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Slovenia Bailout Signaled by Worsening Debt Swaps: Euro Credit

Slovenia Bailout Signaled by Worsening Debt Swaps
A man walks in front of the main entrance of the Slovenian Parliament building in Ljubljana. Slovenia’s two-week old government is struggling to prop up banks hit by recession and saddled with bad loans worth about a fifth of the country’s economic output. Photographer: Marco Secchi/Getty Images

Slovenia’s creditworthiness is deteriorating at the fastest pace in the world after Cyprus as investors speculate a banking crisis will force it to follow the island nation and become the sixth euro country to need aid.

Credit-default swaps insuring Slovenian debt for five years soared as much as 66 percent to a six-month high of 414 basis points on March 28 from 250 on March 15, the last trading day before Cyprus announced plans for its rescue. It’s now up 34 percent at 336 basis points, compared with a 45 percent increase for Cyprus and 18 percent for Portugal in the period.

Slovenia’s two-week old government is struggling to prop up banks hit by recession and saddled with bad loans worth about a fifth of the country’s economic output. Cyprus, which accounts for 0.2 percent of the euro region’s economy, was forced to inflict unprecedented losses on uninsured depositors and senior bondholders as part of the 10 billion euro ($13 billion) rescue of its financial system.

“Since the Cyprus resolution, Slovenia has been in the spotlight,” said Bas van Geffen, an analyst at Rabobank International in Utrecht, Netherlands. “The country’s smallness is now clearly a drawback in the post-Cyprus era, which has fueled speculation that the country might be the next Cyprus.”

Credit-default swaps on Slovenia, which accounts for 0.4 percent of the euro economy, have surpassed those for Spain, Italy and Croatia. The latter was approved to be the 28th member of the European Union last week.

Portugal Swaps

Slovenian swaps rose to within 40 basis points of Portugal’s, the smallest difference in three years and compared with a 114 basis-point gap on March 15. Swaps on Portugal are trading at 426 basis points, Croatia at 308, Italy at 277 and Spain at 273.

A basis point on a credit-default swap protecting $10 million of debt from default for five years is equivalent to $1,000 a year. Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

The yield on Slovenia’s dollar-denominated bonds maturing in 2022 jumped to a record 6.31 percent on March 27 from 4.98 percent, approaching levels that prompted bailouts of other euro nations. The yield was 5.57 percent today.

Worries that Slovenia will fail to implement a 4 billion-euro plan to prop up banks and lose access to financing abroad are raising borrowing costs as the government looks to tap bond markets, though Finance Minister Uros Cufer said April 3 he’s in no rush.

Government Response

“It is important the government responds quickly on its economic policies,” said Tim Umberger, a senior analyst at East Capital International AB in Moscow. “The new government has to continue with fiscal consolidation, bad bank plan and embark on a privatization plan, if it wants to have continued markets access for a possible bond sale.”

Slovenia adopted the euro at the start of 2007, becoming the first post-Communist nation to make the switch, and its economy outperformed that of Europe’s common currency area for most of the past decade before the recession and collapse of the construction industry hit its banks.

The nation’s budget deficit is forecast to widen to 5.1 percent of gross domestic product at the end of the year, mostly due to the conversion of the state’s hybrid loan for Nova Ljubljanska Banka d.d. into equity, the European Commission said in a report Feb. 22.

Bank Failure

Nova Kreditna Banka Maribor d.d., which had a 205 million-euro loss 2012, was one of four banks that failed last year to meet European capital targets set by regulators. Bank of Cyprus Pcl, Cyprus Popular Bank Pcl, known as Laiki Bank, and Italy’s Banca Monte dei Paschi di Siena SpA were the others. Laiki was closed as part of the island nation’s bailout. Five Slovenian banks were downgraded by Fitch Ratings on April 5.

Still, Slovenia’s banking system is smaller relative to the size of its economy than most European countries and more similar to Spain than to Cyprus, according to Umberger and Georg Grodzki, head of credit research at Legal & General Investment Management in London.

Cyprus’s banks, which lost 4.5 billion euros on Greek sovereign debt, had assets about eight times the country’s economic output, more than double the average for the euro area. Slovenia’s were about 1 1/3 times, compared with about three times for Spain and 2 1/2 times for Italy, Bloomberg data show.

Depositor ‘Haircuts’

“The smaller scale of the banking sector relative to GDP makes a Cyprus solution of haircutting large depositors unlikely in our view, but not one that can be discounted entirely,” Bank of America Merrill Lynch analysts Mai Doan and Arko Sen wrote in an April 5 note. The analysts see “meaningful risks” Slovenia will need a 6 billion euro to 8 billion euro bailout.

Public debt in Slovenia is also lower than elsewhere, at 53.7 percent of GDP in 2012, compared with 86.5 percent in Cyprus and 81.6 percent in Germany, though it will rise to 59.5 percent by the end of the year and to 63.4 percent in 2014, according to EU forecasts.

Default swaps on Slovenia are 46 percent higher since the start of the year, the most in the region, followed by 22 percent each for Croatia and the Netherlands. They signal a 22 percent chance of default within five years.

There were a total of 780 swaps contracts covering $717 million of Slovenian debt as of March 29, according to the Depository Trust & Clearing Corp., which runs a central registry for the market. That compares with 306 contracts insuring $281 million of Cyprus’s debt and 13,579 trades covering $20.2 billion of Italy’s.

“Cyprus sensitized people again to small European countries with weak banking systems,” Grodzki said. “Slovenia most likely will require external help to recapitalize the banking system, but the government can probably shoulder the extra debt without having to bail in senior bondholders and depositors.”

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