Stockholm (HedgeNordic) – The coronavirus pandemic and associated shutdowns may have forced banks to start thinking about digitizing their mortgage origination processes. Non-bank lenders such as Swedish mortgage challenger Hypoteket have long been giving borrowers a fully-digital mortgage experience that creates transparency, efficiencies and cost savings in loan origination. Founded by Dag Wardaeus and Carl-Johan Nordquist (pictured) based on the non-bank lending model in the Netherlands, Hypoteket is a fully-digital mortgage lender in the Swedish market that provides mortgages financed by institutional investors through mortgage funds within the Alternative Investment Fund (AIF) framework.
“The mortgage market in Sweden is basically an oligopoly with five, six huge banks. The banks had an information advantage and market power over the small customer, with their intransparent pricing models allowing them to charge excessive interest rates,” explains Dag Wardaeus. “The mortgage customer in Sweden has just been a price taker.” The fundamental shift in regulations that took place in response to the housing crisis limited the role of banks within the mortgage business, enabling new actors such as Hypoteket to enter the market and put the power back in the hands of the consumer.
“We wanted to create a fully-digital mortgage provider, with very transparent interest rates for the mortgage customer, with a very simple digital process to onboard customers and everything that our generation takes for granted.”
“We wanted to create a fully-digital mortgage provider, with very transparent interest rates for the mortgage customer, with a very simple digital process to onboard customers and everything that our generation takes for granted,” says the 35-year-old founder, who is the CEO of Hypoteket’s fund management company. “My co-founder and I embarked on this journey to revolutionize the mortgage market and the mortgage offering to customers in Sweden,” he emphasizes. The other co-founder, Carl-Johan Nordquist, acts as the CEO of Hypoteket Mortgages, the originator and servicer. “But pretty soon, we realized that if we were going to get any institutional investors interested in our mortgage funds, we needed to give them a higher yield than the alternative exposure.”
With two up-and-running mortgage funds, Hypoteket relies on a pass-through model where “investors buy into a pool of mortgages that Hypoteket has originated and earn a yield that reflects the average mortgage rate in the Swedish market,” according to Johan Hasselblad, Head of Funding and Sustainability. Covered bonds, the main source of funding for commercial banks, pay very little yield these days. “We only take a small cut and all the remaining yield goes back to institutional investors,” emphasizes Wardaeus, who runs Hypoteket’s funds alongside fund manager Lotta Åkerlund. “The revolution is not in the structure of the mortgage offering, but in how much yield goes through the system back to end-investors.”
“The traditional way of calculating yield in a pass-through model is that investors will get incoming yields less a management fee, sometimes coupled with a performance fee,” explains Hasselblad. “We don’t do that, as that would mean investors’ yield is pegged to the way we set our mortgage rates commercially.” Instead, Hypoteket created an index that tracks the average actual lending rates among the largest mortgage institutions in Sweden, with Hypoteket’s coupons being based on this index, less a spread.
“Hypoteket relies on a pass-through model where investors buy into a pool of mortgages that Hypoteket has originated and earn a yield that reflects the average mortgage rate in the Swedish market.”
“This creates transparency, predictability and independence,” emphasizes Hasselblad. “Our mortgage funds, therefore, give investors direct exposure to our asset pool and give back a monthly coupon that reflects the average mortgage rate landscape in Sweden. Should market rates rise, our coupon will follow higher, so the investment should be at least somewhat inflation hedged – as long as central banks allow rates to move higher with inflation.”
The Latest Mortgage Fund
“We have been very conservative with our first two mortgage funds, as we issued mortgages with a maximum loan-to-value (LTV) ratio of 65 percent,” says Wardeus. “Our typical client is a person of middle-age who has owned a house or flat for quite some time. This makes a great foundation for asset quality.” With Sweden’s national pension fund AP4 as an anchor investor, Hypoteket has recently launched a new mortgage fund that is lending with LTVs of up to 75 percent.
“We can allow somewhat higher LTVs in the new fund, so demographics are likely to change slightly towards the younger clients,” expects Wardeus. “Coming from a maximum LTV of 65 percent to 75 percent is a milestone in our long-term ambition to become a full-service provider within residential mortgages, which will eventually enable us to service the entire market.”
“Coming from a maximum LTV of 65 percent to 75 percent is a milestone in our long-term ambition to become a full-service provider within residential mortgages, which will eventually enable us to service the entire market.”
Backed by Nordic media giant Schibsted, Hypoteket has issued more than 10,000 mortgages so far, with the funds overseeing around SEK 12 billion in assets under management. Expectations for asset growth are high, with the Hypoteket team targeting to double assets under management by the end of next year. “Reaching a broader market together with an improved pricing strategy, which should increase the average loan size, will be key elements in achieving this,” argues co-founder Carl-Johan Nordquist. “We have had organic yearly growth of around 50 percent since inception, and have now moved away from startup to scale-up in fintech terms.”
Backed by an over-collateralization of 1.8 percent, the new mortgage fund has received an investment-grade rating from Moody’s. “For the first time, we are adding a credit enhancement element into the fund structure, with this protective layer absorbing any potential losses up to 1.8 percent of the capital,” explains Hasselblad. “This may not seem like a lot, but you rarely see any losses in the Swedish residential mortgage market from a historical perspective,” he elaborates. “We are basically not expecting any losses at all, so 1.8 percent should go a very long way.”
“The underlying mortgages originated by Hypoteket are probably among the safest assets you could invest in.”
Set to be listed in Luxembourg, Hypoteket’s new mortgage fund has a credit rating of Baa2. “We designed the new fund to get an investment-grade rating, and we took it one notch above that. With even more credit enhancement from our side, the rating could have been higher, but investor returns would drop as a result,” comments Hasselblad. “We believe investors realize that in a structure like this, the asset pool is what really matters, and that a credit rating is just an extra box ticked,” he emphasizes. “The underlying mortgages originated by Hypoteket are probably among the safest assets you could invest in. We originated our first mortgage back in March 2018 and have had zero losses so far. We obviously intend to keep it that way.”
Place in a Portfolio
With still ultra-low mortgage rates in Sweden – an average of 1.32 percent for new agreements for mortgages to households, what role can a Sweden-focused mortgage fund play in investor portfolios? “We are aiming to replace parts of investor portfolios that are not yielding anything at all with something that is still low risk and can offer at least some yield,” explains Hasselblad. In the last decade’s low-return environment, institutional investors have been forced to climb the credit risk ladder, according to Hypoteket’s Head of Funding. “We would like to offer something that does not require investors to take on a lot more credit risk.”
“We are aiming to replace parts of investor portfolios that are not yielding anything at all with something that is still low risk and can offer at least some yield.”
Some institutional investors may dismiss an investment in Hypoteket’s mortgage funds because of limited liquidity stemming from the closed-end structure with a ten-year lock-up. “We can never promise liquidity with the fund’s current structure, but why would a long-term institutional investor need to have the entire fixed-income book liquid?” ponders Hasselblad. “Liquidity is extremely expensive these days, so investors need to ask themselves how much of their books really need to be liquid, and why. A mortgage fund will earn an illiquidity premium from low-risk residential mortgages. This is basically traditional fixed income packaged differently – Fixed Income 2.0.”
Hypoteket’s mortgage funds “are very much tailored” for pension funds and insurance companies, both because residential mortgages as assets match their long liabilities, but also due to favorable regulations. “Under the Solvency 2 regulation, investing in residential mortgages with full look-through, which our funds enable, is very capital efficient,” explains Hasselblad. “It is very much comparable to short-dated covered bonds. If you compare our yields to those on short-term covered bonds on an unleveraged basis, then there is a quite sizable yield pick-up,” he continues. “Most, if not all, of these benefits are valid under the IORP II framework as well,” adds fund manager Lotta Åkerlund.
“Hypoteket was founded to improve the Swedish residential mortgage market in terms of transparency and ease of use for clients, and in order to give more back to investors than what the banks do,” says Hasselblad, who is responsible for sustainability at Hypoteket’s fund management firm. “These, at least to us, are very relevant features for the S in ESG – transparency, equality (we treat our clients equally – no individual negotiations) and also that we work for a sound and well-functioning financial market, with no excess profits,” he continues. “In the Netherlands, mortgage funds are also seen as contributing positively to financial stability because of long term, solid investors such as pension funds. The same should hold true for Sweden.”
“Hypoteket was founded to improve the Swedish residential mortgage market in terms of transparency and ease of use for clients, and in order to give more back to investors than what the banks do.”
Hypoteket Mortgages, the originator and servicer, is labeled a climate-neutral company by SouthPole. “We have just started a new project together with them (SouthPole) where we will map greenhouse gas emissions and carbon footprints from our mortgage funds as well,” says Hasselblad. “Our ambition Is to align the whole company with the net-zero targets and do so by incentivizing our clients to make green investments or conscious energy-related choices.”
The funds, meanwhile, are set to fall within the scope of Article 8 of the European Commission’s Sustainable Finance Disclosure Regulation – thereby becoming a “light green” fund. “We could potentially do something dark green going forward if we can do a good product both in terms of meaningful volume and having an actual environmental impact.”
This article features in HedgeNordic’s 2021 “Alternative Fixed Income” publication.