TEXT-S&P revises Slovenia BICRA to Group 6 from Group 5

(The following statement was released by the rating agency)

Feb 08 -

OVERVIEW

-- Standard & Poor's lowered its sovereign credit ratings on the Republic of Slovenia to 'A+/A-1' from 'AA-/A-1+' on Jan. 13, 2012. The outlook on the long-term rating is negative.

-- We are revising our BICRA on Slovenia to group '6' from group '5'.

-- At the same time, we are revising our economic risk score to '5' from '4' and the industry risk score to '7' from '6'.

BICRA ACTION

Standard & Poor's Ratings Services said that it has revised its Banking Industry Country Risk Assessment (BICRA) on Slovenia to group '6' from group '5'. It is also revising the economic risk score to '5' from '4' and the industry risk score to '7' from '6'.

RATIONALE

The BICRA action on the Republic of Slovenia (A+/Negative/A-1) follows our lowering of the sovereign credit ratings on Slovenia on Jan. 13, 2012, and takes into account our assessment of the most recent trends affecting the country's banking sector. BICRA groups summarize our view of the risks that a bank operating in a particular country and banking industry faces relative to those in other banking industries. A BICRA is scored on a scale from 1 to 10, ranging from the lowest-risk banking systems (group 1) to the highest-risk (group 10). Other countries in BICRA group '6' are Estonia, Bahrain, and Croatia.

The revision of the economic risk score reflects our opinion that the correction of accumulated imbalances will hamper Slovenia's banking system more severely and for longer than we previously anticipated, notably in terms of credit losses. We now assess "economic imbalances" as having a "high impact" on the banking system, compared with a "limited impact", as our criteria define these terms. We have therefore revised our assessment of "economic imbalances" to "high risk" from "intermediate risk".

We revised our industry risk score because of our view of a "high risk" for "systemwide funding," compared with "intermediate risk" previously. Slovenian banks' funding profiles have a persistently high proportion of net external debt. In addition, the domestic debt capital market for private-sector companies is relatively shallow, and financing costs are rising.

Our revised economic risk score for Slovenia is '5'. This reflects that we have maintained our assessment of "low risk" in "economic resilience," but now see "high risk" in "economic imbalances." We still regard "credit risk in the economy" as "high risk".

Slovenia is an open and relatively wealthy economy, with a relatively large export base that contributes to economic growth. However, this high degree of openness makes it susceptible to shifts in external demand, in our view. Consequently, negative growth prospects for Slovenia's trading partners could continue to affect its economic growth. Slovenia's track record of relative fiscal prudence before the financial market crisis has contributed to a relatively moderate government debt ratio, despite recent increases.

We consider economic imbalances to pose "high risk" for Slovenia's banking system. These imbalances were built up in the past decade of high credit growth and a construction boom. Currently, the Slovenian economy is in a correction phase with limited lending growth and real estate price dynamics. We anticipate a "high impact" on the Slovenian banking sector over the next two years, owing to higher credit losses as asset quality continues to deteriorate, leading to further weakening of profitability and capitalization.

We assess "credit risk in the economy" as "high risk" in Slovenia. Exposure to vulnerable construction and real estate sectors account for 17% of the system's corporate loans. Nonperforming loans show a negative trend: Arrears exceeding 90 days increased to 11.9% of classified claims as of Dec. 1, 2011, from 7.4% at year-end 2010, according to data from the Bank of Slovenia. Retail loans perform better than corporate financings, mainly due to low initial debt leverage.

Our revised industry risk score for Slovenia is '7'. This reflects that we have maintained our assessment of "high risk" in the "institutional framework" and "competitive dynamics," and changed our assessment of "systemwide funding" to "high risk".

With regard to Slovenia's institutional framework, we assess banking regulation and supervision as "intermediate" and the regulatory track record as "weak". Bank supervision is in line with international standards, in our view; the regulator monitors banks frequently and performs annual stress tests. Governance and transparency in the system is adequate, according to our criteria. However, we view the regulator's attitude to rising risks as reactive rather than proactive. From our observation, the banking industry is also subject to state interference.

Our assessment of "high risk" in competitive dynamics takes into account Slovenian banks' moderate risk appetite, demonstrated by the absence of complex banking products. Nevertheless, rapid growth before 2008 and concentrations in the real estate and construction sectors are negative elements. The Slovenian banking sector is dominated by two state-controlled banks that represent almost half of the system's assets, which, in our view, creates market distortions.

We assess systemwide funding in Slovenia as "high risk". Core customer deposits (including 100% of retail deposits and 50% of corporate deposits) fund only 51% of total loans. Net external funding represents a high 25% of total loans. The significant proportion of external borrowings is attributable to parental funding, since foreign banks comprise 39% of the system's assets. Slovenian banks benefit from access to funding from the European Central Bank (ECB), which increased to EUR823 million (or 1.8% of system liabilities) in November 2011, as well as three-year long-term refinancing operations granted by the ECB in December 2011.

The Slovenian government has increased its bank deposits since 2008, which totaled EUR3.2 billion (7% of system liabilities) in November 2011. It also provides guarantees for government banks' bond issuances. At the same time, the domestic private-sector debt capital market remains relatively narrow and shallow, in our view. Private-sector companies and banks have limited access to additional funding sources, and financing costs are increasing.

We classify the Slovenian government as "supportive" toward the domestic banking system. This classification recognizes that the government has a good track record of providing extraordinary support to the banking system in times of stress.

RELATED CRITERIA AND RESEARCH

All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated.

-- Slovenia's Ratings Lowered To 'A+/A-1'; Outlook Negative, Jan. 13, 2012

-- Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, 2011

-- Banking Industry Country Risk Assessment: Slovenia (Republic of), Dec. 17, 2008