April 19 (Bloomberg) -- The ink on the provisional bailout agreement for Cyprus was hardly dry last month before bond markets shifted their attention to Slovenia, another small euro-area country with a banking problem. The Slovenian government’s borrowing costs subsequently shot up.
The fear that Slovenia might be the next Cyprus, with international creditors again forcing losses onto bank bondholders and uninsured depositors, is only partly justified. Slovenia isn’t Cyprus, and its rescue program, when it comes, will probably look like a hybrid between the Spanish-style bailout and the Cyprus-style bail-in.
First, the similarities: Like Cyprus, Slovenia has wrestled with a banking crisis for years and the big banks in both countries have made bad lending decisions. In Cyprus, that involved loading up on Greek government bonds that later had to be significantly written down. By the end of 2012, almost 27 percent of bank loans in Cyprus were nonperforming. Unfortunately, this was only slightly higher than in Slovenia, where nonperforming loans for the country’s three largest banks also rose quickly and surpassed 20 percent last year.
Slovenia’s bad loans were caused by a double-dip recession, a burst property bubble and poor corporate governance. The country’s three largest banks are all state-owned and the cozy relationship between politicians, banks and corporations resulted in many loans going to individuals and companies that were well-connected rather than well-qualified.
Yet there are crucial differences between the Cypriot and Slovenian cases. Cyprus’s banking sector was huge, accounting for more than 700 percent of the country’s gross domestic product by the end of 2012. By contrast, Slovenia’s banking sector is only 143 percent of GDP -- much less than the 347 percent euro-area average.
Slovenia also isn’t as dependent on financial services for growth as Cyprus was. In Cyprus’s case, financial services, and the business services connected to them, accounted for between one-third and half of GDP in 2012. The same industries accounted for about 10.5 percent of GDP in Slovenia. Fears that Europe’s troika of international creditors -- the European Commission, the European Central Bank and the International Monetary Fund -- might force Slovenia to drastically shrink its banking sector overnight, and destroying the economy as occurred in Cyprus, are overdone.
Finally, the sums needed to stabilize the banking sectors in Cyprus and Slovenia differ significantly, as do the potential sources of financing. According to the latest European Commission document, Cyprus must pay for the entirety of its bank recapitalizations. The price for this could be as much as 10.6 billion euros ($13.9 billion), including the cost of resolving Cyprus Popular Bank Pcl (better known as Laiki Bank). The Cypriot banks relied heavily on deposits for funding, with very little equity or debt. To generate 10.6 billion euros in savings, hefty “haircuts” had to be imposed not just on equity and bondholders but also on uninsured depositors.
The cost of recapitalizing Slovenia’s three major banks is only about 1 billion euros, according to an IMF estimate. A recent study by the central bank of Slovenia says the country’s banking sector has roughly 2 billion euros in debt securities and 4 billion euros in equity and loan provisions. So, if Slovenian banks are forced to pay for their own recapitalization, imposing a loss on equity and bondholders would probably yield sufficient savings without the need to hit depositors.
This raises an obvious question: If Slovenia can fund its own bank rescue by bailing in creditors, why is everyone talking about a bailout for this small alpine country? There are two reasons.
First, estimates of the recapitalization needs for Slovenia’s three biggest banks will probably grow. The corporate sector is hugely overleveraged, with an average debt-to-equity ratio of 200 percent last year. That compares with 70 percent for the euro area at its 2009 peak. The banks made more than half of their loans to corporates, of which about a third are nonperforming. With so many loans going bad, the banks’ balance sheets have been hit, constraining their ability to lend. As a result, Companies have defaulted on more of their loans, driving the banks’ portfolio of nonperforming loans ever higher.
Second, a bailout may be necessary to prevent the banking crisis from dragging down the state. Slovenia’s fiscal situation is healthier than most of the euro area’s peripheral countries, with a budget deficit of 4.4 percent of GDP and total public debt at about 54 percent of GDP, according to European Commission figures. Yet those relatively sound numbers didn’t stop Slovenia’s borrowing costs from shooting up after the Cypriot bailout, partly because the government’s debt-redemption profile is unfavorable, with particularly high debt rollovers in 2013 and 2014. In June, the government will have to refinance about 900 million euros’ worth of debt, half of the year’s total.
When the government attempted to issue 100 million euros in Treasury bills on April 9, it managed to sell only 56.1 million euros worth. Then, an auction on April 17 raised double the government’s targeted amount, but that success may be misleading because state-owned banks were the main buyers, probably under pressure from the government to participate.
Slovenia may have to seek official assistance for its banking sector as a way to retain market access. We saw the same with Spain in mid-2012 when the government in Madrid asked international creditors to bail out Spanish banks directly so that the state could continue to fund itself. The difference between Spain and Slovenia is the bail-in precedent that was set by Cyprus in the meantime. Slovenian banks will probably be expected to contribute to their rescue package by bailing in investors; only in this case, depositors are unlikely to be hit.
Whatever the composition of its rescue, Slovenia will likely share one crucial similarity with Cyprus: the need for financial help in a German election year. The closer the German elections, the more the euro area’s main paymaster will extract in exchange for assistance. If Slovenia doesn’t believe it will be able to make it past Germany’s September poll without help, it should waste no time in asking for support.
(Megan Greene is a Bloomberg View columnist and chief economist at Maverick Intelligence. She is also a senior fellow at the Atlantic Council in Washington. Follow her on Twitter. The opinions expressed are her own.)
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