REFILE-Slovenia hit by Cyprus contagion

Thu Mar 28, 2013 2:02pm GMT

(Replaces dollar and euro currency symbols with USD and EUR)

* Sovereign bonds under pressure

* Comparisons with Cyprus unwarranted

* Country could still have access to capital markets

* Government to establish internal 'bad banks'

By Davide Scigliuzzo

LONDON, March 28 (IFR) - Slovenia has been thrown into the spotlight as the next eurozone country likely to seek an international bailout, given the fragile state of its banking sector.

Following the bailout/bail-in farce in Cyprus, Slovenia's dollar bonds have dropped by nine points over the past two weeks as investors worry about the Balkan country's troubled banking sector and the government's ability to tap the international capital markets.

While the government insists that Slovenia will be able to get through the crisis under its own steam, a deal with international lenders could provide a key backstop to fears of contagion, say analysts.

"Slovenia is now inevitably heading to a bailout, the eurozone shot itself completely in the foot following the Cyprus issue," said Tim Ash, head of EM research ex-Africa at Standard Bank.

But while there is no denial among market participants that Slovenia's banking crisis is acute, most observers agree that a comparison with Cyprus is unwarranted.

Slovenia's banking sector assets account for 130% of the country's GDP, compared with 800% in Cyprus, and the Balkan state's debt-to-GDP ratio stood at 54% as of the end of 2012, which is relatively low compared with a EU average of 80%.

Nonetheless, with or without the IMF, analysts believe Slovenia needs to quickly push forward a policy mix comprising fiscal tightening, privatisations and a recapitalisation of its largely state-owned banking sector if it is to stay afloat.

MOUNTING PRESSURE

Pressure on the country is undoubtedly mounting, as reflected by the dismal performance of its sovereign bonds. The yield on the country's 2022 US dollar notes has widened by 120bp over the past two weeks, jumping by a jaw-dropping 80bp on Wednesday alone, to reach 6.2%.

Key from this perspective is whether the sovereign will be able to maintain access to the international capital markets over the next two to three months, as EUR1bn of T-bills come due in June.

According to the IMF, Slovenia's financing needs for 2013 amount to more than EUR3bn, a large portion of which will have to be funded externally given local banks' inability to absorb large amounts of government debt.

The sovereign's issue of USD2.25bn of 10-year bonds towards the end of last year helped pre-finance about EUR1.6bn of this year's requirement, according to Gillian Edgeworth, chief EEMEA economist at UniCredit. The doors of the international capital market, however, are not shut yet, say bankers who cover the region.

"There is a pocket of interest [among investors], so an international bond issue could work, but they would have to pay up massively," said an origination official. "They would need some tailwind as well."

The government might also need to target US dollars, rather than euros. "In euros no way," said a second banker. "US dollar investors are used to volatility. They definitely still have access to US dollars."

The bond market came to Slovenia's rescue in October when the issuance of the 2022 notes, its debut US dollar offering, averted the need for an international bailout. At the time, however, credit conditions looked more favourable for the Balkan state, following the pledge by ECB president Mario Draghi to do "whatever it takes" to save the eurozone.

While that pledge remains, Eurozone policymakers' handling of the situation in Cyprus, together with comments from a senior official that the bailout there could become a template for others, although later retracted, have unnerved investors.

"Market momentum is moving against Slovenia, and quick," said Ash. "It will be tough and expensive for them to put a new issue to bed without significant backstopping from the Troika."

In a sign that appetite for Slovene credit had not disappeared yet, state-owned export and development bank SID Banka last week successfully raised EUR200m through a private placement of three-year senior bonds.

The notes, which are guaranteed by the state, were priced at an interest rate of 3.2% over three-month Euribor.

EYEING BAD BANK SOLUTION

Part of the uncertainty still surrounding the country is due to adjustments that the new governing coalition - led by Prime Minister Alenka Bratusek - has pledged to make to the original 'bad bank' proposal put forward by the previous Janez Jansa administration.

One of the key tweaks now under consideration, according to RBS, is the creation of internal bad banks within each of the country's largest financial lenders, postponing any transfer of toxic assets to an external bank asset management company to a later date.

"Initially, bad assets would be transferred to the internal bad banks and backed simply by government guarantees," said Abbas Ameli-Renani, an emerging market strategist at RBS.

Under the original proposal, assets would have been transferred immediately to the BAMC in exchange for newly-issued government bonds.

While there will be a simultaneous recapitalisation of banks under both arrangements, the new version would not result in an immediate spike in the government's debt level, because the authorities would initially provide banks with guarantees rather than newly issued securities.

One of the downsides, however, is that the plan will keep bad assets on banks' balance sheets and under the same management.

(Reporting by Davide Scigliuzzo; Editing by Sudip Roy and Matthew Davies)