Too Hot for Comfort

As insecurity reigns on global financial markets, and debt crises grip Europe and the United States, the Swiss franc (CHF) has become a lifeboat for investors looking for sound bonds. But as currency traders swim to safety, they are kicking off waves that leave others struggling.

The resulting hike in the franc’s value – which has appreciated by 20 per cent against the euro over the last year – has increased the debt burden for Europeans holding CHF denominated loans, including many Austrians. In sum, Austrian banks such as Erste Bank, Raiffeisen International, and UniCredit’s Bank Austria have lent €51.3 billion in CHF denominated loans in Austria, and €18.3 billion in Central and Eastern Europe via their subsidiaries.

Switzerland itself is concerned about the strong franc harming its exports. Roughly 50 per cent of the country’s GDP is derived from exports, of which 25 per cent alone go to Europe.

In June, total exports dropped by a value of €3.5 billion, while exports to the EU took a 15 per cent cut, leading to exchange rate related losses for major Swiss companies. Nestlé reported a 9.8 per cent drop in its sales, while Roche, the pharmaceutical giant, blamed the upswing in the franc for a 5 per cent loss in profits for the second quarter of this year.

Similarly, for the wealth management units of Swiss banks, the rising franc has driven up costs and dampened profits: Most of the assets they manage are denominated in dollars and euros, while the large majority of their operation and employee costs are in francs.

Accordingly, the Swiss National Bank (SNB) is taking firm action to rein in the Swiss franc’s rise against the euro. In mid-September, the SNB announced that it is determined to hold the exchange rate of CHF 1.20 per euro that it set on Sept. 6. "The Bank is prepared to buy foreign currency in unlimited quantities", the SNB asserted. According to the Frankfurter Allgemeine Zeitung, inner circles say that the SNB is focusing on buying up German and French government securities, considered to be the safest and most liquid.

Biting the bullet

For the many Austrians and Eastern Europeans holding Swiss currency loans, the SNB’s policy comes as a relief. Erste Bank perceived the SNB’s decision to peg the euro/franc rate as a window of opportunity, announcing that it would contact all of its customers and advise them to urgently convert their loans to euros.

However, there is no coordinated approach from Austrian banks. While "some are offering to help customers restructure their debt, others aren’t," said Philip Reading, director of Financial Market Stability and Bank Testing at the Austrian National Bank in an interview with The Vienna Review. "It also depends on individual customers; the richer the person, the more capabilities he or she has to provide collaterals to take on new loans and restructure his or her debt," Reading pointed out. Less well-off customers, therefore, may be left to repay the higher franc denominated loan, with less means.

A further problem is that most of the Austrians affected hold so-called "bullet loans", which are non-amortising. While the customer pays interest every month, she must nonetheless repay the entire borrowed capital at the end of the loan period.

"The currency risk here is that the principal is not gradually reduced, but stays the same," Reading noted. "People build up a repayment vehicle, which they pay into during the loan period and which helps them pay back the capital at the end, but if the vehicle is performing badly, then customers will struggle to repay their loans," he warns.

Banking on the nation

Just across the Austrian border, the Hungarian government announced drastic measures to help the 1.3 million Hungarians who hold CHF loans, 900,000 of whom are struggling with their interest payments. The CHF loan volume held by Hungarian households is equal to a full 18 per cent of Hungary’s GDP.

To alleviate the debt burden, Prime Minister Viktor Orban is seeking the parliament’s approval of a plan that would allow Hungarians to repay their foreign currency loans at a fixed discounted exchange rate of 180 forints per franc, even though the CHF is currently valued at around 236 forints. In essence, this amounts to an exchange rate manipulation.

The Austrian government, however, has reacted vehemently to Orban’s plan, as Austrian banks and their local subsidiaries are major lenders in Hungary and have a total of €6 billion in outstanding CHF loans in the country.

"The Hungarian proposal is to legislate that banks have to bear the losses that customers have incurred," Reading explained.

Accordingly, the Austrian government has sought the support of other EU member states to avert the Hungarian plan. "Private business contracts need to be adhered to," Austrian Foreign Minister Michael Spindelegger stated. "This is not supportable by European law," he emphasised on Sept. 19 at a meeting of EU foreign ministers.

The government’s hands-off approach to the banking sector, meanwhile, seems to have prevented it from devising strategies to help Austrian loan holders.

While the Austrian National Bank has been warning commercial banks of the risks of CHF loans since 2004, it only issued minimum standards decisively discouraging the lending in 2009, threatening that banks would receive a negative risk review if they continued.

It was a case of "too little, too late".

"While the minimum standards were effective in stopping new loans, they came too late for customers who already held mortgages," stated Reading.