## Sweden’s Corporate Vulnerabilities: A Focus on Commercial Real Estate

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**Canonical URL:** [Sweden’s Corporate Vulnerabilities: A Focus on Commercial Real Estate](https://www.imf.org/-/media/files/publications/selected-issues-papers/2023/english/sipea2023024-print-pdf.pdf)

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---

### Overview
- Commercial Real Estate (CRE) debt constitutes a large portion of corporate debt and depends heavily on bank financing.
- Key trends and magnitudes:
  - Net debt-to-net operating income grew from a ratio of around 10 to 15 between 2009 and 2021.
  - Loans to CRE firms represent between 10 and 25 percent of banks’ private sector lending.
  - Non-bank debt now represents close to half of total outstanding bond market issuance.
  - Average loan duration is about 3.5 years, and bond maturity is about 5 years.
  - Foreign holdings of CRE firms’ bonds stand at 53 percent.
  - Among domestic investors, investment funds hold around 21 percent of CRE bonds.
  - Office vacancy rates rose from about 3 percent in 2019 to close to 8 percent in 2021 in Stockholm (similar trends in Gothenburg and Malmö).
- Implication: Elevated refinancing risks and short interest rate fixation increase macro-financial stability concerns; ownership concentration and cross-holdings have risen.

### Vulnerabilities and Contagion Risks
- Amplification channels and contagion mechanisms:
  - CRE firms may draw on contingent bank credit lines to repay maturing bonds or continue operations; currently CRE firms have just under SEK 190 billion in contingent credit lines, enough to sustain funding for 2 years.
  - If banks are willing to lend in addition to converting credit lines into loans, the FSAP stress test shows that, if willing, banks would be able to absorb 1/3 of CRE firms’ market funding.
  - Liquidity premia on funding costs can undermine CRE profits and increase credit risk premia, potentially turning liquidity shocks into solvency shocks.
  - Redemption requests or deteriorating performance would reduce liquidity and boost funding costs, aggravating stress.
  - Asset liquidations could lower property values across the CRE sector, affecting non-bond-issuing CRE firms and initiating fire-sale dynamics.
  - CRE market concentration and cross-ownership: the market is highly concentrated (12 ultimate owners, although ownership may be partial), increasing the risk that shocks become systemic.
  - Hits on bank capital from provisioning charges or outright losses could crowd out credit to the real economy.
- Historical context: CRE problems have triggered or amplified past financial crises; CRE is sensitive to financial cycles and large relative to the system.

### Stress Test
- Samples and scope:
  - Orbis database sample used; largest 100 companies in the sample hold aggregate assets of around 70 percent of GDP and debt of around 50 percent.
  - A broader sample: about 3,800 firms with total assets amounting to US$482 billion (90 percent of GDP) and aggregate indebtedness of US$ 363 billon (70 percent of GDP), or around 40 percent of NFC debt.
- Metrics and thresholds:
  - Interest Coverage Ratio (ICR) = EBIT / Interest Expense. An ICR of less than 1 implies insufficient revenues to service debt without adjustments.
  - An ICR threshold of 1.5 times is applied to account for vulnerabilities to funding risks in addition to earnings risks.
  - Debt is categorized into risk buckets by ICR; lower ICR implies higher probability of becoming non-performing.
- Stress scenario and results:
  - Shocks applied reflecting the FSAP’s adverse stress scenario (noting main impacts from increases in policy rates and real estate price declines).
  - Scenario components referenced: increase in advanced country policy rates (up to 400 basis points for the Swedish repo rate) and 38 percent decline in both residential and commercial real estate prices after two years.
  - Joint shocks significantly weaken ICRs: median ICRs fall below 1.5 in adverse scenarios and below 1 in more severe shocks.
  - Debt-at-risk fluctuated between 20–35 percent across scenarios.
  - Medium and large-size firms were affected similarly.

### Policy Considerations
- Core recommended actions:
  - Encourage better disclosure by supervisory authorities and potentially the Securities Market Association:
    - Bond issuance templates should include disclosure on liabilities, especially those in foreign currency, and contingency plans for market funding dry-ups.
    - Improved disclosure will help investors assess firms, improve market discipline, and distinguish more solvent from less solvent firms, reducing contagion.
  - Enhance data collection:
    - Improve comprehensiveness and periodicity of CRE data (e.g., on rents, vacancies, and transaction prices) and integrate multisource data into a single database.
  - Improve corporate bond market liquidity:
    - Introduce benchmark bonds to increase standardization, reduce price impact of distressed sales, improve bond market efficiency, increase demand, lower funding costs in good times, and boost resilience in stress.
  - Examine the effect of a sudden call on bank contingent credit lines:
    - FI should adjust solvency stress tests or apply supervisory intelligence to examine the impact on banks if all contingent credit lines were drawn down in a short period of time; stress a drawdown of funds and then subject that portfolio to subsequent stress.
  - Evaluate raising capital requirements for banks for CRE exposures to better reflect current risks.
- Rationale: No single measure suffices; making multiple parts of the system more resilient can reduce feedback loops and spillovers.

*Prepared by Svetlana Vtyurina and Rhiannon Sowerbutts. SIP/2023/024 (Section 1).*

### Diagnosis from FSAP micro-prudential stress tests
- Bank capital is insufficient, given concentration, structural issues, and feedback loops identified by the FSAP micro-prudential stress tests.
- All feedback loops should eventually be integrated into the stress-testing model, but quantifying their effect on potential credit losses is challenging.
- The FI should take a flexible approach when considering where in the capital stock to add additional capital or apply more intensive supervisory measures.

### Planning for crisis intervention
- Authorities should plan now for a potential crisis intervention.
- Crisis intervention design principles:
  - Limit moral hazard.
  - Restore market functioning while incentivizing participants to re-enter the market, taking into account costs and risks to the central bank and moral hazard concerns.
  - Be transparent.
  - Ensure equity holders have the chance to recapitalise the firm but are wiped out should the firm be insolvent.
  - Ensure bond holders take losses, for example by write-downs or equity conversions.
  - Target interventions where negative links to the real economy might be strongest.
- Conditional note preserved verbatim: "if EU legislation permits".

### CRE monitoring and data issues
- Monitoring of the CRE sector is hampered by data issues (Fitch December 2022, Sweden full rating report).
- References cited in source preserved verbatim:
  - https://www.riksbank.se/.../towards-a-better-functioning-corporate-bond-market.pdf
  - https://www.fi.se/.../stability-in-the-financial-system-20212/
- Reference to IMF material: Managing Systemic Banking Crises: New Lessons and Lessons Relearned (imf.org).

### CRE empirical indicators and stress-test outputs (figure highlights and labels preserved)
- Selected CRE financial ratios shown in figures:
  - Median ROA (In percent)
  - Median ROE (In percent)
  - Median Interest Coverage Ratio (In percent)
  - Median Total Debt/Total Equity (In percent)
  - Debt at Risk by Firm Size
  - Median Net Debt/EBIT
- Sample segmentation labels preserved: Sample, Large Firms, Small Firms, Medium-Size Firms.
- Firm-size categorization notes (verbatim):
  - "Firm size is derived from the country’s sample firms by asset size: Large=Top 2"
  - "Small=Last 25th percentile; Medium=In between."
- Numerical labels and percentages appearing in figures (preserved exactly as in source):
  - "32%"
  - "57%"
  - Plot axis labels and scenario markers include exact tokens: "Sc 1", "Sc 2", "Sc 3", "Sample Median", "Sc 1", "ICR<1.5", "2<ICR<3", "1<ICR<2", "ICR<1".
  - Debt-at-Risk and Firms-at-Risk charts include scale markers and scenario distinctions with exact strings such as "Scenario 3", "Scenario 2", "Scenario 1".
  - Size buckets in a bar chart display values up to: "0", "50,000", "100,000", "150,000", "200,000", "250,000", "300,000", "350,000".
  - Percent-stacked chart labels show "0%", "10%", "20%", "30%", "40%", "50%", "60%", "70%", "80%", "90%", "100%".
  - Time-series year labels appearing in figures are preserved as: "2015", "2016", "2017", "2018", "2019", "2020".

### Key takeaways
- Identified vulnerabilities in banks driven by concentration, structural issues, and feedback loops imply existing capital levels are insufficient.
- Supervisory response should be flexible and consider adding capital at various points in the capital structure or intensifying supervision where appropriate.
- Crisis-preparedness planning should prioritize transparency, loss allocation (equity wiped out if insolvent; bondholder losses via write-downs or conversions), moral-hazard mitigation, and targeting interventions to limit real-economy spillovers.
- CRE sector monitoring suffers from data limitations that impede assessment and stress-testing accuracy.

*Source: sipea2023024-print-pdf - Section 2 (IMF staff text and figures preserved exactly as in source)*

### Section 1

### Sweden’s Corporate Vulnerabilities: A Focus on Commercial Real Estate

### Overview
- Commercial Real Estate (CRE) debt constitutes a large portion of corporate debt and depends heavily on bank financing.
- Key trends and magnitudes:
  - Net debt-to-net operating income grew from a ratio of around 10 to 15 between 2009 and 2021.
  - Loans to CRE firms represent between 10 and 25 percent of banks’ private sector lending.
  - Non-bank debt now represents close to half of total outstanding bond market issuance.
  - Average loan duration is about 3.5 years, and bond maturity is about 5 years.
  - Foreign holdings of CRE firms’ bonds stand at 53 percent.
  - Among domestic investors, investment funds hold around 21 percent of CRE bonds.
  - Office vacancy rates rose from about 3 percent in 2019 to close to 8 percent in 2021 in Stockholm (similar trends in Gothenburg and Malmö).
- Implication: Elevated refinancing risks and short interest rate fixation increase macro-financial stability concerns; ownership concentration and cross-holdings have risen.

### Vulnerabilities and Contagion Risks
- Amplification channels and contagion mechanisms:
  - CRE firms may draw on contingent bank credit lines to repay maturing bonds or continue operations; currently CRE firms have just under SEK 190 billion in contingent credit lines, enough to sustain funding for 2 years.
  - If banks are willing to lend in addition to converting credit lines into loans, the FSAP stress test shows that, if willing, banks would be able to absorb 1/3 of CRE firms’ market funding.
  - Liquidity premia on funding costs can undermine CRE profits and increase credit risk premia, potentially turning liquidity shocks into solvency shocks.
  - Redemption requests or deteriorating performance would reduce liquidity and boost funding costs, aggravating stress.
  - Asset liquidations could lower property values across the CRE sector, affecting non-bond-issuing CRE firms and initiating fire-sale dynamics.
  - CRE market concentration and cross-ownership: the market is highly concentrated (12 ultimate owners, although ownership may be partial), increasing the risk that shocks become systemic.
  - Hits on bank capital from provisioning charges or outright losses could crowd out credit to the real economy.
- Historical context: CRE problems have triggered or amplified past financial crises; CRE is sensitive to financial cycles and large relative to the system.

### Stress Test
- Samples and scope:
  - Orbis database sample used; largest 100 companies in the sample hold aggregate assets of around 70 percent of GDP and debt of around 50 percent.
  - A broader sample: about 3,800 firms with total assets amounting to US$482 billion (90 percent of GDP) and aggregate indebtedness of US$ 363 billon (70 percent of GDP), or around 40 percent of NFC debt.
- Metrics and thresholds:
  - Interest Coverage Ratio (ICR) = EBIT / Interest Expense. An ICR of less than 1 implies insufficient revenues to service debt without adjustments.
  - An ICR threshold of 1.5 times is applied to account for vulnerabilities to funding risks in addition to earnings risks.
  - Debt is categorized into risk buckets by ICR; lower ICR implies higher probability of becoming non-performing.
- Stress scenario and results:
  - Shocks applied reflecting the FSAP’s adverse stress scenario (noting main impacts from increases in policy rates and real estate price declines).
  - Scenario components referenced: increase in advanced country policy rates (up to 400 basis points for the Swedish repo rate) and 38 percent decline in both residential and commercial real estate prices after two years.
  - Joint shocks significantly weaken ICRs: median ICRs fall below 1.5 in adverse scenarios and below 1 in more severe shocks.
  - Debt-at-risk fluctuated between 20–35 percent across scenarios.
  - Medium and large-size firms were affected similarly.

### Policy Considerations
- Core recommended actions:
  - Encourage better disclosure by supervisory authorities and potentially the Securities Market Association:
    - Bond issuance templates should include disclosure on liabilities, especially those in foreign currency, and contingency plans for market funding dry-ups.
    - Improved disclosure will help investors assess firms, improve market discipline, and distinguish more solvent from less solvent firms, reducing contagion.
  - Enhance data collection:
    - Improve comprehensiveness and periodicity of CRE data (e.g., on rents, vacancies, and transaction prices) and integrate multisource data into a single database.
  - Improve corporate bond market liquidity:
    - Introduce benchmark bonds to increase standardization, reduce price impact of distressed sales, improve bond market efficiency, increase demand, lower funding costs in good times, and boost resilience in stress.
  - Examine the effect of a sudden call on bank contingent credit lines:
    - FI should adjust solvency stress tests or apply supervisory intelligence to examine the impact on banks if all contingent credit lines were drawn down in a short period of time; stress a drawdown of funds and then subject that portfolio to subsequent stress.
  - Evaluate raising capital requirements for banks for CRE exposures to better reflect current risks.
- Rationale: No single measure suffices; making multiple parts of the system more resilient can reduce feedback loops and spillovers.

*Prepared by Svetlana Vtyurina and Rhiannon Sowerbutts. SIP/2023/024 (Section 1).*

### Section 2

### Section 2

### Diagnosis from FSAP micro-prudential stress tests
- Bank capital is insufficient, given concentration, structural issues, and feedback loops identified by the FSAP micro-prudential stress tests.
- All feedback loops should eventually be integrated into the stress-testing model, but quantifying their effect on potential credit losses is challenging.
- The FI should take a flexible approach when considering where in the capital stock to add additional capital or apply more intensive supervisory measures.

### Planning for crisis intervention
- Authorities should plan now for a potential crisis intervention.
- Crisis intervention design principles:
  - Limit moral hazard.
  - Restore market functioning while incentivizing participants to re-enter the market, taking into account costs and risks to the central bank and moral hazard concerns.
  - Be transparent.
  - Ensure equity holders have the chance to recapitalise the firm but are wiped out should the firm be insolvent.
  - Ensure bond holders take losses, for example by write-downs or equity conversions.
  - Target interventions where negative links to the real economy might be strongest.
- Conditional note: "if EU legislation permits" (text fragment preserved exactly as in source).

### CRE monitoring and data issues
- Monitoring of the CRE sector is hampered by data issues (Fitch December 2022, Sweden full rating report).
- References cited in source: https://www.riksbank.se/.../towards-a-better-functioning-corporate-bond-market.pdf; https://www.fi.se/.../stability-in-the-financial-system-20212/ (URLs preserved verbatim as in source).
- Reference to IMF material: Managing Systemic Banking Crises: New Lessons and Lessons Relearned (imf.org).

### CRE empirical indicators and stress-test outputs (figure highlights and labels preserved)
- Selected CRE financial ratios shown in figures:
  - Median ROA (In percent)
  - Median ROE (In percent)
  - Median Interest Coverage Ratio (In percent)
  - Median Total Debt/Total Equity (In percent)
  - Debt at Risk by Firm Size
  - Median Net Debt/EBIT
- Sample segmentation labels preserved: Sample, Large Firms, Small Firms, Medium-Size Firms.
- Firm-size categorization notes (verbatim):
  - "Firm size is derived from the country’s sample firms by asset size: Large=Top 2"
  - "Small=Last 25th percentile; Medium=In between."
- Numerical labels and percentages appearing in figures (preserved exactly as in source):
  - "32%"
  - "57%"
  - Plot axis labels and scenario markers include exact tokens: "Sc 1", "Sc 2", "Sc 3", "Sample Median", "Sc 1", "ICR<1.5", "2<ICR<3", "1<ICR<2", "ICR<1".
  - Debt-at-Risk and Firms-at-Risk charts include scale markers and scenario distinctions with exact strings such as "Scenario 3", "Scenario 2", "Scenario 1".
  - Size buckets in a bar chart display values up to: "0", "50,000", "100,000", "150,000", "200,000", "250,000", "300,000", "350,000".
  - Percent-stacked chart labels show "0%", "10%", "20%", "30%", "40%", "50%", "60%", "70%", "80%", "90%", "100%".
- Time-series year labels appearing in figures are preserved as: "2015", "2016", "2017", "2018", "2019", "2020".

### Key takeaways
- Identified vulnerabilities in banks driven by concentration, structural issues, and feedback loops imply existing capital levels are insufficient.
- Supervisory response should be flexible and consider adding capital at various points in the capital structure or intensifying supervision where appropriate.
- Crisis-preparedness planning should prioritize transparency, loss allocation (equity wiped out if insolvent; bondholder losses via write-downs or conversions), moral-hazard mitigation, and targeting interventions to limit real-economy spillovers.
- CRE sector monitoring suffers from data limitations that impede assessment and stress-testing accuracy.

*Source: sipea2023024-print-pdf - Section 2 (IMF staff text and figures preserved exactly as in source)*

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_Source: https://www.imf.org/-/media/files/publications/selected-issues-papers/2023/english/sipea2023024-print-pdf.pdf_