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Is Sweden economically prepared for a real estate bloodbath?

Sweden, during the early 1990s, saw a financial crisis caused by its commercial real estate sector

As soaring interest rates and high debt engulf Sweden’s commercial real estate firms, analysts are worrying whether the issue will lead to a financial instability kind of situation for the European country.

As per the latest reports, home prices in the country have dropped 11% year-over-year in the 12 months through September 2023, the sharpest drop in 56 global markets tracked by real estate company Knight Frank.

The situation is so bad that financial watchdog Finansinspektionen (FI) is now asking Swedish commercial property companies to reduce their debt and boost equity.

How Bad The Scenario Is?

As per the Finansinspektionen, larger and listed commercial real estate companies needed to reduce their roughly 1,500 billion Swedish Crown (USD 143.68 billion) debt pile in case of further interest rate hikes and a decline in property value.

Ratings agencies have already cut the debt of several Swedish real estate firms to “junk” status.

Agreeing with Finansinspektionen, Riksbank (Swden’s central bank) Governor Erik Thedeen has said that property companies must reduce debt and strengthen their balance sheets.

Noting about commercial property companies ramping up borrowing during the low-interest rate regime and now struggling to pay off/roll over debt after eight rate hikes by the central bank, Thedeen observed, “It’s about selling assets and paying off debt…and it’s about new (equity) issues and taking in more capital.”

Thedeen said the central bank’s decision to keep its benchmark interest rate unchanged at 4.00% in December 2023 “should not be interpreted as meaning that inflation risks have disappeared and that interest rates will fall rapidly”.

Around 480 billion Swedish Crowns (USD 45.91 billion) of debt are due by 2025, according to rating agency Moody’s, which also sees the debt being refinanced at higher interest rates.

Moody’s also believes that Swedish commercial property values could fall as much as 20% from mid-2023 to mid-2025 because of the economic slowdown in the country and Europe.

Sweden, during the early 1990s, saw a financial crisis caused by its commercial real estate sector. The economy, back then, shrank for three years in a row and two banks were nationalised. Although Swedish banks are among the best capitalised financial institutions in Europe, the Riksbank has called on them to restrict dividend payments and share buy-backs so they have sufficient buffers to deal, in case the property sector goes into another crisis.

In Sweden, around 64% of bank lending is related to property, which includes household mortgages. Worries about the real estate sector’s health have affected the crown currency, while foreign investors have been reducing their holdings in Swedish assets.

Knowing The Problem

Swedish commercial real estate companies borrowed heavily when interest rates were low. Since the spring of 2022, as the country went through eight back-to-back rate hikes, these businesses are now struggling with higher costs and refinancing. The problem is aggravating faster due to a slowing economy and a higher number of job vacancies, as property values continue to fall further.

“Authorities say problems are limited to a few firms but have warned a fire-sale of assets by one could hit valuations across the sector. Cross-ownership could make problems worse,” stated Reuters.

Handelsbanken has the biggest exposure to Swedish commercial real estate (loan-wise), followed by Swedbank, SEB and Nordea.

Listed commercial real estate firms had outstanding debt of around 1.8 trillion Crowns (USD 175 billion). The biggest holders of real estate debt are foreign investors, followed by Swedish funds, pensions funds and insurance companies, Riksbank stated further.

The Road Ahead

According to the Riksbank, roughly 105 billion Crowns of debt will mature in 2024, followed by 122 billion in 2025, 105 billion in 2026 and 63 billion in 2027.

Finansinspektionen’s stress tests show banks losing around 50 billion Crowns if a ‘Real Estate Crisis’ breaks out. While these banks have mandatory capital buffers of around 1.1 trillion Crowns, along with additional capital, Riksbank can’t predict whether the property sector crisis will affect confidence in the overall Swedish financial system.

The collapses of regional banks in the United States and Credit Suisse in Switzerland in 2023 also have presented Riksbank with the worry of investors and depositors pulling out their cash en masse from the Swedish banks, if the real estate sector bloodbath starts.

As real estate firms buy back debt, sell assets, and raise equity, markets remain tough. Most of the ventures are now staring at the possibility of debt restructuring, as interest rates may remain high in 2024 too.

Can The State Be Of Any Help?

“During the 2008-09 financial crisis, Sweden guaranteed bank debts and offered subsidised loans to keep credit flowing. During the COVID pandemic, the central bank bought government and corporate debt and the government paid some employee wages, gave companies temporary tax breaks and offered credit guarantees to airlines,” Reuters noted.

“The financial watchdog could ease banks’ risk weight floors for exposure to the commercial real estate sector, currently at 35%, or lower countercyclical buffers which now stand at 2% of risk-weighted assets,” it added further.

Sweden also has the option of setting up a state-backed ‘bad bank’, which will take over underperforming commercial property loans given by banks.

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