The evolution of the European mortgage market

9 min read 1 Mar 22

Residential mortgage markets in the UK and Europe are undergoing a period of transformation as new funding models emerge and new players enter the mix, following in the footsteps of the Dutch mortgage market. Long-term institutional capital, in search of attractive returns and diversification potential, is playing an increasingly important role, with the entry of innovative, non-bank lending platforms helping to disrupt the status quo and create a more diversified lending landscape.

New funding models, new players

Residential mortgage lending across most of Europe is primarily conducted by retail banks, which typically hold these mortgage loans on their balance sheets. Residential mortgage loans are long-term secured forms of finance that arguably sit better off of a bank’s balance sheet for several reasons.

One reason is to do with maturity transformation. Most home loans originated by banks are funded by short-term deposits, which can be withdrawn at any time by customers – with bank ‘runs’, in turn, jeopardising the provision of credit to households and businesses, and thus the real economy.

“Banks still service most of the mortgage market across Europe and in the UK, but this is steadily changing as more non-bank lenders enter the market and disrupt the status quo.” 

European regulators have also required banks to fund themselves with more capital over the past decade by imposing stringent capital requirements on their lending activities, which has reduced the incentives for banks to increase their lending in certain segments. It will also become more expensive for banks to keep mortgages on their balance sheets once the risk weighting floors for mortgage loans are phased in.

More recently, regulators in the Netherlands and Germany have also increased the amount of capital that banks are required to hold against mortgages in an attempt to slow down the significant growth in property prices seen over the past few years. BaFin, Germany’s financial regulator, raised the countercyclical capital buffer for German banks to 0.75% of their domestic assets by February 2023, while an additional 2% buffer is set to be introduced for residential mortgages. In response, German banks may have to increase the rate of interest they charge their customers to maintain returns on their mortgage lending books. For prospective property buyers, the corresponding higher cost of financing could effectively limit the price many can afford to pay.

Finally, stress-test capital requirements to cover credit risk (increase in losses) and interest rate risk (for long-dated, fixed rate mortgages) also add to the capital burden.

To solve for this, funding models in the mortgage market have had to evolve.

Asset managers have stepped up to provide long-term capital to this market on behalf of institutional investors searching for attractive returns and diversification away from corporate risk. To manage their capital and balance sheets more efficiently, retail banks have looked to transfer existing, performing loans and other asset exposures from their balance sheets to carefully selected institutional investors from time to time, in order to meet regulatory capital requirements – while still servicing the loan assets for a fee and maintaining relationships with end-consumers.

The role of institutional capital

The long-term investment horizon of institutional asset owners, such as insurance companies and pension funds, makes them ideally suitable as a complementary source of stable mortgage funding and a good match for their long-term liabilities – something policymakers are all too aware of. From a longer-term perspective, a larger role for institutional investors in mortgage markets may be beneficial to the financial system.

Regulations such as Solvency II have certainly played a part in stoking demand for direct exposure to residential mortgage loans. While mortgages do not qualify for matching adjustment relief, the capital treatment of an investment in a portfolio of non-securitised residential mortgages is particularly favourable for insurance companies relative to traditional fixed income investments of equivalent risk. Residential mortgages sit under the counterparty default module for solvency capital requirement (SCR) calculations under the Standard Formula, and SCR is a function of the loan-to-value (LTV) ratio rather than duration and credit rating. Residential mortgages also provide diversification potential as the underlying risk is linked to individuals rather than corporates or government, which most are exposed to via their corporate credit and equity portfolios.

Dutch and Belgian insurers are heavily exposed to mortgages, representing 25% or more of their investment portfolios in some cases, as they have shifted towards higher-yielding assets, with low capital charges proving attractive while default rates on mortgages have been historically low. Investors also have the potential to receive regular, stable income streams as borrowers pay down their mortgages over time, with low levels of duration. Investors can get floating-rate exposure to the asset class (following an interest rate swap on fixed-rate mortgage loans) which can offer built-in inflation protection because returns typically increase as interest rates go up. These pools are backed by property assets whose value can appreciate in an inflationary environment – thereby lowering loss given defaults.

The Dutch model

In the Netherlands, mortgage origination by investment strategies dominates while the growing role of insurers and pension funds on the mortgage lending market over the past decade has been welcomed – and has helped to diversify the investor base. Institutional investors have accounted for 87% of the total increase in mortgage lending to Dutch households since 2014, with pension schemes accounting for 6.6% of total holdings of Dutch mortgages according to DNB1, the country’s pension regulator. DNB also notes that more than 80% of mortgage investments are made via third-party funds.

Investment strategies offering diversified access to mortgages

Further, investment in a strategy with an asset manager that is buying performing residential mortgage and consumer loan portfolios across different geographies could offer potential for asset owners, including those with an existing allocation to mortgage loans, to gain diversified exposure to the asset class and enhance sponsor/originator, country and asset type diversification within investment portfolios.

If investors can invest in securitisations without facing punitive capital treatment, then investment funds that use term financing (through issuing senior asset-backed securities (ABS) tranches, for example) can be an efficient, cost-effective and non-recourse way to fund the purchase of mortgage portfolios – and potentially offer investors access to higher risk-adjusted returns.

Funding non-bank platforms

As banks have become risk-averse and reduced their lending activities in certain segments, non-bank players, often tech-savvy, are stepping up to fill the gaps. This is helping the transition to a more ‘market-based’ system, akin to the US, which sees a greater share of non-bank mortgage originators and servicers. Around 80% of mortgages were created by banks in the US in 2007; but fast-forward a decade, and more than half were originated by non-banks – with this share reaching a high of 68% in 20202.

Over the years, non-bank platforms have entered the specialist buy-to-let (BTL) and specialist mortgage lending segments – a sector once occupied by retail banks prior to the global financial crisis. This has created an opportunity for institutional capital to fund these platforms to allow them to grow their market share. Borrowers, on the other hand, have greater choice on their lender – potentially opting for a lender that offers the best services and flexibility, and not only the best rates.

Forward flow partnerships

The emergence of forward-flow arrangements, which involves asset managers purchasing pools of newly-originated loans, with bank and non-bank lenders is offering a viable alternative to warehouse financing. Forward flow agreements can be structured according to specific criteria and pre-defined characteristics.

For example, having identified an opportunity in the Irish mortgage market, which has the potential to offer attractive returns with strict underwriting, we negotiated an exclusive mortgage origination partnership with Ireland's biggest non-bank lender, Finance Ireland, to facilitate their entry into the Irish residential mortgage market.

Innovations in the mortgage market

Both bank and non-bank lenders have looked to launch new and innovative products in the mortgage market, including long-term, fixed rate mortgages as borrowers appetite for longer fixes increases amid expectations of rising inflation and interest rate rises.

Long-term, fixed rate mortgages

Long-term, fixed rate mortgages offer borrowers an opportunity to secure fixed rates over the long term. The greater certainty over mortgage repayments and costs for longer, which can represent one of the biggest portions of households’ disposable income, that comes with fixing for longer could be particularly valuable in an environment of higher inflation.

Lengthening the traditional fixed-rate mortgage market is a stated priority of many governments. In the UK, most mortgages have a fixed-rate contract, but the fixed-rate period is mostly below ten years and products offering short-term periods of two, three and five years tend to dominate. This may be starting to change, however. Until recently, long-term fixes had been much more expensive than short-term fixes, but more affordable 10-year deals are being launched in the UK at lower interest rates for homebuyers with lower LTVs.

In contrast, long-term fixes tend to be the norm in other countries with borrowers increasingly opting for fixed-rate loans with reset dates that are 20 or more years away.

In Belgium, for example, it is more common for mortgages to have a fixed rate of interest for the full term of the loan – up to 30 years, with the median maturity of a mortgage loan at origination around 20 years – rather than for an introductory period of two, three or five years. Since 2007, lenders have continued to tighten customers’ access to mortgage loans with long maturities, according to a recent Report from the European Mortgage Federation3.

Ireland evolving into a long-dated, fixed model

In Ireland, non-bank lenders accounted for 14.4% of the number and 18.2% of the value of residential mortgages outstanding at the end of 2020, according to the Central Bank of Ireland4.

In 2021, we extended our partnership with Ireland’s largest non-bank lender, Finance Ireland, to launch a range of long-term, fixed rate mortgage products in Ireland. For the first time, homeowners in Ireland have the opportunity to access a range of long-dated, fixed rate mortgage products of up to 20 years, combined with the flexible features that homeowners desire.

The lending ecosystem continues to evolve

In the Netherlands, non-bank lenders have been bridging the gap for some time. Banks still service most of the mortgage market across much of Europe and in the UK, but this is steadily changing as more non-bank lenders enter the market and disrupt the status quo. The barriers to entry in European mortgage markets are largely self-imposed, but persistent all the same – therefore markets where there are fewer lenders operating and vying for market share, can offer particularly attractive spreads for loan portfolios, in our view.

Asset managers with the structuring expertise and proven execution that have established their presence in the market can enable deep originator and lender relationships – and identify areas offering particularly attractive, scalable opportunities for investors. 

1De Nederlandsche Bank, New mortgage loans mainly provided by institutional investors (, 8 November 2021.
2Wall Street Journal, “Nonbank Lenders Are Dominating the Mortgage Market”, 22 June 2021.
3HYPOSTAT 2021 | A REVIEW OF EUROPE’S MORTGAGE AND HOUSING MARKETS. European Mortgage Federation, November 2021.
4HYPOSTAT 2021 | A REVIEW OF EUROPE’S MORTGAGE AND HOUSING MARKETS. European Mortgage Federation, November 2021. 

The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.