Moody's: Slovakian banking system outlook changed to negative

The outlook on the Slovakian banking system has been changed to negative from stable, caused by the downside risks to economic growth and asset quality within the system, says Moody's Investors Service in a new Banking System Outlook published on March 27th. Moody's expects the Slovakian operating environment will weaken over the outlook period, amidst the broader European Union economic slowdown. This will exert pressure on asset quality, which, in turn, will dampen the banks' profitability. These factors are balanced against expectations of continued good system-wide liquidity and adequate capitalisation.

Slovakia's economic performance largely depends on external demand and is significantly aligned with developments in the external macro environment in Europe and the country's main trading partners, Germany and Czech Republic. As such, Slovakia's dependence on export-oriented industries presents a key credit risk to the banks' performance, because softening demand for these industries' production will lead to higher unemployment levels and non-performing loans (NPLs).

Moody's expects Slovakia's GDP growth trajectory to decelerate to about 1.7% for 2012, down from 3.1% in 2011 and 4% in 2010, with further downside risks as continued uncertainty hinders business and consumer confidence in the country and the broader euro area.

Despite a recovery in profits in the last two years, Moody's believes that the weakening operating environment will depress banks' profitability, due to several macro and domestic specific factors, such as: (i) a slowdown in lending growth; (ii) a likely increase in loan-loss charges, reversing the lower charges recorded in 2010 and 2011; (iii) the payment of a new bank tax, which will be levied by the government for the first time in 2012; and (iv) pressures on interest margins, more recently driven by increased competition for deposits.

Moody's recognises that system NPLs stabilised in 2011 at 5.9%. However, overall, we expect that the deceleration of economic growth in 2012 will contribute to an increase in the rate of formation of new NPLs as well as higher loan-loss provisions. High credit concentrations in the banks' loan books will likely exacerbate the potential downside risks to asset-quality trends. Additional downside risks include the high proportion of high loan-to-value (LTV) mortgages in the banks' loan portfolios, declining real-estate prices, growing household indebtedness and rising unemployment in the higher income segment.

Despite these negative factors, Slovakian banks' capitalisation has strengthened in recent years as a result of profit retention, thus providing adequate loss-absorption capacity under Moody's scenario analysis, whilst funding and liquidity profiles will likely remain relatively stable, as banks fully fund their loan books through deposits, which reduces their sensitivity to changes in market confidence.

Although the system is now facing new risks, as many local banks are owned by Western European banks, which are currently under pressure to repatriate capital, or potentially to sell weaker subsidiaries, the rating agency recognises that the National Bank of Slovakia introduced stricter capital rules to protect capital buffers of local banks, particularly from foreign owners' requests for higher dividend payments, which will partially mitigate these risks.

Moody's also notes that the weakening creditworthiness of the Slovakian government, downgraded earlier this year to A2, and of the main foreign owners of Slovakian banks (on review for downgrade since February 2012) indicate, in our view, a diminishing capacity to provide support to the local banks, in case of need.

The new report, "Banking System Outlook: Slovakia", is now available on www.moodys.com.

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