Swedish Banks: Could They Get Burned By Heavy Baltic Exposure?

The health of Sweden’s banking system is increasingly coming under the microscope given its exposure to the rapidly contracting Baltic economies (Estonia, Latvia, Lithuania). Swedish banks’ outstanding lending to the three Baltic states is around 20% of GDP (US$ 60 billion), mostly in foreign currency. In June, Sweden’s central bank and the financial supervisory authority (FI) both released stress test results, which showed all the Swedish banks weathering the Baltic malaise. However, the central bank and FI’s stress test scenarios were not especially stressful and may soon start looking more like base case scenarios.

Bottom line: While Swedish banks should all meet minimal capital requirements (4% Tier 1 capital ratio) in a stressed scenario, spiking defaults in the Baltics will significantly erode the capital positions of Swedish banks exposed to the Baltic region. Such erosion will tighten lending both domestically and in the Baltics, further cutting into Sweden’s already negative growth outlook for 2009.

It is important to note that Swedish banks have very different levels of exposure to the Baltics. Of the four major Swedish banks (who hold a combined market share of around 75% in their home market), three are exposed to the Baltics, but only two – Swedbank and SEB – have any significant exposure. As of March 31, 2009, Swedbank had approximately SEK 207 billion (US$26 billion) worth of loans outstanding to Baltic borrowers, while SEB had SEK 166 billion (US$21 billion).


*Central Bank of Sweden, Financial Stability Report, June 2009

** Central Bank of Sweden, Financial Stabililty Report, November 2008

How Bad are Economic Conditions in the Baltics?

The three Baltic economies are experiencing some of the sharpest contractions in the world, which is considerable given the general global slump. Both the Latvian and Lithuanian governments see 18% contractions in their economies this year, while Estonia’s central bank expects a 15% contraction.  The graph below highlights how quickly the Baltics’ macro situation has deteriorated.

GDP Growth Rates

(% change compared with same quarter of previous year)


Source: Eurostat

Meanwhile, Baltic housing prices are plunging. In Estonia and Latvia, house prices fell by around 16% and 36% y/y, respectively, in Q1 2009, according to the Knight Frank Global House Price Index, making Latvia the worst performing housing market worldwide with Estonia not far behind. What this means is that even mortgage loans, which historically have very high recovery rates, will not hold up nearly as well as in the past.

How Healthy are Swedish Banks Right Now?

Currently, Swedbank and SEB both appear well capitalized. Given the sharp deterioration in the Baltics, both the banks and the Swedish government have taken precautionary measures to guard against growing credit losses.

By the second half of 2008, as the downturn accelerated, the credit quality of Baltic loans deteriorated rapidly. Throughout the first nine months of 2008, loan losses (as a % of total loans) were less than 1.0% for Swedbank. From Q4 2008 on, Swedbank’s loan losses have increased precipitously, soaring to 7.5% in Q1 2009.While not as severe as Swedbank, SEB experienced a similar trend, with net credit losses from the Baltics jumping to 3.7% in Q109, compared to 2.6% in Q4 2008.


As credit losses soared, Swedbank and SEB employed rights issues to raise additional capital. In 2008, Swedbank’s rights issue totaled SEK 12.4 billion (US$1.6 billion), while SEB’s rights issue during Q1 2009 totaled SEK 15.1 billion (US$1.9 billion). Consequently, as of March 31, Swedbank’s Tier 1 capital ratio was 10.8%, while SEB’s ratio was 12.0%.

Worried about the stability and capitalization of its banking system, the Swedish government introduced several stabilization measures in late 2008. The Swedish government established a loan guarantee fund for Swedish banks, whereby banks issue debt with the Swedish government as the guarantor. Concerned that rising credit losses may erode investor confidence in the banking system, the Swedish government created this program to ease banks’ financing pressures. In November 2008, Swedbank joined the Swedish government’s guarantee program and has since raised SEK 227 billion (US$ 28.8 billion) worth of commercial paper and debt.  SEB joined the program in May 2009.

In a sign that market conditions will continue to deteriorate, the Swedish Central Bank boosted reserves by borrowing EUR 3 billion (US$ 4.2 billion) from the ECB. In the event of a Baltic financial crisis, the reserves boost provides the Swedish Central Bank with more ammunition to support the Swedish banking system.

How Might Swedish Banks Fare Under Increased Stress?

Both the Central Bank of Sweden and the Financial Supervisory Authority (FI) have examined Swedish banks under a number of imagined stress test scenarios. Under the central bank’s stressed scenario, Sweden’s four largest banks would experience SEK 311 billion ($39 billion) in total losses for 2009-10 (not just on Baltics lending, but on lending in all markets, including Sweden), while FI predicts SEK 350 billion ($43.9 billion) in total losses over a three-year period through 2011 in its most stressful scenario. Neither fully discloses all the details behind their assumptions, but there are a number of potential weaknesses in the scenarios they lay out.

Central Bank’s Stress Test

The central bank assumes average loan losses in the Baltics of 10% per year in 2009 and in 2010. Considering that Swedbank’s loan loss ratio in the Baltics reached 7.5% in Q1 2009, this does not seem especially stressful. As Danske Bank points out, loans in arrears in the Baltics are ‘exploding’. In Latvia, loans in arrears jumped to 20.5% of the aggregate loan portfolio of Latvian banks (including Swedish-owned subsidiaries which dominate the Latvian market) at the end of Q1 (up 5.5% from the end of 2008).

Credit losses tend to lag the bottom of a downturn by five quarters, according to FI, meaning the peak in credit losses is still to come. Given the sharp contraction in Q1 2009 and the fact that loan losses tend to lag contractions in economic growth, loan losses will likely continue to spike from current levels.

The spike in Baltic credit losses during Q1 2009 could be just the tip of the iceberg.  Downward revisions in GDP have been fast and furious. Just a few weeks ago, the Latvian government revised down its 2009 GDP forecast to -18% from -12%. In early June, Lithuania’s finance ministry slashed 7% off the country’s 2009 GDP forecast.

Since none of the Baltics contracted on a y/y basis until Q2 2008 and since credit losses tend to lag GDP contractions, peak loan losses will probably not hit for several more quarters, meaning loan losses will likely be much higher than the 7.5% experienced by Swedbank and the 3.7% experienced by SEB in Q1.

Financial Supervisory Authority Stress Tests

The FI