZ-Bank, a co-operative bank, and Signal Iduna, an insurance company.
Seeking greater earnings
Like other German financial institutions, the mortgage banks are looking for ways to increase their earnings potential. Achieving greater profitability within the narrow bands of the mortgage banking licence adds to the challenge. Traditionally, German banks measured success in terms of asset growth. Eurohypo has moved away from this and follows a growth strategy that is focused on profitability. Bernd Knobloch, member of the board of Eurohypo, explains: “For us the most important goal is to increase our fee income, thereby improving our return on equity.”
In their pursuit of greater profitability, the banks have chosen different paths. While some are taking the route to move closer to their respective parent groups, others count their independence as a competitive advantage. With total assets of nearly €100m (DM195m), Allgemeine Hypothekenbank Rheinboden (AHBR), which is part of the BHW group, a domestic building society, will be one of the larger mortgage banks. “The primary focus of our business will be that of a senior lender. Unlike some of our competitors, which are taking on various aspects of the real estate business, we concentrate on providing finance and will not be competing with our clients for development projects or investment opportunities,” says Dr Klaus Schubäus, member of the board of AHBR.
Commerzbank subsidiary Rheinhyp is advocating a loose connection with the other parts of the group. Dr Karsten von Köller, a member of the board at Rheinhyp, explains: “We believe we can best exploit our business potential for the whole group when we present ourselves as an independent unit. Together with Commerzbank und Hypothekenbank in Essen, the group is represented with three different brands in the market.”
Integrating group structures
At the opposite end of the spectrum, Deutsche Bank and Dresdner Bank are seeking to integrate their mortgage banks closely into their respective group structures. Following the strategic alignment of Deutsche Bank group, Eurohypo is part of the Corporate and Investment Bank (CIB) and will be the “centre of competence” for the commercial property activities in Europe. “We intend to focus our activities on arranging transactions to finance commercial properties, and to expand our securitisation activities in order to strengthen our equity base,” says Knobloch. Working closely with the other units within the Global Real Estate group Eurohypo will provide the full range of structured finance and real estate investment banking products.
In an overhaul of the real estate business the property division is one of six core business divisions within Dresdner Bank group.
The mortgage bank will be in charge of all property lending activities of the group. Following the announcement of the takeover of Dresdner Bank by Allianz, the insurance group, informal talks have started between the two parties to examine opportunities that may generate additional property expertise for the new group as a whole.
DePfa Group, one of the largest mortgage banks, surprised the industry last year with its announcement to split up its activities into two separate banks. DePfa-Bank Europe, Dublin, will be the holding company for all public sector lending activities and will act as a holding company for the group and the property bank.
DePfa’s Glauner explains the move. “The market has different rating expectations for these activities. For the refinancing of the public-sector lending business, the rating is of cardinal importance. Property lending, which accounts for almost one quarter of our loan book, is viewed with inherent scepticism by the rating agencies. In order to fully meet our growth potential for both businesses, we have decided to split the two.” Preparing for a separate listing of the two banks, DePfa has taken steps to clear its property book of residual risks. As a result, loan provisions increased from €62m (DM121m) in 1999 to €154m (DM301) for 2000. These were due to a new assessment of the credit risks and loan losses incurred in one of the bank’s branches in West Germany.
Within the confined boundaries of the mortgage banking act, the financial institutions have begun to forge different business strategies. Each bank now seeks to capitalise its core competences.
Lending against commercial properties features strongly in most business plans. It is also a key strategic focus for Eurohypo. For the bank this business segment offers the best growth potential particularly in view of enhancing the profitability. Last year, international lending activities totalled €3.4bn (DM6.6bn) and accounted for 56% of all new mortgage lending of Eurohypo. And the prospects continue to look good. “We still see potential in all of the major European markets,” says Knobloch. “However, looking at the financing of development projects, we tend to take a more cautious approach and expect developers to provide more equity.”
For Rheinhyp, the cross-border business has been a major growth engine for some time now. With 12 European outlets, the bank maintains the densest international network among the mortgage banks. Rheinhyp wrote about half of the new mortgage lending business of around €6.3bn (DM12.3bn) in markets outside Germany last year. In the meantime, the international business has also been a stimulus for the domestic operations. “Last year we have grown substantially in our commercial property lending business,” says von Köller. “This has come from our international contacts as investors are looking for investment opportunities in Germany.” In 2000, Rheinhyp set up a desk in Frankfurt to cater as a one-stop shop for these customers.
AHBR was a little late stepping into the international forum when it moved outside Germany two years ago. But for them the international activities have got off to a good start. After the merger with Rheinboden, the bank will account for nearly 10% of the international business of the mortgage banks as calculated by the Association of German Mortgage Banks. “This is an area in which we want to grow,” says Schubäus. The group maintains offices in the UK, France, Spain and the Netherlands and covers other EU countries through its head office operation.
Deutsche Hyp is also keen to grow its international business. “Today we are represented in some markets, but would like to extend our network both in terms of taking on more personnel in our existing new offices as well as adding new offices,” says Heinz-Jörg Platzek, head of Immobilien Management Board of Dresdner Bank and chief executive officer of Deutsche Hyp. Target markets are the UK, France, the Spain. In central Europe Deutsche Hyp is represented in Warsaw.
HypoVereinsbank (HVB), already Europe’s leading property lender, is using its restructuring to look for opportunities to expand its position internationally. Georg Funke, head of the property division at HVB and board member of the new property bank, spells out the strategy. “In our cross-border business, we intend to focus on big-ticket transactions for international investors, also in those markets in which we are not necessarily represented with an office. Typically, these are complex transactions which require special know-how in structuring deals.”
German mortgage banks are also considering moving into more investment banking activities. According to Capital DATA Loanware, Eurohypo took the lead position in syndications for the property sector ahead of UK bank Barclays Bank and Royal Bank of Scotland last year. Eurohypo bank generated new business in the order of €6.6bn (DM12.9bn) in markets outside Germany, of which it retained €3.4bn (DM6.6bn) on its book. The bulk of the business, €5.2bn (DM10bn), was generated in London. One transaction was the €1bn (DM1.95bn) financing for Canary Wharf Group, where Eurohypo acted as co-arranger, facility agent and security trustee.
Deutsche Hyp is another player that expects to add real estate investment banking to its services. “In the US, we have an experienced real estate team at Dresdner Kleinwort Wasserstein. This team will be relocated to Europe. We see a paradigm shift in the way real estate is looked at in Europe. Rather than looking at property for long-term capital growth, investors seek liquidity and expect to achieve returns on their real estate holdings,” says Platzek. “Modern investment banking products can help to achieve these goals. In terms of business opportunities, this means finding efficient legal structures, facilitating spin-offs of real estate holdings and preparing companies for IPOs.”
Banks with a combined licence, such as HVB or Deutsche Hyp, are allowed to do business as a mortgage bank as well as a commercial bank, and thus able to do business in the US market. However, banks operating under a pure mortgage bank licence are eagerly waiting for the legal framework to change. This is expected to happen some time next year. Rheinhyp and AHBR are preparing to set up offices in New York.
For some time now the retail business has been a challenge for the mortgage banks. Low margins and high distribution costs put pressure on the profitability. “I doubt this is a business which can generate adequate returns, if distribution and production of the loans are undertaken in-house,” says Schubäus of AHBR. “We see our strengths in standardised operations using the internet and in our low cost funding capabilities. In our retail mortgage business, we focus on online mortgages and cooperation with large distribution networks, and the acquisition of loan portfolios.”
Eurohypo and Deutsche Hyp concentrate their activities on the administration of retail mortgages. For Eurohypo, the distribution is undertaken by Deutsche Bank 24, its retail banking arm. Deutsche Hyp has linked with Dresdner Bank to distribute retail mortgages by the branch network of Dresdner Bank.
For Rheinhyp, the business with private customers and its slim margins provides a good means of portfolio diversification as this segment follows different business cycles and provides a different risk profile compared with the commercial property markets. The bank intends to continue all activities under the mortgage banking act, though some of the activities may be outsourced to subsidiaries and affiliated companies.
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DePfa’s moves to gain a competitive edge |
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In a strategic realignment last year, DePfa Group announced the split of its activities into two separate banks with one bank in charge of all public sector lending activities and a property bank. According to Karl-Heinz Glauner, speaker of the board of management of DePfa, the businesses do not make an easy fit, indeed they hamper the development of either business. DePfa expects the model will give it a competitive edge. Under the arrangement, the public sector bank will operate under the Mortgage Banking Act and aim to become a leading provider of financial services for the public sector on a global basis. At the same time, the property bank will offer a wide range of real estate services. Its aim is to achieve its target return on equity of 17% after tax. The international lending is the most profitable business segment among DePfa’s property activities. Consequently, the European and the US markets take priority in the expansion plans of the bank. Rather than merely counting on international investors in the different markets, the bank seeks to generate a certain amount of local business. In order to put down lasting roots in the different markets, DePfa is targeting property investors and developers in the first and upper half of the second division. In today’s market, customers are increasingly looking for individual solutions to meet their financing needs. As a result, DePfa wants to build up its activities in the area of structured finance, advisory work and property asset management. “We intend to move on from being mainly a property lender. We see particular growth potential in the area of property asset management on a pan-European basis,” says Glauner. “The advent of the euro has opened up new investment markets for institutional investors. However, many of these investors are lacking in international experience, especially the medium-sized investors. Also, direct investments tend to be expensive. Pooling the resources in property funds is often a means for investors to venture cross border.” Its first property fund, DePfa Europa Fonds Nr 1, has a investment volume of €500m (DM977m). The fund is targeting shopping centres in southern Europe. In Germany, one of DePfa’s core businesses is providing finance for housing developers. The bank expects to increase its activities, which are highly profitable, and achieve a return on equity before tax of 25% to 30%. With its services for institutional owners of large housing stock DePfa has gained a leading position in the German market. To further increase the already considerable return on equity of 35% before tax the bank has plans to syndicate and securitise some of the long term loans. For the two less profitable businesses DePfa has worked out how to reposition these activities. Whereas the group did not incur any loan losses on its international loans so far, heavy write-offs on the commercial property book in Germany, particularly on its loans in East Germany, have put a dent into DePfa’s profits in recent years. Today these loans are administered by special work-out units. In the meantime DePfa has reorganised this business taking a more cautious approach towards new business. As the whole property market in Germany moves towards more institutional ownership DePfa is confident to be able to generate good business in the future. Two years ago DePfa set up a subsidiary, Hypotheken-Management, to cater for the retail business. Most of the new business in this area is now handled by this subsidiary. In a next step DePfa plans to transfer a substantial part of its existing loan book to Hypotheken-Management. Ultimately, DePfa will no longer have the retail business on the books. |
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The future for mortgage banks |
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After years of solid growth, new business for the mortgage banks declined for the first time since 1994. As construction in the housing industry weakened and demand for loans from the public sector softened, new business at the mortgage banks fell by one fifth in 2000 compared with the previous year. Contrary to the overall development of the business, the commercial property loans outside Germany grew by 38%. With loans totaling €12.5bn (DM24.4bn), the new international business accounted for half the commercial loans. At the end of last year the cross-border business now accounts for 18% of the aggregate commercial loan book (excluding Depfa Group). While the mortgage banks are implementing their business strategies, the law governing their activities has also come under scrutiny. Most experts agree that the Mortgage Banking Act is in need of a major overhaul to allow mortgage banks greater flexibility. Especially those banks operating solely under the mortgage bank licence and those who may not have a close connection to a major banking group find it difficult to compete effectively. The combination of public-sector lending and property finance refinanced by the issuance of Pfandbriefe (mortgage bonds), which was initiated more than 100 years ago, does not fit easily into today’s financial markets. However, opinions on how the law may be modified and reformed are deeply divided. The backbone of the business of mortgage banks is their ability to issue Pfandbriefe (mortgage bonds) to refinance their lending activities. These long term bonds allow fixed rate funding on a five or 10 year basis. In fact, until recently much of the business was driven by this instrument. Over the years, Pfandbriefe have become an important benchmark in the bond market taking second rank behind the government bonds. Especially since the arrival of jumbo and global issues with a minimum volume of £500m (DM977m) in the market a few years ago they have enjoyed great popularity among investors. At the same time, the markets have begun to differentiate among the issues according to ratings and preferring the larger ones as they offer greater liquidity. Hence for the mortgage banks size has become a determining factor. While there is little disagreement among observers over the need to maintain the Pfandbrief as an asset class, the need for specialised banks to issue such bonds is being questioned. Heinz-Jörg Platzek, head of the Immobilien Management Board and chief executive officer of Deutsche Hyp, argues in favour of the traditional form of the mortgage bank as specialised financial institutions. “I believe that the mortgage banking act is a suitable framework for us. It is important to maintain the Pfandbrief as an asset class and to safeguard the quality standards of this instrument. At the same time the legislation needs to be amended to create a level playing field for the mortgage banks in the market enabling them to compete effectively as full-fledged property banks.” For Georg Funke, head of the property division at HVB and board member of the new property bank, the Pfandbrief is but one means to refinance the property loan book: “The main business of a property bank is to provide finance to the sector as well as risk management. This is the basis to create a profitable business. Naturally, the loan book needs to be funded and for this the market offers several options and in some cases the Pfandbrief is a competitive and fitting instrument.” In addition to the Pfandbrief mortgage banks are also exploring other funding options. Rheinhyp was the first to issue credit linked notes. “The first issue covered a spread of loans from different European markets, while the second one, which was put to the market in April, included a large stake of UK-based loans supplemented by some other international credit facilities,” says Dr Karsten Von Köller. Altogether the bank plans to securitise property loans totalling €11bn (DM21.5bn) by 2005. |
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New loans issued by German mortgage banks |
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Demand by public sector loans fell by one fifth in 2000 |
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€bn |
1996 |
1997 |
1998 |
1999 |
2000 |
|
Total New Loans |
143.0 |
162.1 |
191.0 |
198.0 |
154.8 |
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Mortgage Loans |
49.1 |
49.9 |
56.5 |
55.3 |
46.7 |
|
Housing Loans |
31.8 |
32.7 |
38.8 |
32.2 |
21.6 |
|
Commercial Loans |
17.3 |
17.2 |
17.6 |
23.1 |
25.1 |
|
Public Sector Loans |
93.9 |
112.2 |
134.5 |
142.7 |
108.0 |
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Source: Association of German Mortgage Banks Figures after 1998 exclude DePfa |
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Loan book and new business by country |
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Central Europe has provided another avenue for new business |
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EU-countries (in €m*) |
Total loan book |
New business |
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1999 |
2000 |
1999 |
2000 |
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Belgium |
115.9 |
417.9 |
61.5 |
399.1 |
|
Denmark |
107.7 |
– |
35.5 |
41.8 |
|
Finland |
10.0 |
53.2 |
10.0 |
53.7 |
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France |
2,148.6 |
3,473.7 |
1,262.8 |
2,367.2 |
|
Greece |
0.0 |
86.9 |
0.0 |
0.0 |
|
UK |
6,467.7 |
9,737.1 |
4,715.2 |
6,198.1 |
|
Ireland |
226.1 |
270.4 |
38.5 |
120.0 |
|
Italy |
11.4 |
221.8 |
51.6 |
342.7 |
|
Luxembourg |
47.5 |
50.5 |
2.3 |
10.9 |
|
Netherlands |
6,363.1 |
7,673.4 |
2,951.3 |
2,857.8 |
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Austria |
334.0 |
340.3 |
69.8 |
25.7 |
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Portugal |
23.9 |
134.5 |
24.9 |
146.1 |
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Sweden |
891.2 |
1,366.0 |
433.3 |
527.8 |
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Spain |
1,588.7 |
3,087.8 |
674.9 |
1,655.2 |
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EEA-Countries and Switzerland |
1,011.5 |
1,639.0 |
868.9 |
721.5 |
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Poland |
– |
– |
46.5 |
155.1 |
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Czech Republic |
– |
– |
64.8 |
130.1 |
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Hungary |
– |
– |
2.6 |
67.1 |
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Total |
19,347.3 |
28,552.5 |
11,247.0 |
15,622.7 |
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* including international subsidiaries Data after 1998 excludes DePfa |
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Source: Association of German Mortgage Banks |
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