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Swiss Franc Cap Brings Little Solace to French Town Paying 16%

Swiss Franc
An employee handles Swiss francs and euro notes on the counter of a currency exchange in this arranged photograph in Effretikon, near Zurich, Switzerland on Friday, Aug. 12, 2011. Photographer: Gianluca Colla/Bloomberg

Saint Cast, a sleepy French coastal town in Brittany with 19th-century mansions and a mile-long white, sandy beach, sees little in the Swiss central bank’s move to cap the franc that will help it avert financial devastation.

The town, most of whose 3,600 inhabitants are retirees, restructured 3.6 million euros ($5.1 million) of debt in July 2007, using a formula that pegged its interest rate to the Swiss franc after being attracted by the currency’s perceived stability. The franc, which was then at a record low, has risen 37 percent against the euro, threatening to boost Saint Cast’s interest rate to more than 20 percent from 3.99 percent.

The Swiss National Bank’s decision this week to set a ceiling of 1.20 francs to the euro leaves the town with a rate of 15.57 percent. Saint Cast, like the French Riviera town of Saint-Tropez, finds itself in a pickle that’s not of its making, according to Jean Fernandez, 71, a former math teacher who now serves as the town’s mayor.

“There is something abnormal for a little pensioners’ seaside town to be embroiled in a European sovereign debt crisis and for my taxpayers to worry about the currency market or a decision of the Swiss central bank,” Fernandez said in a telephone interview. “I cannot see how the SNB can rein their currency in the long term and that’s now my problem.”

Saint Cast is not alone. Seeking to boost returns or cap costs, French local governments entered into contracts they didn’t always understand. Saint-Tropez, a beach town made famous by Brigitte Bardot, has 24 million euros in debt pegged mainly to the Swiss franc. Argenteuil, a town on the outskirts of Paris where Claude Monet and Alfred Sisley painted, has 40 million euros of franc-pegged loans and 30 million euros linked to the dollar-yen rate.

Strengthening Franc

Many Swiss franc-indexed contracts were signed when the currency traded above 1.60 francs per euro. Saint Cast’s debt had an interest rate of 3.99 percent for an initial period, with the level remaining there as long as the franc stayed above 1.44 to the euro.

The franc began strengthening beyond that level in early 2010, with the pace picking up in November. Saint Cast’s interest rose to 15.25 percent at its June 11 fixing. For the year to that date, the town paid 523,000 euros in interest and 72,000 in principal.

The franc, seen as a haven during global turmoil, surged to a record high of 1.03 against the euro last month as European governments struggled to contain the region’s debt crisis. SNB set the franc’s ceiling on Sept. 6 -- the first time such a limit was set since 1978 -- saying it would use “unlimited” quantities of cash to cap the increase. The franc fell by a record against the euro after the SNB announcement and traded yesterday at about 1.208 francs to the euro.

Small Numbers

Granted, only some French local authorities used risky structured products to fund services such as public swimming pools and libraries. France’s National Auditor said in a July report that local government debt stood at 160.6 billion euros in 2010, of which about 12 billion euros were in structured products, potentially posing “a high risk.”

Etienne Favre, who advises local authorities at FCL consultants in Paris and publishes an annual report in October on local debt, said that he sees “no systemic risk” and that the threat is “concentrated on a small number of borrowers.”

For the communities that did enter into such contracts, the pain is very real.

“Interest rates sometimes fly above 20 percent, it’s not sustainable and penalties to exit the contract are impossible,” Christian Escallier, who advises local authorities at the Klopfer Consultants in Paris, said in an interview. “The banks’ refinancing proposals are even less sustainable.”

Fillon’s Call

French Prime Minister Francois Fillon urged local governments in December 2009 and again in June 2010 to stop using currency-indexed loans. The government is “bringing support to the authorities hit by the problem,” Valerie Pecresse, the government’s spokeswoman, said yesterday.

After Fillon’s remarks, Dexia SA, the Brussels -and Paris-based bank that owns the biggest share of the French local debt, said it stopped selling Swiss-franc products such as the “dual” loans that it marketed to Saint Cast.

According to Dexia sales documents obtained by Bloomberg from Saint Cast’s town hall, the bank’s assessment of the Swiss franc as “more stable and less volatile” was revised in its November 2010 refinancing proposal to show “uncertainty and volatility in the exchange rate.”

Dexia’s currency-indexed loans hit only “a very small number of clients who had their fixing” when the franc soared in August, said Jean-Luc Guitard, director of Dexia France. Guitard declined to comment on terms of specific contracts.

Local Taxes

“When you are a regular borrower, and that’s the case for local authorities, you are taking risks at fixed or variable rates,” he said. He declined to disclose how much of Dexia’s 52 billion euros of such loans are pegged to currency moves.

In Argenteuil, Joel Fournie, a financial adviser to the town, now has four full-time employees working on the loans from Dexia. The town raised local taxes by 20 percent between March 2008 and March 2010.

“It’s not a rich city but very diverse, with people from everywhere,” he said. “We are very, very far from Switzerland or a trading floor.”

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