Sweden's Property Rout Hits Pension Funds Hard and Highlights Huge Risks
Sweden’s pension system is increasingly caught up in a property crisis that’s hit commercial landlords, with one of the state-owned pension funds joining peers that have taken losses on its investments in real estate assets.
Forsta AP-fonden, more commonly known as AP1, saw the value of its investments in properties shrink by 7%, or 5.2 billion kronor ($450 million) in the six months through June. Real estate assets were the biggest drag, followed by private equity funds (-0.77%) and fixed income securities (-0.35%).
“Very few transactions took place on the market during the period, leading to valuations depreciating somewhat, particularly in the Nordics,” Chief Executive Officer Kristin Magnusson Bernard said in a statement. “In markets where external valuers made larger write-downs more rapidly, such as the UK, the market seemed to stabilize faster,” she said.
The development echoes peers in Sweden. The Nordic nation’s largest private pension fund, Alecta AB, earlier this week reported a 1% loss on its alternative investments in the first half of the year — a portfolio comprising mainly real estate assets. Sharply rising funding costs have rattled Sweden’s real estate sector, where many companies have relied on cheap floating-rate bonds to finance rapid growth.
On a more positive note for the AP1, the real estate companies it owns “have retained their excellent credit ratings and continuous access to capital,” it said in the report. Strong development for equities still helped the fund generate an overall return of 6.6% after expenses.
Earlier this week, Charles Daly of Bloomberg News reported that a Swedish pension fund hit by SVB posted a loss on its property portfolio:
The Swedish fund that got caught up in the US banking crisis this spring reported a first-half loss on an investment portfolio comprising mainly real estate assets.
Stockholm-based Alecta said alternative-investment returns were negative 0.9% for the period. Key holdings Heimstaden Bostad AB and Alecta Fastigheter AB were “negatively affected by the rapidly changing interest rate and market situation,” acting Chief Executive Officer Katarina Thorslund said in the report that was released Tuesday.
The fund’s exposure to one of the world’s worst real estate crises will likely stoke further concern among Swedish savers after the pension group lost 20 billion kronor ($2 billion) earlier this year on three failed bets in niche US lenders, including the defunct Silicon Valley Bank. The debacle sparked outrage among Swedes and led to the ousting of Alecta’s CEO and equities chief.
The turbulence stemming from the bank crisis triggered a marked increase in the number of move requests from customers “with clear peaks the days when there was a lot of information about Alecta in the media,” Thorslund said. Since then, requests have returned to more normal levels seen in February, she added.
In the half-year report, the group reported positive returns of 6.6% for the defined contribution Alecta Optimal Pension, compared to negative 12.7% in the same period of 2022. The solvency ratio stood at 209%.
“The loss of 20 billion kronor is an enormous amount and we fully understand that customers and owners have been worried,” the acting CEO said.
It seems that Sweden's residential and commercial property slump, as well as poor investments in Silicon Valley Bank (SVB), have hit some of Sweden's largest pension funds.
A month ago, Simon Johnson, John O'Donnell and Marie Mannes of Reuters reported on how Sweden was bracing for fallout from property slump:
Sweden's government is ready to step in to stem the fallout from a property rout if tumbling prices cause a wider crisis - a potential harbinger of trouble across Europe.
High debts, rising interest rates and a wilting economy has produced a toxic cocktail for Sweden's commercial property companies, with several cut to junk by rating agencies.
House prices are also down by around one-fifth since their March 2022 peak, according to the Organisation for Economic Cooperation and Development (OECD), reflecting soaring mortgage costs.
Swedish Financial Markets Minister Niklas Wykman told Reuters the state has the financial clout to prevent a property market plunge from engulfing the country, one of Europe's wealthiest, and its banks.
"There is a preparedness to act," he said.
"If ... more accidents happen ... or ... new risks are revealed ... or threats to the financial system arise, then the most important thing from a stability perspective is to have a broad tool box ... which the state can use."
Concerns about the property sector are already weighing on the currency, while investors are wondering if Sweden is only the first domino to fall in Europe.
Sweden and Germany are among the worst affected by a widening property slump on the continent, according to Eurostat.
Earlier this week, the OECD warned of 'financial stability risks' in Sweden, pointing to banks' heavy lending to property companies and homeowners, most of whom have floating-rate mortgages that move in lock-step with rising interest rates.
Although Wykman did not outline how his government could act and emphasised that banks were "profitable and stable", his comments underscore growing worry in Stockholm.
In the early 1990s, the collapse of a Swedish housing bubble triggered the nationalisation of two banks, the bailout of a third and a devaluation of the Swedish crown, plunging the country into a deep recession.
"It is clear that Sweden has low government debt and the ability to react if a crisis ... were to develop," said Wykman.
Property is the lynchpin of the Swedish economy, making up 80% of household debt. Weighed down by home loans, Swedes are twice as heavily indebted as Germans or Italians.
Commercial real estate makes up 18% of bank loans, according to the OECD, more than three times the level in Spain or Ireland.
Swedish officials are worried that banks could compound property companies' troubled by cutting credit, triggering firesales that would further drag down the market.
One of Sweden's biggest landlords, SBB (SBBb.ST), is at the centre of the spiral. It is scrambling to salvage its finances after recently seeing its credit rating downgraded to junk.
The company was founded by a former social democrat politician, Ilija Batljan, who built up vast debts, buying public property including social housing, government offices, schools, hospitals, police stations and an army facility.
Hit by soaring interest rates that forced the company to cancel its dividend and scrap a share issue, SBB is now hunting for a buyer of all or parts of its business after Batljan was forced to step down.
SBB had 81 billion Swedish crowns ($7.6 billion) of debt as of March, with around 15% of it maturing within one year.
The company told Reuters it had taken steps to strengthen its liquidity position, including selling a stake in a construction firm.
But SBB's problems, which some analysts blame in part for Sweden's sinking currency, are causing alarm in Stockholm. Its ownership of swathes of public property, puts a question mark over the provision of government services.
Coupled with falling property prices and rising mortgage costs, the crisis also threatens a voter backlash against a government already under pressure over a rising tide of gang violence.
Financial markets minister Wykman said he had held discussions with banks, property companies and investors about the entire commercial property market.
He later told parliament that while he was prepared to act to preserve financial stability, he would not "meddle" or "nationalise for the sake of nationalising", rejecting calls by some lawmakers to intervene in commercial property.
This week, analysts at JP Morgan said big banks in Sweden, which had 1 trillion Swedish crowns of property exposure, were 'ill-prepared' for losses.
The four main banks in Sweden played down any threat. Swedbank (SWEDa.ST) told Reuters it had been careful in lending. Finland's Nordea (NDAFI.HE) said its loans were strong and well diversified.
SEB (SEBa.ST) said it was "strong" and its credit quality "robust". Handelsbanken (SHBa.ST) referred to a recent presentation, where it said that its property lending was conservative and diversified.
"When it comes to the commercial property side, clearly there are contagion risks," Wykman said, without singling out individual companies.
"It could be that one or more company sells assets. It leads to other companies having to revalue assets and that can, in turn, mean that more companies need to make changes."
Also in June, Simon Johnson of Reuters reported that Sweden's Riksbank was worried over commercial real estate, but stated the risk of banking crash was low:
Soaring rates and falling property values are squeezing commercial real estate firms in Sweden, but the risk of a banking crisis is low, the head of the central bank said on Thursday.
Rock-bottom interest rates in recent years encouraged property firms to pile on debt and some have been caught out as central banks have tightened policy at a record pace to fight inflation.
With Sweden's banks heavily exposed to the real estate sector, worries have been growing that problems in a few individual firms could spread more widely and trip up the financial system.
"I judge that the risk of a banking crisis in Sweden is low," Riksbank Governor Erik Thedeen told reporters after the central bank published its regular report on financial stability.
"But there are risks."
Concerns have centred on real estate group SBB (SBBb.ST), which is looking for a buyer after its debt was cut to "junk" status and has been forced to restructure.
But SBB is not alone and Moody's said this week it had taken negative rating action on about 50% of the real estate firms it covers in Sweden.
Property companies have started to deleverage and Thedeen said there was still time for them to restore balance sheet health.
"Basically it's not difficult to say what's this about - it's about debt. It has to come down, otherwise it is going to be very tough for some companies," he said.
Thedeen called on banks not to cut credit to the sector as a whole.
"If they (banks) squeeze too much, they risk setting off something that is going to rebound on them and definitely the system as a whole," he said.
He also cautioned lenders to be "restrained in paying dividends and making share buy-backs" and build up their financial buffers.
Worries about the property sector - which triggered Sweden's last domestic crisis in the early 1990s - have hit the crown currency, which is trading at its weakest level against the euro for well over a decade.
Regulators say banks are better equipped to deal with turbulence in the sector, having beefed up their capital after the global financial crisis in 2008-2009. Bank resolution regulations have also been improved.
But the end of the long period of cheap money has exposed faults lines in the financial system, hitting niche lenders in the United States and forcing authorities to arrange a shot-gun wedding for Credit Suisse.
"I think .. the low rate environment exposed the system to risks and maybe the debate was a bit naive about what kind of risk we were building up during that period," Thedeen said.
The low rate environment has definitely exposed the financial system in Sweden and all over the world to risks and we haven't seen anything yet.
In the US, big banks are reporting but there's hardly a peep on the ongoing commercial real estate crisis, mostly in offices.
Lisa Abramowicz of Bloomberg reports that BlackRock’s Lynam sees credit distress even without recession:
It won’t take a recession to cause a wave of defaults. And Wall Street has yet to fully price in that distress.
That was the view from BlackRock’s Amanda Lynam on Surveillance this morning. She joined a slew of recent guests in flagging concerns around some riskier credit valuations — and reminding us of the potential trouble spots even if the US economy eases out of its inflationary surge without a painful economic contraction.
“Companies are taking reserves against interest-sensitive pockets of the market like commercial real estate, for example. But they’re saying they’ll need those reserves even if there is a soft landing,” Lynam said. “So it’s not necessarily reserves in the case of a worst-case downturn, but it’s reserves even if we kind of get an OK outcome.”
Credit investors will need to be careful, she said, because assessing property valuations may be even trickier with old standards no longer relevant in the post-pandemic area. “There’s going to be a new sense of price discovery.”
Regional banks are likely to feel “most of the pain,” Lynam said, echoing the concerns aired earlier this year when the upheaval at Silicon Valley Bank and First Republic Bank stirred concerns about future CRE lending in particular.
“We’re also seeing that’s where a lot of the reserves are being upticked,” she said. “But I don’t think it’s going to be limited to those areas.”
Today’s news from used-car retailer Carvana Co. helped punctuate the tumult in credit markets. Buoyed by a pandemic boom and then flattened by a post-pandemic bust, Carvana reached a deal to restructure debt and sell as much as $1 billion in stock.
Crossmark’s Victoria Fernandez said credit has a place in investors’ portfolios. But she also had some caveats, such as steering clear of high-yield and being on the lookout for signs of stress.
“We’ve seen some of the lower investment-grade names — not necessarily that their defaults are going higher, but their leveraged components are going higher,” Fernandez said. “You want to be careful and watch that.”
Let me be blunt, with rates staying higher for longer, property values all over the world are going to get squeezed and leveraged players will make the selloff much worse.
Will Sweden be the next domino to fall, igniting more property slumps throughout Europe? Will there be a European banking crisis which will spread to the US and North America? Will commercial property woes in the US sink regional and big banks?
Nobody really knows what is going on, it feels to me like they're trying to mask the size of the problem but if rates keep going up -- a real possibility -- then prepare for something to crack in the commercial real estate market.
We are already seeing cracks appear with news that Barry Sternlicht’s Starwood Capital Group is in default on a $212.5 million mortgage backed by an Atlanta office tower, another sign of mounting distress in US commercial real estate.
Commercial real estate billionaire Barry Sternlicht’s firm just defaulted on a $212.5 million Atlanta office tower https://t.co/EYW3TMpDd7— Leo Kolivakis (@PensionPulse) July 19, 2023
By the time it's all over, there will be plenty of more defaults on commercial real estate mortgages, and not just on those taken out to acquire office towers.
And how will this impact North America's pension funds? Very negatively, some a lot worse than others.
You can only fudge the values for so long, at one point, you need to take big writedowns on these assets.
Anyway, prepare for a rough last quarter of the year and rough year ahead, I think this party in risk assets is coming to an abrupt end and contagion risks will clobber risk assets.
Below, TLDR News reports Sweden's housing bubble is bursting and that's bad news for Swedes but it could lead to a cascade of housing collapses across Europe. In this video, they unpack what all of this means for Europe and how the continent will react to a change in housing.
Also, two months ago, SBB halted payment of its dividend after suffering a ratings cut, in another sign the funding squeeze gripping Sweden's leveraged property sector is worsening. Anton Wilen discusses on Bloomberg Television.