Since the Cyprus bailout last month, rumours have abounded in the financial markets that Slovenia would be the next patient requiring EU/IMF medicine.
Slovenian banks are in dire need of recapitalisation
As part of its regular consultations, last month the IMF conducted a staff visit in Slovenia.
The report does not find fault with the health of the sovereign per se. At 54.1 per cent, debt to GDP ratio is well below the euro-bloc average of 90.6 per cent – although debt levels do seem to be growing rapidly.
However, Slovenian banks (the two largest banks are state-owned) are in dire need of recapitalisation due to the ever-increasing stock of non-performing loans (NPL). This is compounded by the fact that the net debt-to-income ratio of non-financial corporations in Slovenia stood at 1711 per cent in 2011, approximately twice the size of that in Spain and Italy. The euro-zone averages 359 per cent.
According to the IMF Soundness indicators for Q4 2012, the country’s banks had total gross loans outstanding of €43 billion, of which €6.53 billion are bad debts; hence the percentage of NPL to total loans currently stands at 15.2 per cent (or 18 per cent of GDP).
The main factors leading to this large debt burden are the real-estate boom/bubble in the run-up to the euro, and the unsustainable high rate of GDP growth during the same period. Loans for construction projects to non-financial corporations accounted for 12.5 per cent of the bank loan books in 2011.
Furthermore, two-thirds of new short-term loans to this sector were renewals of previous agreements. Worse still, the country is in recession. In 2012 domestic demand shrank, leading to a 2.3 per cent fall in GDP. This year the IMF expects the economy to contract by a further two per cent.
The country also suffers from lengthy and costly bankruptcy proceedings, which in turn reduces the recovery rate on NPLs.
In many ways, the Slovenian issue looks more like Spain and less like Cyprus. In the latter instance, the sovereign could not afford to bail banks out – and given the banks’ low levels of outstanding debt, depositors suffered. The overall balance sheet of the Slovenian banking system stands at €50.8 billion, less than half that in Cyprus.
Putting this into perspective, while total bank assets as a percentage of GDP were north of 700 per cent for Cyprus, in Slovenia the figure is a mere 140 per cent.
Furthermore, Slovenian banks have outstanding debt of circa €2.4 billion, roughly 37 per cent of NPL, and in a scenario where banks would have to come in with the funds should there be a bank bailout, bonds will be bailed-in first, given these have a lower priority vis-à-vis bank depositors.
This was not the case with Cypriot banks flush with cash from deposits. The risk of a bailout threatening depositors (or the Slovenian sovereign) is seen as negligible.
Yields on 10-year sovereign paper hit a high last week before retreating after a successful Treasury bill issuance. The nation intended to auction €500 million of 18-month Treasury Bills; it ultimately sold €1.1 billion – and one would suspect that the country’s banks bought the majority of these holdings. In turn, the state bought back €511 million treasury bills maturing this June, thus extending the Treasury’s debt maturity profile, and relieving some near term funding pressure.
Slovenia will be using this success as a springboard to issue medium-term bonds over the coming days.
At the time of writing, the country appointed foreign banks to run an international roadshow; the nation intends to sell bonds with a possible size of €1-2 billion, depending on the feedback the issue managers receive.
If Slovenia can manage to continue borrowing from the markets, one solution could be to take equity holdings in banks in exchange for sovereign bonds. The banks would then borrow money from the ECB (to recapitalise balance sheets) using these bonds as collateral.
However, given that the banks are already majority state-owned, the market could see this as a net negative and shut-out Slovenia from raising further capital.
The most likely scenario is that the country requests a bailout for the banking system, with the Spanish case acting as a blueprint to this exercise.
The Slovenian government seems to think that €1 billion would be enough to shore up the banks’ balance sheets, and hence would not require a bailout. Most forecasts, however, run between €3-4 billion.
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Curmi & Partners Ltd is a member of the Malta Stock Exchange and licensed by the MFSA to conduct investment services business. This article is the objective and independent opinion of the author. The value of investments may fall as well as rise and past performance is no guarantee of future performance.
Vincent Micallef is an executive director at Curmi and Partners Ltd.