Pressure mounts on Slovenia

Slovenia is suffering in the capital markets today amid speculation on which country will be the next bailout recipient.

The Balkan sovereign can consider itself unlucky - its predicament is nowhere near as severe as Cyprus or other countries forced into the hands of the troika. But the mishandling of the Cyprus situation and the subsequent shambolic communication from various European officials has fuelled contagion and Slovenia is under intense scrutiny as a result.

Slovenia certainly has its problems. The banking sector has seen bad debts continue to rise, with non-performing loans in the 20% region. Most of this is due to non-financial corporates, and ties into another flaw in the economic model. Slovenia has a relatively statist economy: many of the banks are publicly-owned and the large state-sector is unreformed. Close relationships between the banks and the non-financial sector have probably undermined risk management and had a detrimental impact on bank balance sheets.

Slovenia's current account deficit of 4-5% of GDP, while not on the scale of some eurozone members, is still uncomfortably high. Political limbo - a new government was elected only last week after its predecessor collapsed in corruption scandal - has prevented it from taking the necessary fiscal steps.

However, while it is no Finland it is certainly not a Cyprus. Slovenia's banking sector is only about 125% of GDP, well below the EU average and nowhere near the multiples seen in Cyprus, Ireland, UK etc. Its debt/GDP ratio of 54% at the end of 2012 is again well below the EU average. It now has a government that seems ready to tackle the issues, though it is early days.

The question is whether it is too late for Slovenia. Its CDS, which are quite illiquid, shot up 75bps to 400bps today. Bond prices are probably a better indicator, and the 5.5% 2022 bond issued last year dropped sharply to 95. 10-year yields are now well over 6% and heading towards the dreaded 7% - a figure that is widely considered unsustainable. If it can manage to issue debt at more reasonable yields in the next few months then it might have a chance of avoiding a bailout.

Slovenia's travails, as well as a weak Italian bond auction, led to another bout of risk aversion. The Markit iTraxx Europe was 5bps wider at 128bps, while the Markit iTraxx Senior Financials continued to underperform and hit 200bps for the first time since September last year. French and UK banks, as well as the usual peripheral institutions, were notable laggards.

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