Guy Norton in Zagreb -

Just days after the EU signed off on the first tranche of a €100bn banking sector bailout package for cash-strapped Spain in early July, speculation has been mounting that Slovenia might become the latest Eurozone member state to ask for funding to prop up its faltering economy and in particular its heavily indebted banking sector.

Both Bloomberg and the Financial Times fingered Slovenia as the next suspect for an economic rescue package from Brussels in the wake of growing problems at the country's banks. At the heart of the sector's problems are the growing level of non-performing loans that, according to a recent report from Raiffeisen Research, are now running at 16-18% of total lending - sharply up from 11.5% at the end of 2011.

While the analysts at Raiffeisen believe there is no immediate likelihood of Slovenia seeking a Spanish-style banking sector support package from the EU, they do believe that financial problems at the country's banks will impact on the country's economic performance. "From a macroeconomic perspective, the banking sector weaknesses and constrained lending will be a drag on investments and economic growth going forward."

Press speculation about Slovenia's mounting financial woes prompted a quick rebuke from the country's finance ministry: "There is no need to ask for aid from European financial mechanisms, either due to bank capital adequacy or due to fiscal reasons," read a statement. It added that as well as addressing capital adequacy issues at state-owned banks, the Slovenian government was working hard to put its own finances in order, with the budget deficit set to be cut from 6.4% of GDP at the end of 2011 to 3.6% of GDP this year and below 3% in 2013.

Red alert

Nevertheless, there is growing concern about the ability of the country's leading banks to attract sufficient capital to patch up their balance sheets, which have been savaged by the financial meltdown of many of the country's formerly successful corporates. For example, the European Resolution Capital Fund, which recently conducted due diligence at Nova Ljubljanska Banka (NLB), the country's biggest lender, reported that the bank has around €1.5bn of so-called" red category" loans, which will probably never be repaid. That means NLB will likely need yet another round of recapitalisation by the end of 2013, with Slovenian business daily Finance claiming the bank might possibly need to raise as much as €2 billion if its finances continue to deteriorate.

At the start of July, the Slovenian government injected €383m into NLB, which controls a third of the country's banking assets, so the bank complies with the European Banking Authority (EBA) stress test requirements that stipulate a minimum core Tier 1 capital adequacy ratio of 9%.

Ultimately, the government had to stump up all the funds for the recapitalisation after the bank's second largest shareholder, Belgium's KBC, declined to participate. KBC had been expected to contribute €61m to the fundraising, but pulled out citing concerns that its participation could have jeopardised its own receipt of state aid as part of a strategic plan agreed with the European Commission, under which it has agreed to divest non-strategic investments such as its shareholding in NLB. The latest injection of funds follows an earlier €250m recapitalisation of NLB in March 2011. Although the European Commission gave its approval for the latest fundraising, it announced it was opening an in-depth investigation into the bank's restructuring plan that was submitted after last year's recapitalisation. "At this stage, the Commission has doubts that the plan adequately addresses the causes for NLB's distress or foresees sufficient safeguards to limit the distortions of competition created by the state support."

Meanwhile, the authorities in Ljubljana are working on a potential solution to the banking sector's problems in general, with plans for a new institution that could assume bad loans from state-owned banks. The proposed Slovenian Sovereign Holding (SSH), which Finance Minister Janez Sustersic hopes could be established by the autumn, would be a super-custodian of assets that would assume the role of the Capital Assets Management Agency and bring a troika of para-statal funds under one roof.

According to Sustersic, the SSH would assume bad loans from the banks at fair value, thus cleansing them of NPLs in one fell swoop rather than through periodic writedowns. "This cabinet is under no illusion that the situation will fix itself," Sustersic told news agency STA, but claimed that Slovenia had the financial wherewithal to fix its banking sector problems on its own rather than apply for an EU bailout.

While welcoming the concept of the SSH and its potential role in resolving the problem of the estimated €6bn of bad loans in the banking sector, Igor Masten, a former member of the supervisory board of NLB, told Slovenian daily Delo that he believed the authorities were guilty of failing to admit the scope of bad loans as soon as the crisis kicked in in 2008 and taking timely action to tackle the problem. Masten, who advocated the establishment of a so-called bad bank back in 2009, claimed that previous governments failed to address the NPL issue, "because the admission of bad loans would mean acknowledgement of mistakes brought about by the concept of national interest."

Wearing thin

The increasing use of state funds to plaster holes in state-owned banks' balance sheets is proving politically controversial however, with hard-pressed Slovenian taxpayers growing tired of the continuing series of government-funded bailouts.

A recent survey by Delo revealed that just 23% of respondents supported the use of tax receipts to prop up the banks, while 49% wanted to see the banks attract funds from foreign investors instead. Unsurprisingly, the government is hoping that the country's second biggest lender, Nova Kreditna Banka Maribor (NKBM), which is also majority owned by the state, will succeed in attracting foreign capital when it attempts to secure funds for its recapitalisation later this year. "On NKBM, our message is clear: the state will rescue the bank only as a last resort, in the event the security of deposits or stability of the banking system is jeopardised," Sustersic told STA, adding: "We recommend that the NKBM supervisory board find private solutions for recapitalisation."

Under the current restructuring plan, NKBM is looking to offload its majority stake in insurance company Zavarovalnica Triglav as well as increase its core capital by issuing €20.4m in new shares. NKBM's last capital-raising exercise in April 2011, when it became the first Slovenian company to be listed on the Warsaw Stock Exchange, provoked fierce controversy when the Capital Assets Management Agency ordered three state-owned companies - Posta Slovenije, Gen Energija and ELES - to buy the majority of the shares in the €104m offering.

The move prompted Fitch Ratings to downgrade NKBM from 'A-' to 'BBB+' in May 2011, citing "conflicting policy statements during the capital raising with respect to maintaining the state's stake in the bank, as well as a lack of clear strategy from the government regarding NKBM's future ownership structure."

NKBM has since been downgraded further by Fitch to 'BBB' as a result of further asset deterioration. It's not only the weary Slovenian taxpayer whose patience is wearing thin.