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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 its conservative liquidity management policy. The ESM/EFSF’s Early Warning System tracks payments due every month and evaluates countries’ repayment capacities, ensuring, ahead of each bond repayment, that liquid assets can service debt obligations. However, if available cash and bank deposits are insufficient to cover a scheduled repayment three days before the due date – which to date has not occurred – the EFSF would call on guarantees, including via the over-guarantee mechanism if needed, and receive the required funds from shareholders within two business days¹.

The EFSF’s AA+ rating is further underpinned by its strong capital markets access. EFSF issuances are designated as Level 1 HQLA assets and granted a 0% risk weighting under the Basel framework, are included in several SSA and government bond indices, and are eligible for the ECB’s asset purchase programmes. Based on ESM data, the ECB holds about 47% of the EFSF/ESM’s outstanding stock of eligible debt as of March 2020, or about EUR 110bn, which is slightly above one-third of the total outstanding debt issued by both institutions. This preferential regulatory treatment, together with guarantees from its highly rated shareholders, has allowed the EFSF to build a track record of raising significant volumes (notably, EUR 58bn in 2013 and EUR 49bn in 2017) and a strong and well-diversified funding base³.

As the EFSF no longer engages in new programmes, financing existing loans results in predictable funding needs that will decline gradually over the coming years. Outstanding debt securities amounted to about EUR 191.7bn as at end-2018 and annual funding needs are projected at around EUR 19.5bn in 2020 and EUR 16.5bn in 2021. The EFSF’s proven ability to issue across the yield curve, using various instruments with very long maturities and very low funding costs (the 10-year yield is currently near or below 0%), also reduces the significant refinancing risks resulting from the maturity mismatch between its lending and funding: its outstanding loans have very long weighted average maturities (42.3 years for Greece and 20.8 years for Portugal and Ireland), while its funding maturities average around 8.6 years.

Finally, the EFSF’s funding flexibility allows it to raise its cash buffer, as it did in 2018 via additional funding of EUR 2.7bn, further minimising liquidity risks. Scope notes positively that the EFSF’s liquid assets, including cash and cash equivalents as well as highly rated treasury assets, have increased from about EUR 6.1bn in 2016 to EUR 9.4bn in 2018, doubling its coverage of liabilities due within one year from around 21% to 42%⁴. While not expected by Scope, it would be credit negative if this coverage were to decline meaningfully over the coming years, for instance, due to a sustained reduction in the cash buffer.

Despite these credit strengths, the EFSF also faces the following credit challenges:

First, while the EFSF benefits from guarantees and over-guarantees from highly rated shareholders, its shareholder base is highly concentrated compared to other supranationals, which increases its dependence on any one shareholder’s ability to honour guarantees if called. That said, Scope has no doubt that shareholders would be willing to honour any guarantee call should it ever be made.

Second, the EFSF was set up to provide financial assistance to crisis-hit countries, resulting in a weak and concentrated loan portfolio. While the EFSF stopped financing new programmes in July 2013, it continues to finance existing ones until all outstanding bonds and loans are repaid: EUR 130.9bn is owed by Greece (BB/Positive), EUR 24bn by Portugal (BBB+/Stable) following a voluntary repayment of EUR 2bn, and EUR 17.7bn by Ireland (A+/Positive). The weighted average borrower quality is thus non-investment grade. However, in line with its mandate, the EFSF’s demonstrated flexibility to reprofile loans to reduce interest and defer amortisation payments eases repayment pressures on its borrowers. This enhances their creditworthiness and, in turn, reduces the credit risk of the EFSF’s own portfolio. First scheduled principal repayments are in 2023 (Greece), 2025 (Portugal) and 2029 (Ireland).

Finally, despite acting as a lender of last resort to the three programme countries, the EFSF does not benefit from having preferred creditor status as most supranationals. Its debt securities thus rank pari passu with those of private creditors³.

Scope’s supranational scorecard

Scope’s supranational scorecard, which is based on clearly defined quantitative parameters, provides an indicative ‘AA+’ rating for the European Financial Stability Facility. Additional considerations allow Scope to incorporate idiosyncratic characteristics that cannot be assessed in a consistent and comprehensive manner across all supranationals, but which may still affect the creditworthiness of the issuer.

For the EFSF, the following additional consideration has been identified: i) the over-guarantee mechanism, which ensures up to 165% of outstanding debt issues are covered by shareholders. Specifically, based on current ratings, sovereigns rated between AAA and AA cover more than 100% of issuances. Scope’s analysis acknowledges the strength of the over-guarantee mechanism by adjusting the key shareholder rating upwards to reflect 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).

A rating committee has discussed and confirmed these results.

For further details, please see the Appendix.

Factoring of Environment, Social and Governance (ESG)

Scope considers ESG sustainability issues during the rating process as reflected in its supranational methodology. Governance-related factors are implicitly captured in Scope’s assessment of the ‘fundamental rating’, which Scope assesses for the European Financial Stability Facility with a ‘A+’. Environmental and social factors are considered during the rating process, including the risk to ‘stranded assets’ and the benefits from issuing green and/or social bonds, but these had no impact on this rating action, even though Scope acknowledges that EFSF bonds make structural reforms more sustainable and socially easier to implement.

Rating committee
The main points discussed were: i) key shareholders, the institutional set-up and over-guarantee mechanism; ii) mandated activities; iii) liquidity management and buffers; iv) funding activity; v) asset quality; and vi) consideration of peers.

Rating driver references
1. EFSF Framework Agreement

2. EFSF Guaranteed Debt Issuance Programme

3. ESM Investor Relations Presentation April 2020

4. EFSF Annual Accounts

Methodology
The methodology applicable for this rating and/or rating outlook, ‘Supranational Entities’ dated 4 September 2019, is available on https://www.scoperatings.com/#!methodology/list.
Information on the meaning of each rating category, including definitions of default and recoveries can be viewed in the “Rating Definitions - Credit Ratings and Ancillary Services” published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definitions of default and rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale. Guidance and information on how Environmental, Social or Governance factors (ESG factor) are incorporated into the rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The rating was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the rating process. The rating process was conducted:
With Rated Entity or Related Third Party Participation   NO 
With Access to Internal Documents                                NO
With Access to Management                                          NO
The following substantially material sources of information were used to prepare the credit rating: public domain.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Prior to the issuance of the rating or outlook action, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0.
Rating prepared by Alvise Lennkh, Director
Person responsible for approval of the rating: Dr Giacomo Barisone, Managing Director
The ratings/outlook were first released by Scope on 8 May 2020.

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
© 2020 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Analysis GmbH, Scope Investor Services GmbH and Scope Risk Solutions GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstrasse 5, D-10785 Berlin.

Scope Ratings GmbH, Lennéstrasse 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 192993 B, Managing Director: Guillaume Jolivet.