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A 'Bought Deal' Refinancing for the Government

In late October, the IMF warned that Slovenia must recapitalize its insolvent banks 'immediately'. The governor of the country's central bank countered that the result of 'stress tests' had to be awaited first (due in late November).

In the meantime, the current government (a diverse and somewhat unruly coalition) led by Alenka Bratusek has survived a confidence vote in parliament and has managed something of a financing coup, namely the sale of €1.5 billion in new government debt to a single, anonymous investor. It is quite a generous investor to boot, who has accepted a yield way below recently prevailing market yields. In other words, it is a 'bought deal' financing:

"Slovenia's government won a confidence vote and raised 1.5 billion euros in a bond issue on Friday, offering the euro zone country some hope it can still steady its finances and avoid an international bailout.

The dawn vote, by 50 to 31 after a marathon debate, shores up political backing for Prime Minister Alenka Bratusek's disparate alliance as the republic struggles with its worst crisis since seceding from Yugoslavia 22 years ago.

The country later said it had made a private placement of three-year notes worth 1.5 billion euros ($2 billion) to a single investor at a yield of 4.7 percent. "This issue shows that the financial markets are open to Slovenia," Bratusek told a news conference, saying she did not know the identity of the investor. Her foreign minister, Karl Erjavec, said: "Today it is absolutely clear that the government can succeed."

(emphasis added)

With this debt issue, more time has been bought - but the funds won't suffice to recapitalize the banks. That problem still appears too large to swing, and since the government is the main shareholder of the banks, there can be no 'bail-in' of outside shareholders.

An Expensive Bank Bailout Looms

Regarding the amounts that are likely required to recapitalize the banks, Reuters reports:

"The government has earmarked 1.2 billion euros to recapitalise the lenders but the real cost may prove far higher. The banks are being suffocated by an estimated 7.9 billion euros of bad loans, equivalent to more than a fifth of economic output. Toxic loans accumulated with the onset of the global crisis when Slovenia's exports hit a wall and drove the country into the first of two recessions.

Credit rating agency Fitch last week hiked its estimate of recapitalisation needs from 2.8 billion euros to 4.6 billion euros. This would be hard for the government to raise without help from the European Union and International Monetary Fund, which have bailed out other euro zone debtors since 2009. Slovenia's 'bad bank' expects to receive roughly 4 billion euros gross in bad loans, its executive director Torbjorn Mansson said on Wednesday."

(emphasis added)

Reading about the so-called 'bad bank', we are reminded of Spain, where the question that immediately springs to mind when the 'bad bank' is mentioned is: 'are there any good ones?' Slovenia's government continues to insist that the country won't have to apply for a bailout, but its leading bankers seem less sure:

"Slovenia's 35-billion-euro economy accounts for only a small fraction of the 17-nation euro zone, but another bailout following that of Cyprus in March could further dent confidence in the bloc's ability to resolve its government debt crisis.

"The vote of confidence did not erase the possibility of a bailout which depends upon what stress test results will show," said Marko Rozman from the treasury department of Dezelna Banka. "In my view it would be sensible to ask for external help as that would be much cheaper than raising money on the market," he added.

But Bratusek once again rejected bailout speculation."

(emphasis added)

Of course no government wants to be subjected to the tender mercies of the 'troika' after seeing its handiwork elsewhere. Submitting to a bailout may be cheaper, but it also means surrendering fiscal sovereignty, something no government likes to do if it can be avoided.

Bratusek's assurances must be seen in this light - they are a pious hope rather than a firm promise. Over the past week, 5 year CDS spreads on Slovenia's debt have soared by nearly 100 basis points to 417 bps, well above the upper boundary of their recent trading range of 300-350 bps. Using a 50% recovery assumption, this implies an annual default probability of 6.8%. It doesn't sound like much, but currently Slovenia's 5 year CDS spread is the 5th highest in the world among sovereign debtors (only Argentina, Venezuela, the Ukraine and Egypt look worse - admittedly a lot worse).

(click to enlarge)Slovenia - annual default probability implied by 5 year CDS spreads at an assumed recovery rate of 50%.

This recent increase in Slovenia's CDS spreads seems to indicate that the markets were not fully placated by the confidence vote and the 'bought deal', although oddly enough, market interest rates on Slovenia's bonds did fall noticeably, declining by 30 basis points on Friday alone:

(click to enlarge)

Slovenia's 10 year government bond yield, daily

On a longer term basis, yields remain however within the confines of what could be called the 'crisis trading range':

(click to enlarge)

Slovenia's 10 year government bond yield, monthly

It is not quite clear to us why bond yields and CDS spreads have begun to diverge so strongly over the past week, but a realignment one way or the other seems likely, as they usually tend to trend in the same direction.

Finally, to put the problem faced by the country's banks further into perspective, here are their NPL ratios as of Q3 2012 (via an OECD report); while a bit dated, this does give one an idea of the size of the problem:

(click to enlarge)

Non-performing loans, international comparison - the black bar is Slovenia. Total NPLs were closing in on 15% of assets as of Q3 2012.

However, the devil is the details - the following chart shows NPL percentages per bank type. Note that the large state-owned banks held 58% of all loans, foreign banks 34% and small domestic banks the remainder:

(click to enlarge)

Slovenia's NPL percentages per type of bank (large state-owned, small domestic and foreign banks). Foreign banks are skewing the NPL totals downward.

This makes one wonder why the government thinks it needs to wait for stress tests to determine what to do about its banks. What can these tests possibly reveal? The fine distinction between 'completely insolvent' and 'totally bankrupt'? Most likely the tests are mainly seen as a way to gain some more time. Anyway, it seems clear that the task is rather monumental - and the case is additionally complicated by the fact that by far the worst performing banks holding the bulk of the bad loans are state-owned.

Charts by: investing.com, Deutsche Bank, OECD

Source: Slovenia Staggers On