Slovenia dodges bailout as it swallows cost of bank overhaul alone

The Slovenian Central Bank this morning released the long anticipated results of the stress test of Slovenian banks. The full results can be found here, while the press release is available here and a reader-friendly Q&A here.

The release did not begin well, with the English feed of the conference proving slow and laggy – similarly to the tests themselves, whose results have been delayed a couple of times. Beyond that, though, things went much as expected, with the tests showing a €4.8bn hole which needs to be filled, around the expectations of €4bn to €5bn. Below, we lay out our key thoughts:

The macroeconomic scenarios include some optimistic export numbers. As we have said before for Slovenia, and others, relying on exports alone to prop up GDP can be a risky game.

The tests are based on data from the end of 2012. This is a problem with these tests in general, but has been exacerbated by delays in the case of Slovenia. The data are one year out of date – a year where the Slovenian economy has struggled, and non-performing loans held by banks have increased steadily.

The €4.8bn figure is taken from the adverse scenario, and it's not exactly clear why this is done when the figures shown under the base scenario are normally used in these tests. This could be seen as an attempt to be 'extra conservative', or a sign that the base case is a bit outdated in terms of projections or data.

 

€3bn of the money will come from the government and be injected into the three largest state-owned banks (NLB, NKBM and Abanka). €2bn will be in the form of cash, with the rest in the form of government securities. A further €441m will come from a 100% write-down of subordinated debt.

The largest banks will also transfer €1.7bn in non-performing loans to the country’s bad bank – exactly what price this will be at remains unclear. It is also unclear if the bad bank will require further state support. Overall, this is a huge amount of support for the largest banks in the sector. The remaining small banks will be forced to raise around €1.1bn through private sources before June 2014. If they fail, then the government may step in once again (although this will certainly involve further bail-ins).

As a result of this bank recapitalisation, Slovenia's government debt will rise to 75.6% of GDP. Not massive by standards of the eurozone crisis, but high enough that we could see upward pressure on borrowing costs, especially given the poor growth outlook for the economy. It also means that both the public and private sector in Slovenia is heavily indebted. This risks weighing on the economy, and could potentially create a downward spiral as domestic demand, investment and government spending falls.

One of the more astonishing figures (to us) is that the stress tests cost €21 million (around 0.06% of GDP) to conduct, due to fees for the consulting firms such as Oliver Wyman, Roland Berger, Ernst & Young, and Deloitte.

So far, then, Slovenia has managed to avoid the need for external aid, despite a significant overhaul of its banking sector. However, the economy remains in a fragile state, and any shocks to the system over the next six months, as the overhaul takes place, could push the economy into a wider and deeper crisis.

Another positive step for Ireland?

Well we finally have a deal on one of the longest running sagas in the eurozone crisis – the Irish promissory notes deal.

See here for some good background on the whole issue.

Key points of the deal (from Irish PM Enda Kenny’s speech):

·         Last night the Irish Bank Resolution Corporation (IBRC, formerly Anglo Irish bank) was liquidated. The loans it had taken from the ECB through the Emergency Liquidity Assistance (ELA) were therefore terminated and the Irish Central Bank (ICB) took control of the €25bn in promissory notes and the €3.4bn for the most recent interest/principal payment.

·         The Irish government has agreed to swap these notes for 40 year Irish government bonds.

·         The principal repayments will take place between 2038 and 2053. The average interest rate will be 3% compared to 8% on the promissory note.

·         The Irish National Treasury Management Agency (NTMA, which owns NAMA and formerly IBRC) will see its borrowing requirement over the next decade fall by €20bn. The Irish government deficit will be reduced by approximately €1bn a year.

Essentially then, the IBRC was wound down, allowing/forcing the ICB to take control of the promissory notes which were used as collateral for the ELA which it had been providing, in turn allowing the IBRC to continue servicing its bondholders, depositors and any other obligations. It was then agreed to swap these notes for the longer dated lower interest ones.

It seems to be a fairly reasonable idea and a good work-around of a tricky situation. It certainly provides a reduction in the burden with a much lower interest payment and no principal payment for some time.

The main ECB concerns were: monetary financing if the collateral was allowed to be swapped for lower value (longer dated collateral), the further write-down of bondholders and setting a bad precedent for other eurozone members. Most of these have been addressed, although there are a few issues outstanding:

The first issue was mainly a concern while IRBC existed. That said, if the ICB took control of the bonds when the ELA was terminated as the IBRC was liquidated, why were they suddenly willing to exchange them for the new bonds? Surely, these longer dated lower interest bonds have a lower net present value than the previous promissory notes? This may be because the ICB and the Eurosystem tend to hold such assets at nominal value, but it’s hard to argue that the ICB hasn’t taken a loss in some terms.

The second seems to have been dodged as the remaining liabilities will be covered by the Deposit Guarantee Scheme and Eligible Liabilities Guarantee Scheme (see FT Alphaville here for more details) and transferred to NAMA. That said, the role of NAMA now that the ELA has been terminated isn’t clear. Will it still finance these liabilities, if so, how? Surely, it would need to use the new bonds to borrow from the ECB to finance the remaining IBRC liabilities. This isn’t an issue as such, but needs clarification since it impacts: who is holding the new bonds, what interest is being paid and who it is paid to.

On the third issue, the ECB seems to accepted that this is a fairly special case and that setting a precedent is not much of a concern – or is at least less of a concern than the consequences of not giving Ireland a deal on the promissory notes.

A few remaining issues then, but nothing major and no deal breakers – although the monetary financing issue could potentially flare up in our view.

Ultimately, some deal was needed on this front both to reduce the impact of financing the Irish bank bailout on the Irish budget and to maintain political support for the extensive reform programme being undertaken in Ireland. Another positive step in the recovery of the Irish economy it seems. That said, the deal does not succeed in significantly reducing the overall cost of the Anglo Irish Bank bailout and the cost of the bank bailout will continue to weigh on Irish debt - i.e. plenty of challenges remain.

About that Spanish bad bank...

The Bank of Spain has just made an announcement regarding the country’s bad bank plan which fleshes out more details of the proposals following the recent consultation period. The press release and presentation are here and here, respectively.

Key points:

• The bad bank (known as Sareb) will be a for profit company (expecting a 'conservative' return on equity of 15%), majority owned by private investors (read other Spanish financial institutions) with a minority government stake. It will have 8% capital. 
• Its duration will be up to 15 years. 
• A transfer of up to €90bn of assets will take place in two stages. Stage 1 will see around €45bn in assets transferred from the most troubled (already nationalised) banks. Other banks will transfer assets in a secondary stage. (See picture below for the timetable). 

•  The valuation of assets will work from the baseline scenario of the Oliver Wyman stress tests (which we analysed here). It will be adjusted for the ‘costs’ of transferring the assets to Sareb. (See below for a breakdown of rough valuations). 

More details are still to come but here are some of our initial thoughts:

- One phrase that caught our eye was this: “The transfer price is not a reference for the valuation of non-transferred bank assets.” According to whom? Surely just asserting that this is not reference for the valuation of assets means nothing unless the market agrees? As we saw with NAMA, the market will still price broader assets of the prices used in the transfer, hence long standing market distortions in Ireland.

- The delayed/staggered nature of the transfer of assets could create a two tier market for similar assets, since the ones valued in the bad bank will be valued much lower than those kept on by the viable banks. This could hamper the viable banks attempts to sell off assets at reasonable values.

- The write downs, although substantial, still seem lacking in areas (not least due to the flaws in the OW baseline stress test scenario). For example, assuming foreclosed land will be worth 20% of previous value may seem substantial, but when there is an real estate oversupply which could take a decade to unwind the prospect of this land being worth anything soon seems unlikely.

- The timeline looks positive with significant progress expected in the near future, however, the full transfer of all assets to Sareb could run well into middle 2013. This delay could drag out the issue and further distort the price discovery in the Spanish real estate market. Also as Zerohedge points out, this timeline may be fine in a vacuum but with everything else going on in Greece, problems could escalate quicker than expected.

- As we’ve noted before, although the private investment is positive, it looks likely to come from mostly other Spanish institutions. This furthers the ‘nationalisation’ of banking sectors and intertwines the problem banks with the healthy banks. 

- The plan seems to be, since the institution is not a majority owned by the government, that it will not appear in general government liabilities. It's not clear whether this will pass muster with Eurostat, or how any losses/transfers from the public sector will impact government finances.

Overall then, a bit of a mixed bag. Some positive plans and it’s good that the plan is progressing (if a bit later than desired) but still plenty of potential pitfalls.