Description

This one’s very short..

The Swiss National Bank’s equity is spread over exactly 100,000 shares. These shares are held by various public entities, plus also private entities. A portion of the privately-held shares trade on the SIX Swiss Exchange and have traded around CHF 1,000 for a couple of decades. In mid-2016 the price jumped over 50%. Since July 17, 2017, there’s been yet another jump, to an intra-day high of CHF 4,724 last month, even though little has changed value-wise. The current price is CHF 3,675. It’s not easy to find borrow but if you do it’s just a matter of time before it comes back to a more normal price (my target is CHF 1000-1200).

Overview

Here’s the SNB mandate summary from the annual report: “The SNB’s mandate is derived directly from the Federal Constitution. Under the terms of art. 99 of the Constitution, the SNB is required to pursue a monetary policy that serves the overall interests of the country. In addition, the article enshrines the SNB’s independence and requires it to set aside sufficient currency reserves from its earnings, also specifying that a part of these reserves be held in gold. Finally, the Constitution stipulates that the SNB distribute at least two-thirds of its net profits to the cantons”.

So the SNB’s secondary objective is profit. The main objective is successful monetary policy, which of course includes balance sheet expansion (i.e. creating new liabilities and corresponding assets which are then used to purchase other assets via open-market operations). In the private sector, “balance sheet expansion” is essentially levering up, so the central bank is like a hedge fund that is levering up, thus exposing its equity to greater beta. From a macro perspective I’m not seriously concerned because the government and central banks can do all kinds of things to prevent disaster. But from a micro perspective, if one has the opportunity to bet on that equity’s price, it becomes interesting!

The SNB shares’ dividend may not exceed 6% of share capital, which is calculated based on the 100,000 shares’ nominal value of CHF 250 - that means a maximum dividend of CHF 15 per share. The remaining distributable profit goes to the confederation (one-third) and the cantons (two-thirds). Furthermore, for private entities, the number of shares that have voting rights is capped at 100. In other words, the above dividend rule is virtually impossible to overturn. It its website the SNB writes: “due to the legally stipulated maximum dividend of 6%, the price of the SNB share usually develops along similar lines to a long-term Confederation bond with a 6% coupon”.

Here’s an Overview of who owns the SNB’s shares:

Let’s take a look at the SNB’s balance sheet, leverage ratio and dividend yield:

(assets and equity In CHF millions)

A couple of things jump out from this table:

1) Starting in 2008 we see QE’s effect on a central bank’s shareholders: increasing leverage and increasing equity value volatility

2) Up until 2016 the stock price was extremely stable, and only two discrete run ups have brought it to where it is now (summer 2016 and summer 2017). When the price was stable, the yield was always around 1.5%.

Looking at the stock from a yield point of view: bond yields in Switzerland were in the 2-3% range between 2002-2008 and then declined to the 0-1% range. They’ve been mostly negative since 2015 but in the past few months have moved back toward 0%. The yield on SNB shares have been much more stable for much longer: essentially 1.5% that whole time and only in the past few months has declined to 0.4% abruptly (and at a time where bond yields rose). So the correlation between bond yields and the SNB equity yield isn’t that strong and I therefore don’t see why the dividend yield wouldn’t gravitate back to 1.5%, especially with the recently slowly rising bond rates.

Now looking at it from a portfolio management point of view, first of all there’s definitely a risk of the SNB losing money and therefore not paying a dividend (2013 saw a loss and the dividend was zero). And right now, the bank’s managers have an unhealthy 9.2x leverage ratio, no record of out-performance (since 2002, the average performance of foreign investments was 3.6%), and a portfolio of assets likely return low single digits over the next decade or so (not to mention the risk associated with having a fifth of the portfolio in equities at current valuations). As of the latest report, their asset mix is approximately as follows: gold (6%) government bonds (65%) other bonds (10%) equities (19%). Also, they have off-balance sheet liabilities that won’t be mentioned for simplicity sake.

If the stock were to return to its normal yield and trading range, the price would easily end up at CHF 1000-1200. If someone were motivated to sell into an illiquid market, it would suffice as a catalyst. The probability of this occurring would rise in case of losses on stocks.

Why did shares run up like that?

There’s a German newsletter that encouraged people to buy it. It is also thinly traded (over past few years around 100 shares per day on average) so maybe someone moved the market very quickly. Or maybe there’s been some weird type of irrational buying. Either way, the last time rates in Switzerland were above zero was before the run-up.

Catalyst

- Stock simply returns to historical trading range for technical reasons

- Higher rates

- Someone who needs to sell a lot would move the market quickly

- Equity market declines