Why mortgages are still appealing now

Despite major structural changes in the mortgage market, there are interesting investment opportunities for investors in this segment.

Author: Maurizio Pedrini, Head of Fixed Income Credit in Asset Management at Zürcher Kantonalbank

Property prices have remained surprisingly resilient in nominal terms despite a significant rise in interest rates.

The changed parameters on the mortgage market are reflected in numerous factors. This makes it all the more worthwhile to take a closer look at the segment. In the summary below, we outline the conclusions that can be drawn from this and the resulting opportunities.

Property prices

Despite a significant nominal rise in interest rates (which is the relevant factor for mortgages), prices have remained surprisingly resilient. Unexpected inflation, the potential for rent increases thanks to higher interest rates and the very strong demand situation, at least in the residential sector, are supporting the market. As was to be expected, investment properties suffered somewhat more than owner-occupied housing. In our view, however, future risks have risen as the buffer for unexpected adverse developments has become smaller (e.g. unexpected further interest rate hikes).

From the perspective of mortgage investors, the credit side is currently still in the green range. Nevertheless, higher loans should be reduced or avoided. Due to higher interest rate sensitivity, investment properties remain rather underweight in our investment solution.

End of negative interest rates and relative attractiveness

Mortgage investments were practically the only CHF investment able to avoid negative interest rates. For the time being, this argument in favour of mortgages no longer applies. The latter is also supported by the fact that even before the negative interest rate period, a premium of 20 to 30 basis points could be earned after costs compared to the bond market in a long-term comparison.

Mortgages now benefit from two special effects

Firstly, swap rates are currently elevated compared to all bonds. For example, the return (before costs) of our mortgage investment group is 2.48% compared to the return of the Swiss Bond Index (SBI) of 1.56% (both as at 31/8/23). Secondly, competition in the mortgage market is expected to become less intense in the next two to four years, which will support mortgage margins. Mortgages will outperform bonds in the longer term – with lower volatility because duration is always a little shorter.

Displaced swap rates

CHF swap yields are around 15 basis points higher than the long-term average (compared to Swiss Confederation bonds, Pfandbriefe and corporate bonds). Mortgage rates are based on swap rates and are therefore very appealing compared to bonds. 

The integration of Credit Suisse into UBS will lead to an additional reduction in the market share of large banks.

Maurizio Pedrini, Head of Fixed Income Credit in Asset Management at Zürcher Kantonalbank

Competition situation

The integration of Credit Suisse into UBS will lead to an additional reduction in the market share of large banks. Since the financial crisis, the mortgage volume of UBS and CS in Switzerland has stagnated, while domestic banks have grown relatively strongly. This was a direct consequence of the stricter capital requirements, which slowed down large banks in the mortgage business in particular. Both customer behaviour and the balance sheet situation at the new UBS probably even point to a slight contraction in total assets in terms of mortgages. For the first time, however, domestic banks will reach their limits, as new mortgages require additional equity. Most of this can only be generated from retained profits. This should have a supportive effect on margins in the near future.

Stress among mortgage brokers

Due to higher interest rates, ten-year mortgages are less in demand. Shorter maturities mean lower remuneration for brokerage, at least in the short-term. This phenomenon is expected to return to normal over time, as short mortgages need to be refinanced more quickly. In addition, a financing segment important for brokerage – the insurers – is less likely to seek additional mortgages. Major brokers such as MoneyPark and Valuu have reacted and are adapting to the new situation. The system will settle down over time, but grow less dynamically. For investors, this means that diversification of access to the mortgage market is becoming increasingly important.

Insurers are «fully» invested

Most insurers have expanded their mortgage ratio in recent low interest rate years and are now «fully» invested. Furthermore, many insurers do not offer Saron mortgages, which will tend to reduce «traffic» among brokers and margin competition. This in turn has a positive effect on margins. Wide access to the mortgage market is therefore becoming increasingly important.

Shorter maturities

Maturities of new mortgages have become significantly shorter on average. This is particularly important for investment solutions that are geared towards the bond market. However, since these portfolios are very small compared to the market, they can continue to find sufficiently long mortgages without any problems. But broad market access has also become more important in this respect.

Whether it’s relative attractiveness, a changed competitive situation or diversification factors: there is a lot going on in the mortgage market right now. Nevertheless, a clear conclusion can be drawn: for institutional investors in particular, mortgages as a supplement to CHF bonds will continue to be a very interesting investment in the future.


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