Global Economics

Swedish Banks at Risk from Baltic Ills


Scandinavian banks steered clear of subprime ripples, but now a downturn in the Baltics, where some are heavily invested, may make them less secure

Until recently, Scandinavian banks had good reason to be smug. Unlike other European financial institutions such as UBS (UBS) and Royal Bank of Scotland (RBS), which have suffered multibillion-dollar writedowns tied to risky subprime U.S. investments, the more conservative northern banks mostly steered clear of securitized assets and other new instruments.

Instead, they made money the old-fashioned way, investing extensively in the booming economies of Eastern and Central Europe—especially their closest neighbors, the Baltics. While other banks were unveiling big losses, Swedish and other Nordic banks continued to thrive from double-digit economic growth and soaring housing prices in countries rimming the eastern edge of the Baltic Sea.

But just as the American subprime writedowns eventually caught up with big European banks, the eastward-looking investment strategy of Scandinavian institutions is finally coming back to bite them. After initially bucking the global slowdown, Estonia, Latvia, and Lithuania are now in a tailspin, with plunging house prices and much slower economic growth.

That's raising fears for banks heavily exposed to the Baltics, especially Swedish giants Skandinaviska Enskilda Banken (SEB) (SEBA.ST) and Swedbank (SWEDA.ST). "There's a risk the ongoing cooling process in the Baltic economies could change into a pronounced economic downturn," said Stefan Ingves, the governor of Sweden's central bank, in a media conference call. "This would affect Swedish banks with considerable activities there."

Housing and Exports Decline

What happened to the booming Baltics? According to Eileen Zhang, a credit analyst at Standard & Poor's (MHP), they were hit first by an implosion in their fast-growing but overheated housing markets. Then, as the economies of Western Europe began to slow, the Baltic countries suffered a major decline in exports. As a result, Estonia, which enjoyed 7.1% gross domestic product growth last year, will see its economy shrink by 1% in 2008. Latvia similarly will post a mere 0.7% GDP increase this year after growing 10.3% in 2007, while Lithuania's 2008 GDP growth rate will be nearly halved, to 2.3%.

That's especially bad news for Swedbank, which is the largest lender in the Baltics and relies on the region for about one-third of its profits. SEB gets about 20% of its net earnings there. Investors are understandably nervous: Swedbank shares are down 42% since the start of this year and SEB is down 34%, compared with a 22% decline for Stockholm's benchmark OMX index.

The extent of the banks' risk began to take shape in July, when both released first-half results. SEB's net income fell 31% year-over-year, to $711 million. The decline was due primarily to $125 million of credit losses during the first six months of 2008, two-thirds of which originated in the Baltics. Analysts at Citigroup (C) expect losses to rise to $268 million by the end of 2008, up 73% from last year, and to hit $414 million by 2010.

Swedbank fared better in the first half, notching an 8% rise in profits, to $993 million. But it also nearly quadrupled its writedown provisions, to $108 million. Two-thirds of these potential losses came from the Baltics—a ratio expected to remain unchanged in the short- and medium-term. "Signs of overheating in the Baltic economies have raised concerns among investors and other stakeholders," the bank conceded in a statement on July 16. Citigroup figures Swedbank's total credit losses this year will top $297 million and will jump to $873 million by 2010.

Is the Danger Overplayed?

To offset the Baltic economic slump, both Swedbank and SEB are counting on continued success for their low-risk retail and commercial operations across Scandinavia, which provide them with some of the highest loan-to-capital ratios among European banks. Roughly 40% of their funding comes from customer deposits, rather than riskier and more expensive interbank loans, giving both SEB and Swedbank large capital reserves to weather the coming economic storm.

Indeed, some observers argue the danger is overplayed—especially compared with the kinds of losses suffered by UBS, which has written down $43 billion (BusinessWeek.com, 8/12/08). London-based S&P equity analyst Phuong Pham thinks investor fears over the Baltic economies have overshadowed the healthy Scandinavian businesses at both SEB and Swedbank, as well as their limited exposure to the depressed global credit markets.

What's more, many other Scandinavian banks aren't as exposed to the Baltics. Yet the current plight of Swedbank and SEB—and the knock-on effect on the whole sector—goes to show that even banks relatively unscathed by the U.S. credit crunch can face unexpected reversals of fortune from other corners of the planet.

Scott is a reporter in BusinessWeek's London bureau .

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