The Mortgage Export Market.

The move to unite European financial markets has created an attractive mortgage market abroad for U.S. firms. A handful of European mortgage lenders are already in the United States running mortgage operations they acquired. What can the two camps learn from one another, and is there a unified global mortgage market in the making?

ONE OF THE MOST SIGNIFICANT INTERNATIONAL DEVELOPMENTS of the past half-century has been the rise of the European Union (EU). Founded by six countries as the European Economic Community in the late 1950s, the EU now has 15 members, a population greater than that of the United States and its own currency.

Over the next decade) the EU will become an even greater force as its members become more closely intertwined and its territory expands to include the former Soviet satellite states of Eastern Europe. Clearly, multinational corporations and overseas governments that want to deal with this vast and prosperous region will have to think and operate increasingly in European-wide terms.

Despite these broad trends, the Europeans are not on the thresh old of creating a seamless economy. Differences in such areas as taxation, regulation and buying practices will ensure that national markets will remain distinct from one another for years to come. These variations will be no less pronounced in the mortgage industry. Not only will structural differences continue, but European mortgage lenders will be wary about repeating earlier, overly ambitious cross-border expansion.

But there is, nevertheless, a stir in the European mortgage sector. U.S.-style securitization is growing. And institutions are carefully assessing cross-border opportunities. Some European lenders are looking to the U.S. experience for guidance--and with good reason. The United States offers a recognizable model. It is a huge market that has undergone its own transformations in recent years. The U.S. mortgage market has developed securitization to a fine art. And American institutions have demonstrated how the efficient use of information technology can help cross-sell products.

"I'm getting increasing inquiries from European financial institutions who want to understand the U.S. mortgage market," says Don Holton, secretary general of the International Union for Housing Finance (IUHF), Chicago.

Dan Brenneman, vice president and account executive for ALLTEL Mortgage Solutions, Ltd., Bingley, England, senses similar trends. "I think that as time progresses," Brenneman says, "you're going to see more European banks look at the United States, and you will see some United States banks look at Europe."

European banks are already represented in the U.S. mortgage sector. The Dutch bank ABN AMRO has a large operation centered in the Midwest. ABN AMRO, through ABN AMRO Mortgage Group based in Michigan, is the seventh largest mortgage lender in the United States. And London-based HSBC has a significant mortgage business built around its 1988 acquisition of Buffalo, New York-based Marine Midland Bank. National Australia Bank, which owns HomeSide Lending, Inc., Jacksonville, Florida, in the United States, is also active in the Irish mortgage market through its ownership of National Irish Bank.

David Hunter, president of HSBC Mortgage Corporation, Buffalo, New York, says that much of the overseas interest in the U.S. mortgage model grows out of the role that mortgage-backed securities and the nontraditional sources of capital have played in expanding the value of the American mortgage market from about $400 million in the early 1980s to $1.5 trillion at its peak a couple of years ago. Hunter says that the recent strategic alliances involving U.S. organizations and European institutions suggest that the American mortgage model "is rapidly gaining acceptance in many parts of the world." He adds that the mortgage product is a pivotal part of the growing strategy of financial institutions to offer a full range of services.

Holton says that a European institution interested in the United States might be looking either for a partner or an acquisition. The Europeans, he says, have been impressed by the Americans' use of information technology (IT) in retail delivery and distribution. They hope to learn as much as they can about computer-based automated underwriting, which helps an institution decide who gets a loan and who doesn't. And they are looking for ways to combine the Internet with their existing branch networks. "This is a burning question all over the world," Holton says. "How do you move from brick-and-mortar delivery with a loan officer sitting in a branch to some combination of leveraging that and enhancing that with Internet delivery?"

Holton is well-placed to assess mortgage industry trends: The membership of the IUHF is drawn from 64 countries. The greatest fear of the European institutions, Holton says, is that they will be "blind-sided by some new thing that comes their way, and all of a sudden someone's in their back pocket, picking away their traditional customers. These organizations, Holton says, are grappling with a number of questions: Do they, for instance, link up with a portal on which multiple lenders are represented? Or do they establish their own Web sites and try to create brand identity?

Judith Hardt, secretary general of the Brussels, Belgium-based European Mortgage Federation, says that U.S. banks are far ahead of their European counterparts in their use of data. Not only are the European institutions not fully aware of the risks involved in their own mortgage lending operations, Hardt says, but they are also less willing to share data within the industry. The American view, she notes, is that the dissemination of information helps everyone. Hardt is also an admirer of what she sees as American pragmatism. "Whatever makes sense," she says, "they will do it. But in Europe, that's not the way we do business. It's not because it makes sense that we do it. It's because it's acceptable culturally."

ABN AMRO is well-tuned to the benefits that can accrue from operating in an international marketplace. The Dutch bank has been conducting an extended review of its worldwide mortgage business. In addition to the United States and the Netherlands, ABN AMRO has mortgage operations in such markets as Hong Kong, Thailand and Brazil.

The goal of the review, says Stanley Rhodes, president of the ABN AMRO Mortgage Group North America, Ann Arbor, Michigan, will be to look at similarities and differences and develop opportunities for synergies. The review might also lead the bank to create a high-level body to oversee transfers of knowledge.

ABN AMRO is particularly interested in the cross-fertilization of ideas between the United States and Europe. While Rhodes does not expect to see the elimination of "all of the legal nuances between the sovereigns" in Europe, he says that there are things that ABN AMRO does in the United States that will be valuable in Europe as the Europeans move toward a U.S.-style market in terms of providing liquidity and standardization. Neither does Rhodes expect local knowledge to lose its value. "It's a bad mistake," he says, "to think that you're going to the Netherlands or you're going to Germany and apply the U.S. model. It's much easier for someone with the local knowledge of that market to take the best aspects of the U.S. mortgage market and apply it to that market."

Rhodes agreed that, in general, American institutions have been better than the Europeans at squeezing value from information. This, he suggests, is due to necessity, since no bank in the U.S. market has the kind of penetration that the big European banks enjoy in their--albeit smaller--national markets. Rhodes does not see a big difference in the use of information technology between ABN AMRO's U.S. and European operations. He notes that the bank's U.S. IT division ultimately reports up to Amsterdam.

Brenneman says that customer relationship management receives strong emphasis in the United States. But this has not always been the case. Historically, Brenneman says, there was not a lot of sharing of customer data between mortgage operations and retail banking within organizations.

Brenneman, who is based in Britain, says that U.K. institutions do not always make the best use of data. It is not uncommon, he says, for a British bank to have separate call centers for mortgages, savings accounts and checking accounts. "That not only creates confusion for the customer," Brenneman says, "but obviously it's very inefficient."

There is general agreement that American institutions have much to learn from the Europeans about product development. Holton says that the Europeans are, for instance, far ahead in the design of variable-rate mortgages. He argues that this kind of flexibility could have helped the United States avoid the savings-and-loan crisis of the 1980s by removing the squeeze between long-term mortgages and short-term deposits.

U.K. institutions have been particularly adept at incorporating insurance within the mortgage contract--an idea, Holton says, that has been tried in the United States, but without notable success. Hardt attributes much of the European flexibility on product design to the absence of agencies to parallel the activities of Fannie Mae and Freddie Mac.

Rhodes agrees that the dominance of the government-sponsored enterprises (GSEs) has helped stifle product development in the United States. He would like to be able to provide American customers with European-style products, such as interest-only mortgages built around the ability to move funds between investment brokerage accounts and stock market portfolios. But Rhodes is aware that such instruments may not be easy to sell in the United States. He says, "To change the mind-set of the typical American homebuyer that the 30-year, fixed-rate mortgage is the primary instrument that they want will take a long time."

The kind of parochialism found among American customers also extends to U.S. institutions. The U.S. mortgage market, Holton says, tends to be centered on its own activities. "But increasingly," he says, "the U.S. is looking around the world for new approaches. [U.S. institutions] want to know what's going on around the world. It's a slow creep, but it definitely is happening."

Rhodes sees growing interest from European banks in merger and acquisition opportunities in the U.S. banking market. And he believes that a strong mortgage book would be very important to a European bank thinking of acquiring a U.S. bank. He points out that client-oriented banking is very important to the European institutions. "And, of course, the mortgage is a tremendous anchor of a customer base. It provides a solid book [from] which to cross-sell your other lines of business," he says.

Holton believes that a European institution that makes an acquisition in the United States is "probably pretty restricted to its national probably setting rather than thinking in pan-European terms. But this doesn't mean, Holton adds, that the bank could not buy a subsidiary in another European country.

Hardt says that any desire by European institutions to get into the U.S. market will be tempered by their more immediate priorities of mastering the new single currency and working to break down cross-border barriers within Europe. She also points out that, unlike the United States, there is no huge lender in Europe that is solely involved in mortgages. The largest mortgage operations in Europe are small by U.S. terms, with providers tending to define themselves regionally rather than trying to identify with national or cross-border markets.

Brenneman says that part of the reason for a European bank to get into the U.S. mortgage market might be to learn U.S. techniques. But the main motivation, he maintains, would be the traditional one of making a profit. He says that specialist service providers, such as ALLTEL, can bring the expertise that a bank might be seeking and eliminate the need for the institution to get involved in expensive and time-consuming acquisitions.

Raphael Soifer, chairman of Soifer Consulting LLC, Ridgewood, New Jersey, says that it would be logical for a European bank to look to its U.S. subsidiaries for lessons--particularly in securitization--that might be applicable to the European mortgage market. "As the cross-border market for debt securities grows in Europe in response to the euro and the pan-European financial markets that have been evolving," Soifer says, "it will be natural for mortgage securitization to grow.

But for securitization to reach its potential in Europe, Soifer says, the regulators will have to take a more positive attitude. "Many of the European regulators still haven't fully bought into the notion [of securitization]," Soifer says. "But I think they will, because it is a way for banks to reduce their on-balance-sheet risk."

A London-based banking industry analyst, who asked not to be identified, notes that the mutual status of many European banks has meant they have not suffered from the capital constraints that would have encouraged securitization. The analyst adds that the monetary union, and the increasing Europeanization of the banking sector, is likely to set off a chain reaction that will increase the appetite for securitization in Europe. He says it has been legally possible for some years for an EU bank to operate in other member states. But widespread expectations that banks based in the more prosperous northern countries would invade the southern markets and use their greater efficiencies to grab business away from local institutions did not materialize. Nationally based regulation proved a stubborn barrier, and consumers remained loyal to the institutions they knew.

But a shift of regulatory activity and investor focus from a national to a European level is encouraging cross-border banking alliances and even mergers. Suddenly the euro has become a domestic currency, and investors find it easier to compare the performance of banks from one country to another. "There is a bigger drive from banks throughout Europe to start improving their returns on capital," the analyst says.

Hardt is unsure about the role likely to be played by Brussels as the EU continues to integrate politically and economically. She says that Brussels already distributes more money back to EU member states than the federal government in the United States has ever transferred back to the individual states. But she does not see the nation state fading away. EU member countries will retain power in such important areas as taxation, property law and the provision of social security benefits.

"I think that right now Europe doesn't really know where it's heading," Hardt says. "There is no real sense of driving it to one direction or another. We have the single currency, but we don't even know if we will have an economic government."

Hardt believes that American banks will be the drivers of cross-border mortgage business in Europe. She recalls the burst of overoptimistic cross-border expansion among European lenders following the establishment of the single European market in 1992. Much of this early experience was negative, and it left its scars.

Monetary union will undoubtedly encourage the growth of securitization in Europe. Brenneman points out, for instance, that it will become easier to originate a loan in one EU country and deliver it in another. Rhodes suggests that monetary union has been responsible for much of the U.S. interest in the European mortgage market. He believes that the single currency will create new opportunities in Europe. And unlike some Europeans, he is not worried about the current weakness of the euro against the dollar. But Rhodes also warns that progress may be slow, with different countries embracing the aspects of monetary union at their own pace.

Holton notes that many European institutions are looking more closely at the advantages offered by securitization. He says that the Europeans tend to lack an understanding of the concept of a secondary mortgage market, "which forms the predominant part of the U.S. market. They want to know about secondary mortgage market securitization almost as a way to supercharge their income and balance sheets with new funding."

Brenneman believes that major U.K. lenders are looking less to the United States than to continental Europe and the unfolding situation regarding monetary union. But he also predicts that their view will broaden out as globalization becomes a theme of the financial services industry.

David Anderson, chief executive of the Yorkshire Building Society, Bradford, England, predicts that the arrival in the U.K. of such third-party service providers as ALLTEL and Countrywide will drive costs down by putting these sophisticated skills within easy reach of a wider set of institutions. But he argues that continued low margins on new business will inhibit the development of securitization. "Until margins on new business widen a bit," Anderson says, "it's unlikely that there is going to be large-scale new business written with securitization in mind."

If anything, Anderson says, margins are likely to narrow further over the next two to three years. He cites the number of new entrants to the market, the widespread upgrading of IT systems and a push to create Internet-based operations.

A sharing of ideas

Hunter says that the U.S. organizations have the experience to help European banks free up their capital. "In most parts of the rest of the world, even in Canada," he says, "mortgages are still a shelf product. [The U.S. organizations] are saying: 'Here's an opportunity to create the mortgages, tie up your customers, get your capital back and create servicing rights.' That's started to happen both in the primary market and also the subprime markets."

Hunter is impressed by the ability of European institutions to cross-sell--"to tie the customer up in a one-stop shop," he says. By contrast, he notes that U.S. banks face obstacles in the form of disclosure regulations. But he says that the Americans have been more flexible on IT and are more advanced in such areas as telemarketing, the Internet and front-end platforms. The European tendency, he says, has been to develop in-house models and to stick with them. "We have been more receptive to the idea that you develop something and then throw it away. And it's going to last for two or three years and then the next one comes along."

Hunter says that ideas can move very quickly from country to country within organizations. He says that HSBC is poised for this, having just gone through the branding of its global operations under the HSBC banner. Across the industry, Hunter says, you are going to see much more sharing of information. You're going to see a total integration over the next five to 10 years of best practices from both sides of the globe."

The attitude of the U.K. toward European monetary union remains a major question mark. Britain has so far remained outside the euro, and the issue has sparked bitter debate about perceived threats to national sovereignty. The Labor government of British Prime Minster Tony Blair is generally sympathetic to entry, but it insists that it will only join when the economic conditions are right--and only then after a referendum. The Conservative Party, the largest opposition party, is controlled by "euroskeptics," who are hostile to British entry into monetary union. The British debate has evoked varied responses on the continent: a desire that the U.K. play its full part in Europe, exasperation at British aloofness and resentment that British resistance could delay progress toward European integration.

Globalized mortgage markets years away

Rhodes believes that the EU is about a decade away from achieving a cross-border mortgage market. He says that the establishment of the euro will help break down barriers: More people will live and work in countries other than their own; and these migrants will be less bound to traditional, local methods of obtaining mortgages. Rhodes also argues that the financial services sector has been irrevocably globalized. No country, he says, can now exist independently.

As the second largest securitizer of mortgage debt in Europe, Rhodes says, ABN AMRO is well-placed to learn from the various markets in which it operates. The bank is already beginning to modify its processes both in Europe and Asia to accommodate the possibility of increased use of securitization. And ABN has started employee exchanges to help transfer knowledge.

But all of this is not to argue, Rhodes says, that a unified international mortgage industry is even a distant prospect. "The one thing our study has taught us thus far," Rhodes says, "is that the differences in the local markets are so vast that there is no way to run a [mortgage] product on a global basis."

Brenneman says that mortgages can mean different things in different European countries. In some markets, he says, mortgages function as loss leaders. In others, they are major profit centers. These differences, he says, reflect variations in regulatory regimes and cultural attitudes. Whether these wrinkles smooth out, Brenneman says, will depend "on what the market is going to do over the years.

For its part, ALLTEL is hoping that changing economic factors will increase the levels of redemptions in the more traditional European mortgage markets, as borrowers pay off their mortgages and replace them with loans that offer better terms. The new mortgage could be offered by the borrower's bank or by a competing institution. The increase in this kind of activity would create opportunities for ALLTEL's third-party services and allow client institutions to respond to changes in demand without increasing their employment levels.

Brenneman notes that in Germany a strong desire for stability is reflected in the popularity of fixed-rate products with long payment periods. High prepayment penalties mean that refinancing is not a practical option, even when interest rates drop.

In terms of mortgages, the United States will remain different from Europe, even as the European countries remain distinct from each other. But Europe is in the early stages of a transition that will produce market structures that may be most easily recognizable from the other side of the Atlantic. Those institutions--both European and American--that have experience with U.S. ways will have a definite advantage in this new and evolving environment.

Robert O'Connor is an American freelance writer based in London. He writes on a number of topics, including finance and information technology, for publications in Europe and North America.