On 23 February, S&P revised the outlook on SEB and Swedbank’s A ratings to Stable from Negative. These were the Swedish banks hardest hit by the sharp downturn in the Baltic States’ economies, which was the principal cause for the sector’s malaise. S&P now believes that Latvia, Lithuania and Estonia are about to emerge from their recent sharp economic correction. The stable outlook therefore reflects S&P’s view that these banks have now passed the most difficult phase in the cycle. However, this encouraging story was contradicted by Moody’s in its Banking System Outlook for Sweden, published on 9 March. While it acknowledged that the outlook for the Swedish banking system is improving, Moody’s maintained its negative outlook. It cites asset quality deterioration – particularly in the Baltic States – and falling revenue due to rising funding costs as the key risks facing the sector. Its ratings for Swedbank (A2) and SEB (A1) remain on negative outlook. The key question that arises from all this is: which rating agency’s view more accurately reflects the current state of play in Sweden’s banking system?

We believe that there are clear reasons to favour the more positive view of Swedish banks put forward by S&P. First, the macro-economic scenario is improving. The IMF’s GDP projections suggest that the Baltic economies should shrink much less in 2010 than they did in 2009, before returning to growth in 2011. And Swedbank and SEB’s exposure to these economies, which contributed the majority of each group’s considerable loan losses in 2009, has shrunk over the past twelve months to a more manageable 12% and 9.4% of total loans respectively at year-end. Moreover, the Swedish economy, which accounts for the majority of Swedish banks’ operations, is predicted to return to growth this year.

GDP growth in Sweden and the Baltics*

Source: Bloomberg, IMF.   *Data for 2010 and 2011 are drawn from IMF projections.

Away from the macro-economic picture, banks’ fundamentals now look strong. Each of the four major Swedish banks ended 2009 with a stronger Tier 1 ratio than they enjoyed at the start of the year (see chart).

Major Swedish banks’ Tier 1 ratios

Source: Company data

And most encouragingly, following significant provisioning efforts in 2009, their loan losses appear to have peaked. The chart below shows that all four banks’ loan losses decreased in Q409 from Q309 levels. It also demonstrates the link between Baltic exposure and loan losses. Swedbank, whose Baltic exposure is the greatest of the four banks, registered 2009 provisions that totalled almost 2% of total loans. The equivalent figure for Svenska Handelsbanken, which has negligible business in the Baltics, was around 0.2%. Baltic exposure and the performance of Baltic economies are therefore crucial to Swedish banks’ credit quality. Both measures are steadily improving, bolstering the view we share with S&P that the worst should now be over.

Major Swedish banks’ loan losses

Source: Company data

But while we believe that the Swedish banking sector is now on a much more secure footing, risks remain. Moody’s, for example, points out that Swedish banks have a relatively high dependence on wholesale funding, though we would add that this is mitigated by their long-standing use of the liquid covered bond market to obtain funds. And, of course, Baltic risk is far from the only risk banks carry on their books. For instance, while 3% of Nordea’s loan book is exposed to the Baltics, another 4% is exposed to the struggling shipping sector. Finally, we fully expect the recovery in the Baltic countries – and, indeed, in Sweden itself – to be protracted, resulting in a lengthy period of relatively high (though falling) loan losses. Overall, however, we believe that the risk of a Swedish bank failure has been averted. The banks’ strong capital ratios and the improving economic outlook are the main reasons for which we, like S&P, believe that the major Swedish banks are now skating on thicker ice. The fact that CDS spreads on Swedbank and SEB tightened following S&P’s announcement but did not react to Moody’s more negative statement suggests that the market agrees.

Nick Smallwood - Credit Analyst

Disclaimer:

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