Overall, recent developments don’t point to a drastic CRE scenario. We expect only modest asset-quality deterioration and increased performing loan provisioning at Swedish banks.
Consequently, we think Swedish banks will weather the storm. Crucially, they still have capacity to provide further support to real estate borrowers by taking on more property exposure. Their non-performing loans (NPLs) are low, and loan to value (LTV) ratios are still healthy. Meanwhile, their profitability is strong after successive rate rises helped to widen their net interest margins.
Warding Off Worst-Case Scenarios
Faced with worst-case scenarios, CRE companies could implement an array of measures to mitigate the situation, while banks would likely also offer renegotiated terms and conditions for those companies at risk of breaching their covenants (whether LTV or ICR).
For Swedish banks, even if the estimated value of their collateral were to fall below the loan value, they would still have the option to retain the asset and divest it later once market stresses have eased. This tactic was used successfully in previous crises, and at higher LTV ratios than today.
Bank assets such as higher-yielding property portfolios with inflation-linked rents and leases that oblige tenants to meet buildings’ tax, insurance and maintenance expenses—typical of Nordic light industry, logistics and warehousing—would likely bounce back faster. By contrast, lower-yielding portfolios with no indexation or cost pass-through—typical for Swedish residential—would be much slower to recover and more likely to suffer write-downs.
European Banks Are in Good Shape
Meanwhile, across Europe, we think the risk of contagion from Swedish CRE lending is low. We find that most European banks’ property exposures are manageable, their LTV ratios (averaging about 50%) give them a significant cushion against property losses, and their NPLs are yet to increase.
With a handful of exceptions, European banks’ exposure to US CRE is also modest, representing only a small fraction of their overall US loan books. The majority of European banks also perform well in our financial stress tests based on scenarios such as the GFC and previous banking crises. In the UK, the Bank of England’s recently published Financial Stability Report shows that here too, banks are relatively resilient to a severe stress-test scenario.
Across Europe’s residential property markets, it’s also rare to find the characteristics that have made Sweden’s so volatile: a majority of interest-only loans on variable or short-term fixed-rate deals; no requirement for most households to pay down their debt below 50% of property values; and a relatively low level of fiscal support for householders.
Overall, we think the problems facing Sweden’s banks will impact their profits but not their solvency, and we expect relatively moderate hits to their capital buffers. For Swedish CRE companies, we think the real estate downturn will in most cases be survivable. And for property markets across Europe, we see Sweden as an outlier rather than a sign of things to come.
Additional Contributors: Ravi Dasari | Analyst - European Banks Credit Research
