DBRS Confirms European Financial Stability Facility at AAA Stable Trend

DBRS, Inc. has confirmed 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 is Stable.

The confirmation of the AAA rating reflects the “irrevocable and unconditional guarantees” provided by Euro area member states as stipulated by the EFSF Framework Agreement, the creditworthiness of EFSF guarantors and the strong commitment of member states to provide support if necessary. The ratings entirely depend on the Support Assessment, in which the credit ratings of the EFSF’s core guarantors are the principal factor. The Support Assessment is viewed to be at a level equivalent to AAA. DBRS does not consider it necessary to provide a full Intrinsic Assessment given the nature of the EFSF’s capital structure. DBRS defines the core guarantor group as the Federal Republic of Germany (AAA Stable), the Republic of France (AAA Negative), the Republic of Italy (A low, Negative) and the Kingdom of Spain (A low, Stable). These four guarantors are the largest by guarantee size and cumulatively account for 83% of the overall guarantor pool.

Given the strong political commitment of member states to the monetary union and the added benefits associated with diversification, the EFSF ratings are not sensitive to a one-notch downgrade of any single core guarantor. DBRS changed the trend on France’s AAA long-term ratings to Negative from Stable on November 7, 2014. If DBRS were to downgrade France by one-notch to AA (high), it is unlikely this would result in a downgrade of the EFSF ratings. However, the EFSF ratings could be lowered if several core guarantors experience ratings downgrades or there is a marked deterioration in the creditworthiness of a single core guarantor. 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 guarantors to the monetary union.

The EFSF’s loan portfolio is characterized by a high degree of concentration and relatively weak asset quality. Loans totaling €187 billion have been committed to Greece, Portugal and Ireland. Of this amount, €142 billion was disbursed to Greece (B, Under Review with Negative Implications). Credit risks have recently increased due to developments in Greece. This is reflected by DBRS’s decision to place Greece’s ratings Under Review with Negative Implications on February 4, 2015. Nonetheless, elevated credit risk does not call into question the commitment of the Euro area member states to honor their EFSF guarantees.

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. However, in the event of a default by a borrower, the shortfall would be covered by guarantees and credit enhancement measures. The over-guarantee structure backing EFSF obligations (with maximum overguarantees by each guarantor of 165%) 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 and which DBRS rates AAA / R-1 (high), has since become the sole institution to provide financial assistance to Euro area member states facing financing difficulties. Nevertheless, the EFSF will remain active in the markets until its loans are repaid.

DBRS believes the commitment of core guarantors to support the 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. 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). The EFSF is governed by the Framework Agreement, which was signed by all Euro area member states in 2010. Given the importance of the EFSF/ESM mandate, DBRS believes core guarantors are highly likely to provide support in a stress scenario.

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

The principal applicable methodology is 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 the European Financial Stability Facility and the International Monetary Fund. 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: Roger Lister
Initial Rating Date: 27 July 2012
Most Recent Rating Update: 12 September 2014