DBRS Confirms AAA on the European Financial Stability Facility, Stable Trend

DBRS, Inc. (DBRS) confirms the European Financial Stability Facility’s long-term issuer rating at AAA and short-term issuer rating at R-1 (high). The trend on both ratings remains Stable. There has been a change in the rating nomenclature. The former foreign and local currency issuer ratings of the EFSF are now consolidated into one long-term issuer rating and one short-term issuer rating.

The confirmation of the AAA rating reflects the irrevocable and unconditional guarantees provided by Euro area member states, the creditworthiness of EFSF shareholders and the strong commitment of shareholders to provide support if necessary. The ratings largely depend on the Support Assessment, in which the credit ratings of the EFSF’s core shareholders are the primary factor. DBRS does not provide a full Intrinsic Assessment given the nature of the EFSF’s capital structure. DBRS defines the core shareholder group as the Federal Republic of Germany (AAA Stable), the Republic of France (AAA Stable), the Republic of Italy (A low, Negative) and the Kingdom of Spain (A low, Negative). These four shareholders are the largest by guarantee size and cumulatively account for 83% of the overall guarantor pool. Because Germany and France alone account for 51% of the EFSF’s guarantees, the weighted median rating of the core shareholders is AAA.

Given the strong political commitment of member states to the monetary union and the added benefits associated with shareholder diversification, the EFSF ratings are not sensitive to a one-notch downgrade of core shareholder ratings. In other words, a one-notch downgrade of any single core shareholder is unlikely to result in a downgrade of the EFSF ratings. However, the EFSF ratings could be lowered if several core shareholders experience ratings downgrades or there is a marked deterioration in the creditworthiness of a single core shareholder. Specifically, a two-notch downgrade of France or Germany or a one-notch downgrade of both would likely result in a downgrade of the EFSF ratings to AA (high). Furthermore, multiple notch downgrades of Italy or Spain would likely put downward pressure on the EFSF ratings, particularly if the credit deterioration raises concerns about the cohesion of the Euro area or weakens the political commitment of core shareholders to the monetary union.

With a very small amount of paid-in capital, the EFSF ratings principally rely on guarantees provided by Euro area member states. Proceeds from loan repayments are used to meet EFSF debt obligations, and in order to mitigate credit risk, financial assistance programs are designed with policy conditionality. However, in the event of a default by a borrower, the shortfall would be covered by shareholder guarantees and credit enhancement measures. The over-guarantee structure backing EFSF obligations (165% of maximum lending capacity) provides further support to the ratings. The guarantees and over-guarantees from Germany and France alone cumulatively cover a substantial portion of all EFSF loan commitments.

With the EFSF no longer engaged in new lending programs, loan commitments are effectively capped. The European Stability Mechanism (ESM), which started operations in October 2012, has since become the sole instrument to provide financial assistance to Euro area member states facing financing difficulties. Nevertheless, the EFSF will remain active in the markets until its outstanding debt either matures or is retired.

DBRS believes the commitment of core shareholders to support EFSF is very strong. The EFSF was created to protect financial stability in the Euro area. It has been an integral part of a broader policy response to the Euro area sovereign debt crisis and an illustration of the commitment of member states to preserve the monetary union. Given the critical importance of the EFSF mandate, core shareholders are highly likely to provide support in a stress scenario, in DBRS’s view. The EFSF was established as a temporary multilateral financial organization in May 2010 and incorporated as a private limited liability company (a société anonyme under Luxembourgish law) in June 2010. The EFSF is governed by the Framework Agreement, which was signed all by Euro area member states in 2010.

However, the EFSF’s credit portfolio is characterized by a high degree of concentration. Loans totaling €188 billion have been committed to Greece, Portugal and Ireland. Of this amount, €145 billion was extended to Greece (CCC high, Negative). Notwithstanding the relatively high loan concentration in weaker euro area sovereigns, financial assistance programs were designed with policy conditionality to mitigate credit risks and potential losses are covered by highly credible guarantees.

Notes:
All figures are in Euros (EUR) unless otherwise noted.

The principal applicable methodologies are Rating Supranational Institutions and Rating Sovereign Governments, which can be found on the DBRS website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales.

The sources of information used for this rating include European Financial Stability Facility and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer and did not include participation by the issuer or any related third party.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

Lead Analyst: Michael Heydt
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 27 July 2012
Most Recent Rating Update: 16 November 2012