Central Banking from the Bottom Up
Central Banking from the Bottom Up
A Stock Analyst's Guide to Central Banks
From his office a few blocks from the River Rhine in Dusseldorf, Theo Siegert had been scouring the world for investment opportunities. His research process had thrown up an under-appreciated banking stock headquartered across the border in Switzerland, and he started building a stake. Siegert knew a bit about the banking business – he was already a non-executive director of Deutsche Bank – but this stock was different. In his home country, as in many others, central banks tend not to trade freely on the stock exchange. Not so in Switzerland. Before long, Siegert had become the largest shareholder of the Schweizerische Nationalbank, the Swiss National Bank.
On the face of it, it was a compelling buy. The bank has a monopoly on the issuance of Swiss Francs, one of the most sought after currencies in the world. While not the Dollar, it is still a top ten currency for international payments and global foreign currency reserves, and the Swiss National Bank has an exclusive license to issue it. Other currencies have penetrated the domestic market – the Euro is accepted in stores around Geneva and the WIR franc is a private community currency used by some small businesses – but network effects keep the Swiss Franc dominant. It has all the features of a sustainable competitive moat.
At the time Siegert bought it, in early 2009, the bank also held a stockpile of gold and a portfolio of foreign government bonds. It still owns the same 1,040 tonnes of gold (stored in vaults as far away as London and Canada to reduce risk) although they are now worth a lot more ($74 billion) with the gold price having hit record highs. Incremental buying of securities has also seen the investment portfolio balloon to $822 billion. Alongside its bonds, the bank diversified into foreign equities. It even holds 74 million shares of Nvidia, making the Swiss National Bank a top 40 shareholder.
When Siegert disclosed his stake, the Swiss National Bank was run by a former hedge fund manager, Philipp Hildebrand (now Vice Chairman of BlackRock), whose skills would have been handy in managing such a portfolio. But maximizing returns wasn’t part of his mandate which, more loftily, is to ensure that “money preserves its value and the economy develops favorably.”
That didn’t mean he couldn’t make money. Like most central banks, the Swiss National Bank generates earnings from “seigniorage” – net income it earns on assets funded through currency issuance. The bank’s seigniorage margin isn’t as high as Starbucks’ (as discussed here a couple of weeks ago) but on banknotes, at least, it’s not bad. The Swiss National Bank spent 37 million Swiss Francs last year maintaining 76.3 billion Swiss Francs of banknotes in circulation, equivalent to a cost of 0.05%. The yield on corresponding securities drops almost straight to the bottom line.
Because the bank marks its assets to market, reported earnings jump around a lot but in the thirteen years after Theo Siegert took his stake, cumulative earnings amounted to 174 billion Swiss Francs, equivalent to an average annual return on equity of 12%. (Things went awry in the fourteenth year—we’ll come to that.) His best year was 2017 when the bank earned 14.7 billion Swiss Francs of net interest income, 16.0 billion Swiss Francs of securities gains, 3.1 billion Swiss Francs on gold and 21.0 billion Swiss Francs on foreign exchange translation.
With operating leverage pretty high, most of that was available for distribution. Personnel expenses and general overheads, together with expenses associated with maintaining banknotes, amounted to an aggregate 384 million Swiss Francs. Despite their bumper profits, staff were paid a regular salary of around $160,000 each, leaving around $55 billion for shareholders. By the time the bank filed its annual report for the year, the stock had tripled from its level at the end of 2016.
That Theo Siegert had an opportunity to participate at all is a quirk of history. In 1897, the Swiss held a referendum on whether to establish a government-owned central bank and the public voted no.1 So in 1905, a “privately-owned” central bank was instead set up in which the government retained control, but a minority was listed. Today, just over half of the bank’s capital is held by state institutions, the rest is distributed among 2,600 private sector shareholders of which Siegert remains the largest.2
Sadly for him, though, the opportunity comes with a caveat. It would be difficult for the Swiss National Bank to pursue its mandate – ensuring that money preserves its value and the economy develops favorably – if it also had to pander to the demands of private shareholders. So it limits private shareholders to voting just 100 of their shares – equivalent to a 0.1% position – leaving Siegert with 4,910 shares on which he is ineligible to vote. And it caps the dividend at 15 Swiss Francs a share, equivalent to a 0.4% yield at today’s price of 3,850 Swiss Francs. Of the remaining distributable net profit, a third accrues to the central government and two-thirds to regional cantonal governments.
As a result, the 10.4 kilograms of gold per share the bank carries and its 1.2 million Swiss Francs of overall net assets per share (at March valuations) remain out of grasp for private shareholders. At best, the stock is a safe haven, providing a preferred return in a strong currency, with no counterparty risk. There was a time not too long ago when a 0.4% yield was considered attractive.
The Swiss National Bank isn’t the only listed central bank in the world. The Bank of Japan, the South African Reserve Bank, the Bank of Greece and the Banque Nationale de Belgique are all also listed on their local exchanges. But the Swiss National Bank is the largest relative to its domestic GDP and a bottom-up analysis of it provides a window into the world of monetary economics.
To see how the world of money works from this differentiated perspective, read on…
