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Tuesday June 8, 2010 - 19:05:41 GMT
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Forex Blog - SNB Intervention Orgy to Save Exports or Banks from Loan Losses?

What started out in March 2009 as SNB’s version of QE (unsterilized intervention to prevent excess appreciation in CHF) to counter the great recession, while protecting Swiss export markets (watches, cheese, drugs, chocolate and skiing), it has morphed into a very different objective…saving the Swiss and European banks from large loan losses to CEE (Central and Eastern Europe) states.

 

CHF and to some extent EUR denominated loans into the CEE corporate and mortgage markets were prevalent in the early 2000’s until the 2008 crisis.  Over 30% of all bank loans in Hungary for instance are denominated in CHF and 60% of all mortgages are denominated in CHF.  Nothing like funding in foreign currencies when your local currency is falling like a stone – HUF is down 32.5% vs CHF since Lehman failed…was down 35% into the spring of 2009 “coincidentally” when the SNB started its intervention policy.

 

And loans in CHF (and EUR) are not simply limited to Hungary.   They were made from Estonia to Poland.  While firms have used hedging strategies to handle FX risk, homeowners have no such hedge and banks simply adjust mortgages to compensate for the currency gain or loss (surely with some fat spreads as well).  Clearly a loan costing 30% more than 6 months ago is dubious…default risk soars.  Write downs loom for lenders if the CEE currencies continue to depreciate against the CHF and EUR.  And markets know that in every Western European government capital, the local banks are too big to fail.  The governments are widely seen on the hook for making banks partially if not fully whole on crap loans written to CEE homeowners and firms in CHF.  Keeping the CHF from rising is a lot more important now to the health of the Swiss and EU-wide banking system than it is for Rolex and Nestle. 

 

Indeed SNB reserve numbers for May were eye popping today.  SNB went BOJ in May...BOJ vintage 2004.  It was an orgy of intervention. Reserves jumped a record CHF78.8bln in the month (unlike most c banks SNB reports its foreign reserves in CHF – it sold CHF in the month for mainly EUR).   Indeed on May06 or day of the flash crash in US equities, the SNB allegedly bought EUR16.5bln for CHF (day EUR exploded higher against all sorts of currencies, though especially AUD and Asian EM FX like KRW and IDR).  The prior record was CHF28.7bln jump in April.  And this is not simply out of self-interest…not limited to Swiss banking losses.  This is EU-wide banking losses…Austrian banks have probably the highest relative (to assets) exposure of any European country to foreign currency loans in Hungary.  Surely the ECB and Eurogroup have called in this favor from the free-rider Swiss authorities (ridden the ERM and EMU wagon for decades with small cost…proxy membership with little of the adjustment downside for a country with its own currency).

I am having a heck of a time getting recent data on cross border lending in Europe (not a bank analyst and not my forte…hope to spend tonight on BIS site) but I did come across a press release from the NBH today that shows households in Hungary paid down a net HUF29bln in foreign currency loans in April alone, more than they did in January, February and March combined.  Recall that the SNB in April (until May’s orgy) was a record month for SNB intervention…surely the Hungarian scramble for CHF was a key flow driver SNB hoped to neutralize.  Without SNB selling CHF where would CHFHUF have traded in light of the amount of CHF buying from Hungary alone…talk about a potential vicious cycle.  The press release also noted the total household loan stock at the end of April was practically level with that at the end of 2009 at HUF7.846trln, and 66pc of the total was still in foreign currency-denominated loans…the decline in the HUF vs the CHF is adding to total foreign currency loan stock for households as fast as the households can pay down the loans…treading water.   However, not all CHF demand is from households trying to pay down CHF loans with HUF income streams.  Hungarian households have significant foreign currency deposits in the banking system and presumably use some or at times all of this to pay off CHF loans (in April foreign currency deposits fell HUF21bln).  Still one would think that either households or Hungarian banks with enormous FX risk are actively buying CHF as well.

It is less clear how foreign banks (Western European banks) fit into the local lending world in CEE states like Hungary (someone tell me – surely this is not state secret).  I suspect that they have much of the exposure through loans to local banks or part ownership in local banks and either directly or indirectly face significant losses on CHF and EUR lending here and may also be buyers of CHF to cover any unhedged FX risk in local market loans.   

How can a country not in the EZ or ERM2 have a banking system lending to households some HUF5.18trln in foreign currency of a total HUF7.846trln?  Soros is Hungarian…maybe as a race they are born FX trading masters and click away all day and night on retail FX websites managing that risk.  I doubt it.  Or maybe they used pre-Lehman assumptions and rating agency practices in considering exchange rate risk…early entry into EMU would limit forex risk. 

After a brief search of the web I did come across this; European bank losses to CEE loom large and while I can’t verify all the facts in it I did find it interesting to read and if anyone has the JPM research referenced, please forward to me if possible. 

If the report is right about the JPM research and European banks face “$50 billion in new capital needed by European banks to cover losses in Central Eastern Europe from mortgages” and we add in losses from subprime fiasco not fully accounted for along with loans and lines of credit to Club Med governments (large losses if marked-to-market), and still highly leveraged balance sheets one has plenty to worry about when it comes to banking crisis part deux. 

But what about the new SPV Eurogroup just approved…some EUR440bln in credit if fully drawn (or is it really EUR387bln given 120% guarantee?).  This SPV is to help states unable to borrow in the capital markets secure financing for the next 3 years (until god comes down from the sky and hands Greece and others a trillion in euros), but does nothing for banks in need of capital.  Hmmm…sounds like TARP…could SPV designed to help keep countries locked out of the capital markets funded, end up being used to recapitalize European banks?  Note too at G20 when bank capital levels came up amidst a call for higher standards, the meeting decided to put this discussion off…new capital standards could leave European banks exposed…forcing governments, many under water on debt, to pony up capital for banks.  It is also no surprise that Geithner’s call for bank stress tests and public results has gone over about as well as a loud American tourist dining at Tour d’Argent.   

IMF does not have the money to fund wayward governments shut off from capital markets…where things are headed…more Greeces…to allow for stronger European governments to recapitalize their banking systems.  I can only imagine that we are looking at chapter 2 of the great banking crisis of the 2000’s ahead and it will bleed into every major banking sector and open economy on the planet.  Unfortunately, fiscal policy resources are pretty well tapped…the next crisis will be down to central banks making up policy on the run much as happened in 2008 and 2009…quantitative easing and unconventional monetary policy are early in their rollout. 

I can think of two core Europe nations where the next chapter of the crisis could be written, one in and one out of the EU, with high mountains and increasingly vulnerable banking systems…in Switzerland the asset size of the two banks is larger than yearly GDP by several factors which makes a special case of too big to save should it ever come to that and hence demanding outside resources. 

David Gilmore

PS I admit I may be a little over my skis here regarding Alpine capital market slopes and would welcome an alternative view.

 

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