Slovenia will have to shoulder the costs of supporting their banks, which may be higher than the government has envisaged, but in a new report Citi states they do not expect Slovenia to join the club of the bailout countries in the near term. The announced bond issuance provides a window to implement the reform agenda. Still, with implementation risks looming, risk/reward is unattractive, in their view.
Slovenia key issues
The ‘macro issue’: Slovenia’s fiscal metrics do not look too alarming but the official debt/GDP ratio (54%) likely underestimates its true fiscal vulnerability to some degree, due to contingent liabilities. Slovenia’s key macro challenge is its weak banking system (mostly state owned), which suffers from poor asset quality. This raises the risk of costly bank recapitalization being needed.
The ‘bank issue’: Citi’s proprietary stress test suggests a €2.2-3.4 billion (6-10% of GDP) capital need for Slovenian banks and €1.7-2.9 billion post mitigating factors (i.e., liability management). However, it does not foresee bail-in of uninsured deposits, unlike in Cyprus. The setting up of a Bank Asset Management Company (BAMC) would restore the viability of the banking sector, but a thorough and well-communicated plan is key.
The ‘funding issue’: They estimate borrowing needs at c.€2.3 billion to secure funding for the rest of the year. The announced issuance could secure this, but the funding challenge in 2014, at €5.7 billion, remains large.
Key risk events ahead: i) Convergence programme (by mid-May); ii) Privatization programme (also by mid-May); and iii) Details on its BAMC (by June). Failure to show convincing progress on any of these markers may disappoint market participants.
How much does Slovenia need to borrow?
Citi debt-sustainability analysis shows a steep increase in debt/GDP in the coming years, but the ratio may peak at sustainable levels (i.e., slightly below 100% over the next ten years). The cash flow analysis highlights a bigger challenge, as Slovenia is likely to need about €11 billion in the next three years.
No outside help for now… Citi thinks that without a change in policy from the government, a precautionary credit line, albeit beneficial, looks unlikely for now. In their view, the recent developments reinforce the government’s intention to solve the problems on its own.
Should the government experience any problems, it may need to seek a bailout.…but more supply to come… Supply risk has materialised quite rapidly with the launch of the dual-tranche deal. The initial guidance suggests a sizeable concession to secondary market levels. Citi does not expect the Moody’s Corporation (NYSE:MCO) downgrade to put the transaction at risk.
And implementation risks remain: Citi thinks that the implementation risks around the bank recapitalisation, privatisations and further fiscal adjustments are sizeable and cannot rule out that, in the absence of official presence or more meaningful market pressure, the government may take longer to address the underlying structural challenges.
Citi proprietary stress test suggests a €2.2-3.4 billion capital need for Slovenian banks, equivalent to 6-10% of GDP, and €1.7-2.9 billion post mitigating factors (liability management): Citi mitigation reflects the use of liability management actions (e.g., haircuts) of subordinated or senior bonds, should the government wish to reduce the burden of recapitalization. The banks are also exposed to further credit downgrades of the sovereign, which may reduce the available collateral to obtain ECB funds (currently at 10% of banking assets), as well as any stress on the liability side, which may erode their liquidity and require further ECB funding.