Interim Report Q3 2022

In the wake of Russia’s invasion of Ukraine, global growth has slowed and the entire world economy is affected, including the real estate sector. Inflation has accelerated, electricity prices are rising, interest rates are rising at the same time as purchasing power and demand are falling. These are just a few examples of factors that require adaptation, from us and others.

With new market conditions and crises, a capacity to adapt becomes essential

In times of crisis, we are reminded of Darwin’s famous quote: “It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is the most adaptable to change.” Being responsive to change and adapting to changing conditions will be SBB’s greatest strength. Adaptation is the basis for long-term sustainability. Adaptation requires a capacity for new thinking, creativity and resolve. We hope that the measures listed below, which are currently being implemented, will demonstrate precisely this.

1) Sales

We have stated clearly that we will conduct sales to strengthen our balance sheet. From the sales that have been completed 2.0bn remains to be disbursed. Beyond this, we have agreed to additional sales for about SEK 0.8m that are to be disbursed in the fourth quarter and announced a letter of intent for about SEK 9bn. In the fourth quarter, we expect to sell shares in joint ventures for about SEK 2bn. And we will continue to sell assets. SBB also intends to systematically continue to reduce its proportion of joint ventures by means of sales and to sell financial investments to strengthen its balance sheet, increase transparency and focus on its core business.

2) Diversified financing

SBB enjoys a close and long-term relationship with its banks. At the same time, SBB is working actively to broaden its sources of funding. At the end of July, SBB implemented its first unsecured US Private Placement (“USPP”) of USD 100m with five and ten year maturities. Together with the Schuldschein financing that SBB issued in June, the USPP transaction is a further step in the company’s efforts to diversify its funding sources and demonstrates SBB’s strength in the global capital market. Diversification and access to different capital markets and different sources of funding are central to SBB’s continued development. This is also why, after the end of the quarter, SBB signed a credit facility of EUR 750m with one of the world’s largest banks.

3) A new housing company to be distributed to shareholders

This morning, SBB announced that the Group is considering implementing a transaction whereby a sub-Group to SBB, focusing on residentials, will be distributed to shareholders applying the “Lex Asea” rules, with Bostadsbolaget subsequently being listed on Nasdaq First North. Through its distribution to shareholders and listing on the exchange, Bostadsbolaget will become one of Sweden’s largest streamlined housing companies, while SBB’s operations would also be streamlined to focus even more clearly on community service properties. Bostadsbolaget’s balance sheet is initially estimated at about SEK 18bn, equivalent to approximately 10 percent of SBB’s total balance sheet. In SBB’s assessment, the distribution would be positive for SBB’s shareholders and could help reveal values, both in the new Bostadsbolaget as well as in the remaining SBB.

Bostadsbolaget would only hold bank financing, with a LTV of 55 percent. The transaction will  enable increased secured lending in SBB due to the streamlining of the operations.

The Board will present a proposal to the Extra General Meeting.

4) Minority owner with long-term capital

SBB is Europe’s largest investor in social infrastructure and has a strong track record in developing and managing social infrastructure. SBB perceives considerable demand from infrastructure funds and other long-term institutional investors to both acquire properties from SBB and to co-invest in social infrastructure alongside SBB. SBB has identified two sub-groups suitable for bringing in long-term minority owners. Both Swedish and international advisers have been engaged and intensive efforts together with advisers and investors are in progress. However, no decisions  has been made.

Stable core business

The core of SBB’s operations is its long-term ownership of secure, inflation-protected cash flows from property management of social infrastructure in the Nordic region. SBB also owns stable Swedish rent regulated residentials, for which rent levels are low. Our community service properties have an average contract length of about 11 years.

Strongest net operating income to date, high interest coverage ratio and a strong increase in cash flow

The core business continued to deliver strong net operating income over the quarter. Our net operating income for the third quarter was SEK 1,333m, the highest to date. Net operating income over the nine-month period increased by 27 percent, from SEK 2,965m to SEK 3,776m. This has contributed to a strong interest coverage ratio corresponding to a multiple of 4.8, despite rising interest rates.

For the first nine months of 2022, cash flow from operating activities before changes in working capital increased from SEK 1,746m to SEK 2,673m, an increase of 53 percent. Adjusted for non-cash exchange rate fluctuations, non-recurring costs and changes in value and tax in joint ventures, our profit from property management was SEK 3,247m for the first nine months of 2022, up 36 percent. The adjusted profit from property management increased by 24 percent to SEK 1,144m for the third quarter of 2022.

Fixed interest on 80 percent of gross debt

Fixed interest is an insurance premium for times like these. SBB had an average interest rate of 1.89 percent at the end of the third quarter. Interest rates are on the rise and that is why we have taken out long-term fixed-rate loans over the past two years. At the end of the third quarter, our fixed interest term was 3.4 years (3.6). Below, we present a sensitivity analysis (based on the market’s future pricing of STIBOR, EURIBOR and NIBOR) for our average interest rate, which implies that the assumed interest rate, in the summer of 2023, for example, would be 4.9 percent, including the margin on secured loans. We also present a calculation, accounting for sales currently in progress, including SEK 9bn in repayments.

Sensitivity analysis

New loans, approx. 4.9% interest Repayments
in SEK 9bn
Oct 2022 1.89% 1.89%
2023 2.31% 1.86%
2024 2.70% 2.24%
2025 3.07% 2.63%

Given that 80 percent of our borrowings carry fixed interest rates, it will take some time before higher interest rates have an impact on SBB’s earnings and there will be time for these to be offset by inflation-adjusted rental income. In both the scenario with repayments and the scenario without repayments, the increase in rental income exceeds the increase in interest expenses over the next three years. This means that we will be able to continue to deliver a strong interest coverage ratio. All things being equal, this also means that SBB will be able to maintain the dividend, adjusting it upwards for inflation even if the nominal interest rate continues to rise.

Unrealized decreases in property and currency values, as well as extensive unreported overvaluations in the debt portfolio

It is no secret that our holdings in listed assets have declined in value. Nor is it a secret that the entire market is concerned about higher construction and financing costs, impacting in turn the values of our building rights and project operations. External valuations of all of our properties were conducted in the third quarter. The outcome shows a decline in value by SEK 981m, of which residentials accounted for SEK -2,455m, community service properties for SEK 1,355m and other properties SEK 119m. The largest portion pertains to residentials and projects given that the appraisers assume that rents for residentials will rise by significantly less than inflation.

Assumptions regarding next year’s rent levels are of substantial importance in the valuations. The appraisers made the following assumptions regarding inflation in their valuations:

Appraisers 2022 2023 Actual CPI outcome 12m Sept 2022 Difference
Appraiser 1 Sweden 8.50% 4.00% 10.80% -2.30%
Appraiser 2 Sweden 9.00% 3.00% 10.80% -1.80%
Appraiser 3 Norway 5.50% 2.00% 6.90% -1.40%
Appraiser 4 Finland 4.50% 2.20% 8.10% -3.60%
Appraiser 5 Norway 4.37% 2.90% 6.90% -2.53%

As the table shows, the appraisers’ assumptions regarding CPI are lower than recent inflation outcomes.

In the second quarter, we pointed out that we prioritize paying down short-term debt and focusing on extending both interest and capital maturities. This is also why we chose not to use our cash balances in a volatile market to fully hedge our non-current currency exposure. Unrealized changes in currency values has no impact on SBB’s cash flow. SBB receives sufficient income in EUR to cover its interest payments in that currency.

SBB has extensive unreported overvaluations in its debt portfolio. At the end of the third quarter, SBB issued a derivative of EUR 200m, on terms equivalent to SBB’s long-term bond of EUR 950m. The overvaluation was in the region of SEK 260m. If we apply the same swap-valuation for the entire bond, this corresponds to an overvaluation of SEK 1,240m. This shows that SBB’s long-term debt portfolio, with its low fixed interest rate, has an extensive, unreported market value.

Property development and sustainability

SBB is a long-term partner of the public sector in the Nordic region. To ensure that long-term needs for community service properties and housing are met, having access to attractive land that has also been zoned for that purpose, is of the utmost importance. SBB has ensured this by developing a building rights portfolio equivalent to about 69,000 apartments. Holding this building rights portfolio has allowed us to sign a 25-year lease for a preschool with the Municipality of Säter and a 25-year lease with the Municipality of Bollnäs for a bandy hall that was inaugurated last week. We can note that construction prices remain challengingly high and more or less daily news articles tell of projects being postponed due to the currently unfavourable market situation. In turn, this means that needs for social infrastructure are accumulating and, when construction prices reach sensible levels, it is important to be ready with land for development, an area in which our position is strong.

Current new production and investments in existing portfolios have a mark-up of 59 percent, meaning that we will receive cash flows from our projects in the near term, while the return on the remaining investment is 11.6 percent.

SBB’s goal is to be climate positive throughout the value chain by 2030. The analyst firm Sustainalytics assesses SBB’s ESG risk as very low (at 10.7, with the limit for negligible risk being 10) and the risk management is considered to be strong. SBB thus tops the list of comparable companies based on market capitalization. SBB is pursuing the largest certification project in accordance with Miljöbyggnad iDrift to date. We are also continuing to work with our sustainable investments and can mention that our solar park in Hallstahammar is in full production and estimated to be in operation by the end of this year, delivering an annual output of about 10 GWh over a normal year. This corresponds to five percent of SBB’s total electricity consumption.

Profit for the third quarter was burdened by costs for two important social initiatives. During the summer of 2022, we offered 300 young people summer jobs. We have also addressed the resolution of the Annual General Meeting that we should contribute SEK 50m to UNHCR’s work in Ukraine. The contribution will enable people fleeing the war in Ukraine to get a roof over their heads, protection, security, integrity, comfort and health.

Prospects

SBB enjoys favourable cooperation with the leading Nordic banks. Over the next 12 months, approximately SEK 5.2bn of our bonds will mature, with the first SEK 0.6bn already having been repaid. These bond maturities can be paid off with existing liquid assets. At the same time, our core business is delivering a strong net operating income and secure cash flows, where cash flows from operating activities before changes in working capital for the first nine months of 2022 increased by 53 percent.

Rental income from comparable portfolios (like for like) increased by 3.7 percent over the first nine months of the year, corresponding to 0.9 percentage points above base inflation as of October 2021. SBB is a safe asset, even in times of high inflation. The almost automatic indexation for community service properties results in a strong increase in income every year. Inflation was 10.8 percent in Sweden, 10 percent in Denmark, 8.1 percent in Finland and 6.9 percent in Norway in September. All other things being equal, this means that, assuming inflation persists in October, our income next year could increase by about SEK 500m – SEK 600m. Income will also increase due to the completion of new production projects for a further SEK 200m. SBB is fully focused on its core business of delivering much-needed social infrastructure. A secure outcome in terms of net operating income and cash flows, as well as a strong capacity for adaptation, show that we are on the right track to growing even stronger tomorrow than we are today. We can assure our shareholders and our credit investors that we will do everything necessary to continue strengthening our balance sheet and to improve our rating. At the same time, the results of the core business paves the way for the persistence to deliver at least an unchanged dividend to our approximately 350,000 shareholders.

Ilija Batljan

CEO and founder