DBRS Confirms the European Stability Mechanism at AAA, Stable Trend

DBRS Ratings GmbH (DBRS) confirmed the European Stability Mechanism’s (ESM) Long-Term Issuer Rating at AAA and Short-Term Issuer Rating at R-1 (high). The trend on both ratings is Stable.

KEY RATING CONSIDERATIONS

DBRS rates the ESM on the basis of its Support Assessment and its Intrinsic Assessment. The Support Assessment is the primary driver of the ESM’s ratings and is at a level equivalent to AAA reflecting the overall credit quality of the ESM’s core shareholders, as well as their collective commitment to support the institution. The ESM’s Intrinsic Assessment, also at a level of AAA, is underpinned by (1) the institution’s high capitalisation; (2) its strong and effective liquidity management; and (3) its preferred creditor status.

RATING DRIVERS

The ESM’s ratings could come under downward pressure if there were to be a deterioration in the Support and Intrinsic assessments, or if there was a marked deterioration in either assessment. For example, with respect to the Support Assessment, multiple downgrades of core shareholders or a marked deterioration in creditworthiness of a single core shareholder, particularly if it reflected a weakening in their cohesion or a reduction of their political commitment to the Monetary Union, could put downward pressure on the ESM’s ratings. A weakening of the institution’s Intrinsic Assessment, exemplified by a substantial increase in risk exposure, the materialisation of large credit losses or evidence of weaknesses in the ESM’s early warning system could add downward pressure to the institution’s ratings.

RATING RATIONALE

The Support Assessment Reflects the ESM’s Core Shareholders Commitment to the Institution

DBRS defines the ESM core shareholder group as the Federal Republic of Germany (AAA, Stable), the Republic of France (AAA, Stable), the Republic of Italy (BBB (high), Stable), and the Kingdom of Spain (A, Stable). Since Germany and France are the largest core shareholders (61% of the core shareholders’ capital), the weighted median core shareholders’ rating is AAA. While a one-notch downgrade of either would lower the ESM’s weighted median core shareholders’ rating, the entity’s overall Support Assessment could remain at AAA. This reflects the added benefits associated with the multiple sources of support, as well as the overarching political commitment of the ESM’s members to the institution.

In DBRS’s view, the 2017 election outcomes in France, the Netherlands (AAA, Stable), Austria (AAA, Stable) and Germany, somewhat reinforced the commitment from core members to Europe and its institutions. DBRS therefore considers that Euroscepticism risk to Member States’ cohesion remains low. For instance, the current Italian government, while it initially took a more confrontational stance towards the European Commission, continues to support European institutions. Going forward, DBRS considers that the upcoming European Parliamentary elections scheduled for May 2019 will be a relevant checkpoint to assess any potential rise in Euroscepticism across the continent.

A package of reforms has been endorsed by Euro Area countries in December 2018 that strengthens the ESM’s role. These primarily include (1) the provision of a credit line in support of the Single Resolution Board (SRB) for backstopping the Single Resolution Fund (SRF) by 2024; (2) a reinforced role for the ESM in future assistance programmes and debt sustainability issues; and (3) a better effectiveness and enhanced clarity regarding of the ESM’s precautionary credit lines. In DBRS’s opinion, the widening of the ESM’s mission, expected to be ratified in the second semester of 2019, is an indication of the strengthening of its policy mandate, a feature that supports DBRS’s assessment of the shareholders’ commitment to the institution.

The ESM’s Intrinsic Assessment Largely Reflects its Very Strong Capitalisation

The AAA Intrinsic Assessment of the ESM primarily reflects the entity’s capital structure, which consists of €80.48 billion in paid-in capital, serving as a strong backing for the ESM’s bonds and other debt securities, and another €624.3 billion in committed callable capital. The paid-in capital accounts for 16% of the ESM’s total lending capacity (€500 billion of which €410.1 billion is available for new lending) and 90% of its current loan book (€89.9 billion).

The ESM loan portfolio is characterized by a high degree of concentration in the Hellenic Republic (B (high), Positive) representing 67%, Spain (26%) and Cyprus (BBB (low), Stable) with 7%. In DBRS’s view, the strict programme conditionality and review process, the ESM’s preferred creditor status, its strong liquidity management and high capital levels, should continue to mitigate the related credit and concentration risks.

ESM’s Strong Liquidity Management and Preferred Creditor Status Also Support the Institution’s Creditworthiness

DBRS also views positively the ESM’s conservative liquidity management practices. Operational guidelines require liquid assets to cover the ESM obligations coming due in the next 12 months. These assets reflect the ESM paid-in capital, which cannot be lent out as part of a financial assistance programme under any of the ESM’s existing instruments. Instead, these funds are invested in highly rated liquid assets, and act as a capital and liquidity cushion.

Finally, DBRS consider that the ESM preferred creditor status supports the institution’s Intrinsic Assessment by providing additional protection compared to unsecured creditors. DBRS, nevertheless, notes that the financial assistance programme for Spain was negotiated by the European Financial Stability Facility (EFSF, AAA Stable) prior to being transferred to the ESM and therefore does not benefit from the additional seniority provided to the funding of other programmes.

RATING COMMITTEE SUMMARY

The main points discussed during the Rating Committee include ESM’s planned reforms, Greece debt relief measures, ESM’s risk profile and ESM’s core shareholders commitment to the institution.

Notes:

All figures are in Euros unless otherwise noted.

The principal applicable methodology is Rating Supranational Institutions, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/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 at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include the European Stability Mechanism, the European Financial Stability Facility and the International Monetary Fund. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

This rating did not include participation by the rated entity or any related third party and is based solely on publicly available information.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

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

Ratings assigned by DBRS Ratings GmbH are subject to EU and US regulations only.

Lead Analyst: Nicolas Fintzel, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global Financial Institutions and
Sovereign Ratings Group
Initial Rating Date: 4 April 2014
Last Rating Date: 27 July 2018

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Information regarding DBRS ratings, including definitions, policies and methodologies, is available on www.dbrs.com.