We were in Slovenia last week, where we met with the Finance Minister, Central Bank Governor, Bank Asset Management Company, senior politicians from coalition partners and from the opposition, senior managers at the largest local bank, as well as economists and journalists.
Our trip to Slovenia coincided with a pivotal day for the country. The 2014 budget was voted on at 6am along with a confidence vote on the government. On the same day, the Finance Ministry surprised the market with a EUR 1.5bn private placement. The series of events have significant implications for our outlook on Slovenia going forward. We now have more conviction than before in our view that Slovenia can clean-up its banking sector without resorting to outside help. We also take off the possibility of early elections in May 2014 as our base case scenario. The political situation has improved markedly since our last visit at the end of March, although risks remain. For our previous trip notes and for a broader discussion of Slovenia’s banking sector developments in preceding years, see Slovenia Trip Notes | Country at a Cross-road, 28th March 2013.
For now, all eyes are on the publication of the Asset Quality Review and Stress Test results. These are now not expected to be published until mid-December. We expect the first tranche of assets to be transferred from commercial banks to the Bank Asset Management Company (BAMC) in early January. When the AQR/Stress Test results are published, the key figure that the market will be looking out for will be the amount of bank recapitalisation required. Assuming a 50% increase in NPLs amongst the top three banks since the government’s own estimate was published in May, and assuming that asset transfers take place with a 75% haircut, we estimate recapitalisation costs amounting to around EUR 3.0bn. This amount will be used to cover the additional loss at transfer incurred by the banks. A somewhat higher recap may be needed depending on the extent to which the government intends to boost capital adequacy ratios beyond previous levels. We also expect the BAMC to issue EUR 1.6bn of government guaranteed debt to be used for transferring of non-performing assets from the top three commercial banks.
Government funding is substantially improved after the private placement and we now estimate that the government has a fiscal buffer of at least EUR 5.0bn. As such, we see the chances of the government having to seek an international bailout to be slim. For this to happen, we envisage that total NPLs amongst the three banks will have to rise towards EUR 10.0bn, equivalent to half of the three banks’ total loan book. That is a scenario we view to be highly unlikely. We found very little, if any, political appetite amongst government/central bank officials to go for international assistance. In fact, we believe most of the rhetoric of previous months about the possibility of doing so, was aimed at ensuring that domestic political groups toe the FinMin/CB line.
Buy Slovenia USD 22s. Although the bonds have already rallied after the private placement, we believe there is room for much more tightening in spreads. The private placement all but removes funding risk for the sovereign and ensures that a higher than expected bank recap cost can still be absorbed by the government. Moreover, the political situation has improved, in our view, and risks of early elections in H1 2014 have subsided considerably. The implementation of the bad bank plan will still leave Slovenia’s debt dynamics on a better footing than most of its EZ peers, whilst substantially reducing systemic risks from and to the banking sector.