Bank Stress Tests May Compound Losses for Swiss National Bank

Includes: EWL, FXE, FXF, UUP
by: Ophir Chador

The Swiss National Bank's intervention efforts aimed at weakening the franc relative to the euro has resulted in $13.3 billion dollars in losses. However, the real pain may still await the central bank ahead of the eurozone's stress test results slated for Friday release.

Unlike other central banks, the SNB issues shares and is publicly traded. Bloomberg estimates that the bank suffered a second quarter loss of 5.5 billion francs compared to a 1.5 billion franc gain in the first quarter. Final results are scheduled for release on August 13.

Over a two-year period, the SNB has purchased several billion euros to counter gains in the Swiss franc. The measure aimed at reducing deflationary risks while protecting the country's export industry.

The intervention efforts have temporarily halted, leaving market participants to guess at the next level at which the SNB will intervene. Many are speculating that the 1.30 handle will be the next level that the SNB protects. However, that opinion is not uniformly held.

According to Giovanni Staunovo, a currency analyst at UBS, "We don’t expect the SNB to intervene in currency markets unless the franc appreciates toward 1.25 against the euro. It would also depend on the pace of appreciation."

The EUR/CHF is last priced at 1.3475, having bounced off its all-time low of 1.3072 reached on June 30. In recent weeks, the euro has gained ground against its major counterparts. However, the shared currency may have reached a top, as it traded above the $1.30 level earlier in the week. The EUR/USD is last priced at 1.2810.

The next major test for the euro will come later in the week as the European Union releases its stress tests results. High Frequency Economics' chief economist, Carl Weinberg, notes that the stress tests present a "lose-lose situation" for the euro.

According to Mr. Weinberg, "“If any banks fail, the market reaction will be bloody. If no banks fail, the market will sour because no one will believe the results. We think the week will end with a renewed sense of imminent banking sector-crisis” in the eurozone.

For the SNB there exists a real concern of ballooning losses tied to its euro holdings insofar as the central bank answers to its shareholders. The stress tests present something of a wild-card for the central bank's euro position, as market participants are already questioning the metrics used in the EU's hypothetical construction of a stressful environment.

Reports have surfaced indicating that the stress tests assume a 23% haircut on Greek debt and a mere 3% haircut on Spanish debt.

JP Morgan, however, estimates that at 25% haircut on Greek debt and a 10% haircut on Spanish debt would present an "optimistic scenario". The bank offers a "base scenario" that calls for a 30% haircut on Greek debt and a 15% haircut on Spanish debt.

The results of the EU stress tests are scheduled for Friday release, offering investors a weekend to reflect on the meaning behind the numbers. For the SNB, it may prove a weekend of lost sleep considering the level of exposure to the euro that the central bank maintains.

More troubling, however, are the prospects of heightened euro-exposure that the SNB may be forced to undertake should the market react poorly to the results. In addition to frantic selling of global bank shares, the central bank may find itself short of investors.

Disclosure: Author is Short EUR/CHF