SNB’s Danthine Sees Risk of Property Defaults, Correction

Swiss National Bank (SNBN) Vice Chairman Jean-Pierre Danthine said Switzerland is facing an increasing risk of defaults in the mortgage market as well as a “sizable correction” in property prices.

“Specifically, an adverse shock -- such as rising interest rates, lower growth or increasing unemployment -- would leave some borrowers unable to service their loans, increasing the possibility and number of defaults,” Danthine said at a conference in Zurich today. That would spark “a vicious feedback loop of falling prices and impaired balance sheets throughout the banking sector.”

The SNB toughened its tone on risks to financial stability after the introduction of the franc cap of 1.20 versus the euro a year ago forced policy makers to keep borrowing costs at zero to help weaken the currency. Danthine said there have been increasing “indications of a gradual buildup” of imbalances over the past years, with annual growth rates in mortgage lending and real estate prices averaging 5 percent and some regions and segments showing prices exceeding levels that can be “justified by fundamental factors.”

The government earlier this year toughened lending rules, forcing borrowers to provide at least 10 percent of the value of the property from their own funds without using pension assets. Under the measures, mortgages will have to be paid down to two- thirds of the lending value within 20 years.

‘Certain Risk’

It also made a so-called countercyclical capital buffer, or CCB, available, which Danthine called “an important step.” If activated upon the SNB’s request, the Swiss government could force lenders to gradually build up an additional capital buffer of as much as 2.5 percent of total domestic risk-weighted assets to target certain segments of the credit market.

Economy Minister Johann Schneider-Ammann said in an interview in Bern on Sept. 3 that the measure had been “carefully prepared over weeks and months.”

“If it was needed, it could be used,” he said. “I’m convinced that the impact would be appropriate. It’s true that certain regions, Zurich, Geneva, are carrying a certain risk, but the situation has improved in the last months.”

‘Fire-Sale Spirals’

Swiss officials are trying to prevent a repeat of the country’s last housing-market crisis in the 1990s, which sparked a recession and pushed up unemployment. SNB Chairman Thomas Jordan on Sept. 3 also warned of risks, saying there are signs that residential properties in some regions such as Zurich and Geneva are already “overvalued.”

Danthine said, given the current environment, the buffer would be aimed solely to target developments in the domestic mortgage and residential real-estate markets.

“The CCB should increase resilience by ensuring that an additional buffer of capital is build up gradually during the boom, a buffer that can then be released to cushion losses in an eventual downturn,” he said. “It thus limits the threat of vicious fire-sale spirals.”

In its June Financial Stability Report, the SNB said the mortgage market poses a significant risk to lenders. Home loans have increased by almost 300 billion francs ($313 billion) in a decade and gained 5.2 percent last year to 797.8 billion francs. That’s about 140 percent of gross domestic product.

Outstanding Mortgages

UBS AG (UBSN) and Credit Suisse Group AG (CSGN), Switzerland’s two biggest banks, had combined outstanding mortgages of 240.6 billion francs at the end of 2011, up 2.8 percent from the previous year. Cantonal banks, which are largely owned by the regions, had a 6 percent increase, while the cooperative-based Raiffeisen banks saw mortgages surge 7.4 percent.

Danthine said the buffer will only be activated “if deemed necessary.”

“Most of the time, it is likely to remain turned off,” he said. “If activated, the CCB would be applicable to Swiss banks and to subsidiaries of foreign banks in Switzerland, ensuring a level playing field.”

Still, the SNB said in a statement on Aug. 27 that the buffer won’t be activated this year as there are “some indications of a possible slowdown” in the second quarter of the “exceptionally strong” momentum in the domestic residential mortgage and real-estate markets. Danthine said the measure “can and will be used in a balanced and flexible way to deal with specific cyclical risks” if needed.

“If the CCB generates capital constraints at some banks, these banks will need to decide which sector to keep lending to,” he said. “It may seem reasonable that institutions will prefer to keep lending to the booming sector, while cutting back on lending to other sectors.”

To contact the reporters on this story: Simone Meier in Zurich at smeier@bloomberg.net; Leigh Baldwin in Zurich at lbaldwin3@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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