DBRS Morningstar Confirms the European Financial Stability Facility at AAA, Stable Trend

DBRS Ratings GmbH (DBRS Morningstar) confirmed the European Financial Stability Facility’s (EFSF) 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
The ratings depend entirely on the EFSF’s Support Assessment. This assessment is at a level equivalent to AAA and reflects (1) the unconditional and irrevocable guarantees and over-guarantees provided by Euro area member states as stipulated by the EFSF Framework Agreement; (2) the creditworthiness of EFSF guarantors; and (3) the strong commitment of the member states to support the institution

RATING DRIVERS
The rating could be downgraded if one or a combination of the following occur: (1) there is a marked deterioration in the creditworthiness of a single core guarantor, particularly if it reflects a material weakening of the cohesion of core member states or of the strength of their political commitment to the Monetary Union; or (2) although currently unlikely, both France (AAA, Negative) and Germany (AAA, Stable) are downgraded.

RATING RATIONALE

The Core Guarantors’ Commitment to the EFSF are the Key Rating Drivers

DBRS Morningstar does not provide a full Intrinsic Assessment of the EFSF, given its financial structure that is based on guarantees and over-guarantees. DBRS Morningstar defines the core guarantor group as the Federal Republic of Germany (AAA, Stable), the Republic of France (AAA, Negative), the Republic of Italy (BBB (high), Negative) and the Kingdom of Spain (A, Stable). These four guarantors are the largest by guarantee size, each representing more than 10% of the EFSF contribution key on an individual basis and accounting cumulatively for 83% of the overall guarantor pool.

The weighted median guarantor rating of this group, which is the primary driver of the Support Assessment, currently remains at AAA. Nevertheless, this weighted median could be lowered if France's ratings were to be downgraded. DBRS Morningstar, however, recently highlighted in a commentary European Supranational Institutions that lowering the median rating of the core group would not prompt a downgrade of the Support Assessment per se. The EFSF's Support Assessment would remain underpinned by the strong commitment of the Euro area member states towards the institution and by additional diversification benefits stemming from AAA governments outside the core group.

The EFSF ratings rely primarily on the guarantees provided by Euro area member states, given the very low amount of paid-in capital. Proceeds from loan repayments are used to meet EFSF debt obligations. In the event of default by a beneficiary member state, the shortfall would be covered by the guarantees and credit enhancement measures. The over-guarantee structure backing EFSF obligations (with maximum over-guarantees of 165% by each guarantor) provides additional support to the ratings through its core guarantors.

The COVID-19 Outbreak Affects European Economies, Recovery Will be Monitored

The recent Coronavirus Disease (COVID-19) outbreak, together with its large scale economic impact is severely affecting European economies. The European Commission now forecasts 2020 real gross domestic product (GDP) in the Euro area to contract by 8.7% (Summer 2020 forecast), before a growth rebound of 6.1% in 2021, related to governments' support measures and pent-up demand. While the healthcare crisis has affected all European countries, some have been more impacted than others. To a large extent, DBRS Morningstar highlights that the magnitude of the economic impact seems to reflect the severity of local outbreaks, but also the stringency of the lockdown measures implemented in each country (Europe Macroeconomic Update, July 2020).

DBRS Morningstar considers that the emergency measures announced by the European Central Bank (ECB) and by the European Union (EU, AAA, Stable) to support the Euro area and more broadly the European economies are positive and signal further cohesion among Member States. Nevertheless, DBRS Morningstar will monitor the potential divergences post-COVID-19 in economic, fiscal and debt positions across European countries. Perceptions of such divergences may give rise to further Euroscepticism and could bring new challenges to additional European integration.

The EFSF’s Mandate is not Affected by the Coronavirus Crisis

The EFSF has been an integral part of a broader policy response to the Euro area sovereign debt crisis almost a decade ago, and an illustration of the commitment of member states to preserve the Monetary Union. Given the importance of the mandate of the EFSF, DBRS Morningstar continues to believe its guarantors are highly likely to meet their obligations and provide support to the institution in a stress scenario. While the EFSF's mandate is not affected by the coronavirus crisis, the European Stability Mechanism (ESM, AAA, Stable), which took over its role of providing financial assistance in the Euro area at the end of 2012, is an integral part of the EU response package to the pandemic. In DBRS Morningstar's view, this reinforces the key role of both institutions as well as the commitment of their member states to support them if needed.

A High Concentration in the Loan Portfolio, Inherent to the EFSF’s Missions

The EFSF’s loan portfolio is characterised by a high degree of concentration and relatively weak asset quality. Loans totaling EUR 172.6 billion remain outstanding to the Hellenic Republic (Greece, BB (low), Stable), the Republic of Portugal (BBB (high), Stable) and the Republic of Ireland (A (high), Stable). Of this amount, EUR 130.9 billion is concentrated on Greece. Nevertheless, the elevated credit risk does not call into question the commitment of the Euro area member states to honour their EFSF guarantees.

DBRS Morningstar also views positively the high degree of integration between the EFSF and the ESM. Both institutions operate under the same management and benefit from the same early warning system, which allows the EFSF/ESM’s teams to oversee debt repayments and would allow the institutions to take swift action, if it became ever necessary.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

RATING COMMITTEE SUMMARY
The main points discussed during the Rating Committee include the COVID-19 crisis and its impact on the EFSF’s guarantors cohesion and commitment to the institution, the EFSF’s risk profile.

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

The principal methodology is the Global Methodology for Rating Supranational Institutions (3 March 2020) https://www.dbrsmorningstar.com/research/357589/global-methodology-for-rating-supranational-institutions.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The sources of information used for this rating include the EFSF’s 2019 financial statements and Management Report, the EFSF and ESM Investor Presentation (July 2020), the European Commission Summer 2020 forecast. DBRS Morningstar 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.

With Rated Entity or Related Third Party Participation: NO
With Access to Internal Documents: NO
With Access to Management: NO

DBRS Morningstar 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 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar 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.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/364510.

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

Lead Analyst: Nicolas Fintzel, Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: July 27, 2012
Last Rating Date: January 24, 2020

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