Swedish Banks Under Pressure
A Way to Profit from a Weak Commercial Real Estate Market

Date of publishing: 07.08.2022

Executive Summary

  • Inflationary pressures and recent developments concerning interest rates have put the spotlight on one of the most dynamic real estate markets namely Sweden
  • Demand stifles as prices for Commercial Real Estate (CRE) depreciate while vacancy rates for offices are still on the run compared to peer countries
  • High leveraged CRE companies pose a risk for local banks holding their debt

Market Environment

With a population of approximately 10.4 million, experiencing a gradual annual growth rate, Sweden stands renowned for its breathtaking landscapes, progressive innovation, and robust social welfare system. Demonstrating a commitment to public services, the country allocates a significant 25% of its GDP for government spending. Nevertheless, it grapples with elevated unemployment levels compared to the pre-pandemic years, even as encouraging signs emerge from the 8.3% net inflows of GDP, indicating a positive outlook.

Sweden’s economic landscape is characterized by its independent currency, the Swedish Krona (SEK), and a central bank known as Riksbank, which plays a crucial role in shaping the nation’s monetary policy. In recent times, Sweden’s GDP growth has experienced a noticeable deceleration, now hovering around 61,000 USD per capita. The real estate sector, accounting for approximately 40% of the nation’s GDP, has also witnessed an even sharper decline in year-on-year growth in property prices.
Figure 1: GDP %YoY and real estate prices %YoY Source: Bloomberg Finance L.P

These developments demand close attention, particularly given the significance of the real estate market in Sweden’s overall economic landscape, its strucutre and current state. Through the following examination, we aim to gain a comprehensive understanding of Sweden’s economy and its banking sector’s prospects, using the commercial real estate market as a valuable indicator.

On one hand, the people are confronted with persistently high inflation levels, a concern compounded by the stage of the rate-hiking cycle it is currently in. The Consumer Price Index (CPI) for June has reached a notable 9.7%, surpassing expectations and significantly deviating from Riksbank’s target of 2%. Consequently, there are projections indicating a 25 basis point increase in interest rates during the upcoming decision-making process.

On the other hand, the performance of the Swedish Krona (SEK) against major currencies such as the Euro (EUR) and the United States Dollar (USD) has been weak. This depreciation raises a crucial dilemma for the executive board of Riksbank. Should they opt to lower interest rates in an effort to stimulate economic growth, or should they raise rates to defend the currency’s value and stabilize the exchange rate? This impasse is currently steering the executive board’s outlook towards a rather hawkish stance, signaling a leaning towards tightening the economy.
Figure 2: Individual positioning of the Riksbanks’ board members Source: Bloomberg Market Intelligence

The extant dynamics of the Swedish commercial real estate (CRE) sector have indicated an unfavourable trend due to the previously discussed market conditions. It is underscored by a pernicious blend of persistent high inflation and steep interest rates, paired with a decline in property values. The constellation of these factors has led to substantial impediments facing the CRE sector.

One of the striking financial issues arising from this context is the imminent necessity to refinance approximately $28.69 billion worth of loans within the upcoming years. This impending financial task is posed to CRE companies and adds to the complexity of the prevailing adverse market conditions.

Furthermore, the pattern of short-term liabilities has been on the rise since the onset of 2023. The primary driver behind this phenomenon is the prevailing pessimism among banks about future economic forecasts. As a result, banks have shown a hesitance to dispense long-term debt, leading to a concomitant increase in costlier short-term obligations that the CRE companies are currently facing. Evidence of this pattern is reflected in the average short-term liabilities for companies listed in the Stockholm Real Estate Index.
Figure 3: Short term liabilities (SEK mln) Stockholm Real Estate Index Source: Investing.com

Moreover, the weaker performance of CRE companies has been met with a downgrade in their credit ratings. This has posed a substantial obstacle to the issuance of bonds, thereby necessitating that these companies source an average of 40%-60% of their total borrowing from banking institutions.

The ramifications of this borrowing scenario extend beyond the immediate confines of the real estate sector. In fact, it has far-reaching implications for the broader Swedish economy. The total lending to the real estate sector, notably, constitutes more than 20% of the country’s Gross Domestic Product (GDP) – a proportion that is twice as large as that in the United States. This highlights the pivotal role of real estate lending in the Swedish economy.

Furthermore, the real estate sector also contributes significantly to the banking sector, with property companies accounting for approximately 44% of banks’ commercial lending. This underscores the extent of interdependence between the two sectors.

In conclusion, the Swedish CRE sector currently faces significant challenges arising from high inflation, increased interest rates, and falling property values. These challenges have, in turn, impacted financial dynamics, such as the necessity for loan refinancing, the rise in short-term liabilities, and the decrease in the sector’s credit ratings. Given the real estate sector’s substantial contribution to the national GDP and the banking sector, the implications of these issues may be far-reaching for the broader Swedish economy.

A Picture of the Peer Group

As a peer group for this industry, we consider companies listed in the Stockholm Real Estate Index. The index’s price performance indicates a significant decline of almost 50% in recent years. On the other hand, we have noticed a noteworthy increase in the P/E ratio, reaching 2.26 times at the beginning of 2023. Considering the price decline, it suggests that the earnings of Swedish real estate companies must have also decreased considerably to support such a substantial growth in the P/E ratio.
Figure 4: P/E ratio Stockholm Real Estate Index Source: Bloomberg

Supply and Demand Balance

The weakened earnings results could possibly be attributed to a decline in demand for commercial real estate. The graphs below illustrate the availability of office spaces and the commercial vacancy rate for capital cities in the Scandinavian region. We observe an increase in both measures for Stockholm, whereas they have declined in Copenhagen and Oslo. This observation lends support to our thesis regarding a falling demand for commercial real estate in Sweden.
Figure 5: Office availability in thousand sqm Source: Bloomberg
Figure 6: Vacancy rate (office) Source: Bloomberg Finance L.P

One potential reason for this decline might be the emergence of the home office trend following Covid-19. A survey conducted in 2021 asked people about their preference for working from home, and the results showed that most respondents were willing to work remotely for 2 or 3 days a week. Furthermore, statistics reveal that 40.5% of people worked from home in 2021, indicating one of the most robust home office trends in Europe.

These trends are also represented in forecasts for office Vacancy rates and rents. Vacancy rates are expected to increase even further for Stockholm, while Copenhagen and Oslo should remain stable for the next 12 months. Looking at Bloomberg forecasts for office rents, the picture of a suffering real estate market becomes even more understandable. Stockholm is the only city where rents are expected to decrease even more so that supply can match demand again.

Impact Financial Institutions

Moving on from our overall screening of the Swedish real estate sector there was a diverse set of problems. While the results of the analysis presented enough confidence to proceed with the trade idea, the difficulty was to find the right angle. One of the major players looked at by analysts was a company named SBB (Samhallsbyggnadsbolaget). It was gaining more and more attention in the media due to bad debt structure, foreign exchange losses and the overall lack of demand. Unfortunately, it had further depreciated in price since the onset of our analysis. Moreover, to accurately trade the topic within the given time frame, banks with high exposure to commercial real estate in the Scandinavian/Swedish landscape constituted a viable alternative. The move was supported by analysts most notably from JP Morgan slashing price estimates for financials in the region. Looking at the balance sheet of these lenders soon led onto the main target of our analysis Svenska Handelsbanken.

To further gain confidence a sector specific tool BankFocus was used to look at operational patterns of the individual financial institutions and compare them with the peer group. Most importantly following benchmarks were included: total assets, liquid assets (including available for sale and held to maturity) as well as Gross loans & advances to customers / Customer deposits.
Figure 9: Banks CRE exposure Source: Real Estate Capital Europe
The data presented a striking picture with Svenska Handelsbanken ranking 4th in total assets, 6th in liquid assets but 1st in gross loans and advances to customers among its peer group. This further increased conviction on the trade and provide a clear picture on the most important Swedish institutions and their exposure to the CRE sector.
Figure 10: Key figures bank comparison Source: BankFocus

Trade Structure

The provided data suggests a trade idea aimed at capitalizing on the downturn in the real estate market, which is affecting Swedish banks with significant exposure to commercial real estate (CRE). Despite this situation, we hold a strong belief that the market has already factored in much of this risk. Consequently, we anticipate limited downside potential, with prices expected to fluctuate within a certain range in the coming months. To align with these expectations, we propose implementing an iron condor strategy, involving the simultaneous purchase and sale of two call and put options. This approach combines a slightly bearish stance with a short position on volatility. As Svenska Handelsbanken (SHBA) has the highest exposure to CRE loans compared to its peers, this company is the best fit for such a strategy.
Figure 9: P&L Iron Condor. Source: Bloomberg Finance L.P.
The option payoff diagram represents one share of a contract, indicating that a single contract yields a net credit of SEK 388.04 and carries a maximum potential loss of SEK -543.96. The break-even range lies between SEK 79.6 and SEK 97.6, with the current stock price at SEK 92.18 (as of June 20th). Considering the relatively short time horizon for this strategy, the options are set to expire on December 25, 2023.

Disclaimer The information set forth herein has been obtained or derived from sources generally available to the public and believed by the authors to be reliable, but the authors do not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with WUTIS – Trading and Investment Society e.V.

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