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WorldSeptember 2 2013

Slovenia faces up to economic reforms

With its sovereign rating downgraded and its banks maintaining heavy losses, will Slovenia’s strategy of creating a bad bank and recapitalising its lenders pay off? And how can banks escape the poor lending culture that brought them low in the first place? 
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Slovenia faces up to economic reforms

In the wake of the Cyprus bailout in March, commentators began to cast their nets to find a likely candidate for the sixth EU country to need rescuing. Many selected Slovenia, a small country with a predominantly state-owned banking sector showing heavy losses from poor-quality loans and requiring recapitalisation.

Bad news followed in April with the decision of Moody’s to downgrade Slovenia’s sovereign rating two notches to junk status, citing the state of Slovenia’s banking system as a key factor in its decision. In May, the Organisation for Economic Co-operation and Development revised its 2013 growth forecast for Slovenia downwards to -2.3%, the same as in 2012.

Gloomy picture

Slovenia's troubled banking sector posted overall losses in 2012 for the third successive year and the first-half results for 2013 reinforced the gloomy picture. The country's three biggest banks – all state-owned and representing about half of the banking sector by assets – reported combined losses of €156m with a net impairment expense of €243m.

The biggest cause of these losses has been the banks’ poor-quality loan portfolios, especially in the construction industry and for loans given to facilitate leveraged management buyouts. At the end of 2012, the ratio of non-performing loans (NPLs) averaged 14.4% over the banking sector as a whole and more than 20% in the three largest banks.

Faced with this crisis in the banking sector and the resultant damage to the country’s own standing, the Slovenian government’s response aimed specifically at the banking sector has been twofold. It is injecting funding to recapitalise the damaged banks it owns and has set up a ‘bad bank’ to which eligible banks can transfer some NPLs and so tidy up their balance sheets.

The bad bank, properly known as the Bank Asset Management Company (BAMC), is expected to take on some €3.3bn of the banking system’s €7bn of NPLs. However, the first of these transfers, due on June 28, had to be postponed as the European Commission (EC), whose approval is required, withheld its permission until it had assessed the transfer prices of the assets to be assigned and carries out wider stress-tests.

Nova Ljubljanska banka (NLB) is by far Slovenia’s largest bank, with just under 30% market share by assets. Janko Medja, the bank’s chief executive, expects about €2bn of NLB’s gross loan portfolio to be transferred to the BAMC, dependent on the outcome of the EC’s investigations.

Bad bank

By aggregating into one bank, all the distressed companies’ loans and associated assets held as collateral by different banks, the BAMC should be able to maximise the value of these assets for the Slovenian taxpayer on top of meeting the banks’ need for a rapid clean-up of their balance sheets.

Mr Medja says: “You put all these eggs in one basket and the BAMC, having more time, should be able to extract more value while at the same time optimising the costs.” He expects the EC to announce its conclusions regarding NLB in September and the other banks by the end of the year.

On top of the asset transfers to BAMC, the Slovenian government will inject up to €990m in fresh capital to meet the central bank’s requirement for a core Tier 1 ratio of 9.5%. Already this year it has converted a €320m loan to NLB and a €100m loan to Nova Kreditna banka Maribor (NKBM), the country’s second largest bank, into equity. Further capital increases of up to €500m and €400m have been authorised for the two banks, respectively, with Abanka Vipa, the third of the country's big banks, requiring a further €90m.

In addition, the government is embarking on a wider programme of reforms and privatisation. Other measures include an increase in value-added tax from 20% to 22% from July 1 and fiscal consolidation – the government deficit is forecast by the EC to widen to 5.3% this year.

One of the 15 companies earmarked for privatisation is NKBM. Aleš Hauc, chief executive at NKBM, says that his bank has already attracted some interest from Europe, Asia and the Middle East, but that a successful sale will be also dependent on improvements in the wider Slovenian economic environment. “Potential buyers expect that before the sale the bank needs to clean up its balance sheet and transfer a portion of its bad loans," he says. "Also, with the implementation of government reforms, the country’s credit rating should improve, so our bank will then be even more interesting to strategic partners.”

Silver lining

Not all of Slovenia’s banks posted losses in 2012. One example is SKB Banka, owned by Société Générale, which managed to record a €3.7m profit, mostly attributable to its leasing subsidiary. However, SKB has not been immune to the general decline in asset quality and took a €42m hit to its profit-and-loss statement from net impairment charges.

François Turcot, SKB’s chief executive, admits that 2012 was a difficult year but says SKB fared relatively well with its loan portfolio. “For 2012, we had a net cost of risk of 190 basis points [bps] compared to the banking sector as a whole, which was 451bps,” he says.

Mr Turcot also says that his bank is very conservative in provisioning and expects to see some provisions flow back to the profit-and-loss statement in future years. He is happy to report an increasing market share in loans to individuals, a group much less prone to default than corporates.

One factor in Slovenia’s favour is that it still has a relatively low public debt. However, this advantage is rapidly being eroded. Public debt stood at 21.9% of gross domestic product (GDP) at the end of 2008 and accelerated to 54.5% at the end of the first quarter of 2013. Ratings agency Standard & Poor’s estimates that Slovenia’s public debt will stabilise at about 70% after it pumps in the money needed for its banks. This is still below the average eurozone public debt, which stood at 90.6% at the end of 2012.

Despite some elements of comparison with Cyprus, Slovenia’s banking system is roughly 130% the size of its GDP, while the figure for Cyprus was 750%, so Slovenia can much more easily swallow the cost of clearing up the mess.

The other two big ratings agencies are not as bearish on Slovenia as Moody’s. Fitch downgraded the country’s sovereign rating in May but at BBB+ with 'negative' outlook, it retains its investment-grade status. S&P is even more positive, affirming Slovenia’s rating in July at A- with 'stable' outlook.

A good solution

Mr Turcot supports the government’s moves to form the BAMC and recapitalise the banks. “It’s a good solution,” he says, but warns that the real test will come afterwards in avoiding the same mistakes. “At the end of the day [the government has] to make sure that the banks function differently and will have the latitude to select more closely the loans they want to give.”

Mr Hauc concurs and says that his bank is addressing this issue: “We agree that the lending culture in Slovenia should be improved. During the past year, since the arrival of the new management board, NKBM has implemented measures and organisational changes aimed at improving its performance and reducing the volume of bad loans.”

Mr Medja at NLB also emphasises his bank’s actions to change the lending culture. Furthermore, he insists that he will not be swayed by external pressures. His predecessor, Bozo Jasovic, resigned in 2011 citing ministerial interference in the bank’s disinvestment strategy. Since Mr Medja’s appointment in October 2012, three other members of the management board have been recruited, including two Austrians. None, including Mr Medja, have worked in a state-owned bank before and he expects their private sector background to have a positive impact on the bank.

"We only have one goal and that is to restructure the bank in order to make it profitable again,” says Mr Medja. Although he has not come under direct pressure from ministers, he says that interest groups are trying to influence him, particularly through the media, and he expects to need a couple of years’ track record in fending off external pressures before outsiders realise things have changed.

Mr Medja, who admits to a certain frustration spending the summer waiting for the EC’s decision, says that further delays by either Brussels or Ljubljana will be harmful.

“There are two ways," he says. "You can always be waiting for another analysis and talking to another party, but time costs a lot of money. I don’t want to blame the EC for the delay, [as blame for that falls] on the side of Slovenia as well, but we have to make sure that we finish this now because wasting another quarter will create huge damage.”

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