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Scope Ratings GmbH has today assigned the European Financial Stability Facility first-time AA+ long-term issuer and senior unsecured foreign-currency ratings, along with a short-term issuer rating of S-1+ in foreign currency. All Outlooks are Stable.

Summary and outlook

The AA+ rating assigned to the European Financial Stability Facility (EFSF) reflects the supranational’s highly rated key shareholders, strong guarantee mechanism and excellent capital markets access. However, the EFSF’s mandate to lend to crisis-hit countries results in weak asset quality, and its shareholder base is highly concentrated. The Stable Outlook reflects Scope’s assessment that the risks are broadly balanced.

The rating could be downgraded if: i) key shareholders are downgraded; ii) the cash buffer significantly reduced; and/or iii) access to capital markets were meaningfully impaired. The rating could be upgraded if: i) key shareholders are upgraded; and/or ii) the EFSF’s liquidity buffers significantly and permanently increased.

Rating drivers

The EFSF’s AA+ rating is primarily supported by its highly rated shareholders. Specifically, lacking any meaningful capital, 13 euro area member states provide irrevocable, unconditional and timely guarantees and over-guarantees on the EFSF’s debt issuances, which are then reallocated to the public accounts of member states providing the guarantees in proportion to their share of the guarantees. These several guarantees – which are pro-rata the member states’ share in the capital of the European Central Bank (ECB) and governed by an intergovernmental agreement, the Framework Agreement¹ and by a deed of guarantee – are highly credible.

This is because a failure to honour the guarantees would raise questions on i) the value of the sovereigns’ remaining guarantees; and ii) whether European governments are likely to support other European institutions if ever needed, in particular, the European Stability Mechanism (ESM). The four largest euro area economies – Germany (AAA/Stable), France (AA/Stable), Italy (BBB+/Stable) and Spain (A-/Stable) – together guarantee 83% of the EFSF’s liabilities, providing them with significant control in the EFSF’s decision-making bodies. These four sovereigns thus constitute the EFSF’s key shareholders, with a weighted-average rating of AA- per Scope’s methodology.

From this starting point, the EFSF’s AA+ rating is further underpinned by its strong institutional set-up, specifically, an over-guarantee mechanism of up to 165% of the EFSF’s outstanding securities, resulting in EUR 724bn in guarantees for a maximum lending capacity of EUR 440bn. As the EFSF stopped approving new facilities in July 2013, the applicable programme authorised amount (the maximum the EFSF is authorised to borrow under EFSF guarantees) is EUR 241bn². Based on Scope’s sovereign ratings, adjusting the shares of the EFSF shareholders to the over-guarantee mechanism results in a 100% coverage of EFSF debt issuances by sovereigns rated AA or above.

Specifically, sovereigns rated between AAA and AA – Germany (46.7%), the Netherlands (9.8%), Austria (4.8%), Luxembourg (0.4%), Finland (3.1%), France (35.1%), and Belgium (6.0%) – together cover 106% of the EFSF’s liabilities. Scope’s analysis acknowledges the strength of the over-guarantee mechanism by adjusting the key shareholder rating upwards by several notches, which reflects the differential to the current AA rating covering 100% of outstanding EFSF liabilities under the over-guarantee mechanism. Currently, this differential is one notch. Should the differential increase (decrease), the adjustment would also increase (decrease).

The EFSF’s AA+ rating also reflects