Editor’s note: Moody’s Investors Service released the following statement in conjunction with a ratings action it took today on Slovenian sovereign debt.
New York, April 30, 2013 — Moody’s Investors Service has today downgraded Slovenia’s government bond rating to Ba1 from Baa2. The outlook remains negative.
The decision to downgrade Slovenia’s sovereign rating was driven by the following key factors:
1) The state of Slovenia’s banking sector
2) The marked deterioration of Slovenia’s government balance sheet
3) Uncertain funding prospects that heighten the probability that external assistance will be needed
RATINGS RATIONALE
The first key factor underpinning today’s rating action is the ongoing turmoil in the country’s banking system and the high likelihood that the sovereign will be required to provide further assistance and capital injections. Asset quality at the banks deteriorated considerably in 2012 and has continued to deteriorate since. At Nova Ljubljanska Banka (Caa2/negative/E), the country’s majority state-owned lender and largest bank, non-performing loans (NPLs) reached 28.2% of total loans in 2012. NPLs reached 28% at Nova Kreditna Banka Maribor (Caa2/negative/E), the second largest bank, and were approximately 20% system-wide at end-2012. The authorities have been injecting capital and providing assistance to the three largest banks since 2011, and Moody’s expects bank asset quality to continue to deteriorate given the weak economic environment. The economy entered recession once again in 2012, contracting by 2.3% as a result of the banking crisis, and Moody’s forecasts that the economy will contract by a further 1.9% in 2013 before a weak recovery in 2014 where growth is expected to reach 0.2%. Risks remain skewed firmly to the downside and the economic outlook will depend to a large degree on the stabilization of the banking crisis.
Delays in establishing the Bank Asset Management Company (BAMC, the “bad bank”), following a political transition, suggest that the sovereign remains heavily exposed to contingent liabilities. Moody’s estimates bank recapitalization costs in the order of 8-11% of GDP. In Moody’s opinion, implementing the BAMC’s mandate is essential for stabilizing the banking system.
The second key factor underlying Moody’s decision to downgrade Slovenia’s government bond rating is the substantial increase in Slovenia’s government debt metrics. Slovenia’s general government debt at the end of 2012 reached an estimated 54.1% of GDP, up from 22% in 2008. Slovenia’s fiscal debt burden remains among the lowest in the euro area, where the average is approximately 93% of GDP. The ratio for Slovenia, however, is likely to exceed 60% at the end of 2013 and not expected to stabilize until 2014-15 at above 65% of GDP, excluding BAMC debt issuance. However, the level at which debt metrics for Slovenia will peak is very uncertain and will depend in part on whether the government will need to provide further assistance to the banking system. The level will also depend on the new government’s fiscal targets, which are likely to be less ambitious than the previous government’s targets, and on the macroeconomic outlook. Risks are skewed negatively and debt levels could exceed 70-75% of GDP after the banking system’s issues have been resolved, but are unlikely to reach unsustainable levels. Nevertheless, risks to bondholders have increased and the sovereign’s cost of funding is likely to be prone to volatility.
Given the marked deterioration of the government’s balance sheet and the sovereign’s limited debt tolerance as reflected by its increasing cost of funding, Moody’s has changed its assessment of Slovenia’s government financial strength, the third factor in Moody’s sovereign bond rating methodology, to ‘medium’ from ‘high’. The adjustment to the factor score leads to a change in the sovereign’s rating range as indicated by our methodology to Ba1-Ba3 from Baa2-Ba1.
The third key factor leading to the rating action is the uncertain funding environment facing Slovenia, which heightens the risk that the sovereign will require external assistance to meet its financial obligations. Moody’s notes that Slovenia’s recent efforts to manage the sovereign’s liabilities have been relatively successful. The sovereign issued 18-month treasury bills to retire outstanding instruments maturing in June 2013, easing liquidity concerns and decreasing rollover risk. With the treasury bill swap, Moody’s estimates that the sovereign now holds enough liquidity to meet its funding needs through the end of the year, excluding a potential capital infusion to the banking sector.
Despite the recent success, the sovereign’s cost of funding remains elevated and sensitive to financial market confidence. Slovenia’s vulnerability to external shocks, like those brought about by the crisis in Cyprus, could make it difficult for the sovereign to fund itself at sustainable rates, which increases the likelihood that authorities would need to request an external assistance program.
The negative outlook reflects Moody’s view that the challenges of the banking system remain substantial. The weak macroeconomic environment amplifies these challenges and increases the possibility of losses to bondholders.
WHAT COULD CHANGE THE RATINGS UP/DOWN
Although unlikely in the near future, a substantial improvement in economic conditions, a more benign funding environment, and stabilization of the banking system without more support being required than what authorities currently expect would lead to a stable outlook.
Slovenia’s sovereign rating could be downgraded again in the event that the sovereign experiences a material deterioration in funding conditions; such a deterioration is most likely to result from economic or financial shocks arising from Slovenia’s banking sector or from the euro area sovereign debt crisis. A substantial weakening of Slovenia’s macroeconomic environment could also jeopardize the stabilization of debt metrics, resulting in a loss of creditworthiness.
CEILINGS
As part of this rating action, Moody’s has made the following adjustments to country ceilings for corporate and structured ratings:
Local Currency Bond Ceiling — Baa2 (from A3)
Local Currency Deposit Ceiling — Baa2 (from A3)
Foreign Currency Bond Ceiling — Baa2 (from A3)
Foreign Currency Deposit Ceiling — Baa2 (from A3)
The lower ceilings reflect the increased risk of events which would, in Moody’s view, damage the credit standing of substantially all debt issuers in Slovenia, including severe economic and financial dislocation such as would be expected in the unlikely event of Slovenia leaving the euro area.
The local currency country risk ceiling reflects the maximum credit rating achievable in local currency for a debt issuer domiciled in Slovenia. The foreign currency bond and deposit ceilings are assessed to be in line with the local currency ceilings given that Slovenia uses the euro as its legal tender.
METHODOLOGY
The principal methodology used in this rating was “Sovereign Bond Ratings Methodology” published in September 2008. Rating ceilings were set in accordance with “Local Currency Country Risk Ceiling for Bonds and Other Local Currency Obligations” published in March 2013. Please refer to the Credit Policy page on www.moodys.com for details.