Not to be Bitten by Same Dog Twice: Slovenia Update

Since the Greek private sector debt restructuring, many understood that Cyprus was vulnerable. The timing and policy response is that took most by surprise.   The experience spurred investors to look for the next potential candidate for aid and many have settled on Slovenia.  

The general story is now well appreciated.  It is a small economy.  Last year's deficit was about 5% of GDP.  This year's forecast of 5.1% is likely optimistic given the downside risks to growth and upside risks to interest rates.  However, the main problem is not with the state sector, and around 60% the debt/GDP is nearly 2/3 of that euro area average.

Rather the larger problem is with Slovenia's banks.  The three largest are state-owned.  The OECD estimates that 30% of their loans are in trouble, following the collapse of the construction industry.  The non-performing loans are estimated at near 20% of GDP.  

Slovenia's capital needs, to cover maturing bonds, finance the deficit and aid to banks is estimated to be around 3 bln euros this year.  The 10-year bond yield has risen 83 bp over the past month and is easily the worst performing in developed and emerging Europe.  Yesterday the government sold 18-month bills that were scooped up.  It managed to raise twice the funds it sought and the 1.1 bln euros (largely from domestic investors) has emboldened the government to seek to raise more money shortly.  Reports suggest it is considering a 3- or 5-year euro bond. 

International demand for Slovenia bonds may still be light pending plans to restructure the banks.  Official indication that it could privatize a bank is not the same as a bona fide plan.  Moreover, there is some concern that the sovereign's debt rating A-minus by S&P and Fitch could be cut to match Moody's Baa2.  We note that Slovenia's credit rating is above Hungary's, but it is paying about 75 bp more than it.  The cost of insurance in the CDS market is also more expense in Slovenia than Hungary (338 bp vs 311 bp). 

While Slovenia indeed has serious challenges facing it, we suspect that many observers rushed to judgment, having been bitten by Cyprus did not want to be bitten by the same dog twice.   The actual pressure on Slovenia seems modest as opposed to intense.  The government is about a month old and is only beginning to congeal now.    Based on current information, we think that, contrary to what seems like conventional wisdom, a formal request for aid is not imminent.