Repercussions Of The CHF Unpegging: The Fat Lady is Clearing Her Throat


Swiss Franc Revaluation Repercussions – Swiss, Polish and Austrian Banks in the Crosshairs

The SNB’s unexpected suspension of the EURCHF minimum exchange rate continues to claim victims. There have been a number of spontaneous combustion events striking forex brokers and hedge funds, but there are also effects that will only play out over a longer time period.

As reports, the credit rating agencies feel compelled to reevaluate their ratings of a number of European banks and their covered bond issues, i.e., European-style mortage-backed securities. Contrary to “normal” MBS or ABS, the assets backing covered bonds remain on the balance sheets of the issuing banks. This makes them safer for investors, as e.g. non-performing assets are usually replaced with performing ones, and other safety-enhancing measures are often taken; at the same time, it means that banks issuing these bonds are exposed to risks that in US style MBS are borne by investors. According to the report:


“Noting that while the move is credit positive for the Swiss sovereign, Moody’s said that the removal of the peg is credit negative for Austrian, Polish and Swiss banks and to covered bonds exposed to euro/Swiss franc exchange rate risk”


Most affected are apparently Austrian banks, with 17% of their mortgage covered bond assets denominated in CHF and Austrian households exposed to the tune of €25 bn. to CHF denominated mortgage loans. The “bad bank” that is administering the wind-down of the assets of Hypo Alpe Adria, an Austrian bank that fell victim to the 2008 crisis and has turned into a major headache for the country’s taxpayers, has taken a hit as well. 21% of its public sector covered bonds are denominated in CHF, which is so to speak adding insult to injury, as it makes the already horrendously expensive wind-down even more so.



When this happens, it’s all over.

Photo via



Typically CHF loans to consumers are not hedged, so that defaults of borrowers have now become far more likely. The banks may well have hedged their own exposure with currency derivatives, but derivatives don’t make losses “disappear” – they merely shift them to third parties. Moreover, this doesn’t alter the fact that borrowers as a rule enjoy no such protection. Another problem is that governments may react to the situation by shifting the losses suffered by mortgage debtors back to the banks – this has e.g. already happened in Hungary. Not surprisingly, this policy has been hugely popular with the country’s population, but very costly for the banks. Since the necessary write-downs have already been taken, no further damage is to be expected from CHF mortgages outstanding in Hungary – the main danger for the banks is rather that the governments of other countries may consider adopting similar policies.

Apart from its populist appeal, there is in fact something to be said for such a policy, as banks have as a rule neglected to warn borrowers sufficiently of the foreign exchange risk when they were marketing these loans (although it is of course mentioned in the small print that this risk is borne by borrowers). This was mainly due to the fact that they themselves gravely underestimated these risks prior to the 2008 crisis, but then again, they are supposed to be the “experts”.

In addition to the direct costs that Swiss, Polish and Austrian banks may be faced with due to an increase in mortgage defaults, their refinancing costs are likely to rise as well if they are downgraded by the rating agencies. Numerous European banks are already on negative credit watch, so the probability that they will be hit by further downgrades is quite high. Nevertheless, already battered bank stocks in Austria didn’t react much to these developments, which indicates that the markets believe that the damage will be limited.


Erste BankAustria’s Erste Bank, daily. The stock has already weakened considerably over the past year, and the market has so far not dished out any additional punishment as a result of the CHF revaluation and its likely consequences.


Comfortable Illusions Shattered

While banks are by and large probably will probably only suffer minor flesh wounds due to the CHF revaluation, the SNB’s decision has wider implications. Virtually every mainstream analysis of the abandonment of the peg has concluded that the SNB has “lost credibility” as a result of dishing up this surprise. This is quite funny in a way, as there was once a time when central banks surprised markets quite often. Contrary to today’s policy of central bankers communicating every move they intend to make carefully in advance, they once thought it essential to keep market participants on their toes by regularly surprising them. This had a distinct advantage: it raised risk the premiums embedded in risky assets, as it wasn’t possible for market participants to know for sure whether the central bank had their back.

While the CHF peg was in place, the Swiss Franc became a very tempting carry trade funding source, as the risk of untoward exchange rate fluctuation had seemingly been eliminated and interest rates in Switzerland were at the same time among the lowest in the world. The sudden dissolution of the peg was therefore quite painful for a number of market participants. More importantly though, it has also shattered a number of comfortable illusions.

For one thing, relying blindly on the assertions of central bankers is no longer possible and can in fact be a costly mistake. The SNB underscored its commitment to the peg up until the proverbial last minute. In addition, the idea that central banks have nigh omnipotent control over markets has suffered quite a blow. The unrelenting faith in central banks has been a major characteristic of the post crisis asset bubble, so this is quite an important development. The SNB’s decision to abandon the exchange rate peg wasn’t entirely voluntary after all – it pulled the plug because it was overwhelmed and faced with large and growing risks. The extent of central bank intervention is capped both by its potential effects on the currency and the effects of monetary inflation on the economy. Note in this context that the wording the SNB used when announcing the peg was a bit unfortunate: it actually said it would “buy foreign currency in unlimited amounts” if necessary. Apparently though there was actually a limit beyond which it didn’t dare to go.

The realization that there is no such thing as central bank omnipotence will make markets far more susceptible to a reassessment of risk, especially if more surprises along similar lines should surface. This year seems therefore likely to deliver a lot more excitement than the last several years. Current levels of margin debt can probably be regarded as a microcosm of the system-wide leverage employed in risk assets. We conclude from this that the markets are intensely vulnerable to a change in sentiment. Recent developments in commodities, especially crude oil, show that when an indicator that normally serves as a warning signal fails to work for an extended time period, it merely means that the eventual break will be all the more energetic. In the case of crude oil it was a giant net speculative long position in the futures market, which had been in place for quite some time before the market began to swoon. Once prices begin to move in the wrong direction, the process of unwinding such excessive positions as a rule greatly exacerbates the breakdown.


NYSE-margin-debt-SPX-growth-since-1995NYSE margin debt and the S&P 500, adjusted for CPI, via Doug Short – click to enlarge.



The events surrounding the suspension of the CHF peg are a reminder that the fat lady has yet to sing. We’ve only just heard her clearing her throat.


Charts by:, Doug Short/Advisorperspectives


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