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WorldMarch 2 2015

CEE reels from Swiss franc exposure

As the Swiss National Bank removed its cap against the euro, the risk of borrowing in foreign currencies was made clear, as countries that had been busily borrowing in the Swiss franc reeled at the impact of its sudden appreciation. 
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CEE reels from Swiss franc exposure

The alpine valleys of Vorarlberg in Austria are tucked between the borders of Switzerland and Liechtenstein, and the state shares with these neighbours a distinct, and almost indecipherable to outsiders, dialect, close economic ties and a penchant for borrowing in Swiss francs.

The latter was a quirk that emerged in the mid-1990s, which has since spread throughout Austria and even, at the behest of Austrian banks, to central Europe. The trend started because many of the citizens of Vorarlberg worked in Switzerland, and earning Swiss francs made it easier to borrow and save in the currency, too. This logic was furthered by the fact that the interest rate on a franc loan was about one-third of that for loans denominated in Austrian schillings or, later, in euros.

But, the risks of incurring debts in a foreign currency were far graver than borrowers, and indeed bankers and regulators, had expected and Austria and central Europe have been dealing with the problems caused by this spate of lending in Swiss francs since the start of the global financial crisis in 2008. The problem has been further exacerbated by the January 2014 decision by the Swiss National Bank (SNB) to remove its cap against the euro, causing the franc to soar in value.

“There was pressure across the region to offer loans in francs because the interest rates were so low,” says one Austrian banker. “Of course, it’s on the first page of every book about banking not to lend to people not earning in that currency. Yes, it was a mistake, but Austrians had benefited from this for 20 years and the rest of central Europe saw that and wanted it too.” 

Hungary resolution

Regulators and banks have been clamping down on lending in Swiss francs since 2008, and the scale of the problem is certainly smaller than it was at the start of the global slump, but enough of these loans remain on the books for the currency’s sharp rise to cause problems. Most banks are solidly capitalised and therefore able to ride out the shock, but overstretched borrowers are starting to have an impact on local politics, particularly in Poland and Croatia.

One country that has already acted to resolve the situation is Hungary. At its pre-crisis peak, almost half of all mortgages in the country were in Swiss francs. When the Hungarian forint dropped against the franc in late 2008, Hungarians started to struggle. The ratio of non-performing loans soared from about 3% in 2009 to more than 20% of outstanding loans by 2011. Political pressure to help indebted Hungarians became enormous. The government of prime minister Viktor Orban, who returned to power in 2010 with a pre-election promise that he would help foreign exchange borrowers, pushed through two aid programmes.

In 2011, borrowers were given a window during which they could repay the lump sum of their loans at 180 forints to the franc, which was about 30% better than the market rate at the time. One-quarter of the outstanding Swiss franc-denominated loans were repaid in the period, with the costs split, unevenly, between banks and the government. Return on equity for the Hungarian banking sector plunged from 10.1% in 2010 to -3.8% in 2012. The controversial scheme also caused the forint to plunge in value in late 2011, hurting foreign exchange borrowers who had been unable to raise the funds needed to clear their loans.

Foreign currency loans still made up more than half of outstanding loans, worth about €9bn, prompting Mr Orban to push through a second rescue package in late 2014, when borrowers were left with little choice but to convert their franc- and euro-denominated loans to forint-denominated equivalents, based on the exchange rate on November 7, 2014: 256.5 forints to the franc.

The scheme caused some grumbling among consumers, many of whom had taken loans when the rate was closer to 160, and relief among banks, which had feared a more costly scheme. Most of these complaints disappeared in January, however, when the forint sagged to 308 against the franc, following the SNB decision.

“The plans by the Hungarian government to convert Swiss franc loans couldn’t have happened at a better time,” says Nick Spiro of Spiro Sovereign Strategy, a credit risk consultancy. The Hungarian government’s plan has more or less ended the issue of foreign currency loans, but they continue to haunt other banking systems across other regions.

Poland's plan

Swiss franc loans remain a problem in Poland, where they account for some 9% of the gross domestic product. About 550,000 borrowers have such loans, with 14.6% of outstanding loans and 37% of household debt denominated in Swiss francs. So far, borrowers in Poland have a good record of repayment, with just 3.1% of franc-denominated mortgages in arrears, slightly lower than the 3.6% for zloty loans. However, the worry is that this figure could get much worse. The zloty lost about one-fifth of its value against the franc when the SNB dropped its peg.

“If sustained, this devaluation of the Polish currency relative to the Swiss franc would be credit negative for Polish banks, because it increases the cost of instalments for borrowers of Swiss francs, which would negatively affect banks’ asset quality,” says ratings agency Moody’s in a research note released in January.

Polish policy-makers are shying away from the more radical Hungarian response. One reason is that, unlike in Hungary, the interest on Polish loans was floating and pegged to the three-month Swiss Libor rate, which helped borrowers as the SNB steadily cut rates. Another is that regulators clamped down on such loans before the crisis, meaning that most of those with franc-denominated loans are middle and upper-middle class people in the country’s largest cities. This group has generally low rates of unemployment and rising income on the back of Poland’s solid economic performance.

Andrzej Jakubiak, the head of the Polish Financial Supervision Authority, has floated a plan that would convert franc loans into zloty ones at a cost of about 1.2bn zlotys (€284m) a year over the next two decades. However, Mateusz Szczurek, the country's finance minister, is cool to the idea, with concerns about the risks of banks accruing unpredictable losses over such a long period of time. Besides that, policy-makers are pressing banks to pass through negative Swiss interest rates to their customers, which would erode the banks’ margins but provide relief to borrowers. Banks are also promising to narrow their often very wide spreads on foreign currency conversions.

Getting political

With the Polish parliamentary elections scheduled for October 2015, the issue, and the way that it is dealt with, has political as well as economic ramifications. Most of the Swiss franc borrowers form part of the natural electorate of the ruling centrist Civic Platform party of current prime minister Ewa Kopacz. In opinion polls, the party is currently neck-and-neck with right-wing opposition party Law and Justice, which is using the ongoing problem to its advantage by expressing concern about the fate of Swiss franc borrowers.

It is not just borrowers that are suffering. The slump in the value of the zloty has caused some concern at the banks that are most exposed to franc loans, especially those without large foreign parents. The most exposed banks are BPH Bank, with more than 50% of its loans in francs; Bank Millennium, with about 40%; mBank, with more than 30%; and Getin Noble Bank, with about one-fifth of its loans in francs. Of these, BPH is a unit of US conglomerate General Electric, mBank is owned by Germany’s Commerzbank, Millennium is part of Portugal’s Banco Comercial Portugues and Getin is a Polish banking group.

Millennium has seen its share price fall by 12% in the month following the SNB’s decision about the Swiss franc, while Getin’s shares have fallen by more than 17% in this time. However, despite tremors, Polish banks are well capitalised and should be able to handle the shock of the Swiss franc's appreciation. Stress tests in 2014 showed that a 30% rise in the franc would cause the sector’s Tier 1 capital ratio to fall by only 20 basis points to 13.28%.

Croatia's costly business

In Croatia, where elections are also planned this year, the government of prime minister Zoran Milanovic has unilaterally frozen the exchange rate at Hrk6.39 to the franc (the pre-SNB rate) for the rest of the year. While euro loans are more popular (part of the country’s legacy of sending workers to western Europe, mainly Germany), franc loans account for 16% of household sector borrowing, with about 4% of the population holding such loans. The exchange rate risk is to be borne by the banks, with the central bank estimating the negative effect on bank income at about Hrk400m (€52m).

“This is a temporary relief. The intention is to find a solution later this year,” says Vedran Sosic, deputy governor of the Croatian National Bank.

Possible solutions include following the Hungarian model, although the central bank estimates that the cost of such a move could see Croatia’s international reserves fall from €7.8bn to only €2.9bn. Another idea is to convert franc loans to euros. There are also suggestions that banks could convert mortgages into long-term leases. Croatia’s banks are overwhelmingly foreign owned and well capitalised, with a capital adequacy ratio of more than 20%.

The problem is smaller in neighbouring Serbia, with about 22,000 franc loans accounting for 14% of household loans and 3.3% of gross domestic product (GDP). The government, in the middle of completing a crucial €1bn standby agreement with the International Monetary Fund, has ruled out taking dramatic action to help franc borrowers.

There have been scattered protests in Romania, where about 4.5% of outstanding loans, worth about €2.5bn, are in Swiss francs. Many banks have already restructured some of these loans, because about one-quarter were in arrears last year. The central bank has called for continued negotiations over problem loans, with central bank governor Mugur Isarescu warning that converting loans into Romanian leu, at the same rate as when the loans were originally taken, could cost €1.3bn.

Austria's lesson learnt? 

Given that the trend of lending in Swiss francs began in the country and its banks were the ones that helped popularise the idea, it is unsurprising that Austria has been hit by the appreciation of the Swiss franc. Loans in the currency became widespread in Austria, despite the central bank issuing warnings about their danger as far back as 2003. At their peak in 2008, the country and its 8 million-strong population had 270,000 Swiss franc-denominated loans worth €40bn. The crisis showed the true risks of borrowing in a foreign currency, and banks pressed their customers to switch into euros. By 2008, the central bank had essentially banned such loans.

“We stopped these loans in Austria six years ago, and tried to convince people to move out of Swiss francs,” says Michael Mauritz, spokesman for local lender Erste Bank. “We wrote people a letter every quarter stressing the risk of staying in the franc.”

The number of franc loans has steadily declined to 150,000 contracts with a value of €25bn, or 19% of household loans. If corporate loans are included, franc-denominated loans come to €30bn, or about 10% of Austria’s GDP. But that still poses a problem for some banks. Including corporate loans and their exposure to borrowing elsewhere in central and eastern Europe (CEE), UniCredit Bank Austria has €13bn in franc denominated loans, Erste has €10bn and Raiffeisen Bank International has €4.3bn, according to Moody’s. 

The franc’s appreciation may “cause a retrenchment of the activities of Austrian banks in CEE, mainly in Hungary, Romania, Croatia and Serbia. Indeed, across the region,” warns Demetrios Efstathiou of Standard Bank.

Austrian banks and their customers had an even higher appetite for risk at home than Poles, Romanians and Hungarians. More than 70% of franc-denominated loans in the country were so-called 'bullet loans' with the customer borrowing more than was needed to buy a property and parking the excess in a mutual fund or life insurance contract. The customer then paid off the interest only, and expected the fund to generate a high enough return over the life of the mortgage to allow for a repayment of the capital at the end of the loan. That made Austrians even more susceptible to currency swings and market shifts than their CEE counterparts.

Apparently, the past few years have hammered home the benefits of a more conservative approach. “This is a lesson learned by the banks, and regulations are now in place that should prevent a repeat of that curse,” says Christian Gutlederer, spokesman for the National Bank of Austria. “We need to make sure that this does not happen again.”

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