Could Slovenia be the next domino to fall... triggering the Universe to implode (or just a bailout)?

Euromoney Skew, Sid Verma
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Cyprus crisis fuels Slovenia bailout debate.

Cyprus is different. It can be firewalled. It is just 0.2% of the EU’s GDP, after all. And a €10 billion bailout is a drop in the ocean for the eurozone, compared with historic capital needs in Ireland, Greece and Spain at roughly €64 billion, €50 billion and €40 billion, respectively.

By now, this sanguine consensus has been all but demolished with the botched bailout attempt that has failed to trigger global market tremors but still exposed the hole in eurozone policymaking, with officials openly acknowledging the mess in Cyprus.

What’s more, the crisis has emboldened anti-austerity and Berlin critics, and, in a sense, cast a shadow over banks’ capital and funding structures now a dangerous taboo has been broken: insured depositors could, in theory, receive a haircut in any restructuring.

So what about Slovenia? The ECB on Friday rejected fears the country was poised for a bailout, with Slovenia's banks saddled with some €7 billion bad loans, feeding speculation the sovereign could be the next domino to fall.  Slovenia was one of the worst performers in the Euromoney Country Risk survey in 2012, after its score plummeted 11.1 points to 60.5. This leaves Slovenia ranked 11th in the eurozone for sovereign risk and 37th globally.

The sovereign’s score decline last year was underpinned by worsening banking stability and government finances indicators, which fell 1.2 and 0.7 points respectively in the country’s economic assessment criteria. 

Slovenia’s banking sector has plummeted the furthest in eurozone, according to ECR:

In a hilarious post, the blogger and EMEA analyst, known as @barnejek, caricatures the "follow the money" market psychology that has heaped on fears about Slovenia:

"There must be a small country in the eurozone, which has some problems with its banks and which we could sell. Hang on, what’s this little thing east of Italy that no one really knows about but occasionally makes some noises in the media? Slovenia! OMG, this is so exciting! Banks in Slovenia have NPLs reaching 20%? Some of them did not meet the ECB stress tests? The government recently collapsed and there’s a risk of an early election? I guess we’ve found a retirement trade. And don’t bother me with details that assets of the Slovenian banking system are only around 135% to GDP or that the total government financing needs for this year are projected by the IMF at 7.7% of GDP (slightly below Germany, Austria or Finland). Who cares that if the IMF’s forecasts are to be believed then Slovenia will meet both fiscal Maastricht criteria next year as it still has debt to GDP below 60%. And also, I’ve never believed in this cyclically-adjusted primary surplus mumbo jumbo...

Right, and when you’re done selling Slovenia, maybe we should look into Slovakia – there’s gotta be some connection!"

Here's more face-value analysis from the aggressively young Peter Attard Montalto, EM analyst at Nomura:

The core of both countries problems is also much more banking sector than fiscal. Slovenia has a difficult fiscal balancing act and a very tight funding programme path to negotiate, with large risks to the deficit –but fundamentally it can (bar more serious eurozone deterioration outcomes being realised) cope on its own from a solely fiscal perspective. Cyprus was similar though with larger near -term bond redemptions to cover.

While Cyprus has EUR2.5bn of redemptions in the coming four quarters, Slovenia only has EUR76mn. Given its half the size, out until end-2016 Cyprus has EUR4.9bn of redemptions, while Slovenia has EUR4.0bn.

Given this backdrop Slovenia has always said that even if it ever did need a bailout it would seek one for its banking sector rather than for the government itself. Indeed, the government has already been able to shoulder a EUR4 bn bailout of banks last year, of which around EUR1.5bn has been disbursed so far.

This is the nub of the difference and why we are sceptical Slovenia is in the same position – Cyprus already had a loan from Russia in 2011because of problems funding and dealing with its budget. It then asked the EU a year ago for a bailout. Slovenia has not asked for a bailout and been strenuously denying that the government would ever need one, specifically playing down the possibility that the banking sector would need one in the short to medium run.

As such, the amount of read across to Slovenia must be very limited in our view. The fiscal path may be similar, but the level of debt is much lower at only 60% this year vs. a projected 93% in Cyprus. The difference in the banking sector sizes vs the size of the fiscal is also key and hence their ability to provide their own bailouts so far.

The downside risks to Slovenia however are clear with its new government under PM Bratusek, after previous PM Jansa's government collapsed at the end of February under a cloud of a corruption scandal against him. Just like Bulgaria (and indeed paralleling Cyprus), she has signalled a push onto pro-growth policies and against austerity, which will also slow the pace of fiscal consolidation and cause debt to creep up further, albeit still well below Cyprus.

While PM Bratusek has a narrow majority of 2 in the 90 seat parliament, ongoing protests and increasing unemployment will mean the risks of her coalition collapsing.

Also, with early elections, which polls suggests would force further populism and less fiscal consolidation political risk remains high. This is why we think risks to the A- rating are still very much to the downside.

Cyprus has already rejected a good/bad bank solution but there is light at the end of the tunnel, reckons Montalto:

"Key to the market latching onto and initiating this self-fulfilling cycle however will be the comparisons it makes to Cyprus and the banking sector with this topic in focus. While the banking sector in Slovenia is much smaller than that of Cyprus as compared with the economy, Slovenia has a much higher loan to deposit ratio at 153% in the latest data as compared with 105% in Cyprus.

But this is the killer:

"If we consider that some EUR7bn of bad debt or at risk debt has been identified by the central bank in Slovenia, and then that the bailout is EUR4bn and provisioning is already at 42% we can see that the bad debt is covered. However, the additional critical issue, and why the IMF says an additional EUR1bn is needed, is because some banks have tier 1 capital below the required 10% level which therefore is a gap of about this size.

Hence the need for bailouts is just as great.
The other particularly troubling issue here is that the still - somewhat limited volume of debt to write down on condition of a bailout (either at banks themselves or via an aggregation at a bad banks) leaves open the door such that a deposit bail - it might be on the table even if our gut instinct is to reject that possibility in any bailout talks.."

As a result, Cyprus contagion and EU politics will inevitably hold the key:

"It is not so much that we trust in the EU's proclamation that the deposit tax in Cyprus is a “one-off” (we don't), it is more that the political dynamic of Slovenia is totally different to Cyprus especially when it comes to Germany. The exposure of German banks to Slovenia is much lower than to Cyprus (at EUR7.6bn vs EUR3.1bn); however, other key votes like Austria and Italy have larger exposures to Slovenia than Cyprus (for Austria EUR12.6bn for Slovenia vs EUR0.9bn for Cyprus, and for Italy EUR7.6bn and EUR1.3bn respectively).

Equally there is not the same political imperative regarding Russian oligarchs and laundered money in Slovenia as in Cyprus. Hence, while Germany and opposition parties in Slovenia might still drive a hard bargain, we don’t see them having the same difficulties as Cyprus, nor the same necessity of not bailing out depositors.

Politics will be the main thing to watch going forward because of its impact on both fiscal and banking sector policy. Additionally, we must watch market contagion forcing the government's hand on a bailout – both through cost and availability of debt.

As we have said above, ultimately this will be more about the spiral of expectations and self-fulfilment rather than necessarily core fundamentals."

Let's hope when push comes to shove EU policymakers don't throw chilli sauce into the eyes of European solidarity like they did in Cyprus.