Buying a home in Switzerland is difficult. Homes are expensive and lending is typically restricted to those with a 20% deposit and significant income. Migros Bank, an offshoot of the Swiss supermarket, recently launched a product that reduces the deposit requirement to 10%.
Migros bank has launched the new product under the brand Cactous. According to the bank, 9 out of 10 Swiss households are unable to buy because they don’t meet Switzerland’s rigid financing requirements, which require a 20% down payment.
Lending rules in Switzerland are set by FINMA, Switzerland’s banking regulator. Tight Swiss lending rules have been a bone of contention for banks and borrowers for some time. FINMA issues banking licences and can sanction licence holders that don’t comply with is regulations. In extremis it can withdraw a licence.
Individuals in Switzerland are heavily indebted. With average debt of 222% of net disposable income, Swiss debt was ranked the 4th highest in the OECD in 2020. Much of this debt is mortgages used to buy homes. Property prices are also high, with an average 4-room home costing more than CHF 800,000.
FINMA’s lending restrictions are aimed at avoiding the structural financial risks that come with overextended borrowers in a tight highly priced housing market. Inevitably, that doesn’t please would be buyers and banks that would like to expand their mortgage businesses.
However, Migros Bank appears to have found a way around the 20% deposit requirement. Instead, borrowers put down 10% and Cactous provides the other 10% in the form of a subordinated loan. Should the borrower default on the loan, the 10% invested by Cactous would get paid out only after the entity lending the first 80% was paid. This means the 80% mortgage component would be exposed to the same level of risk under the current system.
As is this case with such things, there is no free lunch. In return for putting in the 10% subordinated loan, Cactous makes a turbo-charged return on it of 5%, a rate far higher than current market interest rates. Blended together the overall mortgage interest rate might be 10% to 15% higher than a normal market rate mortgage.
Effectively, in aggregate, it’s a more expensive mortgage with compartmentalised risk buckets. Earlier experiments with such structures led to a boom in the slicing and dicing of mortgage-backed securities in the noughties, which contributed to a financial meltdown.
Mortgage-backed securities take pools of mortgage assets and sell shares in the pool. These pools can be sliced and diced to create shares of different risk levels and returns. While the riskiest shares pay the highest returns, they are the first to take a hit. The problem with this slicing and dicing is that it can concentrate risk. An entity with too much exposure to the risky slices could run into financial trouble in a bear market.
FINMA will need to make sure that Cactous has a strong enough balance sheet to absorb the higher risks associated with its subordinated loans. However, these assets could always be packaged up to find a home elsewhere. This happened last time inflicting financial pain on many unsuspecting investors.